The Market Structure of Professional Team Sports - Essay Example

THE MARKET STRUCTURE OF PROFESSIONAL TEAM SPORTS Introduction Since the time of Adam Smith, economists have argued that the best way to allocate resources in an economy is through the operation of free markets, where individual firms try to maximize profits guided by the invisible hand which also ensures that maximum social welfare is achieved. This is related to the theory of perfect competition which is often used as the benchmark by which to analyze other alternative institutional arrangements or market forms. In a perfectly competitive model of the economy, it is assumed that alls firms in an industry try to maximize profits in selling a homogeneous product to consumers who also try to maximize their utility. The Market Structure of Professional Sports In the case of professional team sporting industry, we have leagues, such as the National Basketball Association or the National Hockey League which try to maximize their profits by providing utility or enjoyment to spectators or consumers. However, economists have in the past considered sporting leagues as examples of monopolies. It is therefore useful to assess the difference between a monopoly and the ideal market system of perfect competition. This is so because a monopoly is the sole supplier of a product or service, just as a professionals league is the sole supplier of sports entertainment in a particular geographical area. As such monopoly it is able to set the price as price maker, unlike a price taker in a perfectly competitive system. There is however a peculiar characteristic of the sports industry that deserves examination. It is the fact that the league cannot determine its output level as measured by the number of games held, because it depends on how many teams have been admitted as members of the league, and how many times the league mandates games to be played in a season, considering that greater frequency can cause spectator interest to flag. Unlike a firm in the economy, the team or group of players cannot turn out a salable product, for every contest requires the presence of an opposing team. The product, which is the competition of two teams, can generate great attendance and revenue only if there is interest in the competition, which depends on how closely or evenly matched the teams are. The “uncertainty of outcome” hypothesis posits that close competition between two teams is what generates economic benefits to the league. Domination by one single club is not beneficial to the league because the certainty of outcome reduces interest in the sport. Where there is interesting competition even if it involves only two excellent and highly competitive teams, the other games match-ups can also benefit, the effect of what is called externality. What is observed here is the basis of the natural monopoly hypothesis of professional sports. Such monopoly is reinforced by the fact that historically existing leagues resist entry of new ones as in the case of four U.S. team sports: basketball, ice hockey, baseball and football. The costs of entry would be high in terms of labor costs and reduced ticket revenue as well as lower income from television coverage, thus discouraging the entry of new leagues that want to obtain monopoly profits. In the United States, sports monopoly is granted to incumbent leagues. For example, the U.S. major league baseball teams have a franchise covering an area that is big enough to exclude same-league teams from the immediate city and its environs. Increasing the geographical area would affect revenue of the sports in the area, so there is sound logic in limiting or restricting the expansion of the number of teams in a certain region. Two teams in a particular sport may coexist in a defined geographical area; however, they do not usually compete against each other in the sports field, but only in economic terms. In Europe, such as that in Milan or London, two or more teams may compete in both sporting and the economic sense, but they are prohibited from encroaching on the monopoly power granted to incumbent leagues by competing on the same days. The leagues maintain the “the uncertainty of outcome” logic in the way they redistribute resources such as the revenues generated and the allocation or transfers of players between strong and weak teams. The objective is to generate and maintain interest in the sport by improving the quality of competitions between teams. Without this basic concept, the sports would fail to attract interest among consumers. The Cartel: An Alternative View There is, however, an argument that because of the ways the leagues operate, it should be considered as more of a cartel than a monopoly (Downward and Dawson, 2000). A monopoly is a single firm that supplies a market. A cartel is a group of firms which, by agreement, act as a single supplier to a market. It is an oligopoly with the added characteristic of collusion among members in the pursuit of the members’ common interest. In a cartel, mutual behavior is by agreement only and these agreements need to be enforced. If they are not, or better opportunities for members of the cartel appear elsewhere, then they can break down. . The cartel needs disciplinary tools, and it must be seen to be willing to use them. All members must be willing to suffer disadvantage occasionally to punish ‘cheating.’ Most crucial to the success of a cartel, therefore, is the ability to reconcile potential conflicts of interest within the group. While aspects of a cartel’s activities can resemble a monopoly, the concept of a cartel is a better conceptual description of a sporting league. It is a more general concept that helps to capture both the monopoly characteristics of leagues while at the same time allowing the analyst to explore the actions of and pressure exerted by particular interests or clubs ( Downward and Dawson, 2000). One of a league’s primary tasks (acting as a cartel) is to decide how to divide revenues between members. The need to maintain uncertainty of outcome, by preventing domination from successful teams, has been, a central factor affecting such decisions. At the other extreme is the equal division of revenue between members. Monopsony in Sports. In contrast to monopoly where the firm or league dictates the price and obtains monopoly profits as sole supplier, in monopsony we have a situation where there is only one buyer. The concept of monopsony in sports has been applied to leagues which are the only buyers of player services, and the players have little choice but to accept the terms of the buyer. In the NCAA in the United States, students who play in the league have to be content with receiving benefits that undervalue their talents – free tuition and free board and lodging. The schools they play for are monopsonists – the sole buyers – who are at the same time monopolists in that they are the sole sellers of basketball sports games to the spectators and TV viewers. Where the monopolists have to negotiate with a team representative who demands better economic benefits for the players, we have a situation called bilateral monopoly (Baumol and Blinder,1997). Since both parties have conflicting goals, the two sides must negotiate based on the relative bargaining power of each, with a final price settling in between the two sides’ points of maximum profit (Investopedia). Conclusion This paper has discussed the market structure of professional team sports leagues mainly in the United States. First, it was determined that sports leagues’ behavior gave the economists the impression that they are monopolists in the sense that they are price makers – that is, they determine the price that can be imposed on tickets and TV rights. On the other hand, some analysts believed that, while showing monopolistic characteristics, the manner of making decisions within each league yielded insights into the possibility that they are a form of oligopoly engaged in collusion, called cartels. Decisions such as how profits should be distributed, and how players should be transferred among teams in order to preserve “uncertainty of outcomes” in sports contests on a continuing basis, and thus maintain public interest in the sport, – these are indications that leagues manifest the characteristics of cartels. What about the narrowing or expansion of geographic scope of a league’s franchise area? An expansion would probably hurt the league because of the potential economic competition that may be created. On the other hand, it is up to the league and its incumbent members to decide whether they would welcome new teams. There is an ideal number of teams in a league that can maintain consumer interest. The addition of new sports would also not help. For example, the NBA would not benefit from diversifying into baseball, as it needs to focus on the sports where its core competency lies. REFERENCES Baumol, W. J. & Blinder, A. S. (1997). Microeconomics: Principles and policy (7th ed.), Orlando, FL: The Dryden Press. Baye, M.R.(2000) Managerial Economics and Business Strategy. (6th ed). New York:McGrawHill Downward, P & Dawson, A. (2000) The Economics of Professional Team Sports. London: Routledge Investopedia on bilateral monopoly. Retrieved June 6, 2008 http://www.investopedia.com/terms/b/bilateralmonopoly.asp Truett, L.J. & Truett, D. B. (2004). Managerial economics: Analysis, problems, cases (8th ed.). Hoboken, NJ: John Wiley & Sons. Read More