CHAPTER TWO

Leagues: Structure and Background

INTRODUCTION

Professional sports leagues are unique business structures in a free market economy. As was mentioned in the introduction to this book, leagues combine elements of cooperation and competition and allow independent team owners to seek monetary gains that might otherwise be unavailable if pursued unilaterally through the playing of disparate contests. Indeed, it is doubtful whether professional team sports could survive in the absence of leagues. Leagues offer an enticing, profit-maximizing structure to teams both on and off the playing field. Though professional sports teams are clearly competitors on the field, leagues benefit owners by providing organized regular and championship seasons of play and offering a unitary set of playing rules, both of which are designed to maximize fan interest and, consequently, team profits. Off the field, competition among teams is generally limited to the pursuit of scarce playing and managerial talent. Professional sports leagues are cooperative endeavors away from the playing field, with teams jointly engaging in numerous practices that maximize the profits of the collective entity. Sports leagues, like other forms of entertainment, also deliver a unique product. In essence, the competition that is delivered to the consumer serves as a diversion from everyday life. In that sense, and because of the historic accessibility—whether at the gate or via broadcast—the business has been argued to be “recession proof.”

Each of the major professional sports in the United States has one league. This has important public policy implications. The closed league structure typical of U.S.–based sports leagues allows teams to establish constitutions that govern the locations of their franchises, conditions of entry into the league and relocation within the league, the labor market for players, and rules of the game, as well as permitting teams to pool their broadcast rights for negotiation and sale. This cartel behavior has been widely criticized. However, it is possible that this off-the-field cooperation among teams allows the on-field competition between teams to endure. It is also important to note that, in a free market economy, professional sports leagues have adopted many characteristics of an alternative economic system—socialism—particularly with respect to planning and the redistribution of income. Indeed, it seems that the higher the degree of socialism, the stronger the league. The collective strength of the league is more important than that of the individual teams within the league. Revenue sharing in leagues is discussed in Chapter 5.

American sports leagues have also adopted the single-entity structure. Major League Soccer (MLS) was the first entity to use this model, in which an entire league is controlled by a single operating company. Investments are made in this company, rather than in a particular franchise. This format was developed for several reasons. First, it helps to avoid the self-destructive behavior displayed by owners in other nascent sports leagues whose desire to win led them to pay more than they could afford for athlete services. This ultimately contributed to the demise of these leagues, because so many teams went out of business that the league could no longer survive. By adopting a single-entity structure, competitive bidding among owners for players is eliminated, sidestepping a major cause of league failure. It also can help a league to avoid many of the problems that can arise from having discrepancies in managerial expertise across teams, particularly in areas such as talent evaluation and marketing acumen. In addition, this structure allows sports leagues to evade the application of antitrust laws in management–labor disputes. The single-entity seems to be quite helpful in allowing a league to survive its startup phase.

Following the lead of MLS, most new leagues have since adopted this operating structure. Despite its strengths, the model may not prove to be an effective method of running a mature league. It places a disincentive on individual investors to engage in entrepreneurial behaviors, because the benefits of such tactics are likely outweighed by their costs. The whole may be weaker than the sum of its individual parts. The WNBA and the NBA D-League, two leagues that began as single entities, altered their structure to a traditional league model as they matured. Even MLS has morphed a bit towards the more traditional model as it has evolved, allowing teams an increased amount of autonomy in recent seasons. MLS teams can sell sponsorships in an increased number of categories (including jersey sponsorships), because league-sponsor categories are no longer exclusive with each team. In addition, teams can retain the transfer fees of players that they develop and sell. The league also adopted a designated-player rule (aka the “Beckham rule”) that currently allows teams to be assigned up to three star players with only a minimal amount ($335,000) paid for by the league counting against its team salary cap; the rest of the player’s salary above the $335,000 level is the team’s responsibility.

Globally, two additional league structures warrant discussion. The model most typical of sports leagues outside of North America is that of promotion and relegation. This open model of competition provides for teams to enter and depart the lower leagues within a domestic league’s hierarchy depending on their competitive success or failure. Rather than the league making periodic strategic decisions to expand to new markets, as occurs in North America, the number of teams at each level of the hierarchy remains constant in the open league structure, but the membership of each league changes every year as teams migrate between levels of competition based on their previous season’s performance. Although the benefits of an open model of competition are numerous and include increased competition, a reduction of the league’s monopoly power, and, arguably, a better economic model, it is highly unlikely that any of the established closed leagues will ever migrate to such a model. The reason? Money. Although teams that are promoted to a higher level of competition may realize a financial windfall, the opposite is also true. Given the risk-averse nature of the owners, it is difficult to imagine them adopting the open league structure that is prevalent throughout the world.

The final league structure addressed here is the “super-league.” In one version of this model, the top teams from each country’s top domestic league in a particular geographic region compete against each other for regional sporting supremacy. The highest profile league of this type is the Union of European Football Associations (UEFA) Champions League. This extremely lucrative annual tournament of the top European clubs has been held in various formats since 1955–1956 and has morphed into the most prestigious club event in soccer. Teams qualify for the event based on their previous season’s performance in their respective leagues and the strength of their domestic league, with the highest ranked European leagues receiving up to four places and the lowest ranked only receiving one. Up to 77 European teams compete in the league, which is a combination of qualification play, a round-robin group stage, a home-and-away knockout tournament phase, and a final game. The UEFA Champions League generates a significant amount of revenue through the sale of television rights, sponsorships, and new media deals. In 2008–2009, these revenues totaled EUR 825–850 million. Note that this sum does not include gate receipts or other locally generated revenues, which are kept entirely by the home club.

The league has a revenue sharing system in place through which the majority of the central revenues are shared among the participating clubs based on their performance in the Champions League, the strength of each team’s domestic league, and the performance of the team in that league. The revenue sharing system rewards the strongest teams from the strongest leagues an excess share of the rewards. The remainder of the UEFA Champions League revenues is shared among the national associations, leagues, and clubs that comprise UEFA through a “solidarity” fund and covers UEFA’s organizational and administrative costs. The effect of this aspect of the revenue sharing plan is to give more money to the lesser national associations. Overall, it is fair to conclude that the super-league model is highly capitalistic in nature and monetizes the stronger European clubs that participate in it. This can lead to the participating teams furthering their competitive advantage over the nonparticipants from their domestic league—in other words, the rich are getting richer. Other examples of this structure in global futbol are the Copa Libertadores (South America and Mexico), the CONCACAF Champions League (North and Central America and the Caribbean), the CAF Champions League (Africa), and the AFC Champions League (Asia). Some additional global league issues will be examined in Chapter 3.

No matter the structure, all professional sports leagues are concerned with the same two issues: competitive balance and revenue sharing. Although both topics are addressed at length in Chapter 5, it is appropriate to address competitive balance briefly here. Perhaps the best way to think about competitive balance is in its alternative—competitive imbalance. Competitive imbalance can take several different forms, all of which are arguably bad for the league as a collective.¹ The first is if one team dominates the top position in a league over an extended period of time (i.e., dynasties). This is bad for the league, because although casual fans may be drawn to the league because of the excellence of the one team, this interest will almost certainly wane over time because there is little uncertainty of outcome. In addition, fans of the other teams in the league may unite for a period of time to rally against the dynasty, but their interest will wane if their team does not have a realistic chance of winning a championship over a prolonged period of time. A predictable league ultimately becomes of little interest to its followers. Closely related to this is the second form of competitive imbalance: domination of the top of a league by the same teams over an extended period. For example, Celtic or Rangers have won the Scottish Premier League title every year since 1986. Again, there is little uncertainty of outcome, and fans of other teams will ultimately lose interest. A final form of competitive imbalance is the domination of the bottom of a league by the same teams over an extended period. This is bad for a league, because fans of those teams will lose interest in the team and sport, and bringing them back into the fold will require a substantial on-field improvement—contending for a championship. Habitually losing teams also impose costs on the rest of the teams in the league in that their contests against the weaker teams are less attractive and thus typically prevent them from maximizing their revenues in these games.

Leagues use a number of mechanisms to promote competitive balance, including a reverse-order draft in which the worst teams are given an increased opportunity to select the best incoming talent in the league’s entry draft; salary caps and floors, which are designed to compress the range of team spending on playing talent such that all teams are spending relatively close to one another on their athletes; luxury taxes, which penalize teams that spend beyond a proscribed threshold on player salaries and are thus meant to rein in teams inclined to spend excessively; relegation and promotion, which incentivize teams to win championships so that they may be promoted to a higher level of competition and reap the financial rewards and disincentivize losing contests to prevent the financial harms associated with demotion to a lower level of competition; and revenue sharing, which theoretically provides teams with an increased ability to spend more on player salaries and thus remain more competitive than they would be in the absence of the receipt of these revenues.

In the first reading, Shropshire and Rosner look at how sports survived the economic downturn that began in late 2008. In “On the Global Economic Downturn and Sports,” Shropshire and Rosner maintain that even the sports industry is vulnerable to a long-term recession. In the second reading, Michael Danielson provides a comprehensive analysis of the role of leagues in the business of professional sports. After giving an overview of league structures, the author then discusses the importance of both on-field competition and territorial exclusivity for the individual teams within the league. Danielson subsequently addresses the issue of geographic exclusivity in professional sports leagues in great detail. In the concluding excerpt, Roger Noll elaborates upon one specific alternative to the closed league structure embraced by North American professional sports that is embraced by much of the rest of the world, the open league model of promotion and relegation. He reviews this model through the lens of the English Premier League, widely considered the top soccer league in the world.

Notes

1.  George Foster, Stephen Greyser, and Bill Walsh, “The Business of Sports.”

POSITIONING OF SPORTS IN THE U.S. ECONOMY

ON THE GLOBAL ECONOMIC DOWNTURN AND SPORTS

Kenneth Shropshire and Scott Rosner

This has been an unprecedented time. Bear Stearns, Lehman Brothers and Washington Mutual failed, the U.S. automotive market is in disarray, Merrill Lynch was forced to marry Bank of America, AIG, Fannie Mae and Freddie Mac were bailed out and a federal rescue package was implemented that delivered nearly one trillion dollars to the distressed global economy.

On a visit to the Wharton School in 2009, Sam Zell was asked about how the economic downturn will impact the sports industry. He responded, “I don’t know. I think we’re going to find out. [On the] corporate side of sports [there are] usually less suites than demand. We’ll see [if that continues]. We’ll also see in about a month with the sale of the Cubs.” This hesitation and uncertainty is unusual in the sports industry. Broadly, the old logic seemed to be that sports, movies and other low cost forms of entertainment would always serve as a form of diversion, particularly during hard times. However, as tickets have become increasingly expensive and significant sports sponsors and advertisers have withered, the more problematic that premise has become. Historically, sports properties, teams, successful leagues and the like have been an asset that appreciates in value, provided an owner is able to hold on long enough and have deep enough pockets to withstand the somewhat inevitable operating losses. But the ongoing financial crisis is having a real impact on merger and acquisition activity and an operational impact on ownership. The longer these economic hard times go on, the harder it will become for some owners to maintain their grip given their reduced liquidity. Expect owners to be on the hunt for capital. But who to borrow from? With the elimination of investment banks and constipated credit markets, borrowing is harder than ever. If you are in need of operational cash for your business, most likely the prudent move is to take a reasonable deal from a lender if it is available today, as the offer may not be available tomorrow. And if these deals are unavailable, who to sell to? Deal flow may slow to a trickle, as there is likely to be a decrease in the supply of interested buyers. Thus, it is fair to conclude that with regard to stock and credit markets, the sports industry is no different than any other industry. Both are long term propositions on which the short to medium term financial crisis is having a real impact.

Most sports franchises should expect an operating downturn, with decreased spending by both individual and corporate customers and sponsors likely to be the norm as a result of the financial crisis. However, these operational impacts will not be felt equally across all teams (even within the same league). It should be mentioned that all teams are different, because all markets are different—some markets are going to get hit worse than others. The automotive woes hit Detroit, the financial sector struggles hit New York City, and other cities where the housing glut is unlikely to abate any time soon like Miami, Phoenix and San Diego are feeling the pinch even more. To the extent that all teams in a league rely heavily on local revenues (less in NFL, more in NHL, NBA, MLB), this could be bad news for teams in the impacted cities. Decreased corporate spending means fewer luxury box rentals (for the ones not rented for upcoming season(s) via long-term deals) and fewer, less lucrative team sponsorship sales (again, only for those categories that the team is selling now, not the ones locked in to long term deals). With the opening of two new ballparks in New York City and one in Dallas it is clear that sales of seats and suites are not as vigorous as they were in better economic times. There is a point at which the ‘sports as diversion’ theory becomes problematic. Consumers have to make tough decisions and between tickets to the game or food on the table, we all know what wins. Discretionary income is labeled as such for a reason. Declines in individuals’ discretionary income means decreased ticket sales (especially day of game sales in MLB) and decreased concessions sales (fans that do go may spend less on food, drink, etc.). There even exists the possibility that local media rights fees could decrease (but again only if these rights are on the market). Oh, and that new facility that provides a transformational moment in the economics of the franchise, funded in part (or increasingly rarely, entirely) by public money? Highly unlikely. Politics, budget shortfalls and higher order governmental priorities will stand in the way.

On the larger level, the impact of the financial crisis on league operations will again vary, as it affects all leagues somewhat differently. The longer market unrest goes on, the greater the chance of impact. It’s cyclical too, with the amount of pain endured depending on when your bigger sponsorship or television deals are up for renewal. Now would not be a good time, for example, to seek to renew your AIG deal.

Looking at a sampling of sports enterprises, NASCAR seems to be getting hurt the most in the short-term because of volatile gas prices and the depressed auto industry, with the LPGA and PGA Tours’ medium term prospects a bit more uncertain because of the nature of its sponsorships relating to the financial services industry. In the short-term, NBA and NHL season ticket sales were not terribly hurt in 2008–09 because their selling season came before the downturn occurred, but they too will get hurt in 2009–10 if the recession endures through their next selling season. Both leagues’ day-of-game sales should take a hit in 2009–10. The NFL may have less immediate concern for the 2009 season because it requires less dollar commitment for tickets but sponsorship sales in their open categories should become more and more difficult should the economy not make a positive turn. The issues are similar for MLB, except that their business has a greater dependence on revenues from ticket sales, and 2009 leaguewide attendance was down 7%. All of the major North American leagues have their national television deals locked in for the next several seasons (and the NFL even managed to extend its deals with Fox, CBS and DirecTV for additional seasons). The networks are clearly banking on the advertising market rebounding in the distant future.

At the collegiate level, the economic downturn is impacting not only endowments, but the level of giving during this current period. The largest impact is on construction of new facilities, with the constipation in the credit markets taking a toll on facility financing. Long term broadcast and sponsorship deals, again, are less problematic. The BCS television negotiations led to a lucrative long-term deal with ESPN, with the latter putting enough faith into the future of its monthly subscriber fees and advertising marketplace for the demographically attractive college sports product so as to allow the annualized rights fee payments to increase well into the double digits.

Unfortunately at the lowest levels of the sports pyramid, the impact is likely to be the most severe. From parents having to make the decision not to pay that Little League fee, to school districts having to decide between books or the gymnastics program, to cash-strapped local municipalities dramatically scaling back and in some cases even shuttering recreational facilities and programs, sports is likely to be the loser. In all circumstances too, the sports world is flat. Sponsors locked in for both the 2012 Olympics in London and 2010 World Cup in South Africa, bear close watching. If problems hit them, replacements could be hard to come by.

So the answer to the question of whether the sports industry is recession-proof is ‘No.’ If it ever was appropriate to refer to sports as recession (or even depression) proof, those days are clearly gone. There is perhaps a level of resistance due to the emotional involvement of sports fans with their teams, but the business does not have endless elasticity. That is particularly the case if you need to sell an asset now, have ticket inventory to move, or have new broadcast or sponsor deals to renegotiate. This is clearly not the ideal moment. However, all is not lost. Like the stock market, in the long run, the basic long term philosophy about the strength of the sports industry seems true. Wharton professor Jeremy Siegel provides the following guidance on the broader economy. “It is foolish to pick the bottom of either the stock or other financial markets in today’s environment. In the short term, anything can happen, since emotion dominates economics. Yet at these levels it is virtually certain that stocks will be a rewarding investment for long term investors.”

The power of sport is in its enduring emotional value to the consumer. The simplicity, enjoyment and the diversionary power are enjoyed by all. That is harder to pull away from and is different from the decision to pull away from the gas guzzler SUV and move to the hybrid. For the best qualities in sport, there is no substitute and the financial foundation of the game—the fan—is grounded in the fanaticism that is the basis of that label. While it is doubtless affected by current macroeconomic conditions, the sports industry will remain vibrant in the long-term.

OVERVIEW OF THE PROFESSIONAL MODEL

HOME TEAM

Michael Danielson

The business of professional team sports requires organization of teams into leagues. Leagues bring together a set of places that provide the primary market for the collective product; they provide the framework in which teams meet to produce games; they structure games into seasons, playoffs, and championships. Customers prefer organized games among teams competing for pennants, division titles, or a place in postseason play. As Commissioner Pete Rozelle constantly reminded NFL owners, “if you didn’t belong to a league, and just had teams arranging scrimmages against one another, you couldn’t expect many people to watch.”¹

The necessity for teams to be organized as leagues structures relations between professional sports and places. Leagues exercise controls over the location and relocation of teams, territorial rights, suitability of places for teams, the number of places that can have franchises, and who can own teams. They determine how revenues will be shared among members, negotiate national broadcasting arrangements, and bargain collectively with players. These league activities raise complicated issues of public policy, whose outcomes shape the way places connect with teams and leagues.

STRUCTURING THE GAME

In performing their functions, leagues have developed a common organizational structure, composed of individual teams operating collectively under direction of a commissioner….

Leagues are associations of teams rather than independent entities; they exist to promote the common interests of their member teams, which are separately owned and operated firms. League rules are determined by member teams, and are only effective as long as individual teams abide by them. Teams collectively make league decisions on relocation, expansion, revenue sharing, and network broadcasting contracts. Extraordinary majorities usually are required on important questions like moving or adding teams. These special voting requirements increase the power of individual owners or small groups of teams with common interests, such as large-market teams desirous of protecting their territories from competition and their revenues from sharing arrangements.

Team interests often conflict with the collective welfare of a league. Revenue sharing reduces income for some clubs in the interest of lessening economic differences among all teams in a league. Few teams can resist the attractions of unshared revenues from luxury boxes, better stadium and concessions deals, and broadcasting income outside league control, even though these revenues tend to increase disparities within a league. Conflict has been intensified by the rapidly increasing economic stakes of professional team sports. Newer owners who pay hefty prices for their teams and carry substantial debts are particularly interested in maximizing team revenues, which intensifies conflicts within leagues over revenue sharing, broadcasting deals, labor contracts, and expansion fees.

Differences among league members are amplified by the people who own major league franchises. Most are rich and powerful individuals who have been successful in other businesses and are used to having their way. Strong egos and personal animosities among owners exacerbate conflicts within leagues over relocation, expansion, and sharing revenues. Baseball owners, in the words of one, “never learned how” to be “both competitors and partners off the field.”² Owners in the NFL have been more willing to subordinate individual for collective interests; they were the first to adopt an amateur playing draft, and developed the most extensive revenue-sharing arrangements in professional team sports. Still, sustaining collective concerns has been a constant struggle within the NFL….

Leadership has been an important factor in the interplay of league and team interests. Formidable political and public relations skills enabled Pete Rozelle to expand league authority despite an increasingly diverse and contentious set of NFL owners. Another strong leader, David Stern, revitalized the NBA, turning a league plagued by drugs, weak franchises, and declining television appeal into a vibrant organization that pioneered the development of salary caps and league marketing, while expanding successfully and securing lucrative network television contracts. Under Stern, the NBA has emphasized league interests and league services to teams in marketing, promotions, and local broadcasting. National broadcasting revenues also have boosted the power of league officials. The dependence of NFL owners on the commissioner’s ability to make good television deals greatly enhanced Rozelle’s authority over all aspects of the game.

…. League officials are concerned about a set of places; they worry about market coverage and being in major markets. Increasingly, the focus of leagues is national and international, while teams are preoccupied with their metropolitan and regional market. David Stern promotes the NBA as an entity rather than a set of teams…. In Stern’s approach, individual teams become units of the business like Disneyland or Disney World, and places where they play are the sites of particular business units in the same sense that Anaheim and Orlando are for the Disney empire. Of course, there are critical differences between the NBA and Disney; each of the NBA’s… teams is individually owned and operated, most play in public arenas, and the owners collectively hire and fire the league commissioner as well as pass judgment on league decisions affecting ownership of teams, relocation of franchises, expansion of leagues, suitability of arenas, national broadcasting deals, and sharing of revenues.

COMPETITIVE LEAGUES

Professional teams have a collective interest in producing games that involve enough uncertainty to sustain the interest of their customers. Competitive leagues are good business; close pennant races and more teams in contention for post-season play increase attendance and broadcast audiences. A league’s ability to produce competitive games, teams, and seasons determines how many places will have successful teams at least some of the time….

A league’s collective interest in competitiveness co exists uneasily with the desire of individual teams to be successful. Team success means doing better than other clubs by winning more games and championships. Winning teams attract more customers, command more local broadcast revenues, earn additional revenues from postseason play, and make more money for their owners. Both winning teams and competitive leagues are good for business, but teams that win most of the time reduce league competitiveness. This situation leads to arguments that teams have a rational interest in winning, but not so often as to dominate a league and undermine the viability of weaker teams…. Winning, however, can be a profitable business strategy even if a team dominates its league. Great teams and dynasties usually are good business for the triumphant team, if not the league….

For most teams, the incentives to win also are more powerful than the rewards of increased competitiveness. Although closely contested games, pennant races, and championships are collectively desirable, individual teams understandably are wary of the risks inherent in highly competitive enterprises…. Noneconomic considerations reinforce the attractions of winning teams over competitive leagues. Most people who own teams are highly competitive; they are used to success, and success in professional sports is measured by won–lost records and championships rather than profits and losses…. Fans reinforce the drive for victory; fans care more about rooting for winners than whether the home team plays in a competitive league. And winning itself increases pressures to win again, heightening expectations of players for bigger contracts, of fans for another victorious season, and of owners for the thrill of another championship.

Among the four sports, the NFL has been most committed to increasing competitiveness. League control of television and sharing of most revenues were acceptable to NFL owners because these policies promised a more attractive product by increasing the ability of teams to compete regardless of market size. The NFL also uses scheduling to increase competitiveness, matching teams for games outside their division with opponents with similar records during the previous season…. However … only one team can win the World Series, Super Bowl, Stanley Cup, or NBA championship. Leagues, however, can create more winners by increasing opportunities to participate in postseason play. Leagues can be subdivided into conferences and divisions whose winners make the playoffs, and “wild card” teams can be added to increase the number that advance to post-season play.

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[Ed. Note: The author’s discussion of owners is omitted. See Chapter 1 for a discussion of this topic.]

TERRITORIAL RIGHTS

Teams in a league have substantial shared interests in the location of franchises. As a result, league control of franchise locations has been a cardinal feature of professional team sports from the start. The National League limited franchises to cities with populations of 75,000, with each team granted exclusive territorial rights in its market area. The National League and American Association agreed in 1883 to preserve exclusive territories for teams in each league. Contemporary territorial rights generally include the city where a team plays and the surrounding area within fifty or seventy-five miles of the team’s home turf. Each NFL team has “the exclusive right within its home territory to exhibit professional football games played by teams of the League,” with two teams in the same territory, as in the New York area, having equal rights.²⁰ Territorial rights include broadcasts within a team’s area, except for games covered by league contracts with national networks.

Territorial exclusivity enables teams to avoid competition for local fans, viewers, media, and broadcasting and advertising dollars. Exclusive territories focus fan loyalty and support for the home team…. Territorial controls are the basic instruments by which teams and leagues regulate their relations with places. Exclusive franchises are based on the notion that places belong to a league and its teams; territories are staked out and controlled by private league rules. Territorial controls are vigorously defended as indispensable to professional team sports…. Without these protections, professional sports are seen as facing economic ruin and places could lose their teams….

Territorial rights have been relatively static during the rapid expansion of metropolitan areas and urban regions. Fifty or seventy-five miles, which once extended the control of most teams well beyond the urbanized portion of their home territory, now encompass a diminishing portion of the far-flung regions that supply teams with customers and viewers….

Territorial rights have the most substantial impact on the location of professional teams in large metropolitan areas; with or without exclusive territories, smaller areas can sustain only one team in a sport.

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Because territorial exclusivity primarily protects franchises in the largest markets from competition, these rights reinforce the advantages of teams in the major urban centers. Limiting the number of teams in large metropolitan areas exacerbates market differences by forcing most owners to operate in smaller areas with less revenue potential. League controls also severely constrain the ability of small-market teams to move to larger markets that could sustain another franchise or support a more successful team…. The other side of this coin, of course, is that more places have teams because the number of franchises in the largest metropolitan areas is limited by leagues.

Territorial restrictions also reduce competition among teams to be in a particular place, thus increasing the leverage of teams on places. Most places have to deal with a single team in each sport. In the absence of competition from other teams for stadiums and arenas, holders of exclusive franchises are able to drive harder bargains with public agencies for leases, tax concessions, and other subsidies. Franchise controls, however, do not guarantee that a team will be able to capitalize on its market monopoly.

References

1.  Ross Atkins, “With Super Bowl Settled, Comes Another Showdown,” Christian Science Monitor, Jan. 26, 1981.

2.  John Fetzer of the Detroit Tigers, quoted in Thomas Boswell, “Baseball: Riches or Ruin?” Washington Post, Dec. 21, 1980.

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20.  National Football League, Constitution & Bylaws, Sec. 4.2 (1970).

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AN ALTERNATIVE MODEL

THE ECONOMICS OF PROMOTION AND RELEGATION IN SPORTS LEAGUES: THE CASE OF ENGLISH FOOTBALL

Roger G. Noll

Unlike in the United States, most of the world’s major professional sports leagues are not composed of a permanent roster of teams. Instead, major leagues promote and demote teams at the end of the season. The primary criterion for promotion and relegation is on-field success: The best teams in the highest ranking minor league are promoted to the major league, and the worst teams in the latter are reassigned to the former.¹ In larger countries, several lower leagues are organized hierarchically and the same promotion and relegation system applies down the line. In English football (soccer), for example, the hierarchy involves seven levels of leagues, and the bottom two levels are further divided into hierarchical divisions.

The primary difference between a system of leagues with fixed membership and a promotion/relegation system is that the latter permits a form of entry that is not feasible under the former. In leagues of fixed membership, entry occurs through expansion of a league or the formation of a new, competitive league. In the United States, expansion has been the primary means of entry into major leagues, although at some time during the 20th century the four most popular team sports experienced successful entry in that at least some of teams in a new league merged into the established league.² Entry and exit of leagues are substantially more common for minor league sports.

To prospective entrants, expansion and league entry have disadvantages. Expansion requires super-majority approval from established teams and entails paying a substantial entrance fee. Entry by an entire league requires that the incumbent league has left several viable franchise locations unexploited and that several entrants—not just one—are willing to suffer significant financial losses in the early years while the new league becomes established.

Promotion and relegation do not rule out these forms of entry, but this system makes other forms of entry feasible. First, an entrepreneur can buy a minor league team, hire high-quality players and coaches, and earn promotion to a higher league. Second, an entrepreneur can form a new team, enter into the bottom league, and then gain promotion to higher levels. In both cases, after a few years of successful play a team can be promoted all the way to the major league, although in the case of de novo entry in England this strategy requires at least eight promotions and therefore takes at least a decade.

These forms of entry require no approval by, and no payment of expansion franchises to, existing major league teams.³ The main disadvantages of this form of entry are that teams must start at the bottom rather than immediately enter at the league level that they seek and then must dominate lower leagues to gain promotion, which implies that they may have to field teams that are too good (and too expensive) for the leagues in which they play.

The purpose of this article is to explore how promotion and relegation affect the economics of a sports team and league. Two questions are theoretical: Under what conditions will leagues with promotion and relegation experience more entry? and How does promotion and relegation alter the business strategy of established teams and leagues? The other questions are empirical: Does promotion and relegation produce measurable effects on entry and operations? To answer the second set of questions, this article examines the history of English football.

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THEORETICAL ISSUES

Entry in team sports has two distinct components. One is entry of a team into a specific location, and the other is a net increase in the number of teams that play in a league. Although the second type of entry requires the first, the first does not require the second. That is, a team can enter a particular location by changing the place it plays its home matches (relocation), or a new team can enter one location while an old team in another location exits the industry…. Note that both relocation and promotion/relegation require entry and exit in different local markets. Alternatively, entry can cause a net increase in the number of teams (expansion, new leagues).

Promotion and relegation are a substitute for either relocation or expansion. In the first case, a higher league enters a new city (the home of the promoted team) while simultaneously exiting the home of the demoted team, whereas the lower league does the opposite. In the second case, a higher league promotes more teams than it demotes. If every league in the hierarchy follows this practice, the effect is net entry for the sport through the creation of new teams at the bottom of the hierarchy of leagues. Likewise, leagues can demote more teams than they promote as a means of contraction.

Team Strategies

The strategic decisions of a team are first whether to enter or exit the industry and then, conditional on entering (or not exiting), the level in the hierarchy of leagues to seek. The tactical decisions include picking the optimal team quality—that is, acquiring players and coaches of appropriate skill—to achieve the target league. Although the sequence of decisions is first to make the entry/exit decision, then the decision about league level, and finally a sequence of annual team quality decisions, logically each earlier decision is based on expectations about the financial consequences of later decisions, so it makes sense to discuss decisions about league attainment and team quality before examining the entry decision.

Team Quality

The effects of promotion and relegation on team quality depend on how movement between leagues affects team profits. In principle, promotion and relegation can affect profits in two ways: A team’s revenues and costs may differ in different leagues, and the presence of relegation and promotion may affect the interest of fans (and hence revenues).

Conceivably, good and bad teams could benefit from the promotion and relegation system. For the best teams, the reason is clear: Promotion is an additional reward for winning, and so conceivably can increase fan interest in games, assuming that fans prefer that their home team compete at a higher level. For the worst teams, the prospect of relegation also conceivably could increase interest because more is at stake in late-season games and because fans expect that in the next season the average quality of opponents may be lower. Whether these effects are present, of course, is an empirical matter, but if they are then sports that make use of promotion and relegation will earn higher revenues.

The other effect of promotion and relegation on team profits has to do with whether a team actually is better or worse off financially by being promoted to a higher league. To understand why promotion may not be profitable requires delving into the standard economic theory of a sports league. A sports team operates in two types of markets: a local market for selling tickets and concessions and a national or even international market for selling broadcast and licensing rights. In both cases, the demand for a team’s products depends on its absolute quality, the quality of its opponents, and the team’s tradition (or playing history). In addition, especially for local products, demand depends on exogenous demographic attributes of the city in which the team plays home games. In general, teams in more populous, wealthier markets will generate more revenue, holding constant the quality of the team and its opponents and the number and quality of its local competitors. All else being equal, a team in a better market will have a higher marginal revenue product of increments to team quality, so that teams that play in the best locations generally have a higher optimal quality than teams in worse locations.

Ignoring the possibility that the existence of the promotion and relegation system increases demand and taking as exogenous the number of teams in each league, the optimal distribution of teams among a hierarchy of leagues is for the best league to contain the teams that face the most intensive demand for the sport and for each league in the hierarchy to contain the teams with the best markets among those remaining after higher leagues have been filled. A promotion and relegation system forces a departure from the optimal allocation of teams at least half the time (and most likely virtually all of the time), given the unavoidable uncertainty associated with won–lost records during a league season as well as the requirement to relegate some teams even if the composition of the league is optimal. Thus, promotion/relegation inevitably has costs in terms of sportwide profitability.

Promotion and relegation reduce total revenues in a sport in the following way. When a team in a better market is demoted while a team in a worse market is promoted, all teams except the promoted team are likely to suffer financially. The demoted team will have an optimal relative quality in the lower league that is stronger than the team that was promoted, and so its demotion will reduce the expected won–loss record and hence the revenues of every team in the lower league. Likewise, the promoted team will have a lower optimal relative quality in the higher league than the team that was demoted. Hence, every other team in the higher league must play one home game with a team that has lower average quality than the team it replaced, causing each to have lower revenues. In both leagues, therefore, promotion/relegation reduces outcome uncertainty (competitive balance) and thereby reduces the demand for the other teams.

Although promotion/relegation inevitably creates a cost, this cost could be small. That is, if the differences in local market demand are small among a large number of teams, the revenue loss from distributing teams suboptimally is likely to be small and may be offset by the demand-enhancing effects of promotion and relegation as described above. Indeed, the most plausible explanation for the widespread adoption of promotion/relegation systems, given that they are certain to cause a suboptimal distribution of teams among leagues, is that the demand enhancing effect is present and that differences in market conditions are small among lower echelon teams in a stronger league and higher echelon teams in a weaker league.

Although theory does not yield a robust qualitative prediction about the effect of promotion on a team’s profits, a team in a lower league may have an incentive to seek promotion to a higher league than the one to which it would be assigned if the sport maximized joint profits. Whether such an incentive exists depends on two factors. One factor is the possibility that a promotion and relegation system causes an increase in the demand for games involving teams that are candidates to change leagues, as discussed above. The other factor is the effect of promotion on team specific revenues and costs.

In general, promotion into a league that is too strong for the market in which the team is located will have two economic effects. On the plus side, because the team’s opponents are better and the higher league receives more attention from the press (basically, free advertising), the demand for the team’s products should increase. On the negative side, the optimal quality of the team will be higher in absolute terms but lower in relation to other teams in its league. Promotion increases the marginal revenue product of quality and so causes the team to spend more on players if it joins a higher league. But a team from a market that, under an optimal assignment of teams to leagues, would be assigned to the lower league will have a higher optimal relative quality in the lower league than its optimal relative quality in the better league. Thus, a team that should be in a lower league from the perspective of sportwide profit maximization expects to finish higher in the standings in the lower league but spend more money for players in the better league.

Whether promotion is profitable to a team, then, depends on the net effect of all of these factors. Specifically, are the benefits of promotion (more revenues from playing better opponents, more exposure, and the possible demand-enhancing effects of the prospect of promotion in the year in which promotion is earned and of demotion later when the team returns to its optimal league) greater or less than the costs (higher salaries and a lower finish in the better league)? As a practical matter, this question is empirical, not theoretical, but the answer almost certainly is in the affirmative, for teams never refuse to be promoted.

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[T]he equilibrium spread in team quality in the top league is lower than it would be in a league of the same teams with fixed membership. In other words, the effect of promotion and relegation is to increase competitive balance in the top league among the teams that are members; however, because the teams in the top league may not be the optimal allocation of teams to that league, this effect could be offset by the presence of teams in weak markets that have low optimal relative quality in the top league.

The extent to which promotion/relegation improves the overall quality of play depends on the supply of inputs for all teams in the market. The assumption that the supply of inputs is not perfectly inelastic is unexceptional for all inputs except players. For players, supply elasticity has two elements. One component is related to whether children decide to devote themselves to developing their athletic skills and then, as teens, to launch a career in sports. Presumably this elasticity is tiny, especially in the short run. The other element is the nationwide supply of existing players to professional teams. Because soccer is the primary sport in much of the world (most of Europe, Latin America, and Africa), even for a soccer power like England the supply of professional soccer talent is likely to be reasonably elastic, although not perfectly so if players prefer to play in their home country. Hence, the preceding simple model yields two important conclusions:

Entry and Exit

The preceding model has implications with respect to the simultaneous entry of one city and exit of another in a league. Recall that promotion/relegation generates more of this form of entry and exit than does voluntary relocation in a league of fixed size. A team moves from one location to another while staying in the same league because it believes that the new location is sufficiently more profitable that it will offset the costs of relocating. Because the cost of quality is the same in all locations, the source of profit differentials is differences in the intensity of demand. Hence, team relocation in closed leagues tends to be from weaker to stronger markets. By contrast, in a promotion/relegation system, a new city is added to a higher league because the team in that city does well on the field and perceives its profits to be enhanced by joining a better league, whereas the new city in the lower league is added coercively—the entrant has been forced to exit a more profitable league because of its poor on-field performance. In at least some cases, the demoted team would not want to relocate to the city of the team that replaced it through promotion/relegation.

Another form of entry into a league, whether from de novo creation of a new team or a permanent change in the league assignment of an existing team, arises when the entering team operates in a more lucrative local market than the worst existing team. Exogenous changes in the geographic distribution of people and wealth affect team revenue functions and so alter the set of optimal locations for teams in a league. In a world of perfect information, incumbent teams in a league would be able to identify these locations, and teams could relocate as soon as demographic shifts changed the list of optimal team locations. But if local market responsiveness in areas without a team is uncertain, local entrepreneurs plausibly can detect a favorable shift in local demand before teams that are located elsewhere. Under these conditions, an old team is likely to start to improve or a new team is likely to be formed in a growing local market before another existing team detects that the area is more profitable than its current location.

The preceding argument provides an unobvious economic explanation for a phenomenon that, among sports aficionados, is regarded as a cultural difference between North America and the rest of the world: In other nations, major league teams virtually never relocate. The absence of team movements is attributed to the deep roots that a team has in its local community and, as a result, the unacceptability of relocation to its fans—even in the United States, fans have deeply resented some relocations (e.g., the Brooklyn Dodgers and Cleveland Browns). In any case, this observation, if true, can be interpreted as an assertion that in most of the world relocation costs are higher relative to the costs of forming a new team than they are in the United States. De novo entry can be cheaper under promotion/relegation for two reasons: Expansion fees are avoided and information costs associated with assessing new markets may be lower for residents of an emerging market. Hence, the absence of team relocation is a plausible consequence of a system of promotion and relegation.

League Strategies

The principal strategic decision of a league is to determine its size. The decision to expand is a response to growing demand, which makes an increasing number of locations viable franchise sites. But expansion is not usually in the interests of the most successful teams. Expansion entails increasing the number of teams in smaller markets that have no serious chance of winning a championship. Hence, on average, expansion reduces the average revenue of teams because it reduces the average market potential of teams and hence the average quality and consequentiality of matches. Moreover, expansion requires adding competitors in national markets like broadcasting and licensing or, if national rights are pooled by the league, sharing the revenues from these rights among more partners. Thus, if expansion teams have, on average, weaker demand than incumbents, expansion reduces the national revenue of incumbents.

For the most part, leagues expand not because doing so is in the best interests of incumbents but because they are forced to do so. One purpose of expansion is to inhibit entry by competitive leagues. Another purpose is to satisfy demands from political officials in return for their support for favorable policies regarding sports, such as favorable tax treatments, antitrust exemptions, and stadium subsidies.⁸

New leagues are formed to take advantage of two sources of excess demand for professional sports. First, monopoly leagues usually do not place multiple teams in areas in which demand is sufficient to support more than one or two teams and, by setting monopoly prices, undersupply demand for products in national markets, such as television broadcasts. Second, monopoly leagues typically do not place teams in all financially viable franchise locations.

In leagues of fixed size, both types of excess demand arise for three reasons. First, teams either have exclusive territorial rights or, collectively, teams in areas that could support entrants can veto territory-invading expansion or relocation if either requires a supermajority vote of incumbent teams. Second, incumbent leagues set a monopoly price for an expansion team that exceeds that which is justified by the revenue potential of some otherwise viable locations. Third, relocation costs and imperfect information prevent efficient team relocation and league identification of all financially attractive expansion sites. In deciding on expansion, then, leagues seek to balance the benefits to incumbents of expansion and a lower probability of successful entry by competitive leagues against the cost of adding to the number of teams in weak markets or increasing competition in strong markets. Inevitably, this calculation leads a monopoly league to be smaller than the number of teams that would exist under competition or the absence of league-created entry barriers.

The promotion/relegation system reduces pressures to expand by providing a mechanism whereby teams in markets that have become stronger due to demographic shifts can enter an established league. Promotion/relegation has two benefits to incumbents: The system creates a barrier to entry by new leagues into unoccupied attractive markets (a team in a lower league is already there and likely to seek promotion itself if the market warrants it) and it provides a mechanism for limiting the total number of teams in the league that play in weak markets. Whereas this system denies incumbents the opportunity to charge expansion fees, it compensates them by not forcing them to play more games against weak teams and to share national markets with more teams. But regardless of whether promotion/relegation is more or less profitable for the best teams than expansion, the one unambiguous prediction is that leagues using this system ought to be less inclined to expand.

The last effect of a decision to adopt promotion/relegation pertains to its effects on player costs. Abstracting from the demand-enhancing effects of the system, leagues have a good reason to adopt fixed membership—doing so reduces equilibrium quality and, if player supply is not perfectly elastic, player wages. Yet all major European soccer powers use promotion/relegation, which seems to be at odds with the assumption that leagues maximize profits.

Two explanations for this phenomenon are consistent with the standard economic model of a for-profit sports league.

First, until very recently, the world market for soccer players was monopsonized. Players were signed to their first contracts while still in their midteens, sometimes by an amateur or semiprofessional team that was owned and operated by the professional team in their home neighborhood. Subsequently, if a player switched teams after a contract expired, the new team was forced to pay compensation—a transfer fee—to the old team. For strong professional players, transfer fees typically ran in the millions of dollars, which was an order of magnitude more than the players’ salaries. These fees applied to international transfers as well as movements within the same country and were enforced by the international governing body of soccer, the Federation Internationale de Football Associations (FIFA). Thus, secure monopsonization of the player market ensured that at least some of the demand-enhancing effect of promotion/relegation would be passed on to teams.

This explanation for promotion/relegation may have disappeared. In December 1995, the European Court held that the transfer fee system violated the single-market principle by inhibiting free movement of labor (see Jeanrenaud & Késenne, 1999). As a result, European players can move freely within Europe after their contracts expire….

A second explanation for the dominance of promotion/relegation arises from the fact that an extremely lucrative part of professional soccer is international matches, especially between the best teams in the top leagues. In Europe, the top teams in national Division 1 leagues qualify for the Champions League in the following season, which involves playing several very lucrative matches. Leagues want their best teams to be competitive in the Champions League to make participation in these matches more profitable. Hence, it makes sense to adopt a system that, all else equal, produces stronger teams. Thus, adoption of promotion/relegation is much like an arms race: Conceivably, all teams and top leagues would be better off without it, but once one nation adopts the system, the others have a financial incentive to follow.

THE ENGLISH NATIONWIDE FOOTBALL LEAGUE

England is widely regarded as having one of the most successful sports leagues in the world—the English Premier League….[T]he English Premier League is roughly comparable to Major League Baseball (MLB), the National Basketball Association (NBA), and probably behind only the National Football League (NFL) in profits per team and average franchise value, while its best teams are comparable to the best in any league, including the NFL.

The basic institutional structure of English football has been stable for several decades. As in all countries, the overall governing body for English soccer is FIFA, located in Switzerland. FIFA determines the eligibility of teams and players for international competitions, such as the World Cup, and insists that internationally sanctioned teams must play only other sanctioned teams or else they and their players lose eligibility for international competition. Because international competition is very important to players and teams, this sanctioning power enables FIFA to regulate the business activities of soccer.

Below FIFA is the Union of European Football Associations (UEFA), which sets rules for European Football that are not dictated by FIFA, organizes international competitions within Europe, and supervises national football organizations. The Football Association (FA) represents all of the British Isles in UEFA, including Ireland as well as England, Northern Ireland, Scotland, and Wales. Each of these political jurisdictions has its own top (Division 1) league, its own hierarchy of minor leagues, and its own national team for competing in the World Cup, the Olympics, and other international championships. The FA sanctions and governs all professional and amateur football leagues and teams in the British Isles.

The Premier League stands at the top of the hierarchy of English leagues. Below it three other leagues collectively are called the Nationwide Football League and individually were called Divisions 2, 3, and 4 until 1992 but since have been called Divisions 1, 2, and 3. Historically, all four leagues collectively were called the Nationwide Football League until 1983, when the leagues began to sell their names to corporate sponsors. The leagues were known as the Canon League Divisions 1 through 4 from 1983–1986, the Today League in 1986–1987, and the Barclays League from 1987–1992, when the Premier League decided to withdraw from the Nationwide Football League. In the 1992–1993 season, the lower leagues became Divisions 1, 2, and 3 and retained the name Barclays League, whereas the top league became the English Football Association Premier League.

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Entry

The purpose of this section is to examine entry and exit in the top four English leagues to see if this history supports the theoretical arguments about the effect of promotion and relegation on entry into a major league and to determine the extent to which promotion and relegation cause instability in league membership through entry and exit. To summarize, the core predictions of the theory of a sports league are that the system of promotion and relegation reduces the rate of expansion and the entry of new major leagues but provides opportunities for new teams to enter or for teams in more rapidly growing markets to improve their quality and earn promotion while teams in declining markets gradually descend the hierarchy of leagues.

Unfortunately, the effect of promotion and relegation on the entry of new leagues is not observable because of the institutional rules of football. In England, as elsewhere, entry of top-ranking leagues is essentially impossible in the present environment. One of FIFA’s rules is that if a national team or any professional and amateur team wants to compete internationally, whether in major championships or just friendly (exhibition) matches, it must have a national governing body that enforces FIFA rules, grants franchises to leagues and teams, and certifies the eligibility of players. Another FIFA policy is that each country should have only one major league, usually called Division 1, although in England it has been called the Premier League since 1992. In the United States, MLS is the designated Division 1 league. Thus, entry of competing major leagues is precluded because FIFA and the English soccer authority are unlikely to sanction one. Nevertheless, FIFA and its subsidiary bodies (including the FA and the U.S. Soccer Federation) do allow entry of competing minor leagues. In England, monopoly leagues occupy the first five levels of the hierarchy, but the lower levels have competitive leagues.

An important aspect of the history of English football is that neither leagues nor the FA recognizes territorial rights. Teams can form anywhere, can move their home venues, and can be promoted into a league with a nearby local competitor. The only limitations are league rules regarding the suitability of a playing site in terms of the size and quality of the field and stadium. Because territorial rights are not enforced, large cities have many teams…. The absence of territorial rights reduces the “big market, small market” demand disparity; however, this check is limited because the most successful teams enjoy some immunity to competition due to the fan attachments that they have accumulated during their histories.

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In essence, the size of top professional football in England has remained roughly the same for more than three fourths of a century…. no net entry has occurred, either from new leagues at this level of quality or expansion of existing leagues. The economic growth of the past 50 years, the arrival of television with its new major source of revenues, the creation of lucrative international competitions for professional teams, and the boom in sports since the mid-1970s have substantially increased the demand for English football and the revenues of the teams. But this growth in demand has not led to growth in the number of teams in the top four professional leagues. By contrast, the number of teams in the four major professional sports in the United States has more than doubled in this period. Nine new leagues have entered, six of which have survived by being merged into the established league, and all four leagues have added expansion teams every few years since the 1960s. Thus, for more than half a century, the behavior of the top four leagues in England and the four American major leagues is consistent with the theoretical prediction that a system of promotion and relegation reduces the propensity of new leagues to enter and old leagues to expand.

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The main benefit of promotion and relegation is that it enables entry of teams into high-quality leagues; however, extensive entry is not guaranteed. Instead, the same small core group of teams could simply rotate membership in the leagues, with neither entry nor exit among this group.

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[Ed. Note: Author’s review of the history of promotion and relegation practices in England is omitted.]

The history of the Premier League reveals two core facts. First, a few teams have rarely spent any significant time out of the Premier League and account for most of its championships. Second, there is considerable turnover in Premier League membership among teams that are not frequent challengers for the Premier League championship. Premier League championships have been relatively concentrated.

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[T]he teams that played in the Premier League fall into three basic categories: a core of more or less permanent members, a group that is referred to as yo-yo teams because they move up and down with regularity, and a group of teams that only occasionally make the Premier League (and then for only 1 or 2 years).

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[T]urnover within the three divisions is extensive. Except for Premier League members, teams cannot conveniently be divided into a large majority that have a stable league assignment and a minority that are on the margins between two leagues and so alternate back and forth. The dramatic rise and fall of about one fourth of the teams in a decade, and the slower but real turnover that takes place among the teams that do not stay in the Premier League for long runs, show that during the course of a decade the promotion and relegation system has a substantial effect on the composition of all of the leagues. A surprisingly large fraction of teams in the lower leagues occasionally have runs that last several years in which they ascend to Division 1, and maybe even the Premier League for a few years, before falling back to Divisions 2 and 3. The next section examines recent history to determine the financial consequences of these runs.

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Recall that the economic theory of a sports league points to an inefficiency of turnover: An assignment of teams among the leagues may not be a good match with relative local market demands… many of the teams that were promoted in these years were not among their league’s leaders in revenues. Had promotion been based on revenues rather than on-field performance, fewer than half of these teams would have been promoted.

… [E]ach league shows very large revenue disparities among teams in the league. In the Premier League, Manchester United has far more revenues than any other team…. In all leagues, revenue disparities are larger than for major leagues in the United States….

The substantial overlap in team revenues among the leagues reflects two factors. First, in every year a fairly large number of teams play in lower leagues than their market demand justifies. Second, the revenue data are consistent with the hypothesis that the promotion/relegation system has a positive benefit for at least some teams in that revenues are enhanced by the prospect of promotion. A more formal econometric model is necessary to disentangle these effects completely but quite a bit can be discerned from the raw data.

The financial data provide clear evidence that league assignment affects revenues and so creates a powerful incentive to seek promotion…. In every case both revenues and attendance increase when a team is promoted, with the average increase nearly £5 million. Attendance at home league matches is probably a better indicator of the revenue effect of league status than is revenues, for the latter reflects many other revenue sources, such as participation in tournaments and international matches and the “parachute” policy of giving some of the television revenues of the Premier League to teams that have been demoted in the previous 2 seasons. Hence, revenues can vary from year to year for extraneous reasons. On average, a promotion to the Premier League was accompanied by an increase in home attendance of about 6,000 per game. Of course, revenues and attendance in both leagues were growing during this period but not by nearly this amount.

Interestingly, demotion is not always accompanied by a drop in revenues and attendance…. In all cases but one, demotion was accompanied by a drop in attendance, typically by a few thousand per game. Thus, demotion usually causes teams to be worse off financially; however, the drop in revenues and attendance is less than the gains from promotion, so that teams end up better off in the demotion year than they would have been had they not played in the Premier League in the previous season. These facts confirm that promotion has a hysteresis effect: The benefits of promotion persist after a team is demoted and average more than £4 million in the first year after relegation.

The meaning of the data on transfer fees and wages is not as clear as it is for revenues and attendance. Wages include all employees, not just players, and in particular the salaries of management. Hence, movements in wage data do not necessarily reveal the trend in total player salaries. Transfer fees reveal the attempt of teams to … improve their team (a positive number) or to sell quality players (a negative number); however, these numbers also are affected by extraneous events, such as injuries, retirements, and unevenness through the years in the number of players who seek employment with another team after their contracts expire. In some cases, teams seriously seek to improve themselves to stay in or return to the Premier League, as reflected in large expenditures on player transfers and higher wage bills.

Notwithstanding the caveats, the data indicate that teams do not all pursue the same strategies in response to promotion and relegation. In some cases, teams take advantage of their promotion to sell the players that made promotion possible and consequently stay briefly in the Premier League. In other cases, teams on the cusp between Division 1 and the Premier League put forth great effort to gain and keep promotion.

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The propensity of some teams to weaken themselves after promotion is to be expected from the fact that some promoted teams are not among the revenue leaders of the league from which they were promoted. The yo-yo teams plausibly operate in markets that cannot sustain competitive teams in the Premier League, so when they are promoted they do not make a serious attempt to stay. In this case, the motivation for promotion is not to obtain a permanent place in the higher league but to take advantage of the hysteresis effect in attendance. For teams in lower leagues that have higher revenues than some teams in higher leagues, the incentives are likely to be different. Their best assignment is likely to be in the higher league, and so they are more likely to make the expenditures that are necessary to increase their chance of staying in the higher league….

IMPLICATIONS

The financial and playing field experiences of the four leading British football leagues are generally consistent with the predictions of the theoretical model that can be tested using the financial data that are available. Promotion/relegation clearly has led to turnover in league membership among the four leading leagues; however, promotion and relegation between Division 3 and the National Conference has led to very little successful entry into the top echelon of teams. Apparently the combined size of the four leading leagues is sufficiently large that almost all viable franchise locations—especially for the top two leagues—were occupied early in the 20th century. Nevertheless, turnover between the Premier League and lower leagues is substantial in the time frame of a decade. Teams that play in rapidly growing markets or that switch from poor to strong management can rapidly ascend from Division 3 to the top leagues.

The financial information indicates that promotion is financially attractive as well as desired by fans. Both revenues and attendance at league matches tend to increase substantially when teams are promoted. Moreover, the reward from promotion seems to endure for a while after a team is demoted, giving teams that are marginal for a higher league a financial incentive to field teams that bounce back and forth between a higher and lower league.

Of course, this article is only a beginning. The next step is to estimate econometric models of team performance, revenues, attendance, wages, transfer fees, and other financial variables to provide more precise estimates of the effects described above and to determine whether the noisy indicators of player costs can sustain tests of the effects of promotion and relegation on team strategies regarding players.

Applications to North America

Drawing conclusions about United States and Canadian sports from the experience of English football is hazardous and, as a practical matter, probably irrelevant because North American leagues are not likely to experiment with so dramatic a change in format as the introduction of promotion and relegation. Nevertheless, the English football system seems to be a very attractive solution to the perpetual problem of leagues with substantial disparities in on-field success and revenue among their teams.

Promotion and relegation have three significant advantages and one significant disadvantage. On the plus side, this system allows the top league to be smaller, have higher average revenues, and be more balanced competitively, although the latter effect is muted by the yo-yo teams that seek only occasional, brief promotion to profit from the hysteresis effect on revenues. On the negative side, teams that are relegated do worse financially than they would if they finished in the bottom group of teams in the higher league. This disadvantage may be offset by the advantages but the issue cannot be resolved without running an experiment.

A promotion/relegation system can be implemented in two ways: by constructing a lower league from the existing minor league system or by dividing the existing major league. Sports with independent minor league teams are the most likely candidates for the first method.

Changing relations with minor leagues is not likely to be viewed favorably in baseball. The vast majority of minor league baseball teams, and all in the top two classifications, operate as farm teams for major league franchises. This structure enables major league teams to monopsonize the market for players who have any serious chance of becoming major leaguers through the amateur draft. Farm teams are expensive … but this cost is more than offset by the salary suppression that arises from the fact that players must have 3 years of major league experience before they qualify for salary arbitration and 6 years before they become unrestricted free agents. In addition, baseball has some attractive open markets that are valuable as potential expansion sites … which would be lost if minor league teams in those areas could qualify for promotion to the majors. Thus, baseball does not appear to be a good candidate for rearranging its minor league structure to accommodate promotion and relegation.

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The second approach to implementing a promotion/relegation system is to divide the existing major leagues to create a significantly smaller top league. The basic idea would be to shrink the top “major-major” league to something between 16 and 20 teams. Perhaps in tandem with expansion or promotion of some minor league teams, the remaining major league teams would be placed in a “minor-major” league with a comparable number of teams. All teams in both leagues would be treated as a “major league” in that all would participate in league governance, would have the same relationship with minor leagues, and would participate in the market for major league players. As the Premier League did when it shrunk to 20 teams and Division 2 did when it reorganized from two coequal leagues to the present Divisions 2 and 3, leagues would implement this system by demoting the major league teams with the weakest records in the season before the plan was implemented. To make the system more palatable to owners, players, and fans of demoted teams, the system could promote the 4 best teams in the lower league at the end of each season.

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Notes

1.  Secondary criteria are a team’s stadium quality, revenue potential, and adherence to league rules. In some cases relegated teams are not those with the worst records, and teams are denied promotion because of operational shortcomings.

2.  New U.S. leagues that managed to have at least one team enter an established major league were the American League and the Federal League in baseball, the Basketball Association of America, the first American Basketball League (1947–1949) and the American Basketball Association in basketball, the All-American Football Conference and the American Football League in football, and the World Hockey Association in hockey. Only one entrant, the Basketball Association of America (BAA), has managed to supplant the incumbent as the dominant league. In the late 1940s, the BAA merged with the incumbent National Basketball League and the first American Basketball League to form the National Basketball Association. Most of the teams in the merged entity were from the BAA. See Noll (1991) for a history of this era.

3.  Entry into the lowest league requires approval, but low leagues do not charge high entry fees.

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8.  For example, to obtain an antitrust exemption for their merger, the National Football League and American Football League granted an expansion franchise to New Orleans, the home of Senator Russell Long, who sponsored the legislation.

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References

Jeanrenaud, C., & Késanne, S. (Eds.). (1999). Competition policy in professional sports: Europe after the Bosman case. Brussells, Germany: Standard Editions.

Noll, R. G. (1991). Professional basketball: Economic and business perspectives. In P. D. Staudohar & J. A. Mangan (Eds.), The business of professional sports (pp. 18–47). Urbana: University of Illinois Press.

Ross, S. A., & Szymanski, S. (2000). Open competition in sports leagues. Retrieved from http://papers.ssrn.com/paper.taf?abstract_id=243756.

Discussion Questions