Individual Team Incentives and Managing Competitive Balance in Sports Leagues: An Empirical Analysis of Major League Baseball
Published 10/1/2008
Author: Michael Lewis
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Executive Summary
Major League Baseball and other professional sports leagues have long been concerned with competitive imbalances caused by differences in local markets. The fear is that in the absence of salary caps or other regulatory mechanisms, smaller-market teams will be unable to remain competitive. In response to concerns about competitive balance, Major League Baseball recently created a revenue-sharing system that transfers funds from teams with high local revenues to teams with low local revenues. The notable characteristic of this system is that revenue-sharing payments increase as team’s local revenues diminish.
This research uses a structural dynamic programming model to analyze ownership’s payroll investment decisions. This model is designed to estimate the relationship between optimal payrolls and local-market populations and the influence of long-term customer equity dynamics on payroll investments. In addition, the author analyzes the impact of a recent policy intervention that has implemented revenue transfers from high-local-revenue markets to low-local-revenue markets. The statistical results indicate that market population has a significant impact on the value of a team’s payroll investments. For example, optimal payrolls double as the population increases from 2.5 million to 7.5 million.
In addition, rather than improving competitive balance, the adoption of revenue sharing has decreased the incentives for small-market teams to remain competitive. The author finds that before the creation of the revenue-sharing plan, small-market teams invested in payroll as if each victory returned approximately $600,000, whereas large-market teams invested as if each victory brought a return of $1.2 million. Following the adoption of revenue sharing, the teams in the smallest markets began behaving as if each victory brought only a return of $300,000, whereas the behavior of the teams in the largest markets did not appreciably change. The results suggest that the adoption of a revenue sharing based on having minimal local revenues has created disincentives for teams in smaller markets to remain competitive.
The author uses the estimation results to evaluate alternative approaches to managing competitive balance. Specifically, an analysis suggests that basing revenue-sharing payments on local-market population and (higher) attendance rates would reduce payroll dispersion. The key to this proposal is that the disincentives created by the current system are replaced with incentives that would encourage teams to invest in building their customer bases.
Biography
Mike Lewis is Assistant Professor of Marketing in the Olin Business School at Washington University. His research focuses on issues such as consumer response to loyalty programs, methods for customer valuation, and dynamic pricing. His research has appeared in Journal of Marketing Research, Management Science, Marketing Science, Journal of Marketing, and Journal of Retailing. Before obtaining a PhD in Marketing from Northwestern University, he earned an MBA from the University of Chicago and a Master’s in Industrial Engineering from the University of Illinois. His professional background also includes experience at Northwest Airlines. He was formerly an assistant professor at the University of Florida.
J Marketing Research, Volume 45, Number 5, October 2008
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