The NFL Economic Structure

For an econ class I wrote a paper regarding the NFL and various topics discussed during our coursework.  Since it seems incredibly relevant for this site, I figured I’d post it here.

The NFL as an Oligopoly

Jay Ratkowski

March 26, 2010

Introduction

Like so many Americans, I am a fan of professional football.  However, on a personal level, I am fascinated with so much more than the action that takes place during games.  My interest level extends to the inner-workings of the league, which makes it natural to explore the economic factors at play in the NFL.  In this paper, I’ll be exploring the idea of the NFL within the oligopoly model.  This exploration will involve looking at ways the league is financially structured and the various regulations imposed by the NFL that prevent one team from becoming too successful.

About the NFL

The National Football League (NFL) is among the most popular sports in the world.  From meager beginnings 90 years ago, the NFL grew into a multi-billion dollar industry that captures a major share of an increasingly fragmented entertainment industry.  For the purpose of this paper, I will avoid explaining the fundamentals of how the game is played and instead examine the sport from a financial perspective.

The league today consists of 32 teams spread across 23 states.  Each team can have a maximum of 53 players making up their offense, defense and special teams units.  With a minimum salary of $230,000 (for players in their first season, the minimum goes up with veteran status), the absolute minimum total salary for NFL players is a staggering $390 million.  What’s more astounding is the actual number is just under $3.4 billion in salary.  It is no wonder this league requires the leadership of people with strong financial and legal backgrounds.

So how does the NFL bring in enough revenue to cover salary expenses and remain extremely profitable?  Essentially, they have a very popular and in-demand product and have found numerous ways to monetize the sport.  A majority of revenue comes from television broadcasts.  Most NFL games are broadcast on a regional or national basis through major television networks (Specifically Fox, CBS, NBC and ESPN).  The networks negotiate contracts with the NFL, paying the league for the right to televise games.  The incentive for the networks is that they will have fixed costs for the life of the contract and can rely on the NFL to bring a large viewing audience and thus high ad revenue.  Through all of their television agreements, the National Football League currently earns close to $4 billion per season (Futterman, 2009).

The remainder of the league’s $7.6 billion in revenue comes from luxury suite sales, tickets, merchandise and sponsorships.  The luxury suite sales are a huge revenue boost for most teams.  For example, in 2009 the Dallas Cowboys earned about $80 million from luxury suite sales alone (Badenhausen et al, 2009).  Ticket revenue, the package (season tickets) and individual sales of seats for games, accounted for close to $1.3 billion in revenue last year (the average ticket price is $73.99 [Greenberg, 2009], a stadium typically has about 70,000 seats and there are 256 total regular season games).  Finally, sales of jerseys, hats, mugs and just about anything else that can be associated with the NFL brand, is a major source of revenue.

Despite a deep recession and struggles of other major sports, the NFL continues to strive and grow.  The most recent Super Bowl (the league championship game) was the most watched television program ever (Flint, 2010).  The league has recently expanded internationally, playing regular-season games in Canada and the UK.  The NFL continues to increase its hold on people through licensed products like video games and fantasy football.  Seemingly, the league can do no wrong.

However, there is a major concern on the horizon.  Like any organization of this size, the NFL has a very complex economical structure.  A powerful union, anti-trust laws, extensive labor agreements, revenue sharing and the basic reality of 32 businesses competing within the same governing body creates potential financial chaos.  To help manage many of these issues, the league structures many of their operating philosophies around the oligopoly model.

What is an oligopoly?

An oligopoly market structure is a system where an industry is dominated by a fairly minimal number of firms.  With an oligopoly, each firm must take into account the actions of its competitors when making strategic decisions.  For example, until recently, television was completely dominated by four major networks (NBC, ABC, FOX, CBS).  If you look at the programming of each network, they all follow a similar pattern (generally news at the same time each night, similar programming based on time of day, similar advertising models, etc).  One network typically does not want to make a dramatic change, because if the competition does not follow they could be left out in the cold.  Instead, each firm would rather slowly fight for more market share within a stable environment.  To ensure stability, firms often practice collusion, meaning they work together in setting prices or with other strategic initiatives.

How Does the NFL Fit?

In this case, the industry is professional football and each team represents a separate firm.  Each team has individual ownership and management structure.  Teams compete both for sports-related accolades and financial and market gains.  More successful and popular teams can leverage this power in the form of higher ticket prices, merchandise sales, and ability to attract the most talented players.  However, the teams must operate as a group.  They compete within the same league that has its own governing body and uniform set of rules.  Each team employs players that are members of a single labor union.  Two of the most important systems that help keep the league operating in a stable environment are the concept of revenue sharing as well as the Collective Bargaining Agreement.

Revenue Sharing

Part of the agreement between the league and teams, much of the revenue earned through the league is shared by the teams.  Television contracts, ticket sales and merchandise revenue make up the majority of shared revenue throughout the league (again, television money is the dominant revenue stream).  This practice is essential for balancing league-wide power and keeping the NFL a successful league.

Not all revenue is shared, however, and this presents a possibility for a competitive advantage.  Teams are constantly trying to find ways to expand unshared revenue.  Some examples of unshared revenue include concessions, luxury suites, local advertising/sponsorship agreements and non-football stadium use (concerts, other sporting events, etc).  While many would argue that aggressively pursuing unshared revenue deteriorates the league-first motto, team owners like Jerry Jones of Dallas say these revenue streams create incentive for bettering the league.  When referring to expensive new stadiums, Jones said, “If you don’t have some unshared revenues, those stadiums never get built because of all the debt. You think people are going to build those stadiums if they were sharing the revenue 32 ways? No. Why did they get built? Because of the incentive.” (Moorhead, 2006)

The NFL Collective Bargaining Agreement

Most recently adopted in 2006, the Collective Bargaining Agreement (CBA) is an agreement defining bargaining practices between the NFL Players Association (NFLPA) and the NFL.  The agreement applies to all football players who either currently play professionally for an NFL team or who are seeking employment with an NFL team.  The agreement covers eligibility requirements for players, minimum salaries, contract terms, anti-collusion measures, the salary cap and countless other labor issues.  Some of the most relevant issues are covered below.

The Salary Cap

The salary cap is the maximum amount that teams may pay to its players in a given league year.  Implementing a salary cap is one way the league attempts to create a level playing field and theoretically allow all teams to remain competitive.  The amount of the salary cap is generally calculated as a percentage of total league revenue divided by the number of teams.  In the most recent season, that number was 57.5% of revenue, which worked out to $128 million per team (Associated Press, 2009).

Part of the salary cap and the initiative to keep teams financially equal involves a minimum salary.  To encourage spending and increase competition, the CBA defines a minimum salary amount for player contracts.  The amount is determined as a percentage of the salary cap amount, and increases each year of the CBA.  In 2006, the amount was 84% of the salary cap ($85.68 million).  The agreement calls for that number to increase by 1.2% each season, but never to exceed 90% of the salary cap (NFL CBA, 102).

Bending the Rules

As with most sets of rules, NFL teams have found ways to gain competitive advantages by using the system in ways it may not have been intended.  The most prominent way of doing so is with the signing bonus.  For many years now, teams have put more and more emphasis on larger signing bonuses in order to reduce salary cap impact.  For example, if a player is signed to a 5 year contract and receives a signing bonus of $20 million, the amount can be prorated over the life of the contract at a salary cap cost of $4 million per season.  This way, teams can give players huge incentives to sign a contract with them while somewhat minimizing the impact on their salary cap.  The drawback to this method is that signing bonuses cannot be forfeited through contract termination.  Meaning, if a team cuts a player, their signing bonus must still be paid and in most cases the costs will be accelerated and charged in the year the player is released.

Anti-Collusion

Collusion is always a prevalent risk with oligopolies, and the NFL takes specific actions to avoid such behavior in the case of their most prominent employees, the players.  The CBA has in it anti-collusion measures that bar teams and representatives (agents, etc) from engaging in actives that impact decision-making regarding:

(a)  whether to negotiate or not to negotiate with any player;

(b)  whether to submit or not to submit an Offer Sheet to any Re- stricted Free Agent;

(c)  whether to offer or not to offer a Player Contract to any Unre- stricted Free Agent or Undrafted Rookie;

(d)  whether to exercise or not to exercise a Right of First Refusal; or

(e)   concerning the terms or conditions of employment offered to any player for inclusion, or included, in a Player Contract. (NFL CBA, 155)

If it were proven a team engaged in collusive activities, that team could lose draft rights, face monetary penalties and/or have impacted player contracts terminated.

Other Items in the Agreement

The CBA covers other items that preserve the oligopoly model for the NFL.  One such section involves league expansion.  Not only is the NFL a difficult market for other teams to enter, but such entry must meet league approval.

Not to diminish the importance of the topic, free agency is actually an essential issue within the CBA.  In order to promote competition, increase salaries and allow players different employment options; free agency occurs when a player contract either expires or is terminated.  The player is free to seek employment with another team.

Antitrust, the League Opinion and the Future

Recent history shows the NFL might disagree with the oligopoly assessment.  An ongoing case that is currently awaiting review in the US Supreme Court may determine whether the NFL is a collection of 32 competing businesses or a single entity (American Needle v. NFL).  With items such as revenue sharing and the CBA, the NFL is acting as a single entity.  In the American Needle case, the NFL created an exclusive apparel licensing agreement with Reebok.  American Needle argues that the NFL is a collection of teams and the agreement with Reebok is anti-competitive.  The NFL argues that the move was made as a single organization.  In the lower courts, the NFL’s side has been upheld.  Now the NFL is actually encouraging Supreme Court review of the case, hoping to gain comprehensive anti-trust exemption.  Gaining such status would allow the league to make decisions as a single entity without facing punishment under anti-trust or monopoly regulations (Schuck & Flinn, 2010)

This case will be just part of a very big year upcoming for the league.  The CBA is currently in its final year and all accounts have both sides far apart on negotiations.  The NFLPA executive director DeMaurice Smith has been outspoken against the owners (Brandt, 2010).  Smith has used tactics typical of a lawyer to portray the owners as greedy and attempting to take money away from the players.  Surely this public campaign can only hurt the negotiation process.  Failure to decide on a new CBA could result in a lockout for the 2011 season (basically, no football).

Conclusion

Without extensive legal background, it’s tough to say how the courts will eventually define the NFL.  Before exploring the concepts outlined in this paper, I probably would’ve gone along with the idea that the NFL is one league and thus one entity.  However, it’s hard to argue for that concept when you consider the league is made up of 32 different teams all with unique ownership and competitive strategies.  If I had to guess, I’d say the Supreme Court will probably side with the NFL as a singular entity for marketing/licensing purposes, but little else.

Sources:

Futterman, Matthew. (2009, March 24). NFL, DirecTV Extend Pact in $4 Billion Dea. The Wall Street Journal. Retreived March 18, 2010 from:
http://online.wsj.com/article/SB123786503490122053.html

Badenhausen, Kurt, Ozanian, Michael K., Settimi, Christina. (2009, September 9). Recession Tackles NFL Team Values. Forbes. Retrieved March 12, 2010 from:
http://www.forbes.com/2009/09/02/nfl-pro-football-business-sportsmoney-football-values-09-values.html

Greenburg, Jon. (2009, September 9). NFL FCI 2009.  Team Marketing Report. Retrieved March 18, 2010 from:
http://www.teammarketing.com/blog/index.html?article_id=96

Flint, Joe.  (2010, February 9). Super Bowl XLIV game a ratings winner. The Los Angeles Times. Retrieved March 23, 2010 from:
http://articles.latimes.com/2010/feb/09/entertainment/la-et-bowlratings9-2010feb09

The Associated Press. (2009, May 15). Final adjustment increases salary cap. ESPN. Retrieved March 23, 2010 from:
http://sports.espn.go.com/nfl/news/story?id=4169590

Mororhead, Clay. (n.d.). Revenue Sharing and the Salary Cap in the NFL: Perfecting the Balance Between NFL Socialism and Unrestrained Free-Trade. Vanderbilt Law School. Retrieved March 18, 2010 from:
http://law.vanderbilt.edu/publications

Schuck, James P., & Flinn, Victoria A. (2010, March 12). Supreme Court to weigh in on American Needle v. NFL. Lexology. Retrieved March 23, 2010 from:
http://www.lexology.com/library/detail.aspx?g=035c2570-3b75-4927-a73f-1c7e75e5c6ed

Brandt, Andrew. (2010, February 6). Union head fires first public shot. The National Football Post. Retrieved March 23, 2010 from:
http://www.nationalfootballpost.com/Union-head-fires-first-public-shot.html

No Author. (2006, March 8). NFL Collective Bargaining Agreement 2006-2012. NFL Players Association. Retrieved March 14, 2010 from:
http://www.nflplayers.com/