The NBA is a Cartel

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Published: June 26, 2011
Am I Fighting One Hydra Or Seven Mouths?

Am I Fighting One Hydra Or Seven Mouths?

Am I Fighting One Hydra Or Seven Mouths?

 

An Economic Analysis of the NBA, Part I

Next Installment:
An Economic Analysis of the NBA, Part II: The NBA’s Labor Revolutions

The New Orleans Hornets, our team, is, beyond the shadow of doubt, the most interesting team in all of American sports for the time being. What’s so attention-getting about a team that wasn’t interesting enough to be on national TV even when they were on 8 game win streaks . . . twice? Let’s rack ‘em up:

Chris Paul, David West, NBA Ownership, the CBA, sharing a small market with a deeply rooted NFL team, attendance benchmarks, revenue benchmarks, a lease with only 3 remaining years, 3 relocations, a few near sales, and two of the largest disasters in American history not even a mere 5 years apart, and a 10,000 season ticket sales goal. Sure, there’s more, but let’s get on with the article.

This may seem like a jumble of issues, too varied to discuss coherently. This is not so. There is a common thread, and understanding this common thread sheds light on all these issues simultaneously. This common thread: Economics.

In this article, we develop some insight into what will determine if we have a lockout, what will be necessary to end it, and how it will likely affect the sale of the team.

Oh, we’re having a lockout, I guarantee. Read on to find out why.

To tackle everything that needs a-tacklin’, we’ll need more than one article. As of this writing, I’m planning 4 articles: this one on the NBA and how it functions, likely longer due to the inclusion of background matter, the follow-up post about the player’s union and how it fits in with the NBA, a third piece on the how the fans / customers fit into the picture, and a final bit of scribbling on . . . something I’ll keep a secret until then . . . don’t worry . . . you won’t like it . . . I reserve the right to change this format . . .

The NBA as a Producer

Most of the news in sports is, unfortunately, largely about money in some way. As a result people spend lots of time thinking about money and not bouncy balls or whatnot. Most economic analyses, sadly, start and stop with the concept of money, and not one of the more interesting ones. Examples of this particular flavor of discussion related to the New Orleans Hornets are the financial statements leaked last year, the NBA’s purchase of the franchise, the future purchase of the team by someone and the relationship of this transaction to market size, and the constant cacophony regarding the value of players’ contracts.

Economics is not the study of money, however. It is much more than that. It’s about the production, distribution, and consumption of goods and services. Money is a part of this, as it is the medium of exchange, but there is so much more. Money tends to follow and `mark’ what’s going on with these other aspects of the market. Here, by market, I don’t mean a locale, like New Orleans; I mean the abstract forum where economic constructs, forces, and entities `live’.

One of the most famous recent example of services being shown to supersede money in the NBA or otherwise would be Mr. LeBron James and the televised taking of his tremendous talents to South Beach. While his talents are not money, they can be exchanged for cash and prizes. His talents are exchanged as such, in fact, which gives them economic value. In fact, we often equate things to their monetary value when convenient, though the need for an intermediary or some prerequisite economic systems in many cases is crucial and should never be overlooked. For instance, Mr. James’ talents would be worth far less in a world without the NBA, or in the 70′s.

Restricting our attention to the NBA still leaves a very large market to study. Initially, let us consider the NBA as a business . . . emphasis on a, here . . . singular . . . What is the NBA is in the business of? Why does it exist?

To make money.

The end.

Pureud. (skip to 3:15 if you don’t enjoy the video)

The NBA doesn’t need to win a title. There is one title every year, and it necessarily goes to exactly one NBA team. The NBA produces the title ex nihilo and awards it to itself.

The NBA doesn’t need to win games. There are 1230 wins and 1230 losses in each regular season. The NBA produces them ex nihilo and awards them to itself in matched pairs.

You see, wins, losses, titles . . . these are not distributed or consumed by anyone. Therefore, in this case, they take a back seat to the parts of the NBA that are more concretely economical. The money, in some cases, and in this one, can distract one from the underlying reality . . . trees . . . forest . . .

The NBA makes money by some means, right? What do they produce? What do they bring into the world that is distributed and consumed? And it damned well better have something to do with winning!

Entertainment.

The NBA makes it very entertaining to watch the distribution of wins, losses, and titles to itself.

This is done in a number of ways. One is, of course, a highly skilled set of competitors playing a game that is subtly tweaked year-by-year so that the entertainment value grows. The addition of the 3-point score is a striking example of this constant tinkering. Rewarding a more difficult shot with a larger value isn’t blatantly gimmicky, and it has the effect of greatly altering strategy, tactics, and the dynamics of the game, as it did in this year’s NBA Finals. The same number of wins and titles are produced, but they are distributed in a more entertaining way.

Beyond this there are pretty and talented girls to watch, interludes during stoppages, give-aways, fancy arenas, a wide variety of good food, music, and more, all to make the package as entertaining as possible for the widest variety of people. You can have your birthday announced, publicly propose marriage, and dance for the thousands in attendance. I’ve been able to sit with the radio guys and become part of the show.

And that’s just at the game! I’ve been to pre-game and post-game press conferences as a fan, and I’ve taken tours when it wasn’t even game day. I write articles about all then mention this in other articles about writing articles. What does any of that have to do with the ball going in the hoop?

Then there’s TV, radio, and internet broadcasts: the advertisements there, all the commentary, the variety of graphics, before, during, and after the game. They show us celebrities in the audience. Why? You know why . . . And none of it helps me see a cross-over more clearly. None of it makes an alley-oop happen more often, sadly.

It’s just entertaining.

There are 48 game-minutes, but it takes about 150 minutes to walk out of a game after you walk in . . . or flip away once you flip to it for those watching remotely. For reference, an NFL game has 60 game-minutes and takes about 180 minutes to watch. Both have a ratio of 3:1. Coincidence?

Sure, there are natural stoppages and timeouts, players need rest, coaches need time to recalibrate . . . but people need time to hit the head, buy more stuff, socialize, get excited . . . consume and add to the entertainment.

I would imagine that at this point, I’ve upset a few people by saying the NBA awards wins and titles to itself, rather than teams earning them. I’ve abandoned a few conventions, and that needs to be justified. Let’s look more closely and see what we can find . . .

Not-So-Free Market

The NBA functions as a single entity in some respects, but in others it does not. The basic business model is such that the discussion above holds true, but the constituent franchises are separate businesses with many independent relationships to other firms and distinct markets.

This situation of a group of similar businesses that operate in a similar fashion, have similar branding, consult with one another before making decisions certain decisions, defer to the consensus of the group, is not a free market. Rather, this is called a cartel.

The economics associated with a cartel are between those of a free market and a monopoly, a situation where one firm controls an entire industry (lone seller, etymologically). Prices in the market for the collective products of the cartel are higher than they would be if competition was unchecked, but lower than if produced by a monopoly. There is a strict control of supply and it fails to meet demand, market fluctuations aside, which leads to the higher prices. Consumers of various sorts actually compete for the privilege of giving them money. These sorts of consumers include cities, broadcast networks, and sponsors.

Understanding that the NBA is a cartel leads to a greater understanding of what we see unfold year-in and year-out in this sport. Why don’t teams just go get the players they need in free agency? Mutually-agreed-upon restraint. Why would an owner vote for a CBA that hurts their chances of keeping the face of the franchise? A higher purpose than winning.

A great deal of confusion arises from assuming that the all NBA economic activity is approximated by that of a free market, the simplest of all economic systems. I view this in the same way that it’s ok to view the world as flat. When you are walking to the store, it really doesn’t matter that the surface of the Earth is basically a sphere. In most cases, local considerations outweigh this fact, for instance, the slight curvature of the earth doesn’t affect your stroll to the bodega as much as does a big hill between you and it. But when your considerations reach a certain scale, the approximation fails. Airplane routes look insane when printed on flat brouchures because they only make sense when viewed on a sphere. Economically speaking, the `flat’ approximation only gets you so far in understanding the actual object of study.

The standards by which each member of the cartel operates are set by other members in the cartel for all practical intents and purposes, making them very political constructs. The hot item that exemplifies this for the New Orleans Hornets community is the 10,000 season ticket goal set by the franchise. Mr. Sperling and Mr. Weber have said variations of this numerous times:

There are a couple reasons why (the number of) 10,000 is important. One is, 10,000 is the number the other 29 owners – who have a stake in this team – (use to) judge themselves.

This general principle can be seen in it’s purest form in the Hornets situation. They are owned by the cartel, not by any member. They are, for lack of a better term, the typical team, which is the height of irony. As a person who knows how rare real irony is compared to how overused the word has become, I do take some faint, deep-seated pleasure in this.

Another example of this is about the hot-button topic of the Hornets payroll. With our new understanding of cartels, the following statement is almost too obvious to state:

“Our budget is in the mean with most teams in the NBA,” Demps said. “If you look at us last year, our payroll was about $68 million. That was right in the middle of most teams in the NBA. I think what we will do is we’ll probably still operate around that amount.”

Within the NBA, the franchises compete for a few things: wins, titles . . . remember those? . . . players, and various forms of bragging rights . . . all manufactured internally . . . for free. They do not compete, however, in an unregulated fashion. Beyond the rules of the on-the-court-game, the owners agreed to a system by which they are bound for handling certain decisions.

For instance, in the case of the SuperSonics moving from Seattle to Oklahoma City, there were 2 dissenting with the majority opinion to allow the move: Portland’s Paul Allen, (executive at Seattle-area Microsoft, owner of the Seahawks, and owner of the Portland Trailblazers), and Dallas’ Mark Cuban (Oklahoma City is closer to his market than any other). Nevertheless, the dissenters had to abide by the rules. Similarly, if they vote had been, say, 14-16, the team would have remained in Seattle for a time, since a majority vote is needed to approve a relocation. Owners do not, or can not, go their on way in all cases.

Speaking of owners . . . An interesting and informative little fact is that while over half the owners must agree to a relocation, adding one group of fans to the ticket-buying supporters while removing others, over three-quarters are needed to approve a majority owner, adding one vote, one personality, to their governing body.

Turn this over in your mind a few times . . . understand what it is they consider to be bigger decision . . . understand what it is that they are protecting . . . and what they are not . . .

Teams do no truly compete for players. They are drafted, traded, and signed under a strict set of rules agreed to by the owners and players in some fashion. In the case of Mr. James in the Summer of 2010, not many teams could have actually signed him outright (not that Miami did so, but the fact that they could have forced Cleveland to see the sense of a sign-and-trade deal with the Heat). Rather, Miami prepared themselves for their opportunity by, for all intents and purposes, clearing off their books, save $0.5m.

A billionaire couldn’t just write a $100,000,000 check to Mr. James to lure him, though a few would have if they could have. In fact, he interviewed with the Cavaliers, the Heat, the Bulls, the Knicks, the Nets, and the Clippers. 6 teams. 6 of 30 teams even considered making a pitch to perhaps the most coveted free agent in the history of sports. Does that seem silly? It would be silly if all the teams were free to do as they wished, but they are not. It would be silly if this were a free market; it is not. Not by a sight. It’s not my words that make this so; it’s the economic behavior of the firms in the market that make it so. I’m just putting the correct label on what’s behind that kimono.

Looking closely at the case of local TV deals, we see that the franchises do not really compete in most cases. The local TV deals are made on a team-by-team basis, and that revenue is not shared, nor is there a collective negotiation, but this does not mean they are competing. Clearly the Clippers and Lakers compete, and the Nets and Knicks will be competing on an increasing basis in the coming years, but there is simply not much competition for these dollars in that each franchise isn’t competing with 29 others for every dollar. Rather, the NBA as a whole casts a net over the US (and Toronto) and pulls in money from sea to shining sea like so many fisherman who forgot what the ocean looks like.

The Great Game

Cartels are strong economic entities when viewed from the outside, as evidenced by some of the more famous examples, like OPEC. They are not as strong as they appear from without when viewed from within. The firms comprising a cartel are often inhomogeneous, leading to differences of opinions at best and divergent economic incentives at worst. These inhomogeneities can be many things, but in the NBA the ones that get focus are market size, wealth of the ownership, state support, local TV deals, and arena quality.

The reason cartels are unstable is typically illustrated in by the Prisoner’s Dilemma, at least in academic circles.

Two suspects are arrested by the police. The police have insufficient evidence for a conviction, and, having separated the prisoners, visit each of them to offer the same deal. If one testifies for the prosecution against the other (defects) and the other remains silent (cooperates), the defector goes free and the silent accomplice receives the full one-year sentence. If both remain silent, both prisoners are sentenced to only one month in jail for a minor charge. If each betrays the other, each receives a three-month sentence. Each prisoner must choose to betray the other or to remain silent. Each one is assured that the other would not know about the betrayal before the end of the investigation. How should the prisoners act?

Generalizing this a bit, one can see how this would destabilize a cartel. Let’s take an example from the NBA. Let’s assume we have 30 teams acting in perfect harmony. Without restraint, whether internal or external, one firm could offer more money to two top free agents, thereby winning more games in the upcoming year. These wins add to the entertainment value there a good bit, and the one or two wins taken from a few teams around the NBA don’t really affect their revenue, at least as it relates to entertainment, and kept their costs down since they didn’t have to pay the top two free agents, picking up cheaper options.

The next year another team does the same thing, following the example set by the first team. This still hasn’t affected the market too much, and it’s added a rivalry, driving up the entertainment value of the NBA as a whole. Everyone is happy.

After a few iterations, however, what happens is some teams, selected just by random chance or something equivalent in this case, have really been big losers in this, both on the court and off. Their `turn’ to sign the free agents never comes because now the asking price for the 2 big free agents is higher than it was when this all started, due to inflation-in-the-market, the demonstrated reward that such a pair brings, and the mounting coffers of the few teams that have been winning. They never get their chance to make those franchise-transforming moves.

As a result, their economic incentives are different that they other owners. They want to maximize the minimum reward for being a cartel member, they want stability, while the teams who have been raking in case want to maximize the maximum benefit; they want windfalls. The richer members of the cartel want to protect their individual advantage, even if it means protecting that of their one or two real foes, because one and two were both less than 29 the last time I checked. Yup, still the case.

The cartel is weakened, perhaps becoming an oligopoly economically and a plutocracy politically.

Each faction maneuvers against the other. The richer faction can pick apart the poorer by the same method that originally decayed the cartel: unbalanced economic incentives.

You want to know why the Pau Gasol – Kwame Brown trade happened? That is why. It wasn’t the Lakers and Memphis specifically. It was that one of the wealthy teams, the Lakers in this case, was going to relieve the owner feeling the most burden, Memphis in this case. Memphis wasn’t trying to win more; Memphis was trying to maximize their financial gain . . . which can be viewed as minimizing financial losses if you prefer to not think with negative numbers. It wasn’t genius on the part of the Lakers, stupidity on the part of Memphis, or a conspiracy by the NBA, unless a lion is a genius, a gazelle is a moron, and hunger was created so that lions would eat gazelles while the gazelles were trying to eat grass.

Mr. Kevin Maurice Garnett was traded to Boston for 5 players, 2 first round draft choices and cash. Cash. Did I mention the cash? One can argue that the trade was not as detrimental to Minnesota as the Memphis trade was, but where has Minnesota been since? Nowhere. Memphis got the other Gasol in the deal and made some noise in the playoffs this year, and have been much closer to the playoffs than Minnesota in the years since the trades and had creepily equal records before the divergence. The Garnett trade is another example of this same predatory behavior.

The Jazz gave the pick that turned into Magic Johnson in 1979 for Gail “Stumpy” Goodrich in 1976 (they gave more, too, and signed him to a big deal . . . then he hurt his Achilles early that season). As we all know, the Jazz, despite great attendance, left due to financial losses. Those losses were squarely on the shoulders of management, the business community, and the tax situation. This Jazz move for Goodrich, sadly, was justified. The tax code wasn’t changing, and the businesses weren’t going to get on board unless the team was performing at a higher level than it was, clearly.

The Hornets gave up Kobe for Vlade Divac (in theory Kobe would not have signed with the Hornets, but that is another story). These poorer teams, some dear to us, could not afford to wait for the rewards yielded by these players, at least in the view of the owners at the time . . . all perpetually channeling J. Wellington Wimpy . . . gladly paying Tuesday for a hamburger today . . . but in this case, it’s not the payment date that is in the future . . . the future is the payment.

They had things besides dynastic grandeur on their minds. They needed to win now to keep the lights on, so to speak.

This instability happens in other cartels, like OPEC, with some countries producing oil in amounts differing from that decided upon by the cartel. They do this not some sort of coup, but rather just to take care of some business internal to their country. Other members lower production so that the group’s production is in line with the group’s target, but this amounts to the members who broke rank initially taking money from the coffers of the members who didn’t . . . or waited too long. As such, this soft underbelly of cartels is a general phenomenon.

A less manufactured comes from the fun-filled world of multi-headed animals. Yes, multi-headed animals.

Consider a two-headed snake.

No. Scratch that.

Consider two of them. One has a shared stomach, while the other has two stomachs. Both snakes behave like a Winnebago being driven by two crooks fighting over the wheel in this Summer’s hottest new comedy: Snakes in my Winnebago . . . this film is not yet rated.

As it turns out, these snakes have a shorter live span than their single-headed cousins, but the ones with two stomachs actually end up killing themselves, as one head end up winning fights for food more often, gets stronger, wins more . . . until half its body dies and it follow suit. This lack of understanding of how the good of the whole can outweigh the blind maximization of the perceived good of the one also plays a role in cartel dynamics. Interestingly, the single-stomached snakes can fare better due to their literal gut instincts in each head about how they are connected to the other head . . . when the other guy winsss, I ssstill feel good . . . ssstuff like that . . .

In fact, there is a branch of mathematics called game theory that studies these sorts of processes on an abstract level. The Prisoner’s Dilemma is a standard problem studied by game theorists. The analsyis we just went through, but not the examples, is an informal version of an analysis of a game, and likewise for the discussion of instability. In fact, the game itself predicts certain outcomes as the most likely result of following certain strategies. The instability in game theoretic cartels occurs in real cartels just as the game theory suggests.

Now that is clear that what the system we are dealing with it, economically speaking, and we have demonstrated the explantory value of this observation, let us test the predictive power that comes along with it.

In game theory, an equilibrium is a particular set of actions for all members that can be used repeatedly in such a away that any change from them results in a loss. As such, there is no incentive to make an initial move away from the strategy. An orchestrated move is required to move away from some equilibria, while others are inescapable without a literal game-changer. There are actually many types of equilibria, but we’ll just leave it at this for now.

In the iterated prisoners dilemma, cooperation among the prisoners is an equilibrium only when the game is of some unknown length, otherwise each member will be incentivized to defect at some point before the known end of the game, or if, in the case of an infinite length game, only if future rewards outweigh present losses according to some calculation.

Interpreting this into English: If any owner does not fear the NBA ceasing operations for a while, then cooperation is not an equilibrium; if any owner fears short term losses more values long term gains, then cooperation is not an equilibrium.

Right now, the cartel is unstable, and it must be stabilized.

22 teams are losing money, while 8 are profiting. The losses are to the tune of a cool $300m. Even if this is too large by double, the actual loss is still massive. There are teams losing a million dollars a month in a great enough number to ensure that only a CBA that helps them make money, not win, is passed. When the payroll for at most 15 workers is over $60m in most cases, a lockout of those workers will almost certainly improve their situation. Even if the teams won’t be making money via some slick TV deal, they’ll slow the losses. They longer it lasts, the better for them comparatively: losing less is better than losing more. Every day they don’t pay the players, they make more than most households in the U.S. do in a year. Sign me up.

The lockout will reign unless the cartel is stabilized. That is why revenue sharing among the owners is a key to this CBA, and one that gets little press since most of the media is focused on players. With a CBA that allows for a stable market, we’ll necessarily achieve some parity, leaving luck and quality of ownership as major variables.

Once the situation for enough teams is such that revenue sharing limits their losses, they can ask the players to give up less money, resulting in progress in the negotiations. This won’t solve anything, but it has to be in place, from where I sit, for any deal to be done.

Put another way, the poor owners will gain in this lockout and the rich owners will lose. The rich owners will likely agree to more sharing, and the demands on the players will be correspondingly less.

So what does all this have to do with the Hornets?

I fully expect there to be significant revenue sharing as a part of the new CBA, which will make this New Orleans NBA franchise look more attractive to a buyer, including local buyers, even with an increased upfront cost due to the work done to the franchise and the reduced financial risk. There is no guarantee, however, that there will be interest; the barrier for entry will be reduced, and that is all that can be asked.

We may or may not be able to retain Chris Paul by some means following this season, but with a favorable CBA, we’ll have another shot at him or someone like him . . . at least on paper . . . there is only one Chris Paul.

That brings me to labor and monopolies . . . but that is another post . . .

13 comments
hewhorocks
hewhorocks

Economics talk and game theory....ahhh the salad days. +10 great read

Okithor
Okithor

The 300m loss is split between the 22 losing teams? I dont think I need to ask but which set are the Horents in? The 22 or the 8?

J
J

Maybe Rip is past his prime unless we make a deal with T-Wolves or some other team to unload Okafor's huge contract.

Joe P
Joe P

Amazing post, 42. Thanks for the insight. Does the viability of the top 8 teams depend on the survival of the rest? I mean if a bunch of teams go out of business, and a sort of forced contraction occurs, does that hurt the rich teams? I have to think it would hurt the asssociation in that the association would be producing less entertainment, thus selling less, thus bringing in less $$. Why wouldn't rich franchises compromise in such a way as to ensure the max long term profits of the association. Do they see a future 8 team super league that makes more money somehow? Great stuff man, I can't wait for the rest of the series.

J
J

The Pistons wants to trade Rip Hamilton lets trade for him.Okafor is great trade bait

42
42

I was worried about your comment, hewho. I know you've got the background to jerk a knot in a natural opening of mine of your choice in this series. Keep me correct, man. Supplement or correct in a journal... I'll link it up. Otherwise, I'll march on...

42
42

The 22. It's not obvious to me which teama go where, but I'd imagine the teams profiting, of the top of my head, are: LAL, LAC, NJN, NYK, CHI, MIA, HOU, DAL. It's also not clear if the $300 is the loss of the 22 all totalled or the net loss od the NBA. My assumption is conservative for my purposeses, so I just used it to paint the picture.

Joe P
Joe P

Then who plays center for the Hornets? A definite downgrade? How does that help the team? So you have an almost washed up 2, and a much harder to fill gaping hole at the 5.

42
42

I think your assements are right on, Joe P. Joe G makes some good points, too. Besides a lawsuit from the hotel chain, the Super 8 Association would have to greatly reduce the schedule and while keeping the highest ~120 players, the best, in theory, while dispensing with the rest of the union. That's a bad combination, and the resulting entity would spiral into ruin for all. Any contraction that would shorten the schedule by much, if any, would certainly be out as both parties should oppose that, but I think the union would oppose any contraction whatsoever. I'm not sure what power the union really has in the matter other than enforcing existing contracts, though.

Joe Gerrity
Joe Gerrity

Everyone (players, owners, the league as a whole) loses big if contraction occurs. It won't, though, for a number of reasons. Namely, people are lining up to buy teams.

Joe P
Joe P

I think that is a bad idea because Rip is WAY past his prime, overpriced, and proved to be at least temporarily a bad locker room guy/teammate. And Okafor is probably a top ten starting NBA center, durable, good character, and centers are hard to find. Hornets + Rip - Okafor = Lotto.

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