The Economist: Big Business
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Dr. M. Ray PerrymanJanuary 23, 2013 | 2,668 views | 1 comment
Are professional athletes overpaid? Most people have an opinion about this, sparked by dollar amounts in the headlines when top players sign big deals. If you answered, “Yes!,” your logic may run something like this: how can a person playing a game for a few months a year possibly be worth tens of millions? It’s not as if they’re performing brain surgery or curing the common cold or finding a way to stop climate change. However, the fact is that market forces are alive and well in the arena of professional sports, and athletes are paid precisely what they’re worth (or at least what they’re perceived to be worth given limited information and the impossibility of seeing the future).
The changes in the business of sports were brought home to me recently with the death of Stan Musial, legendary player for the St. Louis Cardinals and my primary boyhood hero, at the age of 92. Stan the Man’s heyday was the post-war era of the late 1940s and 1950s, and he was one of the truly elite who made $100,000 per year. He retired after the 1963 season, but remained active with the Cardinals organization for decades. A genuinely good guy, Musial symbolized the era of radio baseball (in fact, my first awareness of him came from the booming KMOX station in the years immediately before Major League baseball came to Texas). The contrast between professional sports in his day and now is striking in many ways; one of the most profound is the money involved.
Even if you adjust for inflation, salaries for professional athletes are much higher today than they were decades ago. About 25 years ago, for example, a major league baseball player had to make $2 million in salary to make the list of 10 highest-paid players (according to a nifty database maintained by USA Today). Last year, making the top 10 required $21 million. By way of another perspective, Babe Ruth’s $80,000 in 1930 equates to about $1 million now. Clearly, things have changed in a big way.
However, the large salaries are not without basis. Contract negotiations follow basic economic principles, with supply and demand determining price. In terms of the supply, how many people in the world can hit a baseball coming at them at 95 miles per hour, throw such a pitch, run bases at those speeds, and have that special something that makes them a great player? Few, as any kid on a playground, student on a school field, or college baseball player on a diamond will tell you. The incentives to play professional sports are huge (money and fame just to name two), and millions would love to do so. Obviously, however, the precise combination of genetics and opportunities needed for success is exceedingly rare. In other words, the supply of potential major leaguers is very, very small.
On the other side of the equation is demand, which in this context is the willingness (and ability) of teams to pay the huge salaries. The decision process is purely economics, with salary ranges directly linked to the money the team hopes to make off of the player’s talent. In fact, disputes are often settled in arbitrations by examining “comparables” in much the same way one values a house or a business. As I write this column, rumor has it that Time Warner Cable is going to pay the Dodgers about $7 billion for rights to broadcast Los Angeles Dodgers games over the next two decades. The Dodgers, not coincidentally, have one of the highest salary rates in baseball.
Time Warner, of course, views this as a business deal based on likely money made from advertising, subscriptions, and payments from other companies (such as the satellite TV people) to broadcast. Of course, the numbers of people signing up and watching is linked to the quality of the team; the better the players and results, the bigger the revenue for Time Warner.
In all professional sports, ticket sales, merchandising, sponsorships, naming rights, and other transactions depend on the popularity of the team. While a portion of the fan base is of a “die hard” nature and will support the team whether winning or losing, there’s another segment that will follow success.
When the team sits at the bargaining table, you can bet they have analyzed the potential contributions of a player every way you can imagine. The money they offer to pay is no more than the amount they expect to receive back (and then some). In other words, the player is paid only what they are worth to the team.
Looking down a list of the value of professional sports teams (put together by Forbes) lets you know that many teams are doing this very well. The top two are soccer teams (Manchester United and Real Madrid), which both have huge sponsorships for team jerseys, practice jerseys, and merchandise. The third place is a tie: the New York Yankees and the Dallas Cowboys, both viewed to be worth an estimated $1.85 billion. The Cowboys make a fortune from their stadium ($100 million for premium seating and almost $60 million from sponsors each year), not to mention TV deals and merchandising.
And, of course, it is important to note that these deals are ultimately driven by fans. As long as stadiums sell out, ticket prices will stay high. As long as people demand to watch the Dodgers, networks and cable companies will find a way to show them. These professional athletes may not be solving weighty world problems, but they are certainly fun to watch. As long as we keep watching and buying, their salaries will keep rising.
I must admit a certain longing for the days when Stan Musial always played for the Cardinals and there were no free agents, strikes, or bidding wars. We all should miss an unassuming humanitarian who lived more than 70 of his 92 years in the public eye without a hint of scandal. As a matter of economics, however, the modern era reflects the market working at its finest.
Dr. M. Ray Perryman is President and Chief Executive Officer of The Perryman Group (www.perrymangroup.com). He also serves as Institute Distinguished Professor of Economic Theory and Method at the International Institute for Advanced Studies.