Revenue Sharing: A Love Story (Chapter One)

This week's edition of Purple Row Academy focuses on a very polarizing subject around baseball circles, revenue sharing. I'll write this week about the reasons that revenue sharing was put into effect, with future sessions being devoted to the policy's effectiveness and recommendations for improvement. It's a trip back to baseball of ten years ago, when the steroids hadn't yet hit the fan but a growing imbalance in baseball's economic model threatened the league's long-term survival.

First put in play on the recommendation of the Commissioner's Blue Ribbon Panel of Baseball Economics in 2000, the practice of revenue sharing aimed to bring more competitive balance to MLB. Part of this involved every team in MLB paying 31% of their local revenues into a pot that is then distributed equally to all 30 teams (meaning that the Yankees are paying a much higher sum into the fund than anyone else).

In addition, the MLB's Central Fund, made up of revenues from sources like national TV broadcast deals, is unevenly paid out with more going to low revenue teams. Finally, MLB also implemented a Competitive Balance (or luxury) Tax against teams with excessive payrolls, and while this does not officially fall under the revenue sharing umbrella, it serves a similar purpose. Only the Yankees have ended up paying this tax in recent years.

The Revenue Sharing and Competitive Balance Tax policies, per the CBA (which runs through 2011):

Revenue Sharing
1. Net transfer of revenue sharing plan will be the same as the current plan ($326 million in 2006). Net transfer amounts will continue to grow with revenue and changes in disparity.
2. Marginal tax rates for all recipients are reduced significantly through the use of a new central fund redistribution mechanism. Rates reduced to 31% from 40% (high revenue Clubs) and 48% (low revenue Clubs) under old agreement.
3. All Clubs face the same marginal rate for first time.
4. Commissioner's Discretionary Fund will continue at $10 million per year, with cap of $3 million per Club per year.
5. Provision requiring revenue sharing recipients to spend receipts to improve on-field performance retained with modifications.

Competitive Balance Tax
1. Competitive Balance Tax structure from 2002 agreement is continued.
2. Rates will continue at 22 ½ % for Clubs over the threshold the first time, 30% for Clubs over the threshold the second time and 40% for Clubs over threshold the third time. 3. Clubs that paid 40% in 2006 will face 40% rate in 2007.
4. Thresholds reset to $148 million in 2007, $155 million in 2008, $162 million in 2009, $170 million in 2010 and $178 million in 2011.

So why was this policy necessary to implement? Three major reasons were cited by the Blue Ribbon Panel: Revenue, Payrolls, and Competitive Balance. Let's look at each aspect in detail.

Revenue

In the years leading up to the Blue Ribbon Study, the revenue disparity between the big market, high revenue teams and the low revenue teams was growing at an alarming rate. To wit, the seven teams with the highest revenue in 1999 averaged more than double the revenue of the fourteen lowest clubs.

The lowest team in average local revenues between 1995 and 1999, the then Montreal Expos, averaged only $16.332 million in revenue per season. Meanwhile, during this same period the Yankees (who admittedly were a huge outlier from every other team) averaged just over $118 million in revenue per year (that's 723% more per year). Furthermore, the Expos' annual revenue growth rate from 1995-1999 was -14.6%, compared to the Yankees' average growth rate per year of 12.7%. Even more alarmingly, in 1995 there was a 5.5:1 local revenue advantage by the Yankees over the Expos, but just five years later New York's advantage had grown to 14.7:1. In other words, the gap between the haves and have-nots in terms of revenue was growing at a dangerous rate.

The data shows that 70-80% of a MLB team's revenue comes from their local revenue streams, which are largely determined by ticket sales, concessions, and local media contracts. The problem is that economic factors like population base, per capita income, and other demographically oriented statistics largely determine a team's attendance and total revenue. Other factors were very important as well, such as having a new stadium or team, but the local market size was of the most importance.

Top Revenue Quartile (1995-1999): NYY, CLE, BAL, ATL, COL, LAD, BOS, NYM (1998-1999)

Bottom Revenue Quartile: MON, MIN, PIT, OAK, KC, MIL, DET

From 1995-1997, when there were 28 teams, there were seven teams in the top quartile, but upon expansion in 1998 to 30 teams this definition included eight teams in the top quartile. Interestingly, Colorado was part of the top quartile, placing fifth in MLB in average total revenues over the time period with about $100 million. In fact, Colorado was one of three teams (along with the Indians and the Yankees) to turn an operating profit during this time period. This was due largely its winning combination of a new, winning team and a spectacular new stadium.

Therefore, the panel argued, some teams have an inherent, unfair advantage in revenue capability simply due to their location and not necessarily from having a higher business acumen (though the possibility that these teams have more revenues because they capitalize on these advantages well is also a consideration). No matter how well the Twins manage their team, they will never compete with the Yankees in terms of local revenue. Heck, the Yankees' local revenues in 1999 exceeded by $11 million the local revenues combined of six other clubs. On a league-wide scale, the average gap between the top quartile of teams in terms of local revenue and those in the bottom quartile had grown from $48 million in 1995 to $71 million in 1999.

The correlation between these inherent revenue advantages and on-field success was readily apparent to the Blue Ribbon Panel. Because there is no salary cap in baseball and teams can spend as much (or as little) as they want on payroll, teams with higher revenue has more money to offer the best players (whether these players be free agents, the club's own players, or prospects internationally or in the Rule 4 draft) than lower revenue clubs, such that they will be able to retain the services of top players and therefore remain consistently more successful, drawing in more fans and more revenue. The Blue Ribbon Panel saw this trend and decided to take some measures to slow this growth rate.

The fact was that economic model that the league was based on had simply become outdated. The increasing gap between the haves and have-nots, based largely on inherent advantages gained from local revenue base, threatened the long-term vitality of the game.

Payrolls

As was mentioned previously, teams with higher revenue bases usually had much higher payrolls than their lower revenue brethren--and as the gap between high and low revenue teams was increasing at an alarming rate, so too was the gap in payroll expenditure growing. These facts illustrate this point:

  • In 1999, the combined payrolls of the highest two payroll clubs exceeded the combined payrolls of all clubs in the fourth revenue quartile by $30 million.

  • Baseball's highest paid player in 2000, Kevin Brown ($15.7 million) was paid more than the entire Minnesota Twins roster.

  • From 1995-1999, the payrolls of the top quartile went up on average by $32 million (70% increase) while the bottom quartile went up only $2 million (13% increase).

  • The Yankees' payroll was about equal to the sum of the league's bottom five payrolls.

  • The gap between high and low in terms of payroll grew from $45 million to $75 million over the five year period, but more tellingly, the average payroll increased from $22 million to $43 million.

  • In all, the top quartile of teams outspent the bottom quartile on major league payroll by 3.9:1 in 1999, up from 2.6:1 in 1995.

As you can see, the expanding revenue gap in MLB had similarly manifested itself in terms of payroll.

Competitive Balance

While having a higher payroll is certainly not the only determinant in winning, it was becoming an increasingly important one from 1995-1999 as the payroll gap continued to expand. While putting a high payroll team on the field did not guarantee a sterling W-L record, it certainly helped.

  • In 1999, teams in the top payroll quartile averaged 96 wins while the bottom quartile averaged 71 wins, up from 93 and 75 in 1996. The top quartile won on average 9 more games than the second highest payroll quartile from 1996-1999 (1995 was an abbreviated season).
  • The greater a payroll advantage a team had over its opponent, the greater its winning percentage against them both at home (won 60% of games when advantage was 25% or less and 68% when advantage was 250% or more) and on the road (55% to 65%).
  • No team from the bottom quartile or the second lowest quartile (half the league!) won a playoff game of any kind during this time period (only one such team even made the playoffs). There were 158 such games during this period.
  • The second highest quartile won just 24 of these 158 games, about one out of four that they played in. None of them won a World Series game (only one team, the tenth ranked Padres in 1998 even made it).
  • The World Series winners over this time period were the Braves (4th), Yankees (1st), Marlins (5th), Yankees (2nd), and Yankees (1st).

As you can see, having a payroll in the top 25% of MLB was nearly essential in both getting to the playoffs and then winning in them during this time period--and chances were that with the expanding revenue and payroll gaps that this would not be changing much in the near future. Largely as a result of these findings, MLB implemented the Revenue Sharing and Luxury Tax policies.

Next week I'll write about both the positive and negative effects (potential and actual) that this policy would have on MLB from the points of view of the small and large revenue clubs. In the future I'll explore the actual effectiveness of these policies thus far and recommend a course of action to be followed in the new decade.

Sources:

MLB Collective Bargaining Agreement

Blue Ribbon Panel Report on Baseball Economics (Richard C. Levin, George J. Marshall, Paul A. Volcker, and George F. Will)

MLB's Revenue Sharing Formula (David Jacobsen)

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