The NFL Business Model

The Economist print edition
Apr 27th 2006 | CHICAGO

In a league of it's own

America's National Football League offers a business lesson to other sports

ONE of America's most closely watched annual rituals takes place this weekend, when the 32 teams of the National Football League select their next crop of superstars in the college draft. The first few players chosen—probably starting with Reggie Bush, a running-back from the University of Southern California who is rather nimbler than his presidential namesake—will then sign multi-million-dollar deals with their new teams, and field lucrative endorsement offers. Although the draft picks get all of the attention, an arguably more important selection process is quietly taking place in the background: to find a successor for Paul Tagliabue, the NFL's commissioner since 1989, who is stepping down in July.

Although the 65-year-old Mr Tagliabue cannot run, catch or throw with any grace, he is in many ways the league's most valuable player. Whereas picking the right athlete on draft day can give a team an edge over its rivals for a few years, the skilful commissioner has helped the entire league to establish lasting dominance over competing providers of sports and entertainment. Condoleezza Rice has long said that she covets the job; but sadly for Miss Rice, she has other duties at the moment. Whoever the owners choose, however, will need a diplomat's ability to mix coercion and consensus, since the commissioner's job is to sustain one of the world's most effective cartels.

The success of the NFL syndicate stands in stark contrast to the troubles of America's three other main sports leagues: for baseball, basketball and ice hockey. Whereas the NFL's players have not walked out since 1987—before Mr Tagliabue took over—the other three leagues have all faced crippling labour strikes since the mid-1990s, the most recent of which cost the ice-hockey league an entire season last year. As a business, American football has been beating its rivals handily for years. It has the highest total revenues of the four, at nearly $6 billion a year. It has the firmest grip on its labour costs, which have grown only 9% a year since 1990, compared with 12-16% growth in the other three leagues. It remains the most popular of the four big American sports on almost every measure, from opinion polls to television ratings. And it has translated all of this into rising profits. The average football team has a market value of around 3.9 to 4.4 times revenues, compared with ratios of 2.2 to 3.0 for the other leagues.

What is the NFL's secret? Running a sports league is an awkward endeavour, since the owners must co-operate on many business decisions despite fielding teams that compete fiercely. Aside from this quirky element, however, many of the NFL's fundamentals are similar to those of successful firms in other industries: its internal incentives point in the right direction; it has had good leadership for a long time; it has been lucky; and it has followed a sensible growth strategy.

Two sets of incentives have been especially important: the teams' owners share roughly 70% of their revenues with each other; and they stick to a strict salary cap that limits the amount each team can spend on players' salaries. It is little wonder, then, that Art Modell, the former owner of a franchise that moved from Cleveland to Baltimore, once referred to NFL team owners as “32 fat-cat Republicans who vote socialist” on football. But these two policies, taken together, have done wonders for profits, by giving all 32 owners a chance to field teams that are both financially viable and athletically competitive, even though some are in much richer local markets than others. The contrast with English football's Premier League—the richest soccer league in the world—is striking. The lack of a salary cap and the fact there is little revenue sharing means that the league is dominated by the same teams, year after year, while the poorer and less successful teams lose support and flirt with bankruptcy.

But the NFL also stands out when compared with the other three big sports leagues in America. While they let teams in New York and other big cities capture giant local media markets, the NFL negotiates all of its television contracts as a single entity. Its latest contract, which will run until the end of 2011, will bring in $3.7 billion a year from several national networks, which Mr Tagliabue and the league have artfully pitted against one another.

By getting the co-operative bits right, the NFL as a whole benefits in two ways. First, its teams are far more evenly matched competitively than those in other leagues. Several teams rise and fall in the league tables from one year to the next, and every season provides many fresh examples of how any team can win on “any given Sunday”. That keeps supporters coming back, and ensures that the bulk of the games remain interesting, even in the final weeks of the season.

Second, the system lowers risk. “The NFL is a perfect portfolio,” says John Vrooman, a sports economist at Vanderbilt University, because one team's losing season and sagging revenues are offset by another team's banner year. The co-operative arrangements also make costs stable and predictable. Mr Vrooman reckons that even if another American sports league, or a big European football league, were to have similar cashflows to the NFL, the American league's teams would still be 50-60% more valuable because their business is so much less risky.

Unsurprisingly, the NFL's rivals have been trying over the past few years to imitate its winning business model. The baseball league, for example, has adopted a limited form of revenue sharing, but not enough to eliminate the gap between wealthy teams such as the New York Yankees and perennial small-town losers such as the Milwaukee Brewers. The ice-hockey league's owners, after weathering last year's strike better than the players, put in place a new contract with some salary limits and revenue sharing. But it did not go far enough, because the owners of the wealthiest teams were unwilling to compromise for the sake of the cartel.

That is where leadership and luck come in. The hockey league's commissioner, Gary Bettman, is not nearly as adept or respected as Mr Tagliabue—who deftly thrashed out a bargain recently to renew the labour and revenue-sharing system for several more years—and was thus unable to forge a better deal. The NFL is also lucky—and its athletes much less so—because it is the most violent of the four sports. Since the average player does not last more than four years as a professional, labour strikes are difficult and the union is weak.

The trouble with revenue sharing, however, is that it can encourage free-riders. Daniel Rascher, the president of Sports Economics in Berkeley, California, points out that the Cincinnati franchise was the NFL's fifth-most-profitable during the 1990s, despite winning the fewest games during the decade. The team simply skimped on avoidable costs, such as talent scouts, and raked in revenues from the rest of the league.

Although there will always be a couple of Cincinnati's, however, the NFL has managed to limit this problem by letting individual teams keep all of the revenue streams from a couple of high-growth segments, such as luxury boxes. That gives each owner an incentive to invest in a new stadium—17 have been erected or overhauled on Mr Tagliabue's watch—that is designed with profit margins in mind.

Like any good syndicate, the NFL under Mr Tagliabue has also mastered politics. Mr Vrooman points out that the league likes to leave one prominent city without a football franchise, “like an empty seat in musical chairs”, so that teams in other cities can threaten to move if they do not get their way. This invariably prompts state and local governments to contribute public money to help teams that replace old stadiums with new ones. Los Angeles residents have been scratching their heads about why the country's second-largest city has had no football team since 1994. But the NFL has made far more money from new stadiums that have been built using Los Angeles as a threat, says Mr Vrooman, than it could have made by actually putting a team there. There is a lesson in all this for Mr Tagliabue's successor: competition is nice, but if you want it to be profitable, it helps to write your own rules