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Sunk Costs, Market Structure and Football Clubs

January 19, 2017 Leave a comment

Over the holidays I read Stefan Szymanski’s book “Money and Football – A Soccernomics Guide”. Szymanski also co-authored “Soccernomics” with Simon Kuper. There were various references to economic theory through the book which I will refer to on this blog.

Market Dominance

Dominance in a market is often associated with the lack of competition whether it be due to monopoly power, predatory pricing, the scale of investment etc. However this is not the case when it comes to football. Szymanski mentions the fact that there are 27 professional teams withn a 50 mile radius of Manchester Utd. If fans don’t like United, there are plenty of alternatives as there are in Madrid which has 5 professional clubs. In some countries football rivals play in the same stadium:

  • In Germany: Bayern Munich and TSV 1860 Munich,
  • In Italy: Inter Milan and AC Milan,
  • In Switzerland: FC Zurich and FC Grasshopper
  • In Brazil: Botafogo, Flamengo and Fluminense

Football Clubs.jpgDominance in markets usually occurs because of the initial investment required to compete in the first place – set-up costs. If you look at the railway industry (which could be said to be a natural monopoly) the cost of putting down new train tracks by the existing ones or a new line would be excessive and the ability to cover these costs would very difficult. Any benefit that may arise from competition would be diminished by the cost of duplication.

Dominance is easy to explain if there are very large set-up costs, which, once spent, cannot be recovered other than by operating in the industry. Economist refers to these costs as Sunk Costs.

Dominance in a market can also occur in markets where there are less sunk costs. Take for instance the soft drinks industry as an example. It remains relatively inexpensive to set-up a production plant to bottle soft drinks but Coca-Cola dominates the world market with 42% market share, followed by Pepsi with 28%. Their dominance is through advertising which makes up the majority of the sunk costs. Advertising is an example of ‘endogenous’ sunk costs which are determined by the firm as opposed to ‘exogenous’ sunk costs which are determined by technological requirements.
Premier League Players.jpgIn professional football the focus is on player investment rather than advertising, where the big clubs are those that spend heavily on players and win league championships. Teams that win are more likely to attract a larger fan base and greater revenue. Szymanski states that the big difference between football and soft drinks is that the pattern of dominance looks the same in small markets. For instance clubs in the English Division 2 (Division 4 in the old days) still stay in existence mainly because they operate in a different market than the Premiership teams. Of the 88 clubs in the English Football League in 1923, 85 still exist, and most of them still play in the 4 English Divisions. Also those clubs in the lower Division do benefit from intense local loyalty especially through tough times with performance. When clubs get relegated to the Championship from the Premier League, although they lose revenue from TV rights their fan base remains fairly constant. However a lot of these clubs will find it hard breaking into the dominant group – Manchester City, Manchester Utd, Liverpool, Arsenal, Chelsea, Spurs – unless they receive significant funding from an investor who doesn’t expect to see a financial return or have an exceptional season without high profile players like Leicester City who won the Premiership in 2015/16.

Unlike most business in which loss-making firms shut down or merge into other businesses, football clubs almost always survive. This does not prevent dominance, but unlike most industries, it does mean that the pattern of dominance tends to look the same everywhere. Source: Szymanski

Economics – Holiday Reading.

December 23, 2016 Leave a comment

I will be disappearing for a couple of weeks to the beach where there is no internet access. Therefore here are some books that might be worthwhile reading over the festive season – reviews are from amazon.com. I will be back again on 10th January – have a great xmas and new year.

makers-and-takersMakers and Takers: The Rise of Finance and the Fall of American Business by Rana Foroohar

Eight years on from the biggest market meltdown since the Great Depression, the key lessons of the crisis of 2008 still remain unlearned—and our financial system is just as vulnerable as ever. Many of us know that our government failed to fix the banking system after the subprime mortgage crisis. But what few of us realize is how the misguided financial practices and philosophies that nearly toppled the global financial system have come to infiltrate ALL American businesses, putting us on a collision course for another cataclysmic meltdown.

 

 

Circus Maximus: The Economic Gamble Behind Hosting the Olympics and the World Cup by Andrew Zimbalist

Circus Maximus.jpgThe numbers are staggering: China spent $40 billion to host the 2008 Summer Olympic Games in Beijing and Russia spent $50 billion for the 2014 Sochi Winter Games. Brazil’s total expenditures are thought to have been as much as $20 billion for the World Cup this summer and Qatar, which will be the site of the 2022 World Cup, is estimating that it will spend $200 billion. How did we get here? And is it worth it? Both the Olympics and the World Cup are touted as major economic boons for the countries that host them, and the competition is fierce to win hosting rights. Developing countries especially see the events as a chance to stand in the world’s spotlight. This book is also reviewed here by Michael Cameron on his blog Sex, Drugs and Economics.

 

 

Global Inequality: A New Approach for the Age of Globalization by Branko Milanovic

Global Inequality.jpgThis is a scholarly book about global inequality, that is, ‘income inequality among citizens of the world’. It is, as Milanovic explains, ‘the sum of all national inequalities plus the sum of all gaps in mean incomes among countries’.

In his study, Milanovic focusses on the Kuznets hypothesis – that in industrialized countries, inequality will initially increase and then decrease, resulting in an inverted U-shaped curve. In recent times, inequality seems to be rising when all the factors indicate that it should have followed the Kuznets curve. Milanovic explains why the projected pattern did not materialise. One can point to ‘the hollowing of the middle class and the rising political importance of the rich’, but there are other factors. Milanovic explains the phenomenon through the historical data of the Kuznets curve in countries across the world.

This is a learned, but dry and technical treatise on a subject that seems to evade comprehension even by renowned economists and political scientists. That is not to say that Milanovic is a boring writer. This book will be appealing to economic and political science students, but the general reader may find Milanovic’s 2011 book, ‘The Haves and the Have-nots’ more interesting and palatable.

Categories: Financial Markets, Inequality, Sport Tags:

Ireland’s first win against the All Blacks – Positive Externalities and loads of Consumer Surplus

November 7, 2016 Leave a comment

ire-v-abs-chicagoYou maybe aware that the rugby game yesterday morning (NZ time) between Ireland and the New Zealand All Blacks in Chicago created history. It was the first time that Ireland have beaten the All Blacks – the closest they got previously was 10-10 in 1973 at Landsdowne Road (the first International that I ever attended).

Irish supporters, including myself, will take great pleasure in talking about such a result – lets face it we lost it in the last few minutes 3 years ago at Croke Park in Dublin. What all this alludes to is the fact that as part of this entertainment comes without the public paying for it, the public benefits from an externality.

Those who flew to Chicago to support Ireland and went to the game will have no doubt spent a significant amount of US dollars tonight in the bars around town. Nevertheless the satisfaction (utility) derived in US$ from the game would have been much greater than the price they paid for the ticket. This suggest that there is a lot of consumer surplus present – the difference between the price that a consumer WOULD BE WILLING TO PAY, and the price that he or she actually HAS TO PAY. The success of the Irish team will boost merchandise sales and interest for the next Test in Dublin but also has been good for rugby in general. When the All Blacks play overseas there are significant externalities whether it be the revenue generated in hosting the match or the social benefits to society. Furthermore the lead up to the game brings about a sense of delayed gratification (Behavioural Economics). The fact that people have paid for their ticket with the game in two weeks time means that they can reap the pleasures of anticipation of being at the game in Dublin. Research (Smarter Spending – see previous post) shows that owning material things from expensive homes to luxurious cars turn out to provide less pleasure than holidays, concerts or even witnessing Ireland beating the All Blacks. With Ireland’s win national pride increases, along with patriotism and people feeling better about themselves. This is turn brings people together and boosts well-being of the nation especially with the current unstable political environment and evidence that the economic recovery is starting to fade – the challenges of Brexit and recent industrial relations.

One wonders what will happen in two weeks time in Dublin but no doubt there will be externalities.

Football salaries – superstar and tournament effects.

August 22, 2016 1 comment

Amongst the extensive coverage of the Olympic Games from Rio, the start of the Football season in Europe has slipped under the radar. Michael Cameron’s blog post on footballer salaries was timely and in particular his discussion around the difference between the superstar and tournament effects.

Superstar effects – this is where a player is rewarded with a higher salary than his/her team mates for generating higher revenues for their club.

Tournament effects – this is the situation where wage differences are based NOT on marginal productivity but instead upon relative differences between the individuals. Ultimately each player only needs to be a little bit better than the second best player in order to ‘win’ the tournament.

Michael Cameron looks at the salaries of Ronaldo and Messi and states that it is unlikely that either of these players would generate more than twice as much value as the others on the graph below. Therefore the difference in salaries must be generated by something other than just superstar effects; that is, tournament effects.

Football Earnings 2

In contrast, the difference in average salaries in England between Premier League footballers (£1.7 million) and League Two footballers (£40,350) is likely to be a mix of superstar effects (Premier League footballers generate more value for their employers than League Two footballers) and tournament effects (there’s a limited number of places for Premier League footballers, so slightly worse players end up in lower divisions paying less). See graph below.

EPL wages.jpg

One last point: It’s been argued (I saw this argument first in Tim Harford’s book The Logic of Life) that the size of the ‘prize’ for a tournament will be larger the more luck is involved. That is, if the difference between the tournament ‘winner’ and the others is mostly luck, the size of the bonus for working hard to win the tournament must be high in order to sufficiently incentivise the worker to work hard. So, if you buy that the difference in the graph above is mostly a tournament effect, does that mean that the earnings difference between Ronaldo and Messi at the top, and Neymar in third, is mostly down to luck?

Source: Michael Cameron

Wages and performance in the English Premier League

May 7, 2016 Leave a comment

With Leicester City being crowned as EPL champions it was only time before someone in the media produced data showing the correlation between a club’s wage bill and their final position in the EPL. What is so extraordinary about Leicester’s feat what that it wasn’t a one off victory in the FA Cup or something similar but a competition that involved 38 games in the season. With Leicester just surviving relegation last year the odds on them winning the EPL were 5,000 to 1. What is so unique about their feat is that since the 1995-96 season the champion side has spent 225% more on player salaries as the median team. Arsenal, Chelsea, Manchester Utd and Liverpool have paid the highest wages to its squad of players and finished in the top four positions in the EPL 80% of the time. The total cost of Leicester’s regular team (£25m, or $36m) this season was less than a quarter of what Manchester United spent on new players last summer. Furthermore, if you look at Leicester City’s wage bill this year it is 75% of the league median which makes them, after Newcastle Utd in 2001-02, to break into the top four with a below-median wage bill.

Temporary Situation

However, Leicester’s success means that affluent clubs will spend even more money on sports science, video analysis and get the best people to work in these departments. No doubt that this will move the transfer market towards ‘perfect competition’ as information will flow more easily and clubs will not be able to benefit like Leicester in picking up players whose value has been underpriced. Therefore an advantage by one club will lead to only a temporary advantage until other clubs catch up. Consequently things will return to normal as talent will be distributed to those who can pay the most.

Click here to go to The Economist website to access their interactive image.

EPL Wages and Position

Categories: Sport Tags: ,

Pay Ghanaian Police higher salaries and there will be less corruption? Yeah right!

March 5, 2016 1 comment

I came across an interesting paper on the impact of higher salaries on corruption – “Does Raising Police Salaries Lower Petty Corruption? A Policy Experiment on West African Highways by Jeremy Foltz and Kweku Opoku-Agyemang. Ghana Road Network

The research focused on West Africa’s highways where the police were given higher salaries in the hope that this would lead to the end of corruption, inefficiency and bribery by the Ghanian police. However what actually transpired was that it actually energised police efforts to collect bribes rather than decrease petty corruption.

The data was collected using lorry drivers on the roads of Ghana and Burkina Faso. Drivers with all the correct papers were asked to record how many times they were stopped and how much money they paid to police and customs officials along the route – see map. On examining the data of 2,100 long-haul journeys they found that raised salaries for Ghanaian police officers and caused them to increase the effort they put forth to get bribes by 19%, the value of bribes taken at each individual stop by between 25-28%, and increases the total amount taken on the road, even while the reduce the number of times they receive a bribe. Therefore Higher Salary = Greater Corruption.

Economic theory suggests that the opposite should have happened for the following reasons:

  • Corruption involves risk and if you earn a larger salary the loss is much greater
  • Officials are thought to have income targets and they will only behave in corrupt manner to make up for the difference.

Why are the officials more corrupt when they get a pay rise?

  • The researchers suggest that corrupt superiors or greedy family members demanded more money from the officers.
  • Getting a pay rise might have boosted the self-importance of the police and therefore they felt they could demand more money at checkpoints etc.
  • The risk of getting caught is very low

The Economist makes a good point by saying “in Ghana some are astonished that anybody could have believed that higher pay would have made cops less greedy. That is just not human nature.”

 

Categories: Sport

Football Revenues 2016 – EPL teams dominate.

February 1, 2016 Leave a comment

Football Rev - 2015Real Madrid topped Deloitte’s money league for the 11th successive year with $577m.  The combined revenue of the top 20 teams rose by 8% – $7.16bn – from 2013/4 season.

“There are a number of metrics, both financial and non-financial, that can be used to compare clubs including attendance, worldwide fan base, broadcast audience and on-pitch success. In the money league we focus on clubs’ ability to generate revenue from matchday (including ticket and corporate hospitality sales), broadcast rights (including distributions from participation in domestic leagues, cups and European club competitions) and commercial sources (including sponsorship, merchandising, stadium tours and other commercial operations), and rank them on that basis.” Deloitte Football Money League 2016

Barcelona’s achievements in the 2014-15 season have translated to financial success. The European champions have jumped ahead of Manchester Utd, with revenue of $560.8 as compared to $519.5.

However Deloittee predict that Manchester Utd will be making a big push for the top spot next year for the following reasons:

  • £75m kit deal with Adidas
  • £47 million-per-year shirt sponsorship deal with Chevrolet
  • £5.1bn television deal starting in 2016-17 season

The wealth of the English Premier League, mainly due to TV rights, means that 17 of the wealthiest 30 clubs are from the EPL. West Ham Utd sneak in at 20th place but Deloitte noted the success of English clubs was due to two reasons:

  • the relative equality of distribution rights in the English Premier League
  • the performance of the pound against the euro.

Paris St Germain and Bayern Munich who dominate their domestic tournaments are 4th and 5th respectively but to find an Italian club you have to go down to 10th place with Juventus the Serie A winners last season. AC Milan a regular in the top 10 have now dropped down to 14th place.

Categories: Sport Tags:
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