Revenue Sharing Is Dead

The Pirates have been so profitable that they’ve created substantial income tax liabilities for their investors.  The Pirates’ solution to this problem has been to transfer a portion of its profits to these investors to cover their tax costs.  This is one illustration of how revenue sharing works: it serves both to create profits for teams that cannot win on the field, and to create the need for cash to be transferred outside of baseball to cover tax liabilities that exist only because of the profits created by revenue sharing.

We’ll need to parse the numbers later, but it appears that some of the teams receiving revenue sharing (in particular, the Marlins) may be more profitable than teams like the Yankees and Red Sox that fund the revenue sharing system.

Given the information disclosed in these documents, the existing system of revenue sharing will not survive next year’s expiration of baseball’s collective bargaining agreement.  This is not just my conclusion; this is the conclusion of Jayson Stark at ESPN.com.  My prediction is that the current system of revenue sharing will be cut back, scrapped altogether or replaced with a more rational system.

The reactions to the leaked documents are all over the map.  Most of the analysts I’ve read agree with me, and with Jayson Stark, and with Forbes editor Mike Ozanian: the leaked financials prove that revenue sharing does not work.  Sports economist Andrew Zimbalist said that “there’s a reason to be skeptical and cynical about what’s going on (in Pittsburgh).”  Sports Illustrated’s Joe Sheehan concludes that baseball’s revenue sharing serves to “incentivize sloth and aggressively diminish a franchise’s motivation to move upward.”

David Berri, one of the economists I cited here on Monday, put it this way: “ Teams have a choice. They can seek to maximize winning, what the Yankees do, or you can be the Pirates and make as much money as you can in your market. The Pirates aren’t trying to win.”

Ouch.

(And if you think people are upset about the Pirates, you should check out the commentary about the Marlins).

There’s another group of opinions out there, including the one expressed by Brien here.  Rob Neyer’s take seems to be that teams should not be required to spend all of their revenue sharing money.  Neyer focuses on the Pirates: he points out that it would not have helped the Pirates to use their unspent revenue sharing money to retain the established players that the team has shed over the past few years: Jason Bay, Freddy Sanchez, Nate McLouth, Xavier Nady, Damaso Marte, etc., etc.  Good point.

But the Pirates can use revenue sharing for purposes other than resigning marginally productive “established” players.  Why couldn’t the Pirates have signed more Latin American teenagers?  Or built a baseball academy in China?  Is there no use the Pirates could have made of this revenue sharing money?  If so, this state of affairs undercuts the need for revenue sharing  in the first place.  We were told that the Pirates were too poor to build a competitive team.  Instead, we’re now being told that the Pirates don’t need much money to solve their problems, or that the Pirates’ problems are ones that money cannot solve.

Another response to Rob Neyer is that baseball need only pay “poor” clubs the amount that they can productively use to improve their teams.  As we’ve reported earlier, baseball’s revenue sharing system requires recipient teams to file a plan with major league baseball detailing how they plan to use their revenue sharing money to improve the team’s performance on the field.  If the Pirates’ plan says that they only need $10 million in 2011 to fulfill their plan, then we should only pay the Pirates $10 million – not $30 million, or $40 million.  If the Pirates say they need $40 million and only spend $10 million, then we should require them to give back the other $30 million – and perhaps we should give the $30 million to a team that can productively use the money.  Instead of the Pirates using millions of revenue sharing to increase profits and create (and then pay off) investor tax liabilities, why not transfer the money to the Brewers so they can resign Prince Fielder?  Or to the Rays so they can resign Carl Crawford?

Baseball Prospectus’ Shawn Hoffman argues that not all teams have abused the revenue sharing system.  Good point.  Then the teams that successfully use revenue sharing to improve on-the-field performance should be the only teams to receive revenue sharing.  Unfortunately, the current system works in the opposite way: it encourages teams to underperform, as the worst performers are the biggest recipients of revenue sharing.

My preferred alternative is to eliminate the requirement for teams to use revenue sharing solely to improve the ballclub.  This requirement is unenforceable.  I personally favor a revenue sharing system based solely on the potential of each team’s local market.  The Yankees live and thrive in baseball’s biggest market; why not have the Yankees pay something for the semi-exclusive right to this market?  Yes, yes, I know: we can argue on how to measure market size, and we have to deal somehow with the guys who recently paid a premium to buy a team in a big market.  These are serious problems, to be sure.  But they’re child’s play compared to trying to figure out how to force a crummy team to effectively spend millions of dollars to become a championship team.  Hell, if the Mets cannot figure out a way to do it, why should we expect the Pirates to do any better?

OK, maybe you don’t like my proposed system, but that doesn’t mean that we should retain the existing system.  It’s silly and stupid to have a revenue sharing system that is based on the supposed inability of certain teams to afford to be competitive, that then allows these teams to keep the money it claims it cannot spend productively.  This system is like a charity that appeals to us for millions of dollars for disaster relief, and then decides  that disaster relief is a bad idea.  In real life we’d require the charity to return the money, and we wouldn’t make further contributions to the charity.  Only in baseball do we allow teams to (1) beg for charity, (2) decide that they don’t need the charity, (3) line their pockets with the charity and (4) beg for more charity.

The current system is a sham.  The sham has been exposed.  The sham will not survive.  Not in its current form.

I will do my level best to post further analysis of the leaked financial statements in subsequent posts.

16 thoughts on “Revenue Sharing Is Dead

  1. jon

    Thanks.  You put it in words short enough I can understand.  I get Monty Python.

  2. kip

    Yankees taxed just for being profitable, what an injustice.

  3. Interesting argument, Larry.  I’m somewhere between you and Brien.  I don’t think the recent revelations tell us anything we didn’t already know.  They cast what we knew in starker terms perhaps (no pun intended) but I experienced no eureka moment.

    But I think your suggestions for how to improve revenue sharing are fantastic.  It’s just that these leaks aren’t what got me there.  Unlike Brien, I think there’s some truth to the notion that SOME teams aren’t trying to win, and that the Pirates are one such team.  But I also think there are other small market teams that are trying and failing.  And does anyone dispute that Tampa Bay’s success is surprising for a _reason_?

    Baseball’s finances are a spectrum (which is why Joe Posnanski overstates his case here when he says that “one team (and only one team” is playing on “cheat mode”: http://sportsillustrated.cnn.com/2009/writers/joe_posnanski/11/05/yankees.payroll/index.html ), with some teams inside the competitive range of the spectrum and some teams out of it.  And I’m still waiting to hear the idea that will genuinely lift the teams at the bottom of the spectrum.

  4. Glenn G.

    Keep.Them.Coming.

    I love reading all the stories on how these teams are doing everything they can to cheat, but then blaming the Yankees for doing everything they can to win.

  5. I’ll add more when I get a chance in a bit, ut for now I recommend this:
     
    http://www.slate.com/id/2265068/pagenum/all/

  6. KeithinIowa

    I am one that has always believed, if the team can’t make it, then they should move or fold.  It is not a right to have a team in your city.  To me less teams equals more talent, even for the smaller market teams.  I would rather see 20 teams with each having a good product on the field, than 30 teams with some of them being no more than AAA teams.  This stealing from teams that make money is crazy.  But it is a microcosm of society in America as a whole.

  7. Brian

    One idea that to fix this issue to me could be a rule mandating that a team’s payroll must be at least say 80% of what they receive from revenue sharing, this way you ensure that a team that is receiving a large portion of the revenue is at least spending the money on the team. The only other option I see is to institute a salary floor similar to what the NHL has, but I only see that happening if MLB decided to institute a salary cap as well

  8. Keith, I might get behind you on that…when large market teams give up their territorial rights. Until then, I don’t think that’s a realistic or coherent expectation.
     
    Brian, the problem with that is two-fold. One is scale. We’re not talking about a team that can spend $100 million but isn’t, at most we’re talking about them getting into the $60 million range. To that end, where are they supposed to put the money? Jose Guillen and Gil Meche? That’s not working very well for Kansas City. Are they supposed to overpay for Matt Capps in arbitration? Give more money than they have to to pre-arb players? Again, I don’t see how spending money just to spend it is going to help them.
     
    I think everyone agrees that the Marlins are just pocketing the cash and not trying to do much. But Pittsburgh just spent a (relative) ton on the draft, they’re opening up a new facility in the Dominican Republic, and I think I read somewhere that they’re making significant improvements to their minor league training facilities. Those are legitimate places for a re-building team to spend money, and that’s the only way Pittsburgh is going to regain competitiveness.

  9. Rob in

    I really don’t see what the Pirates have done wrong (financially, lately).  The Marlins you can argue, sure (though they’ve at least won a WS recently).  But the Pirates?  They’re investing in their farm system and have ceased blowing money on crappy FAs.  That’s intelligent.  They may finally manage to do something other than suck if they keep that up. 

    Either you have revenue sharing (and lots of it) or you do away with the territorial rights that prevent more teams from moving into big markets.  Since the latter appears to be completely off the table, we’re stuck with the (inferior, IMO) former option. 

    Forcing teams to spend on their major-league rosters is a recipe for disaster (or perpetual mediocrity).  You have to allow for a cycle, wherein a team spends $ to augment a good core built from within and then later tears it down and saves up for the next run, while investing in its farm all the way through.

  10. Rob in CT

    Silly me for skimming.  My bad.  This:

    “I personally favor a revenue sharing system based solely on the potential of each team’s local market.”

    Is indeed a good idea, though the measurement of “market potential” is a devilish detail.  Boston, for instance, is a great example.  Boston itself – not a huge market.  All of New England (plus a certain amount of national following – which they earned)?  That’s a pretty sweet market.

    Also, the Mets… they are kinda laughable and all, but they did start out with a serious disadvantage.  They were the expansion team.  The Yankees had been around for ~60 years already and put down serious roots.  What do you figure the Mets chances were of really splitting the NY market evenly with the Yankees (long-term, not just for a year or two if the Yankees were awful)?  Should there be a modifier for that?

    If I could be convinced that there was a good way to measure market potential, I’d be excited about your idea.

  11. Larry@IIATMS

    Jon, I think you have to be pretty smart to get Monty Python.
     
    Kip, the Yankees are not being “taxed” for being “profitable”.  Revenue sharing is based on a team’s gross revenues, not net profits.
     
    Matthew, the recent revelations tell us a lot we did not know (see for example Maury Brown’s excellent piece today at Biz of Baseball on the Rays, http://bit.ly/dyvKKG).  I have not dived too deep into the financial statements, but there are gems hidden there — for example, it looks like the Mariners are able to exploit their huge geographical exclusive radio-TV territory to make a lot more in local broadcast revenues than anyone would have suspected.  The leaked data also allows us to confirm much of what we’ve previously suspected.  Interestingly, if you read the Jayson Stark piece I cited, it appears that many baseball teams did not know how much teams like the Marlins were receiving in revenue sharing, or the size of the team’s profits. Thanks for the nice words about my ideas for improving revenue sharing.  These ideas are works in process, and need improving.
     
    Glenn, agreed.  I see a lot more people defending the Pirates’ right to lose games and retain profits than I ever saw defending the Yankees’ right to win games and spend money.
     
    Brien, great cite to the Slate article!  I agree with much of it, though much of the math is fuzzy.  The point remains: if the Pirates cannot use all of the revenue sharing money it receives to improve the ballclub, then they should return the unused portion.
     
    Brian, I tend to agree with Brien that forcing clubs to increase payroll is not the best way to get the clubs to improve.  As for salary caps and salary floors … I’ve said a lot on this site already on those subjects.
     
    Brien, your argument seems to be that revenue sharing would work if we could only increase the numbers.  The argument is that the Pirates cannot do much with only $40 million in annual revenue sharing, but if we could increase that number to $80 million or $100 million, then we’d be talking REAL money.  I’m not sure that’s right — to use your examples, they might just end up with that many more Gil Meches and Jose Guillens on the roster.  Or the Pirates just might add that much more money to their bottom line.  In any event, there’s no realistic possibility of increasing the revenue sharing pool at this point.
     
    Keith, baseball is a collective of 30 teams, 30 individual businesses, that try in certain ways to cooperate for the good of all.  It helps baseball if its market is truly national, and this may require baseball to expand into a number of marginal local markets.  If MLB’s presence in Pittsburgh helps drive national TV ratings and national sales of Derek Jeter jerseys, then it may be good to keep baseball in Pittsburgh even if the individual Pittsburgh franchise needs to be subsidized.
     
    Rob, I’ll get to your comments in a bit, they’re good ones!

  12. “The point remains: if the Pirates cannot use all of the revenue sharing money it receives to improve the ballclub, then they should return the unused portion.”
     
    Well, how many people spend every dime of their paycheck before they get their next paycheck just  for the sake of spending it as opposed to putting it in the bank and spending it at the best time? Which is a better idea?
     
    “Brien, your argument seems to be that revenue sharing would work if we could only increase the numbers.  The argument is that the Pirates cannot do much with only $40 million in annual revenue sharing, but if we could increase that number to $80 million or $100 million, then we’d be talking REAL money.”
     
    Well, I guess you could go that route, but that’s not really what I meant. My point was simply that the Pirates aren’t going to expand to a mid-level payroll anytime soon, and even if they could it would be inefficient for them. I mean, could Pittsburgh offer Cliff Lee a megadeal this year? Maybe, but how many wins would that add for them? Would Lee, or any other top tier free agent, even want to accept a deal from them?
     
    The Pirates are going to have to build through young talent, and because of the rules that means cheap talent. It doesn’t mean they couldn’t spend more, but that’s not necessarily their fault either, unless you think they should just throw extra money to pre-arb players for the hell of it or something.
     

  13. Larry@IIATMS

    Rob, no question that it will be difficult to measure market potential.  You have the Boston issue, which is that some teams have great regional appeal, and some markets are more enthusiastic about baseball than others.  You have the problem that baseball allocates exclusive media rights in strange ways — some teams share territories, other teams control vast exclusive territories.  You have the Yankees/Mets problem, the question of whether two teams in the same market really share that market 50-50.  Also, we have to consider whether we really want a plan that will pay sums to the Pirates regardless of results.  What if the Pirates become successful and build a stronger local market?  Or what if they DON’T get any better?  There’s still a lot to think about.
     
    Brien, no one has suggested so far that the Pirates’ plan was to save up as much revenue sharing money as possible until a later date when they’d spend their retained earnings pursuant to some plan.  The argument made by you, and Rob Neyer, and others, has simply been that the Pirates could not efficiently spend $40 million annually to improve their team, and my argument back is that the Pirates should then receive only that amount that it plans to spend in accordance with the terms of the collective bargaining agreement.  The problem with paying the Pirates more than they currently need is that the Pirates end up with taxable income created as a result of revenue sharing.  Because the Pirates are (or at least appear to be) taxed as a partnership, the Pirates’ tax liability is passed on to the Pirates’ partners … and of course these partners then want to receive cash distributions from the Pirates to cover the tax liability.  So the ultimate result of paying the Pirates more than they need to improve the team is that some portion of this money ends up with Uncle Sam instead of in some Pirates’ reserve fund for team improvements.  (By the way, partnership taxation is NOT intuitive or easy to understand.  If the Pirates’ tax situation is not clear, then someone speak up, and I’ll explain it more carefully.)
     
    I think the remainder of your comment highlights a critical flaw in the current system of revenue sharing.  The current system offers the biggest payments to teams that have the lowest revenues, and then cuts back on these payments as a team starts to succeed and build revenues.  But the problem is as you’ve stated.  A team like the Pirates does not need big bucks when it’s hit bottom — it needs just enough to sign and develop good young players.  However, if the Pirates start to succeed with these young players, then they’ll hit the problem currently being encountered by the Rays: revenue starts to grow, but not as fast as the team’s payroll.  Arguably, a team like the Rays needs more revenue sharing money than a team like the Pirates.  Unfortunately, the Rays’ share of revenue sharing is shrinking, not growing, as the revenue sharing system (unfortunately) punishes success and rewards failure.
     
    One possible way to design a revenue sharing system is to funnel cash to teams in accordance with a long-range model for sustainable success.  This model might be the one you’re suggesting: small payments to teams like the Pirates, larger payments to teams like the Rays.

  14. I think the revenue sharing model should be based primarily on market potential, with some modifiers based on the team’s national presence, media contracts, etc.

  15. Larry@IIATMS

    Brien, based on your last post, we’re thinking along the same lines.  Bummer.  I was HOPING for an argument!

  16. I don’t really think we’re that far apart. I’m a philosophical proponent of revenue sharing, but that doesn’t mean I think the formula they use is perfect. I just don’t think the Pirates are doing anything wrong, or even that revenue sharing shouldn’t, in part, go to keeping small market teams profitable. On the one hand, that’s in the long term interests of the big market teams. On the other hand, that’s the price they pay for territorial rights to the big markets. But sure, the formula could work better.

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