E C O N O M I C G O A L S I N S P O R T S
Internalizing Incentives for Competitive Balance in Sports Through the Sale of Broadcasting Rights
i s a b e l wa g n e r (11088982)
Master of Science in Economics
Industrial Organization, Regulation & Competition Policy Universiteit van Amsterdam
Isabel Wagner: Economic Goals in Sports, Internalizing Incentives for Competitive Balance in Sports Through the Sale of Broadcasting Rights, © August 2017
S TAT E M E N T O F O R I G I N A L I T Y
This document is written by Student Isabel Wagner who declares to take full responsibility for the contents of this document.
I declare that the text and the work presented in this document is original and that no sources other than those mentioned in the text and its references have been used in creating it.
The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.
A B S T R A C T
The interest in professional team sports is driven by competitive ance between the teams in a league. To uphold this competitive bal-ance, teams and leagues are often allowed exemptions from compe-tition law in order to be able to reallocate resources among them. Examples for this can be profit sharing between the teams or a collec-tive bargaining for TV broadcasting rights. The reasoning is that only through these measures certain teams can be prevented from becom-ing too dominant.
In this thesis we want to show that by applying the logic that the interest is driven by competitive balance, this should also account for the demand of TV broadcasting rights making these exemptions un-necessary. The revenues from selling TV rights nowadays constitute the main source of income for the teams. If teams realize this and behave as profit maximizers they should have an intrinsic incentive to care about competitive balance in their own league. If that is the case exemption from competition and antitrust law are unnecessary and communication between the teams should be seen critically and skeptically as it might be under the pretense of creating more com-petitive balance but constitute a cartel activity nonetheless that could harm consumers or other market participants.
C O N T E N T S List of Figures ix 1 i n t r o d u c t i o n 1 1.1 Motivation 1 1.2 Research Question 2 1.3 Methodology 3 1.4 Structure 5 2 l i t e r at u r e r e v i e w 7
2.1 Competitive Balance and Owner Objectives 7
2.2 Profit Sharing and Other Measures 8
2.3 Platforms (Multi-Sided Markets) 8
3 d e s c r i p t i o n o f t h e s p o r t s i n d u s t r y 11
3.1 The Industry of Professional Team Sports 11
3.2 Agents in the Industry 13
4 t h e n o t i o n o f c o m p e t i t i v e b a l a n c e 19
4.1 Why We Need Competitive Balance 19
4.2 Measures to Enforce Competitive Balance 20
4.3 Pros of Measures 21
4.4 Cons of Measures 22
4.5 Invariance Proposition 22
5 a p p l i c a b i l i t y o f c o m p e t i t i o n l aw t o s p o r t s 25
5.1 The United States 25
5.2 The European Union 26
6 f o u n d at i o na l e c o n o m i c t h e o r y 29
6.1 Platform Theory/ Multi-Sided Markets 29
6.2 Externalities 30
6.3 Hotelling’s Linear City Model 31
7 m o d e l s t r u c t u r e a n d a s s u m p t i o n s 33
7.1 The General Idea 33
7.2 Teams 34
7.3 Players 34
7.4 Fans 35
7.5 Broadcasters 35
8 m o d e l o f p l at f o r m c o m p e t i t i o n 37
8.1 Stage 2: Competition for Fans 37
8.2 Stage 1: Competition for Players 39
8.3 Best Response Functions 41
9 e q u i l i b r i u m a na ly s i s o f b e s t r e s p o n s e f u n c t i o n s 43
9.1 Analytic Approach 43
9.2 Graphic Approach 48
9.3 Conclusion/ Welfare Analysis 53
10 p o l i c y r e c o m m e n d at i o n s 57
viii c o n t e n t s 11 c o n c l u s i o n 61 11.1 Summary Results 61 11.2 Summary Implications 61 11.3 Appendix announcements 62 11.4 Shortcomings 62 a a p p e n d i x 65
a.1 Issues in the Original Paper 65
L I S T O F F I G U R E S
Figure 1 Best response functions of sA1, sB1 for t = 1,
b = 1and k = 0 51
Figure 2 Best response functions of sA1, sB1 for t = 1,
b = 1and k = 0.5 51
Figure 3 Best response functions of sA1, sB1 for t = 1,
b = 1and k = 1 51
Figure 4 Values of v and sA1B1for t = 1 and b = 1 54
Figure 5 Values of v and sA1B1for t = 3 and b = 5 54
Figure 6 Values of v and sA1B1for t = 5 and b = 3 54
Figure 7 Values of v and sA2B2for t = 1 and b = 1 69
Figure 8 Values of v and sA2B2for t = 3 and b = 5 69
Figure 9 Values of v and sA2B2for t = 5 and b = 3 69
1
I N T R O D U C T I O N1.1 m o t i vat i o n
Competitive balance between teams is seen as the driver behind the interest in professional sports (see for example Vrooman(2009) and Szymanski and Késenne(2004)). The unpredictability of the outcome
of games is what makes it exciting for fans and thus lucrative for broadcasting stations and sponsors. Teams on the other hand have no intrinsic interest in a well-balanced league as being the strongest leads to sportive success and ultimately more money. In order to nonetheless create a level playing field within a given league, sports teams are enjoying some exemptions from competition law. For ex-ample, the four major leagues in the U.S. (NFL, MLB, NBA, NHL) are exempted from antitrust law to be able to sell their broadcasting rights together or to decide on salary caps (Vrooman, 2009). The
col-lective bargaining for broadcasting rights is supposed to ensure that all clubs get a fair share of those revenues whereas the salary caps should prevent that the most talented players are only attracted to the wealthiest teams.
These measures are thought to prevent single teams from becoming too powerful. A dominant position could lead to a vicious circle of wealthy teams buying the best players, winning all competitions and becoming wealthier again. This would have an impact on smaller competitors but also on consumer welfare. FC Bayern München is thought to be the dominant club in the German Bundesliga as they won their fifth national championship in a row taking the suspense out of the league and leaving fans bored and frustrated (Focus-Online,
28.03.2017). Next to being the most successful club, they are also the
wealthiest among their national competitors (Süddeutsche-Zeitung,
22.01.2015). This allows them to contract the best players each season.
Similar situations can be found in the Italian Serie A with Juventus F.C. and in the Spanish La Liga with Real Madrid and FC Barcelona. The new UEFA boss Ceferin is therefore thinking about introducing similar measures as the big leagues in the U.S. to also protect smaller clubs (Focus-Online,28.03.2017). Yet, the actual effects of profit
shar-ing etc. are ambiguous. Theoretical modelshar-ing often does not show a decrease in imbalance when introducing these mechanisms and an empirical look at leagues where those practices are in place still of-ten shows a dominance by a few teams that share the championships among them.
It is therefore crucial to understand team behavior better in order to
2 i n t r o d u c t i o n
be able to analyze these measures. One new approach about model-ing sports teams is to see them as multi-sided platforms connectmodel-ing for example fans and players. Players are generally more attracted to bigger clubs with a large fanbase allowing them to play in front of big audiences. Fans on the other hand are drawn towards clubs that sign big players bringing sportive quality to the team. Another impor-tant player on that platform are TV broadcasting stations. The sale of TV broadcasting rights nowadays constitutes the main source of rev-enue for professional sports clubs. Broadcasters are also interested in well-balanced teams as it attracts a wider audience that will watch the games at home (Huveneers, 2014). From this point of view clubs
can get more money for a higher balance.
We therefore want to introduce the selling of broadcasting into the theoretical model by Bae and Kwon (2008) to internalize the
incen-tive for competiincen-tive balance. They model teams as platforms that compete against each other for fans and players who execute posi-tive externalities on each other leading to imbalanced outcomes. We want to use this model to answer the research question whether the sales of TV broadcasting rights can internalize the desire for compet-itive balance in clubs and therefore lead to a more level playing field. If teams have their own interest in keeping a certain balance through the broadcasting revenue, it would be unnecessary to exempt them from competition law and hence they should be kept from colluding on profits.
1.2 r e s e a r c h q u e s t i o n
The discussion shows that it is not for certain that revenue sharing or other measures actually diminish the imbalance between clubs. Thus it seems that the exemptions from competition law do not fulfill their desired purpose. If that is the case they are not justified and other ways to reach competitive balance should be found. Through exempt-ing teams from these laws consumer welfare could be damaged as collusion between teams on ticket prices or other anti-competitive conduct is more easily sustainable.
Another approach to reach more balance could therefore be to inter-nalize the incentives for the clubs themselves to strive for competitive balance in their league. We therefore want to model the optimal be-havior of clubs to answer the following research question:
Can the sales of TV broadcasting rights internalize the desire for competi-tive balance in clubs and therefore lead to a more level playing field?
For that to happen teams have to realize the position they are in and be aware that the majority of their profits is dependent on competi-tive balance. In order to answer the question we will therefore take
1.3 methodology 3
the model byBae and Kwon (2008) as a base and expand it by
intro-ducing an extra revenue stream for teams coming from the sales of TV broadcasting rights. Through incorporating these extra revenues, the overall profits of the firm are more dependent on competitive bal-ance than on their own quality. Our hypothesis is therefore that in the equilibrium outcome a better balance between the quality of the teams can be achieved compared to the benchmark outcome of Bae and Kwon(2008).
1.3 m e t h o d o l o g y 1.3.1 Bae and Kwon 2008
The model of Bae and Kwon(2008) consists of the interplay of three
agents: teams (platforms), players (input), and fans (consumers). Due to network effects there are externalities between fans and players who each maximize their own utility. Team A and team B are profit maximizing and competing against each other for players and fans. This folds out to a 2-stage game: 1st teams compete for players by setting wages, 2nd they compete for fans by setting prices. The game is then solved via backwards induction.
Each side of the market is described by the Hotelling model of a lin-ear city. Consumers are uniformly distributed on interval xi ∼ [0, 1]
where team A is located at 0 and team B at 1. The distance t of a con-sumer to a team measures their loyalty to the club and θj expresses
the quality of the team which is determined through the amount of talented players.
Players are uniformly distributed on the interval sk ∼ [0, 1] describing
how much they value the network externality from the fans. The in-tensity of the network effects is measured by β and qjis the quantity
of fans of team j.
Bae and Kwon (2008) analyze three iterations of their model: the
baseline model, the addition of consumer preferences and the addi-tion of profit sharing. The two addiaddi-tions are theoretically supposed to bring more balance to the teams. Through the consumer prefer-ence the teams’ profits are also dependent on competitive balance and through the profit sharing their profits are additionally depen-dent on the quality of their component. ThoughBae and Kwon(2008)
find that despite these additions the equilibria will still be perfectly or alleviated imbalanced. We will work with the baseline model to keep the model simple enough to get workable results and also to show that through our addition these expansions aren’t needed to create more balance. The baseline model works with the following utility functions for consumers xiand players sk:
4 i n t r o d u c t i o n
u(xi) =
(θA+ θ) − pA− txi buying a season ticket for team A (θB+ θ) − pB− t(1 − xi) buying a season ticket for team B
u(sk) =
βqAsk+ wA joining team A βqBsk+ wB joining team team B Finally, firms maximize their following profit function:
πj = (pj· qj) − wj· θj
Solving this game leads to two equilibria. The first outcome leads to perfect imbalance where one team hires all of the talented play-ers. The second outcome leads to an alleviated imbalance where both teams hire a positive amount of talented players.
1.3.2 Our addition
With our extension of this model we try to lift the equilibrium out-comes to a higher competitive balance, i.e. a more equal distribution of the talented players. We will therefore introduce an extra revenue stream from selling broadcasting rights into the profit function of the teams. This revenue will come from an exogenous source and depend on the competitive imbalance between the two teams which is ex-pressed as the absolute value of the difference between the two qual-ity levels |θA− θB|. As the revenue from broadcasting is supposed
to increase with a higher balance and decrease with a higher imbal-ance, this expression has to be incorporated in a negative way. Since θA and θB both are between [0, 1] we can simply reverse the
imbal-ance to express the balimbal-ance through (1 −|θA− θB|). Furthermore it
seems reasonable to include it as a quadratic function. This simpli-fies calculations and implies that the higher the difference in quality levels, the higher the loss in broadcasting revenue through an addi-tional increase in imbalance which will give (1 − (θA− θB)2). Finally
we should consider that broadcasting revenue is the main source of revenue for the teams (Huveneers,2014) which is why it will receive
a weighting of k with k > 0.5. This leads to the following adapted profit function for the teams:
1.4 structure 5
1.4 s t r u c t u r e
The remainder of the thesis is structured as follows. Chapter 2 will
give an overview over the existing literature. The discussion will be build around the topic of competitive balance and how it is ap-proached from different angles. Chapter 3 will give an introduction
to the industry of professional team sports as such. It will illustrate the special characteristics of the industry and give an overview of its participants. After understanding the specialties of the industry a bit better, chapter4 will discuss the notion of competitive balance in
more detail. Chapter 5 will then provide some legal background on
how the US and the EU deal with measures to protect competitive balance. Chapter 6 then introduces the underlying economic theory
of our model: multi-sided markets and Hotelling’s linear city model to prepare the introduction of the model in chapter7. After chapter7
explained the assumptions of the model, chapter 8will do the initial
analysis before chapter9discusses the equilibrium analysis. Chapter 10 then describes the policy recommendations that follow from our
2
L I T E R AT U R E R E V I E WThe economic literature around professional sports is centered around the discussion of competitive balance. The notion of competitive bal-ance is used to describe a league or a contest where the quality be-tween the competing teams is of such equal nature that the outcome of the game is uncertain upfront. This uncertainty of the outcome is seen as the driver behind the interest in sporting competitions. It is therefore of interest in welfare considerations by anti-trust authorities and analyzed from different perspectives on the industry.
While some research the origins of imbalance, others look for mea-sures to reestablish it. This chapter will give a small overview of liter-ature on these different aspects, talking about the role of club owner objectives and platform theory as well as the impact of measures such as revenue sharing between competitors.
2.1 c o m p e t i t i v e b a l a n c e a n d o w n e r o b j e c t i v e s
Literature has dealt with the question of whether professional sports teams can actually be treated as profit maximizing or whether they follow a different aim such as maximizing their winning percentage which can lead to different behavior by the team owners. Whereas a profit maximizer’s pure interest is the resulting profit at the end of the season, i.e. revenue minus cost, a so-called sportsman owner’s goal is to achieve the best possible sportive success. To reach this goal he might want to maximize revenue as well but then is only bound by a zero-profit restriction rather than a maximum profit aim (Fort and Quirk, 2004). Fort and Quirk (2004) analyze the effect of ownership
on competitive balance and conclude that competition policy should nudge owners to either be profit maximizers or win-percentage max-imizers in order to alter competitive balance.
They apply a theoretical model where the two types have different objective functions to find out how these types can be distinguished. They compare a league comprised of win maximizing owners with one of profit maximizing owners and the talent choices they will make all else constant. Subsequently, they find that the talent mar-ket will be different regarding the cost of the talent but that they can not be distinguished by the level of competitive balance that arises. However, they suggest to implement a policy instrument that nudges team owners in either one direction depending on the demand for talent to alter competitive balance.
8 l i t e r at u r e r e v i e w
2.2 p r o f i t s h a r i n g a n d o t h e r m e a s u r e s
WhereasFort and Quirk (2004) analyze competitive balance to learn
more about ownership types of team owners, others are interested in the phenomena directly and in measures that are thought to reestab-lish competitive balance between teams.
Szymanski and Késenne (2004) look at competitive balance in sports
and revenue sharing between teams. They use a theoretic model of profit maximizing teams that share their profits coming to the con-clusion that under certain circumstances revenue sharing may have a reverse effect than desired and worsen competitive balance. They thus question the approach by competition authorities to push mea-sures such as profit sharing in order to create more balanced leagues.
Vrooman(2009) uses his model to counter this argument by
introduc-ing sportsmen ownership instead of profit maximizintroduc-ing team owners. Whilst for profit maximizers the invariance proposition holds, the sportsman assumption in his model shows that competitive balance can be increased through profit sharing. Additionally, this can lead to higher wages which can be seen in the decrease of teams monopson-istic powers in all four big leagues in the US (NFL, NBA, NHL, MLB). Next to his theoretic approach of modeling optimal behavior for both profit maximizers as well as win maximizers, he also supports his finding through an empirical analysis of the big four leagues in the US as his empirical analysis shows that American sports leagues have increasingly been led by sportsmen and their monopsonistic power has thus shrunk. He also concludes that the NFL is the most bal-anced and most profitable league in the world.
Both of the above papers base their work on the assumption that a perfect game is one of competitive balance and work with win per-centages or win relations between the opponents as measures for such competitive balance.
2.3 p l at f o r m s (multi-sided markets)
The theory of multi-sided markets as prominently introduced by Ro-chet and Tirole(2003) has since been applied to many industries that
show externalities between different sides to a platform. It has also been used to describe the industry of sports and professional sports teams to get a better understanding of the specialites of the industry.
Budzinski and Satzer (2011) use the theory of multi-sided markets
to describe the sports business and identify useful applications for example in the field of welfare and antitrust analysis. Their paper is a conceptual outline of how the externalities between the different parts of the platforms such as attendees, broadcasters and sponsors work, and their impact on pricing strategies on the one hand and ef-fect on welfare on the other which then gives insight into antitrust
2.3 platforms (multi-sided markets) 9
implications. Their main goal is to incentivize further research in the application of the theory of multi-sided markets in the sports indus-try.
Dietl et al. (2012) take the application of platform theory one step
further by modeling revenue maximizing sports teams as platforms between sponsors and fans where positive externalities flow from the fans to the sponsors and positive or negative externalities are going from the sponsors to the fans. As network externalities through fans are stronger, they are priced less than sponsors. They conclude that the size of these externalities influences the level of competitive bal-ance. They also show that through these externalities, the negative effects from revenue sharing on competitive balance is diminished. They find support for their findings in an empirical look at the dif-ferent leagues that e.g. show difdif-ferent pricing behavior towards fans and sponsors that could be a sign for different approaches to making use of network externalities.
Finally,Bae and Kwon(2008) are the first to analyze how competitive
imbalance arises without assuming asymmetry between the teams and combine that analysis with modeling sports teams as two-sided platforms between players and fans. The teams are competing on each side of the platform - for talented players and for fans. The networks effects originate as players experience positive externalities from a big fanbase and fans enjoy positive externalities from talented players. They include competitive balance in the fans’ utility function and also introduce revenue sharing between the teams. Each of these settings leads to either perfect or alleviated imbalance between the teams. As their model serves as a baseline for this thesis it will be further de-scribed later on.
3
D E S C R I P T I O N O F T H E S P O R T S I N D U S T R YIn the following chapter we want to set the scene for the model by describing the market we are dealing with discussing the industry in general and introducing its agents. We will first talk about the industry of professional team sports as such followed by agents in the industry in more detail starting at the top of the production chain with the associations and leagues that are part of the associations, moving on to the teams that are part of the leagues, followed by the players playing at those teams and the fans cheering for them. Finally, we will discuss TV broadcasters.
3.1 t h e i n d u s t r y o f p r o f e s s i o na l t e a m s p o r t s
The industry of professional team sports can be seen as an economic process. Inputs, such as the labor of athletes and coaches, are com-bined with capital, such as stadia and equipment, to produce a prod-uct that is sold to the consumers, in this case fans and spectators (Downward and Dawson). This economic process leads to economic interest in the professional team sport industry and it becomes of spe-cial importance due to its rise in commerspe-ciality.
This industry stands out from others as teams are not really their own firm in the way that they cannot produce by themselves but need at least one other team to play a game. Even further, more than just one game, it’s rather an actual contest between several teams that gets fans interested. These contests are then usually managed by leagues which will be further discussed in a separate subsection (Dietl et al.,
2012).
Another specialty of this industry is the internal trade-off for teams that they individually want to be the strongest and see other teams as competitors but in economic terms they are rather complementors. Therefore their economic value is dependent on competitive balance within the league which will also be discussed in more detail later on (Dietl et al.,2012). To get a better understanding of these specialties,
the following sections will describe the industry in more detail. 3.1.1 Facts and Figures
Within the industry of professional team spots, soccer1
is standing out for its popularity all over the world. Its importance is also reflected
1 We will refer to it as ’soccer’ throughout the thesis to avoid any confusion with American Football.
12 d e s c r i p t i o n o f t h e s p o r t s i n d u s t r y
in the amount of information and studies about it. Its special stand is emphasized in the next paragraph that will illustrate the special features of the industry by listing some facts and figures. These will mainly concentrate on the big leagues in European Soccer.
Soccer can be seen as the world’s most popular sport and European soccer’s market size is continuously growing (Deloitte,2016). The big
5leagues in European soccer (English Premier League, French Ligue 1, German Bundesliga, Italian Serie A and Spanish La Liga) all ben-efited from a few of their teams being on an international stage and thereby receiving extra benefits and profits. Broadcasting contributed the biggest share of revenues in all of these five leagues ranging be-tween 31% in Germany and 61% in Italy. For smaller leagues the rela-tion is different as their share of broadcasting revenues is often below their game day revenues and sponsoring revenues (Deloitte,2016).
More precisely, the turnover in season 2011/2012 was made up of 2,5 Mrd. Euro from ticket revenue in Europe’s first leagues and the rev-enue from the TV broadcasting rights of 4,8 Mrd Euro (Hirsbrunner and Schnitzler,2014).
As these figures indicate, sport has a huge economic impact in the EU e.g. representing 3.7% of EU GDP in 2004 and employing 15 million persons which equals 5.4% of the labour force. This trend continues and sport can be regarded ’big business’ mainly due to the rising profitability of broadcasting rights (Commission, 2017a). The
indus-try is not only impressive and interesting to government institutions such as the European Commission because of its size but also due to its other specialties that will be discussed in the next paragraph. 3.1.2 Specialties
As mentioned above the industry of sports in general and soccer in particular is different from other ’classic’ industries due to the very nature of the industry but also its ’side effects’. The European Com-mission recognizes that sport "is of great social and economic signifi-cance". It even touches upon and influences most complex issues such as "nationalism, racism and the propensity to violence" (Commission,
2017b). In a more practical sense it also supports social involvement
through investment in facilities, encouraging of being sportive active and education (Deloitte,2016).
These involvements might stem from the fact that soccer follows its own rules. In other economic areas it would be positive for a firm if a strong competitor would have to leave the market but in soccer teams profit from their competitors strength as that makes their own competitions more interesting. An example for that is that the Ger-man Bundesliga became worldwide more acknowledged when Borus-sia Dortmund rose to challenge the dominant position of FC Bayern München which lead to more suspense in the league and hence to
3.2 agents in the industry 13
more interest (Hirsbrunner and Schnitzler, 2014). Thus, while they
have a sportive interest in being successful and winning titles which leads to strong competition, sports also transmits feelings of support and togetherness.
3.1.3 Regulation
Given these characteristics one has to think about how to treat this industry to enhance its benefits whilst at the same time keeping it in order. Some professional teams are in debt despite the overall growth of the industry. Deloitte (2016) comes to the conclusion that
finan-cial regulations at the European level are taking effect as the latest benchmarking report by UEFA states that "combined net losses of European clubs have reduced by 70% since 2011 to €487m". This de-velopment is important to ensure the sustainability of teams. Further financial regulations will be discussed in the description of the legal situation. The legal part will also discuss the question whether the sports industry should be fully exempted from anti-trust law due to its special characteristics.
3.2 a g e n t s i n t h e i n d u s t r y
The main agents of the industry are sports associations which man-age and control leagues, which manman-age and control teams and play-ers and fans that are connected through the teams. These actors are necessary to make the product possible and could be seen as part of the main production chain. Additionally, there are broadcasting sta-tions, sponsors and advertisers who are not directly needed for the industry but who in fact bring a lot of money to it because it will help their own direct business. In this section we will concentrate on those agents that are relevant for our model later on.
3.2.1 Associations and Sports Leagues Tasks
The tasks for associations and leagues often coincide and will there-fore be discussed in the same subsection which is based on Noll
(2003)2. The existence of leagues is grounded in efficient
coordina-tion of teams wanting to compete in a contest. A single team cannot produce its product - the game- by itself but needs at least one other team to compete against. Furthermore, the interest in their competi-tion is increased by not staging single games but a series of contests between different teams leading to one overall champion at the end
2 His work recommendable for anybody interested in knowing more about the func-tioning of leagues.
14 d e s c r i p t i o n o f t h e s p o r t s i n d u s t r y
of a season. This calls for a set framework of coordination which is done by professional sports leagues.
The most obvious task for leagues is to organize the championship itself, i.e. setting up a schedule and the specific rules of the game and to deploy neutral officials who will enforce those rules. Next to that, they need to agree on seemingly simple things such as how to determine a champion. Another important factor is to organize the finances of the championship and the different games. That means, who is responsible for the marketing of the event and who gets to keep the revenue from it. Before being able to address those issues, leagues have to decide on their own set up such as the whether to be an open or closed league.
Natural Monopolies
One question that is relevant for policy makers is in how far leagues are natural monopolies. Leagues claim this status as one can observe empirically poor survival rates of competing leagues. Theoretically the argument is that the top level league is a natural monopoly be-cause there can be only one national champion else the title loses its value. Either way, leagues enjoy the benefits that come with monopoly power and the danger is that monopoly leagues will allow too few teams to join their league than would be socially beneficial as well as setting membership in a way that no competitive league can arise. Being a monopoly could have an impact on the incentives for leagues and teams to create as little as possible competition between them. It is therefore important for competition authorities to separate those sporting decisions that lead to more efficiency from those that are aimed at reducing competition within the league.
3.2.2 Teams
Product, Revenue, Cost
As just introduced, the main product -and reason for existence- for teams is to play games to compete with their opponents. Next to that they might also be active in merchandising as well as for example social projects but these activities are all focused around the actual sports competition. In order to produce those games, teams just like any other firm experience costs and then collect revenue from their product. We will therefore take a close look at these aspects.
As usual the teams’ cost can be split into fixed cost and variable cost. Fixed cost would be for example the facilities used by the team (Downward and Dawson). Due to their high cost, marginal cost of serving a consumer in a stadium are often assumed to be zero. Vari-able cost are for example the wages that players receive (Downward and Dawson) which also constitute the biggest part of (variable) ex-penses. According toDeloitte(2016) "Aggregate wage expenditure of
3.2 agents in the industry 15
the ‘big five’ European leagues increased by 10% to surpass €7.4 bil-lion in 2014/15. This increase resulted in the average wages/revenue ratio rising from 60% to 62%, still well below the 70% threshold that is used by UEFA to monitor clubs’ financial sustainability." The study also finds a development in the Premier League that clubs are invest-ing in the game day experience and experiencinvest-ing record investments in infrastructure and facilities.
Teams generate revenue from different sources. Their major source of income nowadays is selling TV broadcasting rights (Huveneers,
2014). Next to that, they receive a fair amount of sponsoring money
and generate revenue from their primary activity, the game, through ticket sales.Deloitte(2016) finds that despite the growth of the
indus-try, two of the big five leagues still operated at a loss and some teams in the leagues that operated on profit still operated at a loss. This questions the zero profit assumption that is often used in theoretic models. In order to ensure sustainability in the clubs the UEFA intro-duced its Financial Fair Play which will be discussed in more detail in the legal section.
Local Monopolies
Similarly to the question of whether leagues are natural monopolies, the question here is whether it is economically rational to have two teams in the same relevant area, i.e. whether teams are local monop-olies. In leagues with relegation and promotion, teams usually don’t enjoy exclusive territorial rights. One argument for territorial rights is that else local teams will heavily compete for the best players but only one of them can reap the benefits whereas the other will experience a loss as only ’the winner takes it all’. Yet, this argumentation does not seem to hold as one can observe geographical areas with two or more successful teams (e.g. Manchester, Milan) (Noll,2003).
It can then be argued that teams of the same city do compete against each other for fans but rather in terms of quality against the whole league not just towards each other. A rivalry between local teams can even enhance demand for both of them. This leads to the conclusion, that teams are not local monopolies. That means market driven deci-sion as to who enters and exits the leagues seems more efficient than allocating territorial rights (Noll,2003).
A different concern is that teams sell their own merchandise and often are the only ones to do so, so that in this regard they are monopolists. As this is not their core business, the question is in how far that is a cause for concern. Additionally, the question arises whether teams act as monopsonies when contracting players or using sporting venues. If they were the only buyer they could exert bargaining power. Yet, this seems to be more of a concern for leagues than for teams as play-ers e.g. can choose to play for any team within a league but then have to accept the league’s conditions and rules (Farzin,2015).
16 d e s c r i p t i o n o f t h e s p o r t s i n d u s t r y
Ownership
Another debated characteristic of teams is the form of their owner-ship. Literature distinguishes between two types of team ownership that often lead to different conclusions about their incentives and consequences of policy prescriptions. The first type of ownership is the logical profit-maximizing type. The goal of a profit-maximizing owner is to generate the highest profit possible at the end of a sea-son.
The second type is the so-called ’sportsman ownership’ (Vrooman,
2009) or win/winning percentage maximizing type of ownership. The
goal for those owners is to be the strongest team among all competi-tors and experience the highest sportive success possible. In order to achieve this success investments in the quality of a team have to be made. That means that also win maximizers strive for the highest rev-enue possible yet they are not constrained by minimal cost but rather by non-negative profits as they will invest all their revenue into in-creasing the quality of the team (Vrooman,2009).
It seems plausible that these different objectives lead to different be-havior. Indeed,Vrooman(2009) finds that profit sharing between win
maximizers does lead to a higher balance whereas it doesn’t between profit maximizing owners. Fort and Quirk(2004) on the other hand,
find that the pricing choices of teams cannot distinguish the type of ownership as both will price in inelastic portion of the demand. Additionally, one can also not tell these two apart by level of com-petitive balance as prices of talent are not lower in win-percentage maximizers as expected and neither will be the demand for talent. These conclusions are drawn in a ceteris paribus comparison of the two ownership types.
3.2.3 Players
Players can be seen as the inputs to the production of the contests. It thus makes sense to analyze their behavior through the discussion about wages which is based on Downward and Dawson. In a per-fectly competitive situation neither teams nor players would have any bargaining power and wages would be ’just’ in the sense that players received wages that reflect their contribution to the team’s revenue. As in most markets it can be argued in how far the market for play-ers is perfect and one can imagine bargaining power on both sides. On the one hand, there are far more players that want to play profes-sionally than teams can employ. This buying power of the teams is increased when thinking of a few top clubs within leagues that most players would prefer to play for. Similarly, but reversed, we can think of a few selected athletes that are said to have distinctive talent over their colleagues and are competed for by the clubs. In that case these
3.2 agents in the industry 17
few players can exert their bargaining power and take an influence on the wages. Lastly, it could be that both these cases occur so that there is some bilateral bargaining power over the distribution of the rents.
Due to league management policies, sporting labor markets have his-torically been characterized by monopsonistic exploitation through the clubs. But with incidents such as the free agent principle in the U.S. and the Bosman court case in the EU, players have gained more bargaining power. This has lead to an extra-ordinary increase in play-ers’ salaries which might have triggered the salary caps to help finan-cially struggling clubs. Together with the increase of players’ salaries it has also been observed that the gap in income between high earning players and low earning players has widened. This can be explained through the scenario above, that when players get the chance of more bargaining power this will lead to the top players mainly profiting. Whether those wages are exploitative depends on how their salaries reflect their contribution to the team’s revenue.
3.2.4 Fans
Fans are located on the demand side of the market. Thus their behav-ior is analyzed from that perspective. The magnitude of demand is determined through standard economic determinants such as market size, price and income and sporting determinants, mainly the uncer-tainty of the outcome. The idea behind the unceruncer-tainty of the out-come hypothesis is that the interest in a contest is maximized when the competition between the opponents is the fiercest, i.e. when they are of equal quality. Though some examples show that attendance can also be high when teams are in a period of dominant success or after being relegated to a lower league. This may be related to the single team’s fan base and their passionate connection to the club. One should therefore look at overall attendance and interest in these situations (Downward and Dawson).
Something to keep in mind are the different types of uncertainties, whether it is the uncertainty for a specific match or rather the season as a whole. Another sporting determinant for attendance is the player composition of a team where e.g. international players or star players may increase interest (Downward and Dawson).
Dietl et al. (2012) agree that fans demand a competition and an
ex-perience which supports the idea of the uncertainty of the outcome hypothesis. Noll (2003) also thinks demand is increased through a
championship and adds that attendance depends on the significance of the contest. This could be in contrast of competitive balance as a game against a better contestant might be more demanded than one against an equally bad one. Other determinants could be the weather or the day of the week yet those seem to play smaller roles.
18 d e s c r i p t i o n o f t h e s p o r t s i n d u s t r y
3.2.5 Broadcasters
As mentioned above, the revenue from selling broadcasting rights is now a major source of income in sports. Through broadcasting a strong team can attract fans almost anywhere as distance does not as much play a role anymore (Noll,2003). Noll(2003) also suggests
that through centralized sales of TV rights and sharing the resulting profits equally, the revenue gap between teams could be closed com-pletely. Deloitte (2016) also attests a symbiotic relationship between
broadcasters and soccer but raises the question whether growth in broadcasting revenues can continue much longer. So far it grows at an impressive rate but one needs to keep in mind that there are also big differences between leagues regarding the sales of broadcasting rights.
Spain for example has recently introduced collective selling of broad-casting rights in hope that the competitive balance between the teams will be increased (Deloitte,2016). Some changes have also been made
in the selling of broadcasting rights by the DFL for the Bundesliga. A ’no single buyer rule’ leads to more competition between broadcasters and might devalue those rights for the broadcasters but at the same time there will be more game windows which again will lead to more opportunity for profits (Deloitte,2016).
Saying that the leagues benefit from the revenue from selling their TV rights is only one side of the story since broadcasters heavily com-pete to get these rights. That they are willing to finance these fees also from non-sport content shows the importance of soccer to broadcast-ers (Deloitte,2016).
An important aspect in this discussion is that broadcasters are also interested in competitive balance. As Dietl et al. (2012) put it, they
"demand an audience to sell their products". And as has been men-tioned already above and will be discussed in more detail later on, the interest in sports and thus the audience comes with competitive bal-ance between the teams. A great example for this is the global success of the English Premier League. There is not only a group of top clubs, rather than one or two on top, but also smaller clubs can beat the bigger ones any time, thus it’s a very competitive league. The latest proof of that would be Leicester becoming champion in the 2015/16 season (Deloitte,2016).
4
T H E N O T I O N O F C O M P E T I T I V E B A L A N C EThe focus of this thesis lies on competitive balance in professional team sports. This chapter will introduce the notion in more detail. Competitive balance describes the idea that teams competing against each other are of similar quality so that they have equal chances of winning the contest. The basis for this is that the interest in sports is founded on the unpredictability of the outcome (Szymanski and Késenne(2004),Vrooman(2009)) and in order to be unpredictable we
need teams to be somewhat on the same level. In pursuance of pro-tecting this balance the industry has come up with measures that aim at providing teams with similar resources to invest in their quality so that in the end everybody can benefit from a high quality league. These measures are controversially debated as they often require ex-emptions from anti-trust law and their effects are ambiguous. That is why this section wants to give an overview on this topic explaining why competitive balance is important, what measures are introduced to protect it and what their advantages and disadvantages are. 4.1 w h y w e n e e d c o m p e t i t i v e b a l a n c e
Vrooman (2009) explains the importance of competitive balance in
this way: "[The] perfect game is a symbiotic contest between evenly matched opponents". He suggest that the success of a league is deter-mined by the balance between its member teams and finds proof for that in the fact that between the top leagues in the US (NFL, NBA, MLB, MLS), the NFL is not only the wealthiest but also the most egalitarian. Szymanski and Késenne (2004) agree that entertainment
is brought through the uncertainty andDeloitte(2016) illustrates this
picture with the English Premier League. Not only does the Premier League have a handful of top teams, instead of just one or two, the study claims that the global success of the Permier League is due to the fact that also smaller teams can beat any team. A great example for this is the championship of Leicester in 2016. This story shows that the whole league can profit from a certain balance between the teams. Interesting is also the fact that even though authors disagree whether or not it is useful to employ measures of protecting compet-itive balance, they do agree that competcompet-itive balance is what makes sports.
The reason why this discussion is important is that we often see leagues that are dominated by a few teams at the top. Prominent examples for this are FC Barcelona and Real Madrid in Spain or FC
20 t h e n o t i o n o f c o m p e t i t i v e b a l a n c e
Bayern München in Germany. And what could be observed as well is that when Borussia Dortmund started challenging the dominant position of Bayern München, the international interest in the Bun-desliga increased significantly and decreased again when Borussia Dortmund became weaker again (Hirsbrunner and Schnitzler, 2014).
Thus, we should protect competitive balance not only for fan interest, but it actually benefits the whole league. That is why some leagues have introduced measures such as profit sharing as an attempt to protect this balance as is discussed below.
4.2 m e a s u r e s t o e n f o r c e c o m p e t i t i v e b a l a n c e
Over the course of the debate about establishing competitive balance within leagues, several measures have been suggested and/or imple-mented. As mentioned above they are mostly aimed at providing the teams, especially the smaller ones, with enough resources to invest into their quality. The most direct measure to pursue this goal is the idea of profit or gate revenue sharing. Gate revenue sharing is a com-mon practice between teams where the home team shares its gate revenues with the away team. Bigger teams will usually have bigger stadiums and will make more revenue from ticket sales than smaller teams. Through this measure smaller teams can also profit from play-ing against their big components. ’Profit sharplay-ing’ is a more general term which includes more types of money transfers between teams. Another way to ensure a fair distribution of players (quality) is through salary caps. Smaller teams can often not afford the wages that big players are used to from bigger clubs. Salary caps will not move money between the teams but are supposed to ensure that smaller teams have a fair chance to compete for players with bigger teams. This measure rather limits the wealthy teams instead of giving more money to the smaller teams.
A similar idea is behind the concept of luxury taxes that wealthy teams are supposed to pay. This can appear in different forms. It can either be a simple tax that each team above a certain revenue thresh-old has to pay (and will be distributed among the league) or it can take on more complicated forms. The aim here is again to restrict the resources of the wealthy teams to create more balance between the teams (Vrooman,2009).
Another measure that is already in place in several leagues is the collective bargaining of broadcasting revenue. Collective bargaining means that either the league or all member teams together will bar-gain with broadcasters about the broadcasting rights. The revenue from these deals nowadays constitutes the main source of income for teams but not every team gets the same share. The collective bargain-ing is supposed to create more balance in that regard. As weaker teams by themselves would not be able to negotiate a lucrative deal,
4.3 pros of measures 21
the bargaining power of the bigger teams will help them. The collec-tively bargained deals are often complicated in the way the money is distributed among teams as only a certain share is divided evenly between all teams.
As mentioned above, there is dissent in the literature about whether these measures actually show any desired effect. Before implement-ing these measures one should therefore weigh their pros and cons against each other that are discussed in the next sections.
4.3 p r o s o f m e a s u r e s
The main advantage of these measures, given that they are effective, is obviously that they create a more balanced league by equalizing re-sources. Szymanski and Késenne(2004) therefore classify these
mea-sures as pro-competitive agreements. The underlying process is that these measures break the vicious cycle of dominant teams becoming more dominant. Especially against the background of this industry and teams acting as platforms, network effects are likely to lead to an imbalance that reinforces itself over time. If you start with one dominant team with more talented players than the other teams, they are likely to win their competitions which will directly lead to more money and also to a bigger fan base which will give this team even more resources to invest into their quality which will make them even more dominant and so the cycle continues.
Through the above mentioned measures this cycle ought to be broken. The profit sharing breaks the cycle at the point where the dominant team also in relative terms earns more money than the smaller team. By sharing some of its revenues the gap between the bigger and the smaller team can be controlled. The collective bargaining works in similar ways as a measure for redistribution of resources. The salary cap takes effect at the point where the dominant team already has more resources available but through this measure is restricted in the way it can outplay the smaller teams in the competition for talent. The luxury tax might be able to fulfill both effects through restricting the dominant team’s resources and eventually also redistributing them between the rest of the league.
The collective bargaining of broadcasting rights might also be bene-ficial to the broadcasters themselves. Instead of having to negotiate with each team individually they can arrange one coherent deal with all of the teams and the same conditions for each game. It might also lead to the possibility of one winning station being the exclu-sive broadcasters which will give them monopolistic market power as well.
22 t h e n o t i o n o f c o m p e t i t i v e b a l a n c e
4.4 c o n s o f m e a s u r e s
Despite their possible advantages these measures are also heavily crit-icized. The main point of criticism is that they are useless and do not lead to the desired outcome of more balance which will be further dis-cussed in the next paragraph about the Invariance Proposition. The other part to the discussion is that they actually come with negative effects, that especially in the absence of positive effects are undesir-able.
One concern is that these measures will actually diminish incentives for teams if they cannot fully reap the fruits from their success. This decrease in incentives and the collaboration between the teams might then actually lead to less competition in the league (Szymanski and Késenne,2004).
The other big concern is that these measures seem anti-competitive in the light of antitrust law. If teams can be treated as ordinary firms, most of these measures would constitute anti-competitive agreements. A more detailed discussion about this topic will be done in the legal section below.
Lastly, the concern is that these measures might also provoke other anti-competitive behavior. If teams come together regularly to discuss their profit sharing mechanisms they might also be tempted to agree on other things such as ticket prices, e.g. Thus, if these measures do not lead to more competitive balance or if, as we are trying to show in our model, teams should not need these measures to create bal-ance themselves, then any form of communication between the teams should be suspicious and these measures should not be implemented. As discussed above, the collective bargaining of broadcasting rights can be beneficial for both the teams and the broadcasting stations. Yet, the end consumer might be suffering from less choice and higher prices due to this measure. Through the collective bargaining power of teams, broadcasters will have to spend more money to buy these rights which will most likely be passed on to the end consumer. Es-pecially exclusive rights are expensive for broadcasters but also give them the power to set monopoly prices.
4.5 i n va r i a n c e p r o p o s i t i o n
The invariance proposition suggests that revenue sharing mechanisms are without effect on competitive balance. It is often debated and questioned within the literature about competitive balance.Vrooman
(2009) for example supports this proposition by concluding that
rev-enue sharing between teams has no impact on the competitive bal-ance between them.Szymanski and Késenne(2004) on the other hand
show that this proposition does not hold considering the "open mar-ket of European football". Even further, they show that revenue
shar-4.5 invariance proposition 23
ing can lead to less competitive balance. In a different approach,
Vrooman (2009) uses his model introducing sportsmen ownership
instead of profit maximizing team owners. With the sportsmen as-sumption his model shows that competitive balance can be increased through profit sharing.
5
A P P L I C A B I L I T Y O F C O M P E T I T I O N L AW T OS P O R T S
The reason for this section and the legal debate in general is that teams need some economic coordination "to offer their product and to ensure competitive balance" (Farzin, 2015). The issue is that such
an economic coordination is illegal per se under antitrust law. Thus, it has to be decided if and in how far teams can be exempted from these laws. This section will give an overview of what the challenges are of combining professional team sports and its specialties with Competi-tion Law. It will discuss the arguments if and in how far those laws are applicable to professional team sports. It will also describe the cur-rent approach of the U.S. and the EU towards this topic and discuss key aspects in the discussion such as the UEFA’s Financial Fair Play (FFP) agreement. The debate is especially interesting as the UEFA is thinking about implementing similar measures as are already in place in the US (Focus-Online,28.03.2017).
5.1 t h e u n i t e d s tat e s
The Major League Baseball (MLB) is the only one among the top four professional sports leagues in the US (NFL, NHL, NBA) that falls un-der a general exemption from the Sherman Act even though they are all made up of similar venture structures. The form of a joint-venture enables them to collude on different rules regarding own-ership, player contracting, territorial rights, and broadcasting rights. However, the MLB applied for the exemption during a time when the interpretation of "trade and commerce" was still a different one. The other leagues are subject to the Sherman Act as they "affect interstate trade" and are therefore "capable of affecting competition by behav-ing like a cartel or a monopoly" (Farzin,2015).
One important aspect of the discussion about the applicability of the Sherman Act is the question whether leagues actually behave like a single entity rather than a cartel made up of independent firms and could therefore not be convicted of collusive behavior.
One argument for the single entity approach is that clubs would not be able to exist without their leagues, therefore they cannot be con-sidered independent firms. Another approach is that these leagues cannot be exempted from the Sherman Act generally but that certain decisions can be argued as a monopoly decision due to the special characteristics of the industry and in order to market their product. Thus, clubs are organized as independent firms and each decision
26 a p p l i c a b i l i t y o f c o m p e t i t i o n l aw t o s p o r t s
that they make as a single entity has to be analyzed towards its effects on competition which will be done under the Rule of Reason. Some anti-competitive behavior can be protected when it is outweighed by pro-competitive behavior under this Rule of Reason (Farzin,2015).
Next to the MLB being exempted mostly due to historical reasons, the MLS (Major League Soccer) was constructed to form a single entity so that it might be exempted from the Sherman Act as well. The dif-ference lays for example in the fact that the league itself owns all of its teams. Through this the league controls all the revenues generated and also e.g. bargains about the wages with the players directly. This way the league has a control over which player plays for which team and can therefore create a competitive balance between the clubs. Due to this structure the MLS does not need to set up agreements between the different clubs that could be considered anti-competitive agree-ments. Because of these two exemptions each of the leagues has to be analyzed individually under anti-trust law (Farzin,2015).
Despite not being per se exempted from Antitrust Law, the three leagues NFL, NBA, NHL have introduced salary caps (Vrooman,2009).
The collective selling of broadcasting rights has also been exempted by Congress (Szymanski and Késenne, 2004). In general, most
rev-enue sharing agreements have not been challenged in the courts ( Szy-manski and Késenne, 2004), so that all big four leagues employed
some form of measures to protect competitive balance (Hunt,2011).
5.2 t h e e u r o p e a n u n i o n
EU competition law covers antitrust, mergers and state aid. Most sport cases have been handled under EU antitrust rules, which pro-hibit anti-competitive agreements and practices as well as abuse of a dominant position. They are captured under Art. 101 and 102 TFEU. Those cases concern revenue-generating activities connected with sport, such as media rights and ticket sales and regulatory/organizational aspects of sport. The majority of the cases falls under anti-trust but there are also some concerned with state-aid (Commission, 2017a).
As this thesis researches the need for anti-competitive measures such as revenue sharing in order to reach competitive balance between the clubs, the focus of this section will also lie with antitrust cases rather than state-aid cases.
5.2.1 Applicability of EU Competition Law
The question of applicability of competition law on professional sports teams is dependent on the interpretation of Art. 101, 102 TFEU. One part of the debate is whether sports teams can be considered under-takings, another concern is in how far their decisions are of economic or pure sporting nature. When assessing cases in the sport sector, the
5.2 the european union 27
Commission also considers the important social and cultural role of this sector (Commission,2017a).
In ’usual’ economic industries, dominance of firms is to be seen crit-ically but due to the specialties in sports, monopoly behavior might even be desirable which is why Competition Law has to be applied carefully to this industry (Schlosser, 2015). According to the
Euro-pean Court of Justice, soccer teams are economically active and can be characterized as undertakings regardless of whether their intention is to maximize profits or not. Accordingly, associations are seen as ’association of undertakings’ (Hirsbrunner and Schnitzler,2014).
Sub-sequently, Sports is always then part of EU law when it executes an economic activity. Thus, only purely sportive decisions are exempted from Competition Law. However, this clear distinction can be quite difficult to make. (Hirsbrunner and Schnitzler,2014)
5.2.2 Broadcasting Rights
One often discussed factor in the applicability of competition law to sports is the joint selling of broadcasting rights by the clubs. If clubs qualify as undertakings a joint bargaining over the TV rights could be seen as a cartel activity as ’agreement between undertakings’ accord-ing to Art. 101 TFEU. However, the Commission decided to accept this joint bargaining under certain conditions. "These include, inter alia, the sale of sport media rights through open and transparent tender procedures, a limitation of the rights’ duration (usually not exceeding three years) and the breaking down of the rights into dif-ferent packages to allow several competitors to acquire rights." ( Com-mission,2017a).
The general issue with cartels is that it usually drives up prices as the sellers get a monopoly power over the buyers. In this case of joint bargaining this would directly affect the broadcasting stations that would have to pay increased fees to be able to show the games and it would probably affect the viewers at home that buy the packages from the broadcasters as those will raise their own prices in reaction to the increase of their cost. The question is what the upsides are of such collective bargaining that made the Commission decide to ex-empt them from Art. 101 TFEU.
Overall, the Commission supports measures aimed at re-distribution of resources between professional and amateur teams for solidarity purposes and also recognizes the need to protect competitive balance. The specific measure of revenue sharing has not been discussed yet but is believed not to be regarded anti-competitive (Szymanski and Késenne, 2004). One example of possibly anti-competitive measures
28 a p p l i c a b i l i t y o f c o m p e t i t i o n l aw t o s p o r t s
5.2.3 UEFA Financial Fair Play
Uefa’s Financial Fair Play’s overall goal is to achieve long-term via-bility by keeping investors under responsivia-bility and keeping salaries and transfer money from rising too extremly (UEFA, 2017). Yet,
de-pending on the applicability of EU Competition Law it could be con-sidered a decision of an association of undertakings and therefore be illegal under Art. 101 TFEU. It thus serves as a great example to have a closer look at this analysis.
A decision by the UEFA as an association of undertakings that con-straints competition can only go through if the goal of the decision is appropriate and the constraint is necessary and proportionate ac-cording to Art. 101 (1) TFEU. These goals are then weight against the constraints. To evaluate this trade-off alternatives to the decision up for discussion have to be analyzed to see if the same goals can be reached with less restraining effects. Potentially, the FFP is then not compatible with EU Law because it hinders investment and therefore protects the bigger clubs rather than the smaller clubs (Hirsbrunner and Schnitzler,2014).
The Commission and UEFA, however, published a common statement to say that the UEFA FFP does not interfere with EU state aid regu-lations as both of them are aimed at financial independence of the teams. This view could be challenged since state aid restricts finan-cial support through governmental organizations aimed at keeping a fair competition between the teams whereas the FFP also restricts investments by private actors and restricting the clubs as to how they can finance themselves which might be problematic under EU Com-petition Law. On the other hand, the cooperation between the UEFA and the Commission could be justified because the FFP tries to keep clubs from getting into too much debt so that they will not get in the position of having to be rescued by the state which would fall under state-aid (Hirsbrunner and Schnitzler,2014).
The authors question the effect of the Commission’s agreement to the UEFA’s FFP and how consequently it is followed through and actu-ally leads to a fair competition between the clubs which should be the goal of the Commission. They even suggest to take this coopera-tion a step further and to introduce a regulacoopera-tion of the whole market to prevent market failure through inefficient allocation of resources between the teams. That way aspects of competition economics could be combined with financial regulations and the specialties of the soc-cer industry could be considered without having to allow for general exemptions from competition law (Hirsbrunner and Schnitzler,2014).
6
F O U N D AT I O N A L E C O N O M I C T H E O R YThe previous chapters provided some background to embed our model. They set the scene by describing the industry and the forces that make it work. Before we start analyzing our model of platform competition between teams in the following chapter, we want to review the un-derlying economic theory. The main idea of the model is that teams behave as platforms that compete for the different sides of the mar-ket. Each side is then described by Hotelling’s linear city model and exerts externalities on each other. This chapter will therefore give an overview of these three aspects, beginning by discussing platform theory as introduced byRochet and Tirole(2003), followed by the
as-pect of externalities as described byKatz and Shapiro(1985) and then
moving on to Hotelling’s linear city model (Hotelling,1929).
6.1 p l at f o r m t h e o r y/ multi-sided markets
In a market with network externalities, one can usually observe two sides to the market that not only benefit from each other but whose plain interaction is what makes the market worthwhile. Their interac-tion takes place via a common platform. The platform owners thus need to serve the needs of two (or more) sides with their business. That means that they do not only have to choose one price level but a price structure that takes these externalities into account. This often leads to one of the sides being operated even below cost whereas the other side is used to finance the system (Rochet and Tirole,2003).
The gains from trade usually arise from the actual usage of the plat-form not just the membership, e.g. two callers benefit from the con-versation they have and not just from having a phone. The amount of usage depends on the usage fee whereas the presence of users on the platform depends on the membership fee (Rochet and Tirole,2006).
The theory of two-sided (multi-sided) platforms stems from the two separate discussions about network externalities and multi-product pricing. A prerequisite for two-sidedness is that the price structure is important, not just the price level. I.e. the level of p1 and p2 matters
separately for the overall volume of transaction not just the total level of p1+ p2. An example for one-sidedness is buying a razor and razor
blades. There, the end consumer internalizes the externalities of one of the products on the other himself and therefore only cares about the overall price level. The idea behind platform markets is that dif-ferent end consumers benefit from externalities from other end con-sumers. In the example of credit cards, customers benefit from
30 f o u n d at i o na l e c o n o m i c t h e o r y
chands that offer their payment system and vice versa (Rochet and Tirole,2006).
An interesting concept is also the competition between platforms. In some markets users will subscribe to several platforms. Prices on one market are then connected to the availability of platforms on the other side of the market. In the case of multiple platforms, a transaction can only take place if the given buyer and seller share at least one plat-form in common (Rochet and Tirole,2003).
6.2 e x t e r na l i t i e s
We speak of an externality when the decision or action of one has an effect on the utility of another. Katz and Shapiro (1985) find that
there are many products where it is the case that one consumer prof-its from the number of other consumers consuming the same or a similar product. This section follows their work "Network externali-ties, competition, and compatibility" (Katz and Shapiro,1985).
The authors list three ways in which externalities can occur. First, through the "direct physical number of the number of purchasers on the quality of the product". An example for this is that the value of buying a telephone is directly connected to the number of con-sumers that have already bought one. The second possibility is a more indirect effect of externalities. An example here is that with the purchase of an operating system, the consumer benefits from other consumers working with the same system so that developers will be more likely to to create new products for this particular system. And lastly, for durable goods, consumers benefit from post-purchase ser-vice network that will be stronger with a bigger consumer base. For example, when purchasing a car of a certain brand, the consumer wants to ensure that she will be able to have easy access to a service spot for this particular brand.
The network effects that arise in these markets may or may not be bound to one or a subset of firms. The car brand example illustrates the case where the consumer of brand A benefits from other con-sumers of brand A. The software example corresponds to the case where a consumer can profit form other consumer of a subset of firms on the market. I.e. that if several computer manufacturers, but not all, work with the same software so that programs for this software will run on all of these computers. The externalities in the telephone mar-ket will be even wider as each owner of a telephone can make a call with any other owner of a telephone no matter the brand that they purchased. The question of the size of the network effects is then one of compatibility with its competing products.
In a market with network externalities, "consumer must form expecta-tions about the size of competing networks".Katz and Shapiro(1985)
