SBJ/Feb. 17-23, 2014/Opinion

‘Perverse incentives’ have impact on Winter Classic

After last year, most of us know much more about the business side of hockey than we ever cared to. Now, as we rejoice in the memories of the Winter Classic and embark on the exciting Olympic break and subsequent race for the playoffs, let’s just quickly revisit a key element of last year’s CBA negotiations that yielded the NHL’s new economic reality.

One of the most important things to understand in any economic system is this: Incentives matter. With the proper incentives in place, you can get most people to do just about anything you want. The flip side, however, is that many systems have unintended consequences, known as “perverse incentives.” Why do we need to know this? Because the NHL system is full of them. The most obvious example is the tethering of revenue to salary for players.

First, let’s see how the revenue-sharing system helps us to interpret the 2014 Winter Classic. While the game/event is rightly being hailed as another astounding success, perhaps amid the beautiful falling snow on New Year’s Day we momentarily lost sight of the puck, as it were. Revenue sharing makes it hard for owners to make a “profit” on a yearly basis. The Winter Classic shows us clearly why this is.

The Jan. 13 edition of SBJ cited an NHL source in stating that the 2014 “Big House” edition of the Classic pulled in a $20 million profit. But when is $20 million not really $20 million? Answer: When you have to share 50 percent of revenue with players — who share ZERO of the costs of production. Therefore, the true profit to the NHL is actually $5 million (50 percent of $30 million in total revenue = $15 million, minus $10 million in expenses, leaves $5 million in profit). While most laud the Classic as marketing genius and a huge success, the reality is that this is likely the first year that it has actually turned a profit for the NHL. (The 2012 version in Philadelphia earned a reported $15 million versus $10 million in expenses, leaving a deficit for the NHL of $2.5 million, using the same formula as above.)

Understanding this concept has to make owners think long and hard about investments intended to “grow the game.” In most settings, getting a 100 percent return on an investment would be fantastic … but not in the NHL. If a team spending $2 million on a marketing campaign yields $4 million in new revenue, the team only breaks even, since 50 percent of the new revenue ($2 million) goes directly to player salary. However many millions the Winter Classic and the NHL’s Stadium Series in total cost to stage, they need to generate collectively more than double that amount in revenue to be worthwhile from the owner’s perspective. So why am I spending that money? This creates a fairly difficult operating environment for teams when they must earn more than 100 percent return on any investment that they make in order for it to be even minimally profitable. One that, if I’m an owner, makes me very hesitant to invest in anything but the most sure bets.

Aubrey Kent
Philadelphia

Kent is chair of the School of Tourism and Hospitality and founding director of the Sport Industry Research Center at Temple University.

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