(Editor Dre’s Note: I took out an XKCD Comic here to insert my thoughts. This article is a great read with a ton of stuff to read over so I really wanted to insert some spoilers for those that may be scared of math)
- Player’s salaries have stayed even with inflation. Essentially this means their pay has not been going up.
- Owners have been increasing their spending. Management’s operating costs (per their own numbers) have been going up at five times the level of inflation (that’s a lot).
- Even in the ideal case for the owners with the new CBA these problems will repeat themselves in 2020.
- The Owners are asking the players to take a pay hit to make up for bad management practices.
I’ve read/listened to a lot of stories recently about how the current NBA salary structure is threatening to put the NBA out of business. The system is broken these stories say and an out of control salary structure is threatening make small market teams extinct.
The stories are fairly easy to believe. All you have to do is close your eyes and think and very quickly a few examples of grossly overpaid player quickly come to mind.
Spoilers
As I was listening and reading an interesting thing happened. Massive warning bells went off in my head. My brain’s finely tuned financial bs detector, trained to spot where numbers don’t quite add up, called shenanigans. The owner’s claims that Player salaries are driving the NBA into the ground are simply not true. They’re hoping the people they’re bargaining with fail at basic math or aren’t paying attention.
Here, then, is my attempt at explaining what is actually going on. Before that you might want to peruse the following links for background:
I managed to source a link for:
- Larry Coon’s collective barganing agreement (CBA) FAQ at cbafaq.com
- Forbes list of NBA revenues by Team (http://www.forbes.com/lists/2008/32/nba08_NBA-Team-Valuations_Rank.html)
- Wikipedia entry on the NBA Cap (http://en.wikipedia.org/wiki/NBA_salary_cap#NBA_Salary_Cap_history)
- US inflation (http://www.inflationdata.com/inflation/inflation_rate/historicalinflation.aspx)
Back already? Good. Let’s get to the numbers.
The key fact to start with is the following: Players salaries are a fixed Cost at 57% of League Gross revenue.
Let’s repeat that: Players salaries are a fixed Cost at 57% of League Gross revenue!
Any and all cap nonsense is a bunch of hot air. By being fixed to league revenues, player salaries cannot balloon out of control. The league in fact has controls in place in the CBA to keep that number fixed. Those controls are:
- The Luxury tax limit, which is simply set by taking the league’s estimate of gross revenue for the season dividing it by 30 and multiplying by 57% (and adjusted against actual revenue using Control #2).
- The League holding back 8% of player salaries in escrow and using that money to make adjustments to guarantee the 57%. This is the fudge factor that allows them to keep Player Salaries at a fixed percentage of Revenue.
There is a simple equation then for determining how much money the league actually makes:
Profit Margin = League Revenue -Player salaries (a fixed cost) – Team expenses (Variable Cost)
The big problem with a lot of the analysis I’ve read is this is that not all of this information is public and it makes determining the truth somewhat hard. Writers and analysts are left scrambling for answers based on gut and feel because they don’t have all the facts.
This is a problem we can fix. After all in the advanced stats world we deal with complicated equations all the time and this one is much easier.
Let’s lay out the relevant information:
- Using the Luxury tax limit numbers for each year we can figure out Player Salaries (Luxury Tax Limit times 30)
- We can determine League revenue (Player Salaries/0.57).
- We can assume the league made money in 2005 (say 14 million per team or about $420 Million total)
- The League claims an operating loss of 300 Million this year.
- The owners get the 40% BRI number the union claims they want.
- Player Salaries and revenues are locked in at 2.4% percent increases tied to inflation (with one notable exception)
- TV rights go up 21% as they did when last negotiated (the exception)
Under this extremely favorable scenario, the owners will still start losing money by 2020 and looking again at player salaries with evil intent.
Ok, maybe the math is not so simple but the conclusion is clear. The owners are looking to take the money from the talent. Funny that it all comes down to simple incentives in the end.
-Arturo
Wages of Wins Journal 
mmotherwell
June 30, 2011
Wow – that is a story the player’s union really needs to get out there – especially in light of the fact that NBA teams surely make more revenue, because the 57% is based on only SOME of the things the NBA makes money from.
Basketball Related income (BRI)and some of the things not included: http://members.cox.net/lmcoon/salarycap.htm#Q13
Mel Hauser
July 1, 2011
Why don’t the players threaten to start an exhibition season? –I would expect some cable network would be more than willing to buy insurance and book locations. Basketball is an easy sport to set up–and this threat will scare the NBA robber barons
scottat
July 2, 2011
Great article – thanks for the breakdown. However, it’s not as obvious that the owners are at fault as you imply. The main problem with the CBA seems to be that it punishes teams for investing into potential new revenue streams – truehoop has a good example of this: (paraphrasing) if owners invest $100 million in China and gain $120 million, they actually lose something like $50 million under the CBA.
Definitely not suggesting that player salaries should come out of profits (that would be asking owners to play accounting games), but there ought to be some leeway for investment in the future without needing to deduct salaries first. That being said, it sounds like there’s a basis for negotiations if all that is correct, which is good news.
Jeremy Britton
July 2, 2011
This is fascinating detective work. They key insight is that 57% of revenue figure–that locks in a structure of incentive to these discussions people are not recognizing when they talk about the labor dispute. The key questions for me become:
1. What are they spending all this money on?
2. Why?
The dynamic of NBA owner incentives is odd. These are not businesses to owners, they are projects. All of them made money in businesses outside the NBA. None of them grew an NBA team like a startup and squeezed in to the market with a successful product. They don’t feel the failure and the success in the same way because they are heavily insulated from it. My sense is there’s a trophy element to owning a team for these guys. It clouds their good business judgment.
Owning a team is often a vanity project. Having a *winning* team is too. This is different from looking at the operation as a business where winning effects people and the bottom line.
Treating their team like a business would instead put them much closer in touch with the value created by their talent (the players) and the value exchanged with their customers (the fans). They would be concerned with maintaining those two pieces at a high quality while keeping expenses down and revenue up. I don’t see that.
Jeremy Britton
July 2, 2011
@scottat, is your description of $100 in China an investment or a gamble? It’s not clear.
I work with a lot of startups and tech companies in the SF Bay Area. There is a stark difference in companies with leadership who drive them as a business versus a vanity project.
When it’s a business, owners take calculated risks and are invested in the outcomes the people who benefit will receive (e.g. employees, investors and customers).
When it’s a project, they are interested in something more abstract and status-oriented for themselves and a select few within the company. Customers? Eh. Bottom line for the business? Only so far as their investors keep injecting cash.
arturogalletti
July 2, 2011
Scottat,
Let’s walk thru that china example. If the owners spend 100 million in china to generate a 120 million annual revenue they get about 51.6 back this year thru the cba (120 times 43%). If I assume it’s a onetime investment then that number stays at 51.6 every year after that. The payback for that investment is less than 2 years (which is the general rule of thumb for a capital project to get the go ahead in the private sector).
Paul Brian Massari
July 3, 2011
Four simple words to explain the NBA lockout: the owners are lying.
reservoirgod
July 4, 2011
@Arturo:
Hasn’t most of the increase in the owners’ non-salary spending come from the costs of new owners purchasing franchises?
arturogalletti
July 4, 2011
Mosi,
By the publicly available data I estimate half the teams are eligible for the RDA. That’s about $500 million in paper losses a year. I would have to say the change from the 5/50 rule to the 15/10 is the main driver for owner expense.
Eric Arnold
July 5, 2011
This would all be so much more informative if we had an idea of what operating expenses actually were the basis for the increase. (Editor’s Note: Agreed!) For instance: International scouting, increased marketing, higher event (arena) costs/leases, maybe increased interest expenses (although debt from franchise purchase costs should not be in operating expenses), etc.
Most of these expenses would seem reasonable and many of them actually make player’s more money (based on their share of basketball related income).
This is really a very, very incomplete article stub masquerading as a conclusive answer to a complex problem.
BTW, the China example was that the NBA would spend $100 MM and ‘make’ $120 MM back on that complete investment (think borrowing a bank $100 and getting $120 tax free back in a year with no inflation). OK, in this simplistic and unrealistic example, there would be a 20% return. If the investor had to pay 57% of the $120 MM (like owners pay to the players) then the previous example with 20% return becomes a money loser with just $51.6 MM coming back to the league and $68.4 MM (57%) going to the players (who did not invest any of the $100 MM put to risk).
Get it?
Dominic Simon
July 27, 2011
All this would be true if the luxury tax level was really computed by taking 57% of projected BRI. But, in fact, it is 61% (with some further regulations taken into consideration when determining the exact level) and after that the league devides it by 30.
My opinion is that there is no way that one can assume luxury tax * 30 = player’s salaries.
What is true is that the players a secured to receive 57% of the actual BRI – which is calculated at the end of each season.
Or is there anything I am missing?
Dominic Simon
July 28, 2011
I have read some further articles on this page and apparently there are various other pieces of work that are flawed (e.g. the Nets amortization article).
Concerning the Nets article I can not really tell what the issue is because I do not have sufficient knowledge about that particular topic. But here I guess I am right.
But I would be happy to learn how you came to the conclusion that luxury tax = 0,57*BRI.
Eric Arnold
July 28, 2011
Hi Dominic,
I am not reading where the luxury tax number is being argued as an important figure in all of this.
Despite the fact that players seem to think the luxury tax affects them (and I suppose it could affect where they play, but it has no financial impact on them) the luxury tax is basically a system that only financial affects owners amongst themselves. The tax acts as a form of revenue sharing and somewhat of a hard cap. (Interestingly, players seem defiantly against a hard cap, but there is already a hard cap on what amount of BPI they make: 57%)
The players currently get (or did get) 57% of all BPI regardless of whether no teams or every team exceeds the tax limit.
The teams would get any money paid beyond 57% of BPI back through an escrow system, so the tax number does not really matter much for these discussions.
Dominic Simon
July 29, 2011
Hi Eric,
thanks for clearing this up. So, basically even if the cap system in the NBA is considered a “soft cap” there actually is a “hard cap” implemented through the share the players receive.
What Arturo has done here is assume the following:
(1) luxury tax level (for each team) = BRI*0,57 (which is the 57%)/30 and
(2) total salaries = BRI * 0.57 (which is fixed)
Given that, he substituted BRI*0.57 in equation (1) by the salaries equation (2) to get equation
(3) luxury tax = total salaries/30 or the other way around salaries = luxury tax level * 30.
And this what I am concerned about. Because, according to Larry Coon the “tax level is determined prior to the season, and is computed by taking 61% of projected BRI, subtracting projected benefits ($112 million in 2005-06), and adjusting for whether the previous season’s BRI was above or below projections.”
It is nice that Mr. Galletti mentioned the 8% as the “fudge factor” to keep salaries at 57% of league revenues – but it has nothing to do with his calculations (Editor’s Note: Please explain why here). Because the real problem with the “math” above is, that one can NEVER assume luxury tax level * 30 = total salaries.
Additionally, I am a little confused how he “calculated” the figues for his basic year – it seems as in this year he first set a figure for league revenue, multiplied it by 0.57 to get salaries and divided it by 30 – instead of using his “relevant information”. (Editor’s Note: Based on the rules of the CBA, this is how the money for salaries is calculated)
So, my conclusion is that Mr Galetti twisted the numbers and especially the facts (57% and 61% is a little difference) in his favor to prove his doubtful point – maybe he was actually hoping that the people he is selling his story to actually “fail at basic math or aren’t paying attention.”(Editor’s Note: Please provide adequate counter evidence if you are going to use phrases like “twisted the numbers” and “doubtful point”)Should I be wrong with my accusations I would be happy to learn how I am misinterpreting the relevant information.
Dominic Simon
July 29, 2011
Ok, let’s try this again.
To me luxury tax actually is being argued as an important figure in all of this (so I disagree with Eric on that point).
Because, the whole analysis and calculation starts with the luxury tax level which is taken as the basis to calculate the total amount of salary (which is one of the numbers nobody can be sure about).
Following this, the league revenue (another unknown variable) is being determined by deviding the total salaries by 0,57.
And exactly this is what I have to disagree on.
It seems as if you agree with me that your equations are based on incorrect interpretation of the facts – at least there is no note added to this part. Because luxury tax is not 0,57*BRI as you say (instead it is somewhere about 61% of BRI). Thus, it is not possible to compute total salaries on that basis and, in the following, you can not determine the league’s revenues.
This was only possible if luxury tax was 0,57*BRI – because that is the only way one can substitute the variable in the two equations to calculate salaries based on luxury tax level.
Maybe “twisting the numbers” is too harsh – but I also said twisting the facts (which, in my opinion is true – see everything above…)
Concerning note 1: The 8% kept in escrow does actually guarantee that salaries always stay at 57% of BRI (absolutely correct) – but it does not support your argument that salaries are the same as luxury tax level * 30. At least I do not see it and after checking the calculations I did not find any part where the 8% figure was used – so that is why I say it is irrelevant in your analysis/calculation/interpretation (whatever you want to call it).
Note 2: My fault, I only used the numbers given so I calculated 61.3 (luxury tax) * 30 = 1839 (salaries) – leading to 1839/0.57 = 3226,31. Basically the way you taught us to :) so I mistakenly assumed you twisted the numbers and actually used a estimated figure for league revenues (instead of luxury tax level being the estimate) to support your point that salaries and league revenues are growing at the inflation rate (because this year determines the base year). But in fact yor are using rounded figures (luxury tax 2005 is 61.2503 – however you developed that figure).
If there actually is a trick how you used the 8% escrow figure to find a way to let the equation be correct as “luxury tax level * 30 = total salaries” I, again, would be grateful to learn about it – as I also try to figure out the best way possible and with the numbers available what is actually happening in the NBA right now.
Additionally, I am sorry for accusing you the way I did in my recent post – this still is great work. I basically agree with you that player’s salaries are not the critical figure in this situation but I also cannot support the statement that the team expenses alone are to be blamed for the financially poor performance of the league.
I just think that I paid attention and as a result can not entirely agree on the math on which you base your analysis – so maybe you can comment on that.
Dominic