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Crunching Numbers: The Forbes report and its implications

Timlogo_medium

This is  another cross-post of a section of a piece first published  at Blazers Edge. Again, it's a topic of general NBA interest and I figure getting the info out this way is more sensible than a FanShot link to the full column No. 49. I also have an ulterior motive: I'd like to spark a couple of the bright minds here to start thinking about and writing about the NBA on a macro level.

The exchange which follows took place by email between me and Jeff Kramer, who operates the NBA salary website Storyteller NBA Contracts and Salary Info. I had interviewed Kramer earlier this season for my column and when the 2011 Forbes report on NBA team revenues, expenses, and values appeared, I immediately wanted to go over things with him to help clarify my own mind.

Kramer was himself already engaged, writing a piece critiquing an article in the Portland Oregonian by that paper's resident windbag, which is linked below if anyone cares. The numbers which we talk about may be found on the internet, the link for the Lakers page may be found RIGHT HERE and you can use links forwards and backwards from that page to see the numbers for the rest of the league.

While this is a long and economics-related piece (i.e. a bit dull), I really hope that it's a discussion starter. We're about six months from a catastrophic lockout and I think that ideas need to be sussed out by fans around the continent and to "trickle up" to the parties in the labor battle. So start to ponder such things and write about them, Team SSR.

Hike!

Sorry again if this is somehow viewed as "spamming" — that's definitely not my intent.

                         xoxo,

                                          timbo

 

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A Conversation between Jeff Kramer (Storyteller) and Tim Davenport (Timbo)

Canzanologo_mediumTim: Forbes magazine has just published it annual report on the economics of the NBA, which has already been noted on this site. You were quick to note with "A Response to John Canzano's 1/26/11 Column" that the information about last year's ephemeral profi tability of the team had been projected forward to the current season and used as "evidence" that the Blazers should reinvest the proceeds in tracking down another high-value player or players. 

The reality is, as you pointed out in the piece, that this season Portland's salary structure has gone up a ton with Brandon Roy and LaMarcus Aldridge's five year deals kicking in. The team is not actually turning a $10+ Million profit this season, as John Canzano either sloppily or dishonestly implied in his piece.

That's really not what interested me about the Forbes report though. With a lockout of the 2011-12 NBA season seemingly inevitable, the players and the owners separated by a vast distance and giving few indications that a successful resolution is in the offing, it struck me that this year's Forbes report on NBA operations is going to be a vitally important piece of common currency between the two sides in the negotiations. Each team has its operational income (profit) detailed for the entire history of the current CBA.

Each team has its revenue meticulously calculated, its salaries tracked, its ticket prices noted. We see what each owner paid for each team and when and can observe how much capital gain in franchise value has been realized. Truly, this is going to be THE third party evidential document in the forthcoming negotiations. If we as fans understand the numbers cited here, we may anticipate how the 2011 lockout plays itself out, I think.

 Jeff: It would make sense that if Forbes can get access to NBA financial data, then the National Basketball Players Association can get access to the same data. So, as Billy Hunter and his staff prepare for the ongoing negotiations with the owners regarding the terms of a new CBA, they might not be quoting Forbes directly, but they'll be quoting the same sorts of data. And it would appear that their position regarding the financial state of the NBA is similar to that being portrayed by Forbes.

The issue would seem to be that the owners see the data in a completely different fashion. If you take the numbers from the Forbes article and add the 30 operating income amounts, you arrive at a cumulative sum of $182.6 Million. Although this is down significantly from the sum of $318.2 Million from Forbes' numbers from just two years ago, it still would indicate that the league, as a whole, is operating in the black.

However, this conclusion deviates significantly from David Stern's contention that the league lost $370 Million last year. Why such a huge difference? It's essentially because the Forbes data, self-admittedly, does not include taxes, interest, depreciation, and amortization. And the owners absolutely account for those factors when they are presenting their position. 

Which leads me to ask two questions: What is the "true" number when it comes to how much the NBA made or lost last season? And how will this gap affect the negotiations for the next CBA? 

In regards to trying to discover "truth" in the numbers, we as fans will probably never know with full certainty. My own suspicion is that the true number lies somewhere in the middle. Everyone — owners, the union, Forbes, etc. — seems to agree that the league is not as profitable as it was several years ago. My guess is that the league actually did lose money as a whole last season (although some teams made money, more teams lost money), but I think that the $370 million is probably exaggerated through the use of accounting techniques (double-counts of depreciation and the like).

Tim: Myself, I don't accept the fundamental premise that most teams are losing money. I've taken the Forbesoperating income (profit) numbers for the past 5 years for each team and entered them into a spreadsheet. Averaging the income of the last 5 years — that is, during the time of the current CBA — according to Forbes19 teams ran in the black, 9 teams ran in the red (including the Blazers), and 2 teams essentially broke even.

In general, big market teams have been highly profitable — despite their insane salary structure, the Lakers have been clearing pretty close to $40M in each of the last 5 years and the Bulls have made Jerry Reinsdorf more than $10M per season more than that.

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(click table to enlarge — use browser back arrow to resume reading)

Who have been the teams that have been losing money? First you have teams with spendthrift multi-billionaires — Dallas and Portland — as well as the current incarnation of fiscal insanity, the Orlando Magic. Next you have the small market teams that suck on the court and that are not being supported by their fanbases, the contraction candidates. These include Charlotte, Indiana, Memphis, and Minnesota. That leaves just two outliers: the New Jersey Nets, who were epically bad but who are now owned by the richest owner in the NBA, are improving on the court, and moving to a new city, and the Denver Nuggets. You tell me why that team is losing money...

Everybody else in the league, according to Forbes, is making ends meet or making money through basketball operations. To me that means the NBA's business model isn't fundamentally flawed. And the NBA would seem to agree, at least by their actions — they just paid something like $310 Million for a Hornets franchise whichForbes values at just under $280M. If Forbes' methodology for estimating income and value is so wildly out of whack on the rosy side, the NBA would have paid less than the Forbes' estimate of value for the team, not more.

Moreover, the profit garnered through basketball operations is only part of the equation — teams have been appreciating in value constantly. The operating income surpluses are akin to stock dividends to team owners, the stocks themselves have been rising in value, pretty much across the board.

The Milwaukee Bucks, for example, have only broken even over the last 5 years in terms of their operating revenue — but the team that Herb Kohl bought for $19M in 1985 is now valued at $258M — the franchise has averaged a gain of almost $9.5M per year in value over the last quarter century. Not a bad investment.

Not all the owners are like Herb Kohl, however, and that's really what's driving this lockout, I think. The owners that are seeking the most radical changes, I understand, are those who came to the table later and who paid gargantuan sums for their franchises. They seek some sort of return on their investment — merely breaking even is of no appeal if you are, for example, Dan Gilbert of the Cavs who bought in for $375M in 2005 or Wycliffe Grousbeck of the Celtics, who bought in for $360M in 2002. One wants to get something back from this sort of investment if one is a billionaire capitalist.

To do that means fundamentally changing the relationship of the teams and the players. If the current system is "break even" for the owners — that's not good enough for the new breed. They want a return on their hundreds of millions of dollars sunk into the teams.

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Jeff: Right, they want to see the money today.

Even if you accept the Forbes figures as the only numbers in the game (I don't, but I don't want to dwell on that), two things stand out to me. The first is what you were just discussing — the equity value of the NBA franchises is not growing exponentially, as it was 15 or 25 years ago. Bottom-line owners want to turn a profit on an annual basis, and I think that has become harder to do for most franchises during the last 6 years. The field has changed since the last CBA was negotiated.

The second thing that I think the Forbes numbers show is that there is a disparity between the "haves" and the "have-nots" in the NBA. As you pointed out earlier, on one side, you have a team, the Bulls, who according to Forbes have averaged $53 Million in operating income under the current CBA. Also towards this end of the spectrum are the Lakers (who have averaged $39 Million in operating income over the last 5 years), the Pistons ($36 Million), the Rockets ($30 Million) and the Suns ($28 Million).

You brought up the Mavericks and the Blazers earlier — their spendthrift ways have led to them losing an average of $13 Million and $10 Million respectively during the span of the current CBA, and they've dug that grave themselves . But you also admitted earlier that 9 other teams have posted an average number that's negative over the last 5 years — that's a third of the league. And that's before accounting for any taxes and interest payments. Granted, most of the losses have been minimal, but they are consistent. And that's probably not flying well with the owners of most of those franchises.

This disparity seems also to be growing. In 2009-10, the Bulls, Lakers, Pistons, and Rockets each posted their "normal" operating income figure exceeding $30 Million. Also add to their ranks the Knicks who posted a whopping $64 Million in operating income. However, 17 teams showed negative numbers in operating income according to Forbesfigures for last year. A system in which some owners are prospering abundantly while over half of the other owners are struggling to make a profit does not seem destined for long-term success.

Tim: I can see that perspective. It's pretty clear that something has to be done to make life bearable for the financially weaker franchises of the league.

This brings up two big questions: 1. What do you think it is that makes a team like the Rockets so profitable while the Nuggets are so unprofitable? Have these two teams had greatly different salary structures over time? That's really pretty much the question behind the forthcoming lockout, isn't it — how to provide the "weak sisters" of the NBA the sort of financial security that the big market teams enjoy? What's Houston's recipe for success and why is Denver failing to get there? and 2. Why has business gone south for the NBA in 2010? Is it a temporary glitch related to the recession, or is it s permanent structural issue?

Jeff: The answer to the first question is easy — the Rockets have a much higher revenue stream. If you look at theForbes data, you'll see that expenses are pretty much the same for Denver and Houston — the Nuggets have averaged $114.6 Million in expenses over the last 5 years while the Rockets have averaged $122.3 Million. However, the Nuggets have averaged $108.8 Million in income for those same 5 years while the Rockets have averaged $152.0 Million.

That's a huge difference. And judging from what I see in the data, it's not a difference in gate receipts so much as it is a difference in other sources of revenue - corporate sponsorship, broadcasting rights and branding rights.

Tim: The one thing that I'd like to see — which one can't see from the Forbes report itself — are the specifics of that bountiful Houston Rockets revenue stream. Clearly there are teams in need of financial relief in the league and if there's one team out there that I'd be interested in "opening the books" on, that would be the one. They are doing something very successfully in the Houston front office that merits study and emulation...

Jeff: That second question is tougher to answer. I think it's a bit of a structural issue plus the effects of the recession. On the structural side, the CBA was set up with the assumption that year by year, both league-wide income and expenses would increase. In fact, the mechanism used to set the salary cap each year essentially assumes that revenues will increase by 8% each year (the mechanism is somewhat self adjusting, but you get the point). And on the side of player salaries, how many are established to receive the maximum raise of either 8% or 10.5%? Quite a few.

However, league-wide revenue just hasn't increased that much in recent years. And although expenses haven't risen by 8% either, their increase is still running higher than for income. From 2007-08 to 2008-09, expenses went up by over 3% while income stayed essentially the same. From 2008-09 to 2009-10, expenses went up by over 2% while income increased by only 0.5%.

In a multi-billion dollar environment, even a couple of percentage points makes a huge impact. And with no guarantee that things will get better any time soon, at least a minor structural change would seem to be in order.

Chuck_medium

Tim: You note the NBA's league-wide revenue stream has remained the same. That would seem to be largely connected to the league's TV deal, which pays something in excess of $33 Million to each team, as I understand it, and which is periodically renegotiated and renewed in the way that the CBA is periodically renewed.

I think that ratings for the NBA in general have been up, which is the opposite direction that most programming is going as broadcasting becomes ever more fragmented by the multiplicity of options. The next TV contract has the potential of bringing a nice little pile of extra money to each team. So things might look "flat" today but show a strong burst of "growth" tomorrow in terms of TV revenue.

The owners are playing with fire if they thing they can play hardball and cancel a season to extract maximum concessions from the Players Association — many of the fans might not be there are the flipside, as Major League Baseball learned. The TV deal is the goose that lays the golden eggs...

As for implementation of a structural fix, that's the hard part, isn't it? Bill Veeck famously said that "it's not the high price of stardom that bothers me — it's the high price of mediocrity." In no other league are situational "role players" and benchwarmers so richly compensated as the NBA. Once a player gets past the first four years of the CBA-prescribed "rookie contract," the financial floodgates open. I'm sure you could give half a dozen examples of lunatic contracts for marginal players without batting an eye...

Jeff: You mean like Luke Walton's $30 Million for 6 years or DeSegana Diop's $32 Million for 5 years? Yeah, there are plenty of bad contracts out there. And I think the owners are looking to reduce the impact of long term contracts that go sour by removing the guarantee on the last couple of years of those kinds of deals. I wouldn't have a problem with that — if a player is no longer earning his salary, it doesn't make sense to hinder the ability of the team to hire a replacement for him because his guaranteed contract is still on the books.

You bring up a good point about future revenue tied to national broadcast rights. However, that's probably far in the future as the current ABC/ESPN/TNT deal is scheduled to last through the 2015-16 season. So between now and then, teams will either have to look to find alternate sources of revenue or decrease their costs if they want to change their bottom line financial landscape. And it looks as though the owners are focusing on reducing player salaries as they negotiate for a new CBA.

Tim: The owners are pushing three basic ways to "fix" the problem of escalating salary costs, it seems: rolling back salaries across the board (which was accomplished in the National Hockey League after a long and bitter stoppage), reduction of the CBA-determined players' share of total basketball revenue, and establishment of a hard salary cap.

The owners have also threatened contraction — without naming names — but I don't think anybody takes that as more than an early bargaining chip: the economics of a buyout of two or four of their own are too difficult and the benefit of such an action too marginal.

I think the players union has indicated a willingness to accept a smaller piece of a (growing) pie. This still leaves the problems of rich teams and poor teams, however, since in the NBA local TV deals are done by the teams themselves (as in baseball) rather than by the league as a whole (as in football). I know the Lakers make gazillions of dollars off their local TV deal and I assume the case is the same for the Knicks and the Bulls and Celtics as "massive market" marquee teams.

It might be too late in the game to fix this by having the league take over all TV negotiations and splitting proceeds evenly throughout the league. One group of owners would have to play hardball with a subset of their peers, those who already paid premium prices to purchase big market teams who would lose perhaps hundreds of millions of dollars of book value in their investment. Owners of small teams, on the other hand, would be the sudden beneficiaries of an "undeserved" windfall boost in franchise value across the board which would follow their newly heightened revenue stream.

That cow is out of the barn already, I'm afraid.

Jeff: Maybe so, but I'm of the opinion that just reducing player salaries is not going to solve the long-term problem of inequality among teams. The way the NBA is positioned now, small market teams like Indiana or Memphis are limited not only by the salary cap/luxury tax numbers that are set each year, but by their financial position. They don't have the luxury of a $90 Million payroll like the Lakers have. That affects the competitive nature of the league and needs to be addressed.

It's why I'm hoping that the owners, in addition to attempts to reduce player salaries, agree to institute a better system of revenue sharing to decrease the gap between the "haves" and the "have nots." Because if they don't, I'm not sure what alternate course the league can take to ensure that all teams have a competitive chance to win.

Tim: Violations of the luxury tax limit are the only mechanism currently in place for sharing local revenues, as nearly as I can tell. The Lakers get a gazillion dollars in their local TV deal, spend like fiends, and wind up kicking $15 or $20 Million or whatever back into the common pot. It's a crude and unfair system.

That's the question: how to keep the richest teams from skewing the playing field. Mark Cuban makes no pretense of trying to "break even" with the Mavericks. He's tried to move heaven and earth to accumulate pieces enough to win an NBA Championship and has happily run in the red doing it. He's perfectly willing to pay "luxury tax" to the league for exceeding the limit — which means to me that the luxury tax isn't high enough.

If paying double salaries isn't enough to keep the Mavericks, Lakers, Magic, and their peers from acting uneconomically, let's quadruple the tax... "If you rich teams want to 'cheat' the spending limit, fine — but now for every million dollars you go over the mark, you pay four million dollars to the league, money which will go to the teams in the league who DO play by the rules, keeping their salaries under the cap." That's my fix.

Second, the thing that has killed the economics of certain franchises are terrible long-term contracts. Here the NFL shows the way, I think: they have a large signing bonus which is paid up front, then the subsequent contract may be terminated by the team at will at any point.

Roysuit_medium

Let's look at the Brandon Roy deal, the current NBA poster child for horrific guaranteed contracts. Roy might have signed a deal for 5 years, $85 Million, let's say, receiving $20M up front as a signing bonus, for instance, and the remaining $65M over the life of the contract. Whoops, midway through the first season of the deal the chronic knee issue becomes incapacitating. If the NBA did not have guaranteed contracts, the Blazers would have had the option to cut Roy and to be on the hook for just for one year of his 5 year deal ($13M) plus his signing bonus ($20M). I'm not saying they WOULD do this, although making such a move may mean the difference between the Portland franchise turning a profit or losing a lot of money four and five years from now. The choice would be theirs.

The real problem is that the owners who have come to the table lately, who have put down hundreds of millions of dollars to buy their teams, want to realize a return on their "investment." They want to make New York Knicks-style profits on their Golden State Warriors purchase, for example. That's the phenomenon that's driving the owners' militancy, I think. And I don't see a solution for that.

So Jeff, how would you solve the structural problems which you see in the league?

Jeff: I'd offer 4 suggestions. First, to combat the inequality of team revenue, instead of quadrupling the luxury tax, I'd institute a revenue sharing plan. Those categories of revenue that are currently not shared (ticket sales, local broadcasting, branding, corporate sponsorship, etc.) would now have 35% of their amounts put into a league-wide pot and distributed evenly amongst all teams. Under that kind of system, the Forbes numbers would show a profit over the last 5 years for 25 teams instead of 19. And the gap between the "haves" and the "have nots" would be decreased. In other words, I'd rather enable teams to have more of an option to go over the tax threshold rather than punish them more severely for doing so.

Secondly, to combat the killer long term contracts that you're talking about (like Roy potentially), make the 4th year of any contract only 25% guaranteed and the 5th and 6th years of any contract completely unguaranteed. This still gives the player some financial security and stability but gives franchises the opportunity to get Eddy Curry-like deals off their books sooner. This also makes the franchise accountable for the decisions that they make for at least 3 years.

Thirdly, I'd define the so-called "max contract" differently than it exists now. Right now, a "max contract" is either calculated as a percentage of Basketball Related Income or it is 105% of what a player made last season — whichever is greater. And that's just for the first year, in subsequent years the player is often given a raise equal to 10.5% of the first year's salary amount. That not only is confusing, it leads to players making 1/3 or more of the team salary cap by themselves. In a couple of years, Kobe Bryant may actually tie up half of the Lakers' cap with his single salary.

My proposal is to have a "maximum salary amount" each year based on the above-mentioned calculation as a % of Basketball Related Income. But nobody makes more than that. So, if you want the luxury of a ‘max' deal, your salary is tied to how the league does in a given year. If BRI goes way up, you get a raise proportional to that increase. If BRI goes down, so does your salary. You are tying your finances to the overall health of the league. No more automatic raises or "exceptions to the max." Maximum means just that — maximum.

Finally, reduce the maximum raise allowable for the non-max contracts. Right now, the maximum raise is 10.5% of the first year salary for some players and 8% for others. Drop those raises to 8% and 6%. As long as revenues only look to increase a few percentage points each year, it makes sense to limit player raises to get into line with reasonable assumptions about those increases in league revenues.

Tim: I like that "Maximum means Maximum" idea — the automatic escalations of big contracts are definitely a major factor driving overall salary burdens. Well, Jeff, I reckon we've given people something to chew on. If any of you out there have any additional ideas on how to save the NBA from itself, feel free to chime in in the comments section below.

 

 

 

Photo Credits: Canzano logo: johncanzano.com. Jerry Reinsdorf: Phelan M. Ebenhack, Associated Press. Chuck:Andrew D. Bernstein, NBAE/Getty Images. Brandon Roy: Steve Dykes, Associated Press. All images heavily tweaked in Photoshop by Tim Davenport.

2010-11 VIEW INDEX.

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