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MLB's Revenue-Sharing Formula

If there's anything people hate more than a losing team, it's a team that wins all the time. From 1995 to 2000, the New York Yankees won four out of six World Series — and two of those victories were clean sweeps of their opponents. Large-market teams like the Yankees seemed to be using their much larger payrolls to abuse the rest of the league in a show of Harlem Globetrotters-style dominance.

Unlike the NFL, in which the majority of revenue is generated at the national level, baseball franchises traditionally generate and retain a large majority of their revenue locally. Also, unlike the NBA or NFL, baseball has no salary cap. In an era of market competition to buy free-agent talent, it seemed inevitable that the teams in larger markets, which had bigger revenue bases, eventually would win out.

Identifying the Imbalance

In 1999, a “blue ribbon” panel commissioned by MLB concluded that “large and growing revenue disparities exist and are causing problems of chronic competitive imbalance. Year after year, too many clubs know in spring training that they have no realistic prospect of reaching postseason play.”

The panel’s report was a litany of those disparities and a summation of that imbalance:

Revenues: Because of faster growth rates on already larger revenues, by 1999 the top seven teams averaged more than double the revenues of the bottom 14 teams.

Payrolls: The ratio of payroll spending by the top seven revenue teams versus the bottom seven went from less than 2-to-1 in the 1980s to 3.5-to-1 in the 1990s.

Competitive Balance: During those five seasons in the late 1990s, none of the 14 teams in the bottom half of payroll spending won even one of the 158 postseason games played. Every World Series was won by a team with one of the top seven payrolls.

See also: “The Report of the Independent Members of the Commissioner’s Blue Ribbon Panel on Baseball Economics, July 2000,” MLB. (PDF download)

Such revenue disparities accelerated in the 1990s as bigger-market teams began setting up their own Regional Sports Networks on cable TV, profiting directly from subscriber fees and ad sales while other teams began to benefit form the first wave of new stadiums, notes Andrew Zimbalist in May the Best Team Win.

To fix this problem, the panel recommended a break in more than a century’s worth of tradition, imposing significant revenue sharing. After hashing out their competing interests, large-market owners, small-market owners, and the players’ union initially struck a major revenue sharing deal during collective bargaining in 2002. Under the latest version, in effect through 2011, all teams pay in 31 percent of their local revenues and that pot is split evenly among all 30 teams. In addition, a chunk of MLB’s Central Fund — made up of revenues from sources like national broadcast contracts — is disproportionately allocated to teams based on their relative revenues, so lower-revenue teams get a bigger piece of the pie.

Potential Winners and Losers

Revenue sharing makes some franchises significant payers and others recipients. For example, in 2005, the Yankees reportedly paid out about $76 million. Meanwhile, the Tampa Bay Rays, Toronto Blue Jays, Florida Marlins and Kansas City Royals each received $30 million or more, according to the Wall Street Journal.

Under the first version of revenue-sharing (from 2002 through 2006), some low-revenue teams seemed to be gaming the system. While revenue-sharing money is supposed to be used to improve on-field performance, some teams appeared to be using the shared revenue to enhance profits while failing to invest in higher payrolls. Last year Forbes reported that from 2002 to 2006, the Royals’ revenue-sharing dollars doubled to $32 million, while their player costs increased only 6 percent. Likewise, in 2006 and 2007, the Florida Marlins reportedly received more than $60 million in revenue sharing, according to The Hardball Times, but the team had opening day payrolls totaling $45.5 million.

Indeed, for low-revenue teams, there was previously a disincentive to fielding a better team and raising revenue — under the 2002–2006 revenue-sharing plan, more money coming in from tickets meant less money coming in from the shared pool of MLB revenues. Lower-revenue teams paid a marginal rate of 48 percent of local revenues into the shared pool, while high-revenue teams paid 40 percent. The current deal seeks to fix that disincentive, with all teams contributing 31 percent. Lower-revenue teams will keep more of the money they’ll make if they field a stronger team.

Baseball also has a competitive balance tax (aka “luxury tax”) on the portion of team payrolls that go above a pre-set ceiling, which rises each year. However, the thresholds are set so high that this tax typically only affects the top-spending New York Yankees and Boston Red Sox. Going by their opening day payroll of $209 million, this year’s threshold of $155 million and a special 40 percent repeat offender rate, the Yankees will pay $21.6 million in 2008 — equivalent to the entire payroll of the Florida Marlins.

See also: “Breaking Down MLB’s Luxury Tax: 2003–2007” by Maury Brown, The Biz of Baseball.

This hardly seems to be slowing down the Yankees’ payroll spending, which rose from 1.86 times the MLB average in 2002 to 2.85 times the average in 2005, according to economists David Berri, Martin Schmidt, and Stacey Brook, writing in The Wages of Wins.

See also: “$23.88 Million Tax? That’s Life, Not Luxury, for Yankees” by Murray Chass, The New York Times.

Effect on Revenues and Payrolls

So does the new regimen reduce the disparity in revenues and payrolls decried by MLB’s blue ribbon panel?

Sort of. Thanks to $326 million in revenue sharing last year alone, the average revenue differential between MLB’s seven richest teams and its seven poorest fell from 118 percent in 1999 to 67 percent in 2007.

The same goes for the payroll ratio between the seven biggest-spending teams and the seven smallest. It was a ratio of 3.5-to-1 in 2000, and according to the AP’s 2008 opening day team payroll list, that ratio is now 2.9-to-1 (though the Blue Ribbon panel recommended 2-to-1 to promote competitive balance).

There are, as ever, some gaps that remain absurdly vast. This spring, the news broke that the Yankees’ top-paid Alex Rodriguez was due to reel in more in salary this season than all the players on the Florida Marlins combined. In fact, A-Rod could pay all the Marlins players this year and still take home $6 million.

Effect on Competitive Balance

But the bigger question is whether those monetary effects have helped to solve the problem of competitive imbalance that was the original reason for shifting around billions of dollars between teams. Again, the answer is unclear.

On the one hand, last year marked only the second season in baseball’s modern history when all teams’ winning percentages were in a competitively narrow band between .400 and .600. And the seven World Series in this decade have been won by six different teams — none of them the top-spending Yankees — with more than a third of MLB’s teams competing in the series.

On the other hand, low-spending and small-market teams still face much greater hurdles to make it to postseason glory. Washington University’s Olin Business School professor Michael Lewis, writing in The New York Times, noted that below-average-payroll teams have won their divisions less than 10 percent of the time in the past two decades. For example, there's the case of the lower-revenue Colorado Rockies, who did manage to squeak into last year’s World Series via a wild-card berth in the playoffs. Once there, however, they were swept by the big-dollar Boston Red Sox, whose payroll dwarfs Colorado’s by more than 2.5 times.

Ultimately, just as in the nonbaseball corporate world, the bigger fish have a much larger margin for error in their product investments. This cushion of money allows teams like the Yankees to lay down nearly $40 million for pitcher Carl Pavano in 2004 — though fans have seen him win only five games since, as he’s spent most of that time on the disabled list.

But by providing smaller-market teams with a raised revenue floor they can then choose to adroitly invest in player development and savvy statistical analysis of free-agent talent, revenue sharing may help alleviate the systemic and growing inequalities found in MLB at the turn of the last decade.

Big Money Versus Smarts and Luck

Some analysts stress that whatever the impact of revenue sharing, the effect of bigger markets and payrolls on team performance is overrated. Just as in the nonbaseball world, big money frequently gets out-maneuvered by a combination of smarts and luck.

Baseball Economist author J.C. Bradbury concedes that there is some big-market advantage: His own regression analysis finds that every additional 1.58 million residents in a market generate an extra win per season. In comparing the biggest-market Yankees to the smallest-market Milwaukee Brewers, size alone would project a New York team winning 10.6 more games in ten seasons. Between 1995 and 2004, however, Bradbury finds the Bronx Bombers won 26.3 more games on average. Thus, he concludes, city size only accounts for 40 percent of the difference in wins. What accounts for the other 60 percent? Bradbury attributes it partly to the ineptitude or skill of the teams’ front offices.

While low-payroll teams are less likely to win their divisions, the addition of the Wild Card in 1995 put two more teams into the playoffs, introducing a greater challenge — and greater degree of luck — to the process of big-budget teams making it to and winning the World Series. Wages of Wins co-author David Berri writes: "No matter how large the Yankee payroll, the opposing teams will also have good players, especially in the playoffs, when the weakest teams have been eliminated. In the end, when two good teams face off, the outcome can be more about luck than about skill. And with the playoffs expanded to three rounds, winning a title in the 21st century might require more luck than ever before. Unfortunately for the Yankees, luck is the one thing money cannot buy."

See also: “Can Money Buy Love in Baseball?” by David J. Berri, Baseball Analysts.

For proof of this, look no further than the beginning of the 2008 season. Though Alex Rodriguez earns more than the entire Florida Marlins lineup, he spent the first half of May on the disabled list with a strained quadricep muscle; meanwhile, those low-payroll Marlins led their division.

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