“It’s a business.”
How often have you heard these words from management, other fans, or talking heads in the media?
This phrase is rarely used when something good happens—it’s more often used to explain an otherwise unpopular trade, the departure of a free agent that the team was unwilling to pay, or occasionally, an increase in ticket prices.
And this has always been the case. The NFL and NHL, and especially Major League Baseball can trace their roots back to essentially amateur club activities. That’s not quite the case with the NBA. The Basketball Association of America (BAA) was started in 1946 by Walter Brown, who owned the Boston Garden and the Boston Bruins, as a way to fill empty dates on the arena calendar.
In that respect, the NBA’s origin story has a lot in common with the Ice Capades.
It’s true, the NBA did not emerge until the BAA merged with the National Basketball League (NBL) in 1949, and the NBL definitely had roots in club sports, but the NBA considers the first game of the first BAA season (November 1, 1946) to be the start of their official history, barely recognizing the pre-merger history of the NBL.
But no matter how often we say, or hear “it’s a business,” we tend to forget that this is a business once it comes time to discuss player salaries. When we go to the grocery store and buy a can of tomato sauce, there’s a pretty clear connection between the money we spend and the object we purchased. The connection between the money we spend and the staff at the grocery store is less apparent, but still, on the whole, fairly obvious.
Yet when it comes to talking about player salaries, in what is, after all, a business just like a grocery store is a business, we tend to forget that nearly every dime in salary comes from us in one form or another. Instead, we default to talking about what owners are willing to spend, as though they have to pay players out of pocket.
They don’t—except under the most extreme circumstances.
What owners choose to pay their players is more about how much of your money they want to keep than it is a decision about how much of their money they want to spend.
Let’s start with a breakdown of how NBA teams get your money, ranging from the obvious to the subtle:
- NBA League Pass
- Parking and concessions
- Merchandise sales in the arena
- Pop-up merchandise vendors outside the arena
- Team branded merchandise purchased from any outlet, including video games
- If you subscribe to a cable TV package that includes a regional sports network (RSN) that broadcasts games, part of your monthly payment goes to the RSN, and part of that money is paid to the team for the right to broadcast the games. In fact, if you live out of market, part of your cable bill might be going to a team that you dislike.
- If you subscribe to any platform, cable or streaming, that includes a national NBA broadcast partner, part of your monthly fee goes to that network, and part of that fee goes to the NBA.
- Some sportsbooks pay fees to the NBA for data, the right to use logos and player likenesses, and other services, so a small portion of money gambled on the NBA goes to the NBA.
- Advertising: here the amount of money that goes to the team and the NBA depends on what the advertising is and where it is. Progressive, a publicly traded company, has to file quarterly reports with the SEC that break down expenses. About 8% of their revenue is spent on what they term “policy acquisition costs,” which is, basically, all those annoying commercials with Flo. So if you’re a Progressive policy holder, part of your premiums go toward the purchase of ad space on NBA broadcasts. Coca-Cola spends about 30% of their revenue on “Sales, General and Administrative” costs—this is almost as much as they spend on the actual stuff they sell—and the largest share of this line item goes toward advertising. Pfizer spends about 17% of their revenue on “Selling, informational and administrative” expenses, which, again, are primarily advertisements (you might be surprised to know that this is more money than the company spends on research and development). A portion of the money you spend on all these products and services ends up with the NBA and its teams. Some advertising money goes directly to the NBA, (as is the case with the Taco Bell-branded Skills Challenge), or to teams in the form of arena advertisements and in game promotions. Other advertising money takes an indirect path, where revenue from commercials is used by networks to pay for their broadcast license fees.
- Tax subsidies: Many teams have agreements with cities that provide direct or indirect tax subsidies.
So how much of this money do teams get to keep outright? And how much is pooled by the league?
First off, teams get to keep the revenue they collect from ticket sales, concessions, parking, and merchandise sold at, and often around, the arena, subject to the terms of their lease with the arena owner.
At this point, we need to get sidetracked for a moment to talk about arena revenues and leases.
There are some ownership groups that own both the team and the arena the team plays in. This is, after all, how the NBA got started.
However, it is somewhat misleading to conflate the two, as sometimes happens with the Knicks and the Warriors, saying, for instance, that the Warriors own their arena. In reality the Warriors are tenants of Chase Arena, albeit ones with very favorable lease terms. A separate legal entity with its own accounting and books actually owns the arena.
Lease terms for teams may be favorable, as would be the case for the Knicks or Warriors, or they may be unfavorable, which Ted Leonsis implies is the case with the Wizards, but they all impact the amount of revenue that a team keeps from hosting games.
On the other hand, teams keep all of the revenue generated by the broadcast agreements they have with RSN’s and local radio stations. This includes revenue from games and may also include revenue from team-produced and team-sponsored shows that the RSN airs.
Revenue from team-branded merchandise is split with the NBA, as is revenue from uniform patches.
Revenue from league-wide broadcast agreements and sponsorships (e.g. the AT&T Slam Dunk Contest) is divided up equally among all 30 teams.
So that’s where team revenue comes from. The next question is how all this revenue turns into the salary cap.
The NBA’s collective bargaining agreement (CBA) has a lengthy section that details all of the revenue streams that are used to calculate Basketball Related Income (BRI).
The key word here is income.
A phrase keeps cropping up whenever the CBA discusses a revenue source that counts toward basketball related income: “net of reasonable and customary expenses.” Now the current CBA doesn’t provide a definition of this phrase, but the 2012 CBA provides an elaboration, stating that “reasonable and customary expenses” include “salaries and benefits directly related to the operations of the Store or New Venture, promotional and advertising costs, rent, direct overhead, general and administrative expenses of the Store or New Venture.”
What this means is that dollar amount the team reports to the NBA to determine the salary cap is calculated after the team deducts all of the expenses associated with selling tickets, selling concessions, paying rent on the arena, and so on and so forth. Furthermore, only half of the team’s income from luxury boxes, personal seat licenses, ads in the arena, naming rights on the arena and at other team facilities counts toward the CBA’s definition of basketball related income. Broadly speaking, tax subsidies are excluded from the calculation of BRI.
The actual salary cap formula is rather complex, but it can be roughly approximated by totaling the basketball related income reported by all 30 teams and dividing by 60 (the target cap is 50% of the average team’s income).
The financial disparity among teams comes from the fact that even though the income of all 30 teams is thrown into a pool to calculate the salary cap, that income is not divvied up on an equal basis among all 30 teams.
Some teams make considerably more money than other teams, and thus the salary cap, as a percentage of the team’s BRI, is higher for some teams than others.
This would be less of a problem if revenue followed a normal distribution, but it doesn’t. The reason why it doesn’t is because normal distributions work best when there are upper and lower bounds on the value being measured. Human height, for instance, follows a normal distribution because, practically speaking, healthy people have both a maximum and a minimum height.
With team revenue, there is a defined minimum, but there is basically no maximum. So instead of getting a nice normal distribution which can be addressed through revenue sharing, you get a distribution that has more statistical outliers on the high side than on the low side. This usually has the effect of raising the average of all values above the median of all values, meaning that most of the teams in the NBA likely report BRI that is lower than the league average. Median refers to the ‘middle’ of a set of figures, for instance the median of ‘1, 2, 3, 5, 14’ is 3, while the average is 5.
But before discussing that revenue and income disparity, it’s worth noting that the team that spends the most money rarely wins a title. In fact, the team with the highest active payroll has only won the title twice in the past ten years (the 2018 Warriors and the 2016 Cavaliers).
Nonetheless, the ability to spend more is a definite advantage. Over the past ten years, the NBA’s champion has had, on average, the 5th highest active payroll in the league, and the NBA champion has been a luxury tax team every year of the new CBA except for the Spurs in 2014, whose active payroll was 15th(!) in the league.
Toward that end, it has been argued that a team whose owners also own the arena has an inherent advantage in that it can spend deeper into the luxury tax without feeling the pinch that a team which does not own its arena would.
The idea here is that either profits from other arena events could be used to offset a high luxury tax bill or that the lease terms for the team will be generous enough to allow the team to earn more from game-day sales than they would under a market rate lease.
The problem is that there really isn’t a “market rate” lease for an NBA team because there isn’t a market. Teams rarely ‘shop’ for new leases, and there’s not much competition for business among arenas in an NBA city. A survey of older leases collected by the Marquette University law school shows agreements that range from per game fees and percentage splits on concessions in Oklahoma City to a blanket operating agreement in Houston based on a fixed annual payment. The Miami Heat paid a grand total of $280,000 in rent on what is now FTX Arena between 1999 and 2018 and still receive over $6 million dollars in hotel tax subsidies from the city, an amount which is only partially offset by an annual $1M payment to the city’s parks department under a new operating agreement.
Thus it’s possible that teams like the Heat, that have extremely favorable lease agreements with their arena owners, are at no disadvantage when compared with teams that “own” their arena. Determining which teams obtain an advantage from their arena deals requires considering more than just the ownership of the arena.
What about the idea that team losses due to luxury tax payments can be offset by arena profits from other events? The problem here is that owning an arena is not necessarily a profitable undertaking. And even where it is profitable, margins aren’t great. MSG Entertainment had revenues for their fiscal year 2019 of $819.9 million and an operating profit of $86M, and that probably represents the high side of what an arena can be expected to contribute toward the bottom line of its premier tenant, assuming ownership is willing to funnel all the profits from the arena back into the team, which is far from a given.
Arena deals contribute to revenue disparity across the league, but they are not the major driver. Local broadcast revenue is. A team which not only sits in a small market but also regularly has games blacked out because it doesn’t sell enough tickets is going to receive far less revenue from its RSN agreement than a team that sells plenty of tickets in a major market. Additionally, revenue from local broadcasts does not seem to be affected by the performance of the team receiving the revenue, as the recent history of the Lakers and Knicks demonstrate.
But there are signs of change which suggest that the RSN advantage is dwindling. RSN revenues are dropping as the number of cable subscribers drops. Any attempt to offset those losses by raising the monthly fee charged to the cable company is going to be met with strong pushback by carriers that are also under pressure due to the shrinking market. In fact, some carriers have already decided to drop RSN’s all together. RSN’s are also limited in their ability to develop a streaming platform for games, as the league already has NBA League Pass. A reduction in RSN revenue will impact the salary cap broadly, but it will dramatically impact teams which obtain a financial advantage from it.
The NBA offsets part of the revenue and income disparity among teams by a revenue sharing agreement. Unlike the CBA, the revenue sharing agreement is not a publicly available document, but its basic structure has been reported on. There are a variety of complicated details, but the overall formula works like this:
Each team throws 50% of its basketball related income into a pot—thus the amount in the pot is equal to the salary cap for the entire league.
Then each team takes out of the pot an amount equal to the salary cap for the year. So this means that in effect, a team with higher income than average will contribute money, while a team making less than average will receive money.
In order to participate in revenue sharing, a team must generate at least 70% of the average revenue for the league. In principle, this means some teams could be excluded from revenue sharing, but in practice, all teams participate.
As implemented, teams which earn substantially more than the league average do not forfeit quite as much as they would under the formula above, nor do teams which earn less make quite as much, but that’s the basic idea.
In addition, every team that does not pay the luxury tax receives a split of the league’s luxury tax take.
After these distributions, there is still a gap between small market and big market teams, but it is significantly narrower than generally assumed.
The upshot is that every team in the league has, after revenue sharing and the luxury tax distribution is factored in, enough money to spend the full amount under the salary cap, while still leaving a hefty amount of basketball related income for an operating profit, even if they exceed the cap. How much? Well, let’s do some back of the envelope calculations.
First off, there are team expenses that come out of basketball related income, including salaries paid to team executives, coaches, front office staff and team support personnel. Other costs include practice facilities, travel expenses and insurance. Some teams have debt obligations, including revolving credit facilities (basically, a gigantic credit card) with balances. These expenses are not deducted before BRI is calculated, so they come out of BRI along with player salaries.
It is notoriously difficult to put dollar figures or percentages on these amounts, but a 2018 Sports Illustrated piece provides some clues. According to SI, 58% of the average small market team’s expenses went toward player salaries, while major market teams paid roughly 52%.
For the 2017-2018 NBA season, total player salaries came to $3.2 billion. If we assume that player salaries across the league were about 55% of a team’s expenses, that implies that expenses across the league were about $5.82 billion. NBA revenue for the 2018 season came in at about $8 billion, leaving an aggregate profit for the league’s teams of about $2.18 billion, or about $72 million per team.
Here, again, we have to be careful because there is probably not a normal distribution of profit across the league. Since there is no practical ceiling on a team’s profit, while revenue sharing and luxury tax distributions provide a reasonably sound floor for losses, we should expect more outliers on the high side of the average than on the low side, which would translate to an average profit that is higher than the profit of more than half of all NBA teams.
However, even factoring that into our calculations, there seems to be enough of a margin for error in that profit estimate to assume that any team is capable of both fielding a competitive team and turning a profit. Granted, that profit might be less than what some players on the team earn in salary, but it is a profit.
Ultimately, revenue for NBA teams comes from you, the viewer. Some of it comes directly and obviously, as is the case with ticket sales. Some of it is not as obvious, amounting to spare change from your monthly insurance premiums, about a buck from a $150 Miami hotel room, or a few bucks from your monthly cable bill, but in each and every case, that money comes from your pockets, not the owner’s.
In a very real sense, you spend more money on the team than the owners do.
But don’t owners spend money when they buy the team?
No. Not really. Let’s say you buy 100 shares of a stock that pays a $.25 dividend every quarter and costs $8 per share. Five years later, you decide to sell the shares for $2 more per share than you bought them. From your initial investment of $800, you have earned $200 from appreciation in the value of the stock as well as $500 in dividend payments, for a total gain of $700 on your initial $800 investment. So, did you spend money on that stock? Or did you invest the money?
It’s the same basic principle when it comes to an NBA team. Not only do the owners collect profits from the team on an annual basis comparable to dividends, the value of the underlying asset—the team itself—increases in value as well. An owner that holds onto a team long enough will almost always reap more than enough money in annual profits to recoup the initial investment expense, before selling it for far more than they paid for it.
At the end of the day, they’re running a profitable business—one that puts money in their pockets instead of taking it out of them. So the next time you hear someone talk about an owner or a team spending money on a player, remember it’s your money they’re spending.