Winners and Losers under the current CBA (Part 2)

Graphic Comments
September 14 2012 09:10AM

Player Expenses 

This is Part 2 in a series on the winners and losers under the current NHL CBA. For all the preamble see Part 1 here.

In first post, I examined at how NHL revenues have changed over the six years prior to and after the 2004-05 lockout. In Part 2, I take a look at Player Expenses and the resulting Gross Income, over the same time period. 

PLAYER EXPENSES

This is where the owners would us to start and stop our analysis.

We've heard and seen quite a bit of commentary and analysis on what has happened to player salaries in aggregate, or on average. But this is one of the key flaws not only in the analysis, but also in the structure of the negotiations.

The owners and NHLPA are negotiating as if the NHL is a single entity. They aren't. They are individual businesses and a one-size fits all approach only serves to complicate the process. The owners can point to the teams Losing Money, and even some of the Breaking Even teams that are slightly in the red and say, "See! We can't survive under the current system." Meanwhile, the NHLPA can point to the Profitable teams and their skyrocketing revenue growth and say the opposite. Doesn't make for meaningful discussions.

So when we break the teams apart into classifications based on how they were performing under the previous capless CBA, we get the chart at the top of the page.

Keep in mind that these are actual cash expenses, including salaries and benefits, paid out by teams each year. The cap is an artificial construct intended to put a drag on player expenses. It is measured on the average annual value of each contract. But as we've seen with recent contracts, many are front-end loaded so that the cash going out the door is actually much higher than the average cap hit.

THE PRE-LOCKOUT YEARS

In the aggregate, player expenses were growing at about 8.7% before the lockout and slowed to a 7.8% growth rate after the lockout. So the CBA did put a drag, however slight, on player costs. That 8.7% growth pre-lockout was pretty constant among the three classes of teams (±0.1%). Of course individual teams could have been, and in fact were, higher or lower than this narrow band.

The thing to note is that the teams that were Losing Money were actually outspending those that were Breaking Even. Not exactly a great example of sound business management principles being applied there. Sure, the gap was closing, but clearly the basic principle that your first line of defense against losing money is to control your costs wasn't being very rigorously applied at the team level. The excuse that they had to spend so much to stay competitive doesn't hold much water. Detroit was the only Profitable team that was winning Cups in that period; the rest of the winners were in the Breaking Even class.

The league's response to this localized problem of a few teams spending beyond their means was to apply the solution across the entire league. And what a solution that was: they put a cap on salaries to bring down costs for teams that could actually afford what they were paying AND they agreed to a floor so that teams that were already Losing Money were forced to pay more than they could afford.

This truly is the fatal flaw in the current CBA.

THE SALARY ROLLBACK

It took a lockout to impose this solution, but salaries were rolled back 24% across the board. Interestingly, while the five Profitable teams cut back the most (about 33%) in player costs, the Breaking Even teams (almost 2/3 of the league) dropped only slightly (about 10% on average). The six teams Losing Money fell in between, registering a 25% cutback.

So what does this mean? As expected, the Profitable teams had the farthest to come down to get under the cap. Even after the 24% rollback they still needed to cut back further by moving some contracts out in order to get under the newly imposed ceiling. The teams Losing Money appear to have done little else to lower their player expenses other than take the rollback and hope for the best.

It was the teams that were Breaking Even that decided to "spend" some of that one time rollback in salaries by adding some new higher-priced contracts, presumably those being shed by the Profitable teams. (NOTE: this is a macro level analysis, so I'm not going to get into how this actually occurred at the micro level with individual teams and specific players. I will leave that for someone else to dig into.)

I'm guessing some of those Breaking Even teams saw this as an opportunity to add some talented players that the Profitable teams could no longer afford. If only there was some advanced statistical analysis that could have helped them identify which players and contracts were actually bargains and which ones were dogs...

But I digress. The point is, the Breaking Even teams spent a good chunk of their rollback savings as an opportunity to try and get more competitive. This is not such a bad thing. Say what you will about parity, from a business perspective, more competitive teams should not only generate greater league-wide revenues but also spread that wealth around. That's the theory, anyway. 

As we saw in Part 1, the inequality in Revenues actually widened after the lockout.

THE POST-LOCKOUT YEARS

After the one-time rollback in salaries, player expenses started to grow again, albeit at a slightly slower 7.8% pace as described earlier. However, unlike the pre-lockout period, when salary growth was fairly constant at around 8.7% across the league, there was a distinct divergence in growth rates under the new CBA: The Profitable teams increased salaries by 9.3% per year, while the Breaking Even teams dropped down to 7.1% growth in player expenses.

This makes sense given that the Break Even teams had already spent some of their cost savings on more expensive players. What doesn't make sense is that the teams that were Losing Money stayed at the same 8.7% growth rate that they had before the lockout. But although it doesn't seem like they made any kind of change to try and control player costs beyond the automatic savings due to the rollback, I'm not sure these teams could have done anything even if they wanted to.

During this same period, the salary floor was rising at a 13.5% annual rate! The floor almost doubled from $23.0 million in 2005-6 to $43.4 million in 2010-11. The combination of rising revenues not only directly increased the player's share, but ratcheted up the actual percentage of HRR from 54% to 57%. The result was almost exponential growth in the salary cap. To further exacerbate the situation, the salary floor was pegged at a fixed $16 million below the cap. This means that the percentage increase in the floor was even greater than the increase to the cap. 

For example, the second year under this CBA, the cap went up $5 million from $39 million to $44 million, a 13% increase. Because of the fixed $16 million peg, the floor also rose $5 million from $23 million to $28 million, or a 22% increase. This rapidly rising floor quickly caught up to the teams Losing Money and they had nowhere to go but up.

I'm not sure the two sides could have designed a system more destined to fail at the stated goal of helping the smaller market teams if they had tried to do so intentionally.

In this respect, the NHLPA can say what they want about the NHL as a whole not doing enough revenue sharing to allow the Losing Money teams to prosper, but eliminating the floor is the single biggest remedy that is under the PAs direct influence. Donald Fehr can put out revenue sharing ideas until he's blue in the face, but he will have zero control over whether they will be implemented. Offer to lower or eliminate the salary floor and I'm sure the owners will eagerly accept. Sure, that might mean we wind up with some completely outclassed teams, but if the NHLPA wants to save the jobs of players in low revenue locations, this is the best way to do it that is within their control.

GROSS INCOME 

Under some kind of rational business model a competent management team would do their best to ensure expenses were somehow in proportion to revenues. This isn't really the case in the NHL. The chart below plots Player Expenses vs. Revenues for all 30 teams in the NHL for 2004 (the last year under the previous CBA) and 2011 (the last year under the current CBA for which we have data).

 

Revenue vs Player Expenses

There was stronger correlation in 2004 than 2011, but the distribution was still pretty erratic. Instead of making the relationship stronger, the cap and floor actually weakened it by forcing the lower revenue teams to spend more than they should and preventing the higher revenue teams from spending more than they can. This is apparent from the flattening of the 2011 trendline.

The other intersting thing to note from this chart is the number of teams above the 2011 cap ceiling of $64 million. We need to adjust this to include non-salary player benefits, which are about $90 million for the league as a whole, or $3 million per team putting the all-in cap at $67 million. There were still seven teams above this limit. This is due to the impact of front-loaded contracts and illustrates how the cap does not really prevent teams from putting themselves into a dire fiscal situation. Nashville and the Shea Weber contract is a perfect example of how the up-front cash hit from a single contract can put an enourmous strain on a small market franchise.

But let's continue with our class-based analysis and see how teams performed in terms of Gross Income. The players continuously tell us that they are the product. If this is the case, in the business world Player Expenses would then be called Cost of Goods Sold (COGS). Subracting COGS from Revenues gives you Gross Income, and Gross Income as a percentage of Revenues gives you the Gross Margin or Gross Profit.

So in effect the expiring CBA fixes the Gross Margin at 43% for all intents and purposes. Yes, this is based on HRR only, but those additional non-hockey related revenues would have their own COGS, so this is close enough for our purposes. To put it in perspective, a 43% margin is on the low side but not out of the question. It really depends on the industry but you typically would want to target a margin in the 45-55% range unless you're dealing with commodified products that have had the costs squeezed out of them due to intense competition. I think we can agree that's not the case with the NHL.

The point is, the move to a 50-50 split of HRR that everyone seems to be saying will be the final resolution, is technically reasonable from a generic business perspective.

But back to Gross Income. Here is how our three classes of teams made out over the last 11 years:

Gross Income

Before the lockout, the Profitable and Breaking Even teams were basically treading water, albeit at slightly different sea levels, while the Losing Money teams were slowly sinking. Remember that Gross Income is the money each team has left over to actually operate the business. So by 2004, those Losing Money teams had, on average, less than $10 million left to run the franchise after paying player salaries and benefits.

The lockout and new CBA gave those teams an immediate $20 million boost. But it still wasn't enough to get them out of the financial hole they were in. In the following years under the current CBA the Losing Money teams have slowly started sinking again. This should be no surprise since we have already seen that their revenues are growing at a slower pace than their player expenses.

The Breaking Even teams continue to basically break even, although some teams within this group have slipped slightly. If you remember from the introduction to Part 1, post-lockout most of the Breaking Even teams either stayed the Same or performed Worse than pre-lockout.

But look at those Profitable teams go. Skyrocketing revenues and a cap on player expenses sure can do wonders for your financial performance. No wonder they're back again trying for a repeat.

At this point it's useful to split apart the the classificaiton system and take a look at the performance of specific teams for illustrative purposes:

 Gross Income by team

So here we see how the three best performing Profitable teams have fared. Toronto, Montreal and the NY Rangers all started taking off even prior to the lockout. There is some difference in revenues between those teams but the main reason for the variance in Gross Income is that the NY Rangers actually spend some of those revenues on higher player expenses. Toronto's pension fund owners were quite happy milking the cash cow.

At the other end of the scale, we have three teams that were not doing very well back in 1998-9: Vancouver, Anaheim and Phoenix. Anaheim fared better than Phoenix post-lockout, but is slowly sinking once again. Vancouver, however, started to climb out of the hole long before the last lockout, and has continued the trend ever since. The team has for the most part spent wisely, and at the same time grown their revenue streams. That being said, their salary expense in 2011 at $73 million was second only to the Rangers' $74 million. So it remains to be seen whether revenues can increase fast enough to match the spike in player expenses.

For reference, the chart also shows where the median and average for all 30 NHL teams. You can see how easy it is to distort the performance of individual teams by focusing only on the league average. The separation of mean and median does provide an indication of disparity of income among the teams, but in general neither measure is of much use for constructive analysis.

CONCLUSIONS

 The conclusions we can draw from the Player Expense and Gross Income data are as follows:

  • At best the current CBA gave the owners one-time relief on player costs and put a very slight drag on salary growth overall. At worst, it put in place a system that structurally ensured the financially troubled teams would continue to lose money.
  • The best way to fix this problem is to eliminate the salary floor. This will assuredly have other consequences, most likely being a two-tiered league in terms of player talent, but it's really the only practical way to offer financial relief to the most troubled franchises without either vastly increasing revenue sharing (a non-starter for the owners) or implementing another draconian roll-back in player salaries (a non-starter for the players).
  • A new CBA that brings player expenses down to 50% of revenues is a reasonable expectation. I think both sides realize this, and have probably discussed it. The only question is do you rip the band-aid off and do it all at once, or do you ease into it and gradually scale back the player share over the life of the next CBA? The players, understandably, are not interested in taking another haircut on contracts that are already signed. The owners, especially the ones who remain in pretty bad fiscal situations, likely think that immediate relief is necessary and are not willing to consider meaningful revenue sharing.

Put everything together and the solution seems fairly clear:

  1. Freeze the salary cap, or limit it to 1-2% increases, until such time as revenues increases bring HRR down to the 50% level. An outright freeze could easily produce a 50% split within 2-3 years if league revenues continue to rise at the same pace.
  2. Eliminate the salary floor. Loose the screws on the teams bleeding cash. This would not only provide immediate relief to the teams that need it, but also help bring the player share of HRR down to 50%.
  3. Adopt some of the non-cash contract restrictions that have been suggested. Things like limiting contracts to five years and constant annual contract values would go a long way to putting a drag on actual cash expenditures. It is much too easy to circumvent the cap in ways that puts financial strain on smaller franchises under the current rules.

Next time, we'll finish up the series by looking at the part of the business that is hardly ever talked about, Non-Player Operating Expenses, which when combined with the analysis so far, will get us to Operating Income.

Other Posts in this Series

Part 1 - Winners and Losers Under the Current CBA (part 1)

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