September 17 2012 07:57AM
In the previous posts, I examined how NHL revenues and player expenses have changed over the six years prior to and after the 2004-05 lockout. In Part 3, I take a look at Operating Expenses and the resulting Operating Income, over the same time period. I guess you could say this is the money shot. But you probably shouldn't.
So lets continue on this journey into the heart of darkness that is the murky world of NHL finances. But I swear, if I find a feverish and delirious Bruce McNall in a jungle compound at the end of this, I'm going to be really freaked out.
As I explained way back in the introduction to Part 1 of this analysis, you won't find Operating Expenses listed in the Forbes data. But it's easy enough to derive since they give you everything else, and we all know Revenue - (Player Expenses + Operating Expenses) = Operating Income, right?
Right. Now enough with Algebra 10 and Finance 101, here's the data once again classified into financial performance prior to the last lockout:
Two things immediately stand out: the Profitable teams spend more on non-player salaries than other teams, and there is essentially no difference between teams Breaking Even and those Losing Money.
Without a detailed breakdown of these expenses it's really impossible to understand the direction of a causal relationship here, if any. Do Profitable teams spend more on marketing the product, exploiting existing revenue streams, and developing new revenue sources? Or are the larger markets more costly to service? Or maybe their higher revenues allow them to spend more on hockey operations, management salaries, etc.? Probably a mix of all three, but it's impossible to say. The separation from the rest of the league is pretty clear, however.
The fact that the other two classes of teams are pretty close in terms of operating costs over both the pre- and post-lockout periods tells me that's probably a good estimate of the cost of doing business. There might be a floor on player salaries and/or pressures to remain competitive on the ice that are pushing up player costs, but if you're bleeding money your non-player expenses should be kept as low as possible. So assuming some basic business sense among the teams Losing Money, we can assume that operating costs almost doubled, rising from $21 million to $38 million over the 12 year period.
The one caveat here might be that some owners are more savvy than entry level business school practices, and are loading the hockey franchise up with expenses to the benefit of some other business interest. Operating losses can actually be of value. Depending on corporate structures and the inclusion of non-cash expenses in these numbers, the real cash operating expenses may be quite different.
Despite the general correlation of operating expenses between the Breaking Even and Losing Money teams, there is one little blip that bears a little more discussion. Immediately following the lockout, there was a significant increase in operating expenses for the Losing Money teams. If you recall the analysis of Player Expenses in Part 2 of this series, unlike the Breaking Even teams, the Losing Money teams did not turn around spend any of the fiscal relief from the rollback to bring in more expensive players. But it doesn't seem team management was conservative when it came to their own salaries.
Ok, that's wild conjecture on my part. But controversy and salacious accusations sell, so there.
The Losing Money teams were falling slightly behind in Operating Expenses prior to the lockout, probably because they were trying to operate as lean as possible, but they used the extra breathing room to quickly catch up with a 25% increase in that first year. They the fell back in line to their pre-lockout growth trend of about 3% annual increases.
In Part 2, I examined the relationship between Revenues and Player Expenses, and found the correlation pretty weak both with and without the current CBA. That isn't much of a surprise given the structure of the salary cap and floor, as well as the pressure to spend more to put a competitive product on the ice. However, when it comes to operating expenses, we should see a much stronger relationship with Revenues:
Sure enough, the results match expectations. In 2004, Revenues were better correlated with Player Expenses than with Operating Expenses. By by 2011 relative strength of the correlation had flipped. the correlation with Player Expenses dropped from an R2 of 0.57 to 0.46, while the correlation with with Operating Expenses increased from 0.53 to 0.56.
There's still quite a bit of variance, but in general it appears that teams were putting a bit more effort into trying to match money going out with money coming in, at least in terms of a proportional relationship. In absolute terms, there were still plenty of teams spending money they didn't necessarily have.
If you recall, I explained Gross Income as the money left over for operating the business and taking a profit after you've paid for the product, i.e. player expenses. So let's compare Gross Income to Operating Expense. This will really tell us how teams are doing controlling their (nominally more) discretionary costs.
The dotted line represents break-even. Teams to the left are losing money on an operating basis, while those to right are generating an operating profit. The farther away from the dotted line, the greater your profit or loss.
The correlation is actually slightly weaker between Gross Income and Operating Expenses than between Revenues and Operating Expenses, but the increase under the new CBA is about the same. I should note that I'm only showing one year with and without the CBA to keep the chart cleaner and to give an indication how teams were performing at the end of each period. When I plot all teams for all years pre- and post-lockout, the correlation increases by a couple points and the relative change is still the same. So the chart above is fairly indicative of live with and without the CBA.
Two observations on the data. First, pre-lockout, there was much more of a "middle-class" in the NHL with quite a few teams clustered together with $20-40 million in Gross Income and $25-$35 million in Operating Expenses. With a little bit more Revenue and/or a little less in Operating Expenses, most of these teams could easily have moved into the black. But that would take some business acumen and hard work. Much easier to target player salaries as a way to boost up your Gross Income in one fell swoop.
Second, look at the Edmonton Oilers! Ok, you can't because I didn't label them, but the Oilers are that red square at the bottom of the chart, jussssst to the right of the dotted line. They are also the lowest blue diamond on the chart, comfortably clear of that break-even line by 2011.
Say what you will about how Edmonton's management team handles player decisions, from a business perspective, the Oilers are probably the best run of the low revenue teams, i.e. they have been living within their means and doing quite well in recent years. That's not to say they couldn't do more to grow their revenues, but they are definitely controlling costs in line with the revenues available to them. Just wait until they start reaping the benefits from that brand new taxpayer funded stadium...
One final thought on the Operating Expenses. One of the arguments being made to justify the owners' demands despite the huge increase in league revenues is that expenses have also risen, so they're still not making money. There may actually be some truth to this statement. On average, Operating Expenses increased by about $10 millin between 2004 and 2011. If you take all those blue diamonds to the left of the dotted line and drop them vertically by $10 million, most of them get pretty close to breaking even, and some even cross over into small profit territory.
Thus for the majority of the league, increases in operating costs added onto the escalation in player salaries have indeed eaten up pretty much all of the revenue growth that they have generated. Once again, this is an issue of distribution. The handful of teams that were making healthy profits before the lockout, have been making obscene profits under this CBA.
Finally here we are at the bottom line, both figuratively and literally. If you've been reading between the lines and thinking ahead through the previous discussion, the results below should really come as much of a surprise.
The teams that were Losing Money prior to the lockout, were given just enough of a boost to poke their head out of the hole but quickly started sinking back in. Revenue growth really for these teams has never been enough to keep up with base level escalation in player salaries and in the costs to operate a franchise. The decline isn't as steep, and four of the six Losing Money teams performed Less Bad under the CBA, but that's a far cry from good or even adequate.
The Breaking Even teams, on average, continued to break even after the lockout. It's quite possible that the CBA prevented some of them from falling into the same fiscal hole that the Losing Money teams are in, but I'm pretty sure that's not how they viewed their prospects coming out of the lockout. Given that they wrote the deal, I'm pretty sure that most of these Breaking Even teams thought they were about to enter a Golden Age of endless profits. Didn't quite work out that way.
In fact, about half of the Breaking Even teams actually came out Worse under the CBA. Lets look at the Cumulative Operating Income, but switch over to our other team classification system. If you recall, most of the Profitable teams did Better under the CBA, most of the Losing Money teams did Less Bad, and the Breaking Even teams were split between doing about the Same or doing Worse.
In this chart we're simply adding up the Opearting Income or Loss throughout the entire pre- and post-lockout period. More than anything else, this chart goes a long way to showing why we had a lockout last time around, and why we're getting another one. In aggregate, most of the league was doing ok last time around, more or less breaking even or making a little bit of money. But under the CBA, a few teams are quickly acumulating most of the profits, while at the bottom end, the losses have leveled off. It's all those teams in the middle that tell the real story. The CBA has not benefitted them at all, and some are starting to string together money losing seasons and the losses are starting to accumulate.
Here's the same data back into our normal classification system and also as a total for each class, so remember that there are five Profitable teams and six Losing Money teams, with the remainder in the Breaking Even category. As a result the dollar values are distorted compared to the per team charts used earlier, but I wanted to present it like this because this indeed is the money shot:
Those five Profitable teams have accumulated over $1 billion in profits, with 85% of coming under the CBA. At the same time, the red ink has been flowing freely at the other end of the spectrum. In between, the NHL's middle class as a whole has plodded along, but I'm sure they look up to what's happened to those Profitable teams and think the CBA isn't working quite as well as they thought it would, and certainly not how it was sold to them.
That underwhelming performance under the CBA, at least compared to expectations, is certainly a key contributing factor to the owner's willingness to go through this whole thing again. But I'm thinking the number that really sticks in their craw is the $16 billion NHL players have taken home in salaries and benefits over the same period of time. That's actually not much on a per player basis, but as a total it dwarfs even the astronomical profits brought in by the NHL's best performing teams. That, more than anything, is why we're in the mess we're in now.
- The cost of doing business has indeed increased across the NHL. For those middle class teams that haven't seen the huge increase in revenues, those increases in operating costs have pretty much eaten what marginal revenue increases they have had.
- There appears to have been some slight effort to match expenses to revenues, but for the most part teams are all over the place. Based on the data, though, the small market teams should be heading up to Edmonton to see what they can learn about how to operate on a shoestring budget.
- The inequality across the league makes it impossible to have productive negotiations at the NHL level. How can anyone agree on anything when everything is true? NHL teams have taken home $1 billion in profits. No, look, there's losses totalling $600 million over the same period. Both are true, in their own way.
I've outlined my thoughts on the specific changes that I think are necessary to make the current structure of the CBA more likely to achieve the desired results. This time, the discussion leads me to consider the structure of the negotiations at the macro level.
What we have are two sides negotiating terms for the league as a whole despite the fact that the finances of the league as a whole do not scale down to the individual team level. As long as this situaiton persists we will have two problems. First, the negotiating process itself will be extremely difficult. As pointed out above, it's way to easy to have conflicting viewpoints on both reality and potential solutions when dealing in aggregate. Even the analysis I've presented in this series does not necessarily carry through to individual teams within each class that I've grouped them into. Second, and more importantly, whatever agreement is reached by negotiating at that macro level is going to impact the individual franchises quite differently. The performance under the just-expired CBA is a perfect example of this.
There are really only two solutions this lack of scalability. The NHL could transform itself into more of a centrally organized entity. The biggest step in this direction would be much more extensive sharing of revenues. This wouldn't come easy, and I would expect that the only way to implement it would be through greater central control of spending as well. In essence, the NHL facing similar issues to the European Union. In the interests of not making this a four part series, I'll leave that analogy there. The point is, greater financial integration would make it easier to negotiate on aggregate performance and would ensure that the subsequent agreement was applied more fairly across the franchises.
A more radical and unlikely solution would be for the NHLPA re-organize itself into something akin to local bargaining units that deal with franchises on a one-on-one basis. I'm sure the NHL wouldn't like this, but in terms of labour laws, I'm not clear on whether they could prevent it. We've seen moves in this direction with the petitions to the provincial labour boards in Quebec and Alberta. And in the previous lockout, the players in Vancouver actually attempted to form their own PA to take advantage of BC labour laws. I think this is a highly unlikely possibility, from an idealized perspective, if NHL franchises are operating as independent businesses, then their employee contracts really should be tailored to their specific circumstances.
So that's my look into the NHL's finances. Hopefully you've found the journey into the heart of darkness at least a little bit informative. In the end, it's clear there have indeed been some winners under the CBA, but there have been many more losers. Throw in the fact that the players have prospered across the board, and it should be obvious why we've ended up in the final scene of Apocalypse Now yet again. Let the scorched earth campaign begin.
Now you can choose your own winners and losers under the last CBA (R.I.P.). I've loaded all the Forbes data into a Google Motion Chart that you can find below. The chart is fully interactive so you can choose what to put on the axes, how to colour the bubbles and what determines their size. You can also isolate individual teams by picking them from the menu on the right or just click on the bubble that interests you. Then just press the Play button at the lower left to watch how the teams performed over from 1999-2011.
I personally think it would be cool if advanced stats in general were made available in this type of dynamic format. So now that we have nothing better to do during the lockout, maybe somebody that's really keen will work on putting a Google Motion Chart wrapper around all sorts of time-series data. The game-by-game PDO charts would be a perfect candidate, but there are many more applications out there. Here's the developer's info from Google if you want to add something like this on your website.