Part 6: The lack of Capital and Labour Mobility to and from the NBA

6)

Capital and Labour mobility are basically non-existent.

By this, I refer not to the ability of players to move between teams within the league, or owners to move franchises between cities. (So don’t bring up Clay Bennett, Seattle fans. Your pain hasn’t been forgotten). Rather, I refer to the ability of players to use leagues other than the NBA as leverage against various CBA restrictions, as well as owners’ abilities to move their franchises out of the entire Association to less restrictive environments.

Earlier, I described the degree to which star players are squeezed by the Collective Bargaining Agreement, and the reasons they are largely powerless to fight this state of affairs. This begs the question, why would such highly sought-after talents tolerate such a situation? The answer is that even star players cannot expect to make more money outside the NBA. Even with max salaries, the NBA’s overwhelming advantages in revenue create a more lucrative environment for the world’s best players than any other league on the planet. As long as this revenue advantage remains in place, star players will have no choice but to accept the less-than optimal monetization of their talents within the context of the players union and the CBA.

During the lockout, some players took jobs in places like Turkey, while the idea of a barnstorming tour of mid-sized US cities was floated among journalists. These alternatives were all grossly insufficient to provide leverage in negotiations, since none of them presented anything approaching the income potential of the NBA. There’s simply no where else to go.

(For a plan on how some players could overcome these limitations, read my piece on a theoretical Champions League of basketball.)

On the ownership side of things, thanks to principle #1 of this column (the comparative nature of the NBA product), owners of successful, creative, high revenue franchises can’t simply abandon the NBA, and escape the burdens of revenue sharing, draft lotteries and the periodic embarrassments of fellow owners. Without other teams to play, each franchise in isolation becomes a shadow its former self.

When France passes a string of business crippling taxes and regulations, companies leave. Wealthy French actors flee to Russia to escape 75% marginal income taxes. (closer to home, Eduardo Saverin, co-founder of Facebook, moved to Singapore to escape paying US taxes before Facebook’s IPO). When China opened its doors to the world, manufacturing flocked there in pursuit of low labour costs. As labour costs in China rose, those same businesses began to move to places like Vietnam or Indonesia. The development of shale gas in the US has brought energy-intensive businesses back to US shores.

In the NBA, however, redistributive regulatory policies like luxury taxes, draft lotteries and mandatory revenue sharing are all possible well beyond the bounds of other business environments thanks to the inability of any given team to simply pack up and join another league. This phenomenon remains true to such a great extent that one can ask if the NBA really behaves, in effect, as single entity.

Part 5: Kobe Bryant’s New Contract

It is in light of the financial divisions between star players and role players that one should view the recent controversy over Kobe Bryant’s new $25 million per year golden parachute of a contract. The suggestion that star players take less money to facilitate the creation of a championship team is frequently derided as billionaires asking millionaires to take a pay cut. But the Lakers’ salary obligations would remain completely unchanged had Bryant taken less money; they would almost certainly have spent up to the salary cap, and been prevented by the CBA from going higher. The money Kobe would have hypothetically sacrificed would have gone into the pockets of more talented teammates than he would have gotten otherwise. Not a penny more would have gone to ownership (of course a more successful Lakers season would have generated more revenue, but that is an indirect transfer). Having agreed to a fixed distribution of basketball income, the salary of a star is strictly a matter of income distribution between players.

This is not to say that Kobe should have refused the offer and instead demanded, say, a Tim Duncan-type $10 million per year deal. For Kobe as a business person, the question is whether the lost $30 million dollars would be made up by the marginal improvement to his brand associated with the extra handful of wins the Lakers would have seen had he “invested” that money in more talented teammates. In my view, the Lakers would still have been mediocre, with virtually no chance at a championship irrespective of Kobe’s salary over the next two years. So the decision was correct, even if the published justification was not.

Part 4: The divisions within the Players Association

4)

The division within the camps is more important than the division between them.

Not too long ago the NBA experienced a lockout. A sizeable portion of the 2011-2012 season was lost, largely in a dispute over the distribution of basketball related income. Ultimately the sides settled on a (roughly) 50-50 split of BRI. Whether this distribution of income between ownership and labour is fair is, for the purposes of this article, not particularly interesting. Of far greater import is the distribution of the 50% share of income between owners on the one hand, and the 50% share between players on the other.

Player Side

Indeed, it is these distributions of income amongst the players and owners that distort the competitive balance of the NBA. Let us begin with the labour side of things, and list the various rules that redistribute salary across the league’s players and talent across the league:

Age Limit: The age limit shifts salary obligations from raw high school prospects that may not belong in the league to more deserving prospects that do. It penalizes prospects unfortunate enough to be catastrophically injured during their freshman season in college. It also shifts salary from star players who must start their careers later, and accept lower yearly salaries due to the delay in free agency, to the rest of the league. (We will assume the age limit has a neutral effect on player development, which may or may not be true.)

Again, to be clear, we are looking at the effect of this rule on the distribution of salary amongst the players. This rule has zero effect on the owners’ payroll commitments: they are paying the same salaries regardless of the age of rookies.

As for talent, this rule, in theory, shifts talent toward the top of the draft, and therefore to the worst teams. Scouting college freshmen is easier than scouting high school seniors.

Rookie scale contracts: as covered earlier, the rookie salary scale shifts salary from rookies to veterans, and talent to teams picking at the top of the draft.

Max salaries: as covered earlier, maximum salaries shift money from star players who deserve more than the maximum, to the rest of the league, and talent to whichever teams are fortunate enough to have them.

Contract length: longer contracts shift money to injured, old/ineffective and lazy/ineffective players. The longer the term of contract, the more money sunk into non-performing players like Hedo Turkoglu, Gilbert Arenas, and any player who’s semi-official title includes “so-and-so’s expiring contract”.

Longer contracts also shift talent from teams burdened by huge deadweight contracts (multiple teams burdened by Rashard Lewis) to teams with cap flexibility or players performing as expected.

A subset of contract length is the guaranteed nature of contracts in the NBA. The difference between Devin Harris dragging down the Mavericks’ cap and not was the timing of his injury. A few days later, and he’s making millions more. Guaranteed contracts shift money from performing players to non-performing players. Long guaranteed contracts are not inherently pro player. They favour the few lucky enough to sign at the right time.

Hard versus soft salary cap: the specific nature of the salary cap doesn’t influence the amount of money going to the players. The BRI split remains identical in either instance. What the hard cap would change (similar to a severely punitive luxury tax) is the distribution of talent across the NBA. Hard limits (or de-facto limits) reduce the number of cushy jobs at glamour franchises like the Lakers. If LA can spend $90 million on payroll, there’s $60 million to go around after Kobe gets his. If they are effectively capped at $70 million, there are fewer high paying (non-minimum) jobs at a highly desirable franchise.

The tension between stars and the role players who make up the majority of the NBA Player’s Association plays a decisive role in which concessions the Union makes, and which initiatives they fight off. If we look back to the lockout, the players fought tooth and nail against a hard cap and against shorter contracts, while continuing to hold no objection to max salaries or rookie salary limitations. These choices were made to favour the interests of the voting majority of the players union, which is to say, NBA role players and bench players.

The overarching goal of the players union is to maximize the number of career contracts for its members. Every four-year $24 million dollar deal for a guy like Jason Kapono is a success. Like most employees, NBA players want security and stability, even if it comes at the expense of efficiency. Rules like the midlevel exception are essential for such a strategy, and the scourge of team salary caps everywhere. (If one wants to see the pursuit of security and stability for employees taken to the extreme, one need only look to France and Spain, where future generations are being ruined so boomers can have lifetime job security and retire early on a full pension).

Holding down the salaries of the young is a costless concession for the union. Not a single player in the NBA will ever again sign a rookie deal. Players may make a big deal about setting things up for the next generation, but the priority is still on those in the game now. So Anthony Davis makes less than Jason Thompson, and everyone is ok with that. This phenomenon is seen across sports, as amateur or collegiate players (college athletes are really professionals who play for a pittance) have no representation within their future industry until they have already signed their initial contract.

As for the balance of power between stars and the rest, it’s simply a question of math. The union holds a strict up and down vote to ratify any agreement, and there are way more role players than stars. (In this way, the players association resembles the UN, where the US and other democracies are grossly outnumbered by authoritarians and ideologues…not to compare three point specialists to Bashar Assad).

Star players and their agents almost certainly know they’re being squeezed by the CBA, but there is really no upside to fighting this. Firstly, they would probably lose, since they would simply be outvoted by the hundreds of players not affected by the max salary. Secondly, any star player that fights for higher salaries would be seen as selfish, greedy and disloyal. Basketball involves a culture of teamwork and unselfishness, and any player that divides the union over pay increases for a dozen already wealthy stars would see knock-on effects to his brand and status within the locker room.

Owner Side

For another time perhaps. I feel like more has been written about this.

Part 3: The NBA as a rent-controlled league

3)

The NBA is a rent controlled league.

For those of you familiar with the rent control policies of New York, this may ring especially true. Many landlords in New York City are prevented by law from renting their property above a certain threshold; that is, there is a maximum salary from any given rental property. As a result, every single person in the city knows that a rent controlled unit is priced below market value, and thus, an excellent bargain. Normally, the individual willing to pay the highest rent would be chosen by the landlord. Without the market pricing mechanism, potentially hundreds or thousands of potential tenants seek the same property at the same price. So how to distribute these apartments? The answer is a lottery. Where an asset is left obviously under priced due to the distorting effects of regulation, a lottery—that is, chance—is frequently the only fair mechanism for distributing said asset.

Another mechanism for distributing publicly known under-priced assets is sacrifice, frequently in the form of a queue. Anyone who has braved overnight line-ups for Boxing Day deals or concert tickets is familiar with this strategy. If everyone knows the 100 TVs being sold for 80% off are a great deal, there must be a way to fairly decide who has the right to buy those TV’s. An overnight queue allows those individuals most motivated (willing and able to sacrifice sleep, productivity, endure boredom, etc) to emerge with the deal. The undervalued asset goes to those who want it the most, and are willing and able to sacrifice to get it.

Lotteries and queues (or other such need based mechanisms) emerge to provide a sense of fairness among those vying for any prized under-priced asset. That sense of fairness is essential to the credibility of the system in question, and must be maintained to ensure continued stability.

Both of these mechanisms appear in the NBA to handle the distribution of under-priced assets.

The collective bargaining agreement between the players and owners has multiple price control mechanisms, contributing to publicly known* under-priced assets. The first is the rookie scale contract. Rookie salaries are limited to very low dollar amounts for four years, and the team maintains highly valuable rights that extend to rookies’ first extensions (restricted free agency and preferential salary increases) and sometimes beyond (bird rights).

*As opposed to assets undervalued due to inefficiencies in the market. Rim-protectors like Omer Asik or 3&D guys like Bruce Bowen might have been undervalued by front offices at one point, but advances in analytics and SportsVu cameras have brought their value into the open.

The second important price-control mechanism is the maximum salary. The CBA limits the salary of any player to 25-30% of the salary cap in the initial year of a contract, with set raises each year thereafter. A transcendent player like LeBron is limited to the same maximum salary as a merely pretty good player like Joe Johnson. Every team in the league would want Andre Drummond on a rookie scale salary, while every team in the league would want LeBron on a maximum salary (estimates of Kobe Bryant’s value to the Lakers come in at $80 million; that’s $50 million in surplus value. What does that make LeBron worth? Would he be worth $120 million per year to the Knicks on the open market?)

As a first approximation, every single contract that is neither a rookie scale deal or a max contract for a superstar is over-priced. There are a certain number of dollars chasing a certain quantity of added value/wins added/your metric of choice. Many of those wins are locked up in rookie deals or max deals at below average prices, leaving too much money chasing too few wins. Some non-rookie-non-max salaries are bargains, but they are predictably rare.

As a free agent, LeBron James is free to choose any team he wants with cap space; a team that will immediately reap a windfall from production above the value of the contract. Rookies, on the other hand, are obliged to spend four years with the club they are drafted by at low-ish yearly salaries, and highly incentivized to stay for seven years at minimum. The combination of low salaries, exclusive negotiating rights (a rookie cannot sign with any NBA team except the one that drafted him) and the previously mentioned high success rates for top draft picks makes lottery picks and future stars on rookie deals among the most under-priced, universally sought after assets in the National Basketball Association.

The allocation of these highly scarce, highly under-priced, highly sought after young players incorporates the fairness of a rent control lottery (the lottery) with the urgency-based queue system of a Boxing Day sale (the weighing of the lottery towards bad teams).

As long as these price-control mechanisms exist, as long as massively under-priced, universally sought after assets exist, teams will take extreme measures to put themselves in a position to acquire these assets.

Part 2: Basketball as a superstar driven sport

2a)

Basketball is a superstar driven sport, and these stars are relatively easily identifiable as teenagers. If one were to make a list of the best players on each team, and compare that list to the final standings after adjusting for injuries and strength of schedule, the correlation would be extremely high. With all due respect to the Detroit Pistons of 2004, modeling a franchise on the one team without a superstar to win the championship over the course of decades is dumb. (And Rasheed Wallace was way better than people think. He might have been a superstar. And that team was built for an era when physical play was allowed to shut down talent. If there was any era most conducive to allowing a non-superstar driven team to succeed it was the early-mid 2000’s.) I’m not treading on any new ground here.

Chemistry, fit and coaching all shift the actual effectiveness of a team around its true talent level. Greg Popovich gets more out of his players than Dwayne Casey. The Golden State Warriors fit together better than the Sacramento Kings, and playing with DeMarcus Cousins is probably a challenge. These things all matter, but they are simply marginal adjustments one way or the other. This all means that the rational strategy for every single team is to try to acquire a superstar player. This is the single most important consideration in the NBA. A handful of players shift the balance of power of the entire league.

Unlike, say baseball, where many of the best players regularly drop out of the first round and players routinely take four or five years just to make the major leagues, basketball has a significantly higher success rate for top draft picks. Indeed, one of the (faulty) arguments against tanking seems to be that the success rate is not 100%. Yes, it’s possible that you’ll end up with Michael Beasley, or Hasheem Thabeet, but if the options are an (approximately) one-in-two chance of getting one of those guys, and an (approximately) one-in-two chance of getting Kevin Love or James Harden, the expected value of that pick is still absurdly high. There are great players available lower in the draft periodically (Paul George for one), but the likelihood of getting one is significantly lower.

2b)

Young millionaire athletes prefer to live in large cities, ideally in warm weather climates. Teams do not compete on dollars alone. Without redistributive limits on player movement, talent gravitates disproportionately to certain markets. These large markets generally also have the largest revenues. The effect of player collusion can be seen most obviously in Miami, with the big three, but even this month reports have emerged that the Knicks are hoping for Rajon Rondo to force a trade to New York, and are confidently planning for a star to force his way to the team. The leverage held by star players and their agents creates an undeniable distortion of the talent distribution of the NBA.

Series on the underlying factors shaping the NBA (Part 1: The NBA as a comparative product)

There has been much written about the blight of tanking on the NBA. Suggestions such as “the Wheel” or the use of three-year-averages for lottery weighting attempt to address the symptoms of tanking, while leaving the underlying causes intact. To understand why these possible solutions will either fail to address the problem or create more damaging outcomes, I will now explore the core factors shaping the landscape of the NBA.

Table of contents:

The NBA as a comparative product–post 1

The NBA as a superstar driven league—post 2

The NBA as a rent controlled league—post 3

The divisions between the players and their impact on the league—post 4

Kobe Bryant’s contract extension as a transfer between players—post 5

Capital and labour immobility—post 6

1)

The NBA product is not like other experience products, such as dining or theatre or movies. It is a comparative product. One can go to see the symphony in Indianapolis, or eat at the Cheesecake Factory in Sacramento, and enjoy each experience on its own merits. Theatre goers in Minnesota are not forced to watch the local production of Rent immediately next to the Broadway version, exposing the inferiority of the lower budget, less polished attempt in comparison. Nor are diners at said Cheesecake Factory subjected to taunting by fans of fine dining in LA following a perfectly good, but less than championship calibre meal. Every player in the NBA is exceptionally skilled at his craft, and represents the one one-hundredth percentile of global basketball players. The talents of the league’s lesser teams are minimized, however in direct comparison with the absolute pinnacle of the sport through direct competition.

The comparative nature of the NBA product is fascinatingly displayed in the following paradox: there is the simultaneous perception this year that a: the league is filled with mediocre teams offering a mediocre level of basketball (especially in the Eastern Conference), while b: the league is enjoying the deepest talent pool in years. Look at really any team in the NBA in isolation, and one can see skilled players and interesting story lines. There are more exciting young stars in the league than at any point in years, and even the worst teams are staffed by genuinely talented professional players. Yet, when these many flawed teams play each other, the result is a vast middle, just below .500 in the East, and just above .500 in the West. Every game must have a winner and a loser. Whether teams intentionally strategize to lose (76rs) or lose due to inept management/bad luck (Bucks), there will always be bad teams in the NBA.

When evaluating the comparison of NBA teams we must consider 1) The level of parity within any given season 2) The mobility of teams from one level of performance to another between seasons. Whether downward mobility occurs due to intentional rebuilding or ineptness/bad luck is a separate moral question; one which has relatively little bearing on the final shape of the standings.

The comparative nature of professional basketball has tremendous implications for the quality of product produced by consistently bad teams. The raw talent on display at an NBA quality game is drowned out by a home team that consistently loses year after year. The tribal quality of professional sports fandom that works so well to establish loyalty and city wide interest reverses after long periods of dashed expectations. NBA teams cannot thrive without success on the court over the long term. Fan bases can be sustained over periods of failure with the illusion of hope* that their team will one day turn it around. The shattering of this illusion, however, can cause a collapse in the fan base of perennially bad teams.

*Hat tip to Simmons, for an excellent phrase

The effect of the psychology of tribal allegiance on the preferences of sports fans is an interesting topic in its own right. Let’s just say for now that controlling a product that carries with it an almost familial devotion alongside the means to distribute that product (cable television) is a goldmine. A recent study indicated that the most profitable companies carry the lowest customer approval ratings. This doesn’t mean that customer service is irrelevant to business. It just means that being in an industry with inelastic demand is great for profits. After every lockout, fans declare their detachment from the sport in question, then return in greater numbers than ever. As per above, though, there are limits.