Two Minutes for Interference
By: Cole Rodness & Cam McDavid
The Ivey Business Review is a student publication conceived, designed and managed by Honors Business Administration students at the Ivey Business School.
The fall of 1993 marked a critical juncture in the history of the National Hockey League (NHL) as commissioner Gary Bettman announced the league’s intention to pursue expansion throughout the southern United States. Until this time, the league had not established a strong presence in southern states where hockey was relatively overlooked, and it appeared team owners viewed expanding south as the league’s avenue for growth and pervasive recognition. While it is difficult to argue that the popularity of hockey doesn’t grow in the presence of an NHL team, Forbes’s most recent list of NHL franchises and their respective valuations includes four teams that were formed in southern states in the 1990s – Tampa Bay, Arizona, Carolina and Florida – among the bottom five.
Fast forward to 2015 and clearly not all franchises are thriving as intended. Each of these teams reported a net loss in their most recent fiscal year. With a struggling Canadian dollar, NHL revenue forecasts are now even lower than projected a year ago. Owners must have a strong interest in remedying this issue. It is time for the NHL owners and NHL Players’ Association (NHLPA) to reassess the way they view these franchises and how each interact with the rest of the league to ensure continued growth of the sport and financial success of all participants.
NHL Revenue Sources
The expansion was predicated on the NHL’s push to drive TV revenue. The Levitt report, published during the 2004 lockout, offered unprecedented insight into the inner machinations of the NHL’s financial landscape. As per this report, TV revenues comprise a much smaller portion of league revenues compared to its main driver, gate admissions. This trend is still prevalent currently. In Canada, the NHL signed a deal with Rogers Communications worth $5.2B for 12 seasons, or $433M per year, starting in 2013. In the US, the NHL secured a ten year national TV broadcasting deal with NBC starting in 2011 with an estimated inflow of $200M per year, bringing the total TV broadcasting revenue to $633M annually, or 17% of the league’s $3.7B in total revenue projected for the 2014-2015 season. If compared to figures from the Levitt Report, ticket sale revenue accounts for approximately 53% of NHL revenues, with as much as an additional 21% of revenue being derived from in arena revenue, such as food sales, advertising, and box seats.
In the short term, TV revenue streams are not particularly important because contracts in the US and Canada are fixed until 2025 and 2021 respectively, leaving gate revenue growth as the only major potential source of growth for the next six years. As a result, getting fans to games is of the utmost importance to NHL owners, as onsite fans are imperative to revenue generation, and in turn, franchise valuation. It is therefore in the best interest of owners to have teams located in the most auspicious places possible. In the 1990s the NHL pursued growth into major southern US cities to grow national interest in the sport and heighten the value of NHL content to national US TV broadcasters. While this strategy may have been successful in securing a national TV contract in the US and for a few successful franchises, a number of these teams consistently burn through outsized sums of money. There have been several attempts to move these teams to more lucrative geographic markets, but these opportunities are consistently blocked.
NHL Locations
In June 2007, the Canadian Competition Bureau examined the NHL’s relocation policies to test for anti-competitive behaviour. Eventually, the Bureau ruled that the league was not at fault, but during the investigation a number of the NHL’s relocation policies were brought to light. The investigation revealed that the NHL constitution states that the league cannot relocate a franchise unless there are “extraordinary circumstances” to do so. In addition, move proposals must be approved by 75% of the league’s owners, and not occur within seven years of that team’s previous move. Lastly, there are territorial restrictions that deny the locating of a franchise within a 50-mile radius of another organization, without the consent of the residing team.
Restrictions on moves are probably intended to preserve rivalries, encourage private parties as well as municipalities to develop infrastructure around a team, and maintain historical territory rights. However, while these effects may be desired, a number of side effects may affect the league in an even more impactful negative fashion. For example, in 2007 Jim Balsillie, the CEO of Blackberry, attempted to move the struggling Nashville Predators to Hamilton, a Canadian city with a strong hockey fan base, but was denied. By denying Balsillie, the NHL essentially denied itself a more lucrative financial opportunity. This impacts not only the owner of the Predators and Balsillie, but all teams due to NHL revenue sharing agreements.
Share the Puck
In 2012-2013 negotiations, an “industry growth fund” was created as part of Collective Bargaining Agreement (CBA) finalizations. This fund necessitates contributions of $20M annually to the fund, from centrally generated league revenue. When a team is in the bottom quartile of gate revenue generation, it is required to submit a business plan to the league. In the business plan, teams address the steps that they will take to achieve an acceptable level of business performance in future years. If the plan is deemed acceptable, a team is granted money from the fund and expected to follow through on their respective action plans. If objectives are not met, the franchise may lose future eligibility to access the fund.
Alongside the aforementioned fund, the NHL CBA includes a base revenue sharing program, which allocates 6% of total league revenue, primarily away from the top 10 revenue-generating teams, to financially struggling teams. The redistribution is intended to distribute the cost of players’ salaries. These athletes only perform at their own arena half the time, and revenue sharing aims to ensure that all NHL franchises are capable of maintaining a payroll equivalent to a league target above the minimum salary floor, and can perform up to NHL standards away from their home rink. The result of this should be that each team has the ability to provide a group of players with salaries fairly similar to other teams without these salaries being responsible for a franchise’s poor financial performance. However, this reallocation also acts as a safety net, lessening a team’s incentive to increase gate revenues. The gains realized by investment to achieve heightened ticket revenue would be partially counteracted by lessened sharing.
With 50% of revenue generated from the top 10 teams in the league, and a revenue sharing program that pools approximately 15% of total league funds, the bottom performers have less incentive to become financially successful. This structure does not promote competition within the league; owners of wealthier teams subsidize the unprofitable team locations. By limiting relocation opportunities, and providing a financial crutch to underperforming teams, the NHL owners are constricting league revenues.
The NHL, in its apparent attempt to grow TV revenue in order to match other major sports leagues in North America, seems unfocused on developing the most important revenue generator; selling tickets. It has not created an environment that is suitable for a ticket sales centric revenue model. In order to alleviate the struggling teams, it is recommended the NHL owners revisit the NHL constitution and work with the NHLPA to more precisely align the goals of revenue generation and financial success for all teams through future CBA changes.
Changing the Rules
League owners should seek two key changes in the way franchises operate and interact. They should negotiate with the NHLPA to reorganize the revenue sharing program by making a more competitive process for distributing pooled funds. As well, these owners should work with the NHLPA and each other to loosen standards for franchise relocation.
A new process for distributing funds should require the league’s bottom earners to submit a business plan similar to the industry growth fund proposal. Instead of receiving a calculated sum as outlined in the CBA, teams must request the funds needed to execute their plan. The amount of funding provided to the team will be decided based on the quality and feasibility of the proposal. If there are unallocated funds after this process, they will be rellocated back to the top teams. Teams that fail to achieve their actionable steps in their business plan will be subject to review. The review will impose further restrictions and metrics to be met. If the organization fails to meet the conditions once again, the franchise will be ineligible to take part in future profit sharing.
With regards to relocating franchises, the NHL needs to alleviate the restrictions placed on relocation in the league constitution. Teams with low fan interest and small populations should be allowed to move to locations with more favourable characteristics. A notable successful relocation was the movement of the Atlanta Flames to Calgary. Instead of requiring 75% of owner buy-in for a relocation decision, this threshold should be reduced to 51% to increase the likelihood of teams moving to the most economically viable locations. The seven-year restriction on relocating a team should still be enforced to prevent detrimental turnover, and provide cities with a fair chance to foster a fan base and make a return on invested infrastructure. Nevertheless, by adopting a less restrictive stance on the economics of team relocation, the league will be able to realize its growth potential in stronger markets, helping owners to move away from poor markets. Due to the increased revenues of these previously underperforming franchises, every owner who contributes money to revenue sharing stands to benefit as they are required to share less.
Final Score
The current policies pertaining to revenue sharing and relocation, while well intentioned, are misguided. Stringent application of relocation rules drag the financial performance of the league as whole. With the adjusted regulations, poor performing teams can move to a better market, higher revenue teams can save on revenue sharing, and owners can receive a share of a now bigger pie. Limiting the efficiency and flexibility of the market is limiting the potential profitability, revenue, and valuation of teams, and ultimately, the league.
