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November 17, 2011
NBA Lockout
Absence of Reason

by Bradford Doolittle

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Today is day 140 of the NBA lockout. We've lost 117 games to date and there doesn't appear to be an end in sight for this ridiculous pissing match between billionaires and millionaires. Monday's news that the players had rejected the owners "final offer" and had elected to disband their union made me mad. For the first time during these protracted, agonizing negotiations, it took Monday's final blow to finally put me over the top. Until now, believe it or not, I've been able to keep a pretty rosy outlook on the whole fiasco. You see, I made the mistake in assuming that when push came to shove, reason would prevail. Clearly we are not dealing with reasonable men.

Nobody is right. I think the players are more right than the owners--I'll get to that later--but that doesn't forgive their lack of vision, and nothing excuses the owners' collective arrogance. The players, as a group, seem woefully misinformed. They're like some weird sports branch of the Tea Party, spouting off the memes handed down from their misguided leadership because they don't know any better. Now it appears that the future of professional basketball in this country will be decided by groups that determine too many things in this nation of ours: Lawyers and judges.

Granted, both sides are within their rights to take the positions they've taken and employ the tactics they've employed. My journalist wife, who has covered labor disputes in other industries but has no particular interest in the haggling of ultra-rich athletes and team owners, simply shrugs off my complaints about the NBA tussle. It's just the way labor negotiations go, she says. And she's right. Nevertheless, when you consider the scales of the remuneration involved, the public interest in the disputing parties and the effect the lockout has on local economies, this is different. If the auto workers walk out, I'm interested and possibly empathetic to one side or the other, but also am aware that it has no direct bearing on my own life or how I spend my time. Sports may occupy an exaggerated place in American life, but that doesn't make us care any less.

Both the owners and the players have a responsibility to their brethren to negotiate in good faith and land the best deal possible. But that needs to be accomplished within the context of what is reasonable. Who is to determine what is reasonable? To an extent, reason is self-determined. This is a game of numbers and believe or not, it ought to be pretty simple. The sides have to agree to numbers that, regardless of your perspective, are good for the health of the league.

This is where a disconnect has risen. The owners are more concerned with setting the now-extinct union back 25 years than they are about agreeing with what really needs to be done to ensure the continued prosperity of the NBA. The players are more concerned with abstract notions like resolve and solidarity than they are about truly examining what is best for their sport. They speak of preserving the gains of the past for the players of the future, ignoring the fact that if the players can't partner with the owners in a healthy league, the NBAPA's stance is utterly moot.

Here's what we know. By the end of the CBA that expired on June 30, the players were guaranteed 57 percent of basketball-related income. The total BRI last season was $3.8 billion dollars, and the owners earned about $4.3 billion in total revenue. The owners claimed that they lost roughly $300 million last season, meaning that their aggregate expenses totaled at least $4.6 billion. So it cost the owners $1.07 for every dollar that they made.

From the beginning, there has been skepticism over the owners' claims. It was the first issue I identified in Pro Basketball Prospectus 2010-11 as being an impediment to the negotiations. To my mind, this problem has never been adequately addressed. If the league was indeed profitable, and projected to remain so during the duration of a new collective bargaining agreement, then the previous system in place was working fine on an economic basis. Competitive balance is another issue--and a Trojan Horse as far as I'm concerned, but we'll save that for another tirade.

However, if the owners' numbers are legit, then the players bear a responsibility to accept sweeping changes both to the system and the split of revenue. I doubt that many fans or players care whether or not the owners of an NBA team makes a killing from the running of his franchise. But I think that any reasonable person can agree that it is not best for the long-term health of a sport to expect the league to operate at a loss.

The union eventually came to accept that the league was in the red without, as far as I know, ever publicly acknowledging the scale of the shortfall. Since Billy Hunter never adequately disputed the owner's numbers--it would be more accurate to say that the union groused about them--I've come to feel we have to accept the owners' claims at face value. In other words, the negotiations had to begin with the assumption that the owners lost $300 million dollars last season. Future revenue/expense projections have to be based on that fact. This seriously weakens the union's arguments against significant changes to the BRI split and the old system.

Nevertheless, this doesn't answer the question of if it is reasonable for the owners to be unable to break even when their labor expense was a fixed percentage of revenue. If, at the league level, owners knew that they would be paying 57 percent of the BRI to the player, that still left 43 percent, plus non-BRI revenue, for them to make things work out on the bottom line. If they couldn't make the books come out with 43 percent overhead, then why not? Where was all that money going?

It's difficult to take those numbers and compare them to other industries, but we can take a general stab at them by looking at Major League Baseball using Forbes' annual reports, which are generally more useful in the aggregate than at the team level. Or at least they're disputed less. But we're comparing leagues as a whole, so that will be fine. Keep in mind that overhead expenses for baseball includes supporting expansive minor-league systems, much larger rosters, bigger playing venues, larger front offices both on the operations and business sides and more. In a nutshell, you'd expect baseball to have a larger overhead percentage than basketball.

MLB                         NBA
5898   Total revenue       4300
--     BRI                 3805
2831   Player salaries     2169
2545   Non-labor expenses  1948
43%    Non-labor%           45%
522    Operating income     183
662    Etc.                 483
11%    Etc.%                11%
(140)  Profit/Loss        (300)
(Amounts listed in millions)

I'm inferring a lot from these numbers, but they still tell a story. For baseball, I'm using the accepted standard of 48 percent of revenue going to player salaries, which also happens to be the split the NFL player's union agreed to with its league last summer. (The actual figure may be a little lower.) I'm using Forbes' figures for operating income. For what it's worth, Forbes has accepted the NBA's purported league-wide financials as reported.

From there, it gets even trickier. If the NBA had a plus income of $183 million at the operating level, then for its bottom line to be $300 million in the red, the league had to be accounting for $483 million in interest, taxes, depreciation and amortization, which I've summarized here as "Etc." That's 11 percent of total revenue. I've plugged in the same figure for baseball, as I have no idea what the actual figure may be but know that it exists. Doing so turns baseball's healthy operating income into red ink at the bottom line, to the tune of $140 million. No one believes baseball is currently losing money at the bottom line. What's the disconnect? Eight the NBA has a lot more "Etc." or the leagues are following wildly different accounting methods.

Also, I've calculated non-labor expenses as Total Revenue minus Player Salaries minus Operating Income. This is not quite the definition of overhead--some of those expenses would fall on the operating side--but with no real way to split them apart, they've been lumped together. As you can see, these calculations suggest that on a percentage basis, there are more overhead costs associated with running an NBA team (45 percent) than a MLB team (43). There may be good reasons for this but, for the life me, I can't think of what they might be.

In fact, if you examine the leaked financials of the New Jersey Nets that were posted by Deadspin last summer, these expenses become even more difficult to understand.

NETS OPERATING EXPENSES, 2006
Total revenue               99.2
--------------------------------
Player salaries             58.9 (-)
Loss on players' contracts   0.7
Team staff salaries          9.3
Team costs                  12.6
Scouting                     0.9
Public relations             0.5
Game presentation            1.4
Sponsership sales            3.9
Marketing                    3.1
Ticket sales                 5.9
Ticket operations            0.3
Broadcast                    2.0
Systems                      0.3
General and administrative   8.6
Playoff expenses             2.4
Depreciation/amortization   41.0 (-)
Indemnity insurance          3.0 (-)
--------------------------------
Total operating expenses   154.7
Non-labor expenses          51.8
Non-labor%                   52%

I've backed out player salaries, insurance and depreciation so that these figures would match what I've termed "Non-labor expenses" above. The Nets' overhead, as you can see, was roughly 52 percent of their operating income, which seems absurdly high, but certainly possible. It's expensive to do things in the New York-New Jersey megalopolis and these numbers are five years old--the Nets weren't doing too well at the time. There is no way to know if these expenses are typical of every NBA team. The buckets they've been divided into certainly are, but the amount of money dropped into them ... who knows? But if we assume these expenses are representative for the league as a whole, the big question becomes whether there is simply too much fat on the expense side. For example, what are "team costs", and why did the Nets spend $12.6 million on them?

Just for some context, consider the one of the leaked financials from baseball, in this case the 2008 Pittsburgh Pirates:

PIRATES OPERATING EXPENSES, 2008
Total revenue              146.0
--------------------------------
Player salaries             51.0 (-)
Team costs                  12.6
Scouting                    23.2
Game presentation           17.1
Broadcast                    3.2
General and administrative  17.1
--------------------------------
Total operating expenses   124.3
Non-labor expenses          73.2
Non-labor%                   50%

All of my previous disclaimers apply here as well. I don't know how typical the Pirates' statement is for the rest of the teams in baseball. Also, I've aped the same expense categories from the Nets' statement for consistency. Mainly that affects the "Scouting" category which is actually "Player Development" on the Pirates' statement. Pittsburgh spent less money on overhead as an percentage of operating income than the Nets. The percentages are in the same ballpark, so to speak, but it remains counter intuitive that a basketball team would require more overhead to run than a baseball team.

These are simple calculations I've made with freely available information on the internet. They don't make total sense to me, but recently I've come to accept them. Why? This why:

Total revenue          4300
BRI                    3805
Player salaries        1903
Non-labor expenses     1948
Non-labor%              45%
Operating income        449
Etc.                    483
Etc%                    11%
Profit/Loss             -34

Using the percentages figured in the first table, I've recalc'd a simple P&L statement using the 50-50 BRI split the players apparently agreed to. As you can see, this clears up most, but not all, of the owner's losses. Each percentage point of BRI means about $40 million to the owners' bottom line, so you can see why the haggling over the last couple of digits was so intense. But if the players were willing to drop their BRI split so drastically, they must have accepted the reality of the owners' financial plight. Why else would they do it? Of course, the picture looks even better for the owners if their rollback proposal of 47 percent were to go into effect.

That's why I tend to side with the players' current stance even before getting into system issues, competitive balance and revenue sharing. They've made enough concessions to allow the owners a virtual clean slate. Teams can tighten up their operations, see how things unfold with the economy and revisit the issues in the next negotiations if they can't make a little money. I just can't see any reason why the NBA can't make its economics work on a revenue number of $4.3 billion--a number projected to increase annually.

Yet if the players were willing to come this far on the economic issues, why was an agreement not reached? Where was the breakdown? The breakdown, as far as I'm concerned, was with union leadership. The players seemed steadfast in rejecting the owners' last proposal because of system issues. The BRI split might have been palatable if not for the ... well, I'm not sure exactly.

Best I can tell, the remaining system issues just aren't that important. The Bird exception isn't going away. There is going to be a luxury tax, just as there already was, only it's going to be more severe for big spenders like the Lakers. There has been haggling over the midlevel exception, but the owners dropped their push to do away with it altogether. Other aspects of the owners' proposal will likely restrict player movement. That is a legitimate concern for the players, but not at the expense of millions of dollars in lost lockout salary.

If the players are in agreement about the league's current economic situation, and it appears that they are, then they have to expect to make correlating changes to the system in addition to the reduced BRI split. The owners aren't going to budge just to end up with a system that allows player market conditions to affect their guaranteed share of the revenue. Management is entrenched on these issues, has been for two years, and it's a mistake for Billy Hunter and Jeffrey Kessler to advise the players to the contrary. A league that was losing money is going to be more than willing to sit tight. Meanwhile the players are losing out on checks they will never be able to make back.

I don't want to speculate on the possible outcomes for all of the pending and impending legal wrangling that appears to be upon us, but I'll ask one question: If the owners are trying to fix an economic structure that can objectively be proven to be broken, how are the players going to prove that management has not bargained in good faith? As David Stern says, if they were going to do this, why didn't happen a long time ago? And why didn't Hunter and Derek Fisher ever put the owners' last proposal up for a vote? That seems more like a lack of good faith.

Good faith. These are words that appear to have lost all meaning. What chance does good faith have when both sides are more concerned with who wins than what is right?

It's utterly amazing that after 2 1/2 years of negotiations, we're left with more questions than answers. Instead of a settlement reasonable--there's that word again--to both sides, we're left with litigation. Egotism, arrogance, greed--just about every negative adjective you can think of applies to both sides of the labor dispute. Meanwhile, people I know, those who work in the locker rooms, provide security, prepare food for the press, work as ushers, take tickets, etc., are left in the lurch, missing paychecks near impossible to replace in the current economy. All because the players and owners can't figure out how to make a profit on $4.3 billion.

Follow Bradford on Twitter.

Bradford Doolittle is an author of Basketball Prospectus. You can contact Bradford by clicking here or click here to see Bradford's other articles.

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