NBA Lockout

In a few days, the NBA is going to lock out its players.  It's pretty much inevitable.

You're going to hear and read all sorts of rhetoric from the two sides and from media members who don't really "get it."  They'll try to make this a "good guys-bad guys" thing and it's anything but. 

As Michael Corleone said, "It's not personal, Sonny...it's strictly business."

It's my hope here to take the saber-rattling out of this situation and give you a clearer idea of what's truly going on.  Warning: this isn't really about sports, but the basic business dynamics don't require an MBA (come to think of it, I've never found anything that requires an MBA...but I digress).

Finance 101

You'll hear it said that "the NBA is making money," which is both true and completely irrelevant.  The NBA is a league and it doesn't make anything.  If you want to know the financial health of the NBA, you have to ask the profit or loss question 30 times...once each for the 30 actual businesses/teams that make up the NBA. 

Obviously, every business would like to make a profit, but depending on their situation, this can be difficult if such "hidden expenses" like interest on debt and the amortization/depreciation of assets are high.  A business could be reasonably healthy, but because of these expenses, may show a loss.  This is one of the reasons why accountants and financial types keep track of "operating income."  Operating income excludes these hidden expenses leaving a purer picture of revenue less operating expenses.

If you're running at an operating loss, it pretty much means that what you're paying to make your widgets is more than what you can sell them for...not good.

According to Forbes magazine, in 2010 twelve of the NBA's 30 teams posted an operating loss.  That's 40% of the teams in the league and that's a decidedly bad thing.  However, in my opinion, it's not quite that bad since 2 of the 12 operational losers have purely self-inflicted wounds.  The Portland Trailblazers (owner is Microsoft co-founder and noted philanthropist, Paul Allen) and Dallas Mavericks (owner is Mark Cuban, who probably bought the team because of it's name) both spend on players' salaries like they're mega-market teams though they clearly are not.  Put another way, they're irresponsible, but can afford to be.  Oh yeah...Cuban was rewarded for his fiscal irresponsibility with an NBA title this season.

Mismanaged or Just Mid-Market?

You'll likely hear that a big part of the problem in the NBA is that too many franchises are mismanaged.  I don't know if they are or aren't.  However, it's pretty obvious that, if you're the New York Knicks, Chicago Bulls or the LA Lakers, you can charge a lot more for your tickets than if you're the New Orleans Hornets, Sacramento Kings or Milwaukee Bucks.  Even more important, big market teams can make several times what mid-market teams can make in local TV and radio contracts.

It's not a level playing field.

Still, some mid-market teams made money in 2010.  Perhaps the most notable was the Oklahoma City Thunder who posted a remarkable operating income of $12.5MM.  The Thunder is the city's only big league franchise...ever.  In baseball terms, they're strictly Triple-A.  However, when the New Orleans Hornets needed an alternative place to play due to Hurricane Katrina, OKC was chosen and the city received the NBA so enthusiastically that the league helped engineer the move of the struggling Seattle Supersonics franchise to OKC. 

The Thunder inherited a young superstar named Kevin Durant who was joined by star-in-his-own-right point guard Russell Westbrook in 2008.  The Thunder's front office has done a very good job of building around their nucleus and the team has been exciting and very successful on the court.

Some will point to the Thunder as an example of a mid-market team that has done it the "right way."  While I give credit to the Thunder, for the 2009-10 season, they paid Durant and Westbrook a combined $8.6MM.  Durant alone will jump to $13.6MM in 2011-12 and Westbrook will soon follow that same path.

Good-bye OKC operating income.

The Crux of the Matter

Based on the current collective bargaining agreement (CBA) between the NBA players and owners, only about 20 of the current teams can be expected to break even or better in terms of operating income.  In the simplest terms, this means that either the league needs to eliminate "fringe" franchises or significantly change the CBA...ideally by enough to make the current 30 teams viable.

The truth is that neither the owners nor the players want contraction.  For the owners, contraction's a bad idea for two reasons - 1) having 30 significant media markets included enhances their leverage in terms of the national TV contracts and 2) having these markets in the fold minimizes the chances of the formation of a rival league.  While rival leagues seldom succeed for long, they always seem to do two things while they live - raid a couple of your superstars and generally increase players' salaries.

The players, particularly the non-stars, don't want contraction for the most obvious of reasons...fewer job opportunities.

From the owners' perspective, this is where the argument ends.  Contraction or making the CBA more mid-market-friendly.  In the soon-to-commence public relations war, the players and their representatives will seek to add a 3rd alternative...increased revenue sharing.

NBA Revenue Sharing

As I mentioned at the beginning of this article, when taken in total, the NBA is profitable.  The players, while acknowledging the financial problems of the smaller market teams, will claim that the dollars are there...they just need to be distributed more equally.

At first hearing, this may sound good, but it's an absolute non-starter from the owners perspective, and any reasonable business perspective.  If you just bought a mega-market NBA franchise and paid the huge premium for the privilege, you are going to have a very serious and completely reasonable problem if someone tries to cut the (large) anticipated revenue stream that was used to set your purchase price.  You'll also scream bloody murder over the fact that a significant change to the revenue sharing rules would cause the asset you just paid $500MM for to be reduced to $300MM.

When it comes to revenue sharing, it's one of those situations where you simply can't change the rules in the middle of a game.


So What's Next?

The owners pretty much laid their cards on the table when they introduced their $62MM "Flex Cap" proposal.  If the union doesn't accept this in the next few days, the owners may go back to their silly posturing about a $45MM "hard cap" and the elimination of guaranteed contracts.

The problem here is that the owners' Flex Cap proposal may be close to their best offer (though the owners very purposely left key final details open to negotiation).  The union treated the owners proposal like a posturing move (that is, they crapped all over it).  It's possible that the players' representatives made a tactical error here that may cost both sides time and money only to have them end up in the same place they could be right now.

At the risk of repeating myself, the key point is that the owners are determined to come away with a CBA that works for 30 teams, not the current 20 teams who are or could be (if not for owner largesse) in the black in terms of operating income.

The players don't want to give up what they have and this is understandable.  However, if they aren't ready to accept something very close to the owners' Flex cap proposal, the 2011-12 NBA season is unquestionably in jeopardy.

As fans, we're definitely on the outside looking in, but I hope that this helps you be a better consumer of the stuff that the media's about to throw at you.