Posted by John Vrooman on Thursday, January 15, 2015 in National Hockey League.

Interview with USA Today.

Expansion Theory.

How valuable is the Las Vegas market for any sports league? What do you see as Las Vegas’ strengths and weaknesses as a market

Las Vegas is probably beyond the economic edge for expansion of any of the 4 major NA sports leagues. This is probably from both the internal profit max perspective of the leagues and the external zero-profit welfare max perspective of the fans.  The economic weakness of the market is the disproportionate reliance on a now very competitive gaming industry combined with a fluid fan base.

The underlying financial structure of Vegas is fragile. Almost one-half of the home mortgages are still underwater. The secret to success in a marginal edge sports market like Vegas is revenue certainty and the non-traditional demographic is risky business. This is particularly true in the gate revenue reliant (dependent)  NHL and the NBA .

Given the geography of the NHL, how would Las Vegas fit into the league?

Yes the geographical location is great for the Western Conference which needs to get up to 16 clubs for balance scheduling. If the other expansion club was Seattle then the location advantage would be lost unless it was accompanied by the move of the Coyotes to the Central Division or even a relocation to and Eastern market like Quebec City. The general failure of the Sunbelt Strategy of the 1990’s was partially derived from the ill-advised attempt to gain a balanced regional presence to increase TV rights fees in the US. There is more to a successful NHL franchise than simply the geographical balance of its regional location.

Does a tourist city have more potential for attendance problems?

Yes the NHL takes in over half- of its revenue at the gate and so the economic success of the NHL is the most dependent on the size and economic power of its home market. On top of that the corporate client needs to be more than 80 percent of the ticket sales. That model will never fly in Vegas and the attendance will be very volatile, particularly in a non-traditional hockey market very much like the failed snow-bird experiment in Phoenix.

How big of a marketing coup would it be for the NHL to be first into Las Vegas?

Not so much. The NHL is drawing back from its failed sunbelt marketing  strategy and rethinking and retro-locating franchises back in traditional hockey markets. The NBA experimented with the Jazz playing games in Vegas and dropped the plan.

Have leagues been afraid of Las Vegas because of its gambling emphasis?

Yes but there are laws to protect against gambling on games played in Vegas. The major problem is that the economy and politics of Vegas are dominated by the big casinos. The NHL is already embracing daily fantasy gaming; recently the NHL entered a partnership with Draft Kings and the NBA has matched up with Fan Duel daily fantasy gaming (gambling) sites.

Could Las Vegas support both NBA and NHL franchise?

That’s a big no. Vegas is a one-team town at the max. The economic base is too specialized, shallow and limited to support multiple teams. In the previous analysis Las Vegas comes in 6^th or 7^th in the expansion relocation derby that will involve two expansion clubs and 3 relocation clubs at the most. The sluggishness of the economic recovery in Las Vegas has suggested to some that Vegas may become  the next Detroit, except without the Red Wings. Vegas finishes out of the money.

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Vrooman’s NHL Expansion Theory:

 In NHL expansion there are two basic optimization criteria that are internally inconsistent because the NHL is a natural monopoly cartel.

First, there is an internal league optimum where NHL owners (BOG) maximize the total value of all clubs by restricting the number of franchises and charging hefty expansion and relocation fees. In seeking the internal optimum the owners monopolize (one seller) their regional markets by charging half as many fans twice as much for tickets, cable fees, concessions, etc. As a monopsony (one buyer), the League also employs fewer players at lower than competitive wages. The expansion or relocation fee should be set to compensate the members of the League for loss is value because of the expansion.

In maximizing total franchise value the League is also reluctant to duplicate any of its monopoly markets, because it is a negative sum move. The damage to the value of the existing monopoly team is always greater than the value gain to the second relocation or expansion team. If the relocation or market duplication fee is set to compensate the original club for it loss, then duplication should never occur because the fee is always greater than the gain to the second club.

If the NHL (or any other league cartel) becomes too exclusive then rival leagues will form to occupy edge markets and duplicate large monopoly markets. Existing multiple-team markets are usually the vestiges of past rival league (NHL-WHA, NBA-ABA, NFL-AFL, NL-AL) wars and subsequent mergers.

Second, there is an external league optimum that maximizes the total social welfare of owners, players and hockey fans. Because of the monopoly/monopsony power of the League as a cartel, the external optimum is reached with a larger league size and more than one team placed in the larger monopoly markets.

Gate and venue prices are lower and venues are larger and more inclusive to accommodate more hockey fans, and more hockey talent is paid a higher wage consistent with that talent. In this case rival league warfare is superior because it forces the monopoly league toward the external optimum, by filling edge markets and duplicating larger markets.

The League expansion, relocation decisions (as well as venue size, ticket pricing and payroll roster choices) are of course made by the owners to max out the internal optimum that almost always  comes at the expense of the external optimum.

So the question of optimal league size and league expansion has two completely different answers depending on whether potential expansion/relocation is viewed from the internal profit max perspective of the NHL BOG or the external welfare max perspective of NHL fans and players, as well as the owners.

It is also important to realize the NHL is not the only league in town, and that all major sports leagues are in competition with one another for the limited sports and entertainment dollar (American or Canadian).

The multiple team market theorem also applies to the existence of other sports leagues because multiple teams from all leagues can potentially saturate the market.  Market saturation damages the internal optimum and literally defines the external optimum, where the welfare optimizing league would include a club in every market that could make a positive profit, rather than a max profit.

In this respect the NHL’s “sun-belt” strategy of adding 9 teams in nine years and relocating 4 more clubs toward the sun-belt was actually superior in terms of the external optimum (more hockey in the South) but it ended up being inferior with respect to the internal optimum.

This is simply because the $570 million in expansion fees (5x $50million + 4x $80 million) failed to compensate the existing clubs for the profit squeeze caused by the players share of revenue exploding from 57 percent of revenues to 75 percent of revenues just before the 2004-05 lockout.

This “over expansion” (internal perspective) resulted in the hard cap which returned the players’ share to 57 percent after the 2005 CBA and now down to 50 percent after the current 2012 CBA. The sun-belt move South was also inferior form the LEAGUE perspective because the non-traditional sun-belt markets have a very high winning elasticity of demand from no-traditional hockey fans in Southern mid-markets. In fact it could also be argued that the sun-belt strategy has also failed with respect to the external optimum. The are probably more intense hockey fans in one block of Toronto than throughout the entire US Southwest.

So a modest retro-sun-belt relocation would probably be superior with respect to both the internal and external optima.

VROOMAN’s NHL expansion proposal:

Based on a quick analysis of the relative TV market size (a measure used extensively by the NHL) of markets in North America and the economic performance a few sun-belt clubs here is one of many possible proposal for the NHL based on a reasonable application of the external optimum with corrections for what the League will probably do with respect to the internal profit max criterion. In the attached market size table the most favorable expansion or relocation markets are highlighted in green and the best retro-relocation candidates are highlighted in yellow (existing NHL markets in grey).

Best remaining market choices in economic order:

1. Toronto/Hamilton
2. Seattle-Tacoma
3. Montreal/Quebec City
4. Portland  OR
5. Hartford  CT
6. Las Vegas NV

Also attached are the Forbes estimates of financial strength and the actual attendance number for this season. This points out 3 clear candidates for retro-sunbelt relocation highlighted in yellow:

1. Phoenix
2. Florida (Miami)
3. Raleigh-Durham

From the internal perspective the optimal league size is probably a contraction back to 26 clubs. But if the League is seeking expansion it should add 2 clubs to make a 32 team league of two divisions of 16.

The best expansion relocation from the perspective of the external optimum would probably look something like this:

These hypothetical suggestions are based on market saturation and economic performance.

The 2 expansion slots should go to GTA and Seattle.

Arizona Coyotes should relocate to Quebec City

Florida Panthers should relocate to Portland

Hurricanes should retro-locate to Hartford Whalers.

GTA and Quebec City would join the Atlantic Division (8 teams)

Hurricanes/Whalers would stay in Metro (8 teams)

Seattle and Portland would join the Pacific Division (8 teams)

Tampa would move to the Central Division (8 teams)

Las Vegas is next relocation target.

If the league is reluctant to duplicate the Toronto market then Quebec City would become the next best expansion market. If the NHL balks at the duplication of Toronto then Las Vegas could possible get a relocation club.

If the league is reluctant to put 2 teams in Quebec Province then Portland should become the next expansion site from the internal profit max . Seattle and Portland would join the Pacific and Arizona could possible relocate the KC in  the central division (KC strength is Sprint Center; weakness it may not be a 3 team market).

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