Posted by John Vrooman on Sunday, June 10, 2018 in National Hockey League.

Interview with the New York Times.

PDF and Images.

Roger Noll of Stanford had some pretty good stuff today on how the Knights’ miraculous run “attenuates the honeymoon effect,” from the typical three-year window for expansion teams in non-traditional hockey markets.

1) Is that something you generally agree with?

Yes I mentioned that in print in mid-season January:

https://my.vanderbilt.edu/vrooman/2018/01/perfect-storm-in-vegas/

The Vegas Golden Knights are enjoying a perfect storm resulting from the confluence two events. First, the honeymoon period for an expansion franchise in a non-traditional hockey market like Vegas is usually about 3 seasons.

Second, the home attendance in a non-traditional hockey market like Vegas is extremely sensitive (highly elastic) with respect to the quality of the team on the ice. This is especially true for an economically one-dimensional and inverted corporate/tourist season-ticket fan-base expansion experiment like Las Vegas.

The honeymoon effect is common, but the instant success formula is uniquely unprecedented for the Knights because of the historic first-season team quality generated by the uncharacteristically generous expansion draft for the new Vegas club.

Usually the generosity of the expansion draft varies directly with the degree of egalitarian revenue sharing in the respective leagues. The NHL shares the least revenue of all the Big 4 NA leagues by far. (Approximately: NHL 20%, NBA 40%, MLB 50% and NFL 60%).

This is because revenue sharing makes league revenues team interdependent. Revenue sharing is a form of progressive cartelization where the League virtually acts as one big monopoly firm.

Because of the lack of revenue sharing in the NHL, the clubs in the League have historically operated on an economic island heavily dependent on the demand for hockey in their respective market. That was true at least until the more socialistic League-centric Vegas expansion draft.

Traditionally NHL expansion drafts have been the least beneficial of all the Big 4 leagues, but in the case of last year’s Vegas expansion draft the newly egalitarian League has finally decided to give the new kids in Vegas an open shot at the playoffs, if not the Cup.

This generosity is especially true for top net minders left unprotected and available in the expansion draft (existing clubs could only protect 2), but also generally true for defensemen and quality forwards.

This historic Vegas inaugural success is clearly by design of a more forward thinking League, whose BOG has finally realized after several economically isolated sun-belt failures, that each of the individual clubs and League as a whole are only as strong as their weakest club.

2) With the heavy emphasis on entertainment in Las Vegas what is the likelihood that the Knights’ can sustain their success from a marketing standpoint even if the team’s play wanes slightly on the ice? At what point could the team’s “regression to the mean” cost them in the form of declining merchandise sales and gate? In other words, have the Knights bought themselves several more years with their unprecedented run?

The 3-year honeymoon with the relatively shallow and entertainment saturated Vegas fan-base could be extended somewhat by the newly found socialistic league-think mentality of the usually conservative BOG (NHL Board of Governors).

Ultimately, the Vegas Knights synergy window will be slammed shut by the real world effects of the hard salary cap and the interleague competition of the NFL Raiders in 2020.

As long as the Golden Knights are skating, scoring and defending at this Stanley Cup level they can also hold of the challenges of the big, bad and probably overrated NFL Raiders who are scheduled to arrive in 2020.

This is conceivably why the BOG was so generous (if not prescient) in setting the egalitarian parameters for the Las Vegas expansion draft. In effect, the League has reverse engineered its own perfect storm.

The strength of the Golden Knights on the ice derives largely from its depth, particularly on defense with Fleury in goal. Secondary depth after the first line is the underlying feature of the extremely generous expansion draft.

The Golden knights have the draft picks and salary cap room to last about 3 years max before the looming salary cap crash in about 2020, the same year the NFL Raiders are scheduled to arrive in Vegas.

The outside competition with the NFL is similar to the Tennessee Titans crashing the Nashville Predators party in 2001. Initially the NHL Nashville Preds surprisingly held their own against the NFL Tennessee Titans, but it soon became apparent that the novelty of hockey in a non-traditional sun-belt hockey market was risky business.

Both NFL and NHL teams rely heavily on the corporate client season ticket base. The problem is that almost all gate revenue in the NFL is derived from season tickets whereas only about half of the tickets sold in the NHL are season tickets. Corporate season tickets are more valuable than walk up tickets because they are more certain and inelastic with respect to winning and price.

Because of the amount of revenue sharing the cash flow in the NFL is relatively sure money, whereas each NHL club skates on an economic island. Less than 20 percent of NFL revenue comes from the gate compared to almost 50 percent in the NHL. Almost two thirds of NFL revenue comes from national media while national (NA) media is comparative chump change in the NHL (particularly South of the border).

The average NHL team is currently worth about $500 million (the inflated Vegas expansion fee) or about on fifth of the $2.5 billion average value for a club in the NFL. The value of the Raiders will increase from under $2 billion to about $2.5 billion in Vegas, most of which comes from the $750 million stadium subsidy, the largest public subsidy extortion ever paid for a stadium.

3) You had a fantastic point in your column on how home attendance is highly elastic to the quality of play that a team puts forth on the ice. Though the Knights have already sold out season ticket packages for next season, how critical is it for the team to secure additional five and 10-year packages in order to protect to itself if they are unable to replicate their play this season?

The corporate season ticket base is critical to a NHL franchise, because it is relatively certain cash flow that bridges the unavoidable seasonal fluctuations and volatility for team performance on the ice. The key to survival in the somewhat uncertain and inherently risky sports business is cash flow certainty, on both revenue and cost sides of the profit equation.

Another way to stabilize cash flow variance is to diversify risk by sharing revenue, or in the case of the NHL’s Golden Knights expansion draft, by sharing talent. The secret to the Knights success in 2018 is depth and low variance on defense. (Unfortunately for the Knights in the Stanley Cup Finals, depth is also the strength of the Washington Capitals.)

This revenue inelasticity (low variance) is the underlying economic safety-net strength of the NFL. In effect NFL revenue for the Las Vegas Raiders will be more valuable than NHL revenue for the Vegas Golden Knights because it is automatic stone-cold risk-free cash flow.

4) In light of this season’s surprising run, do Bill Foley and George McPhee face even more intense pressure in the coming years to build a winner on and off the ice? By the end of the 2021-22 season, when the collective bargaining agreement expires, how will the Knights be judged versus other top expansion franchises in pro sports history?

Foley and McPhee did a great job with their NHL-stocked hockey talent largesse and the Knights rookie performance on ice is already epic, but the destructive forces of NHL nature are relentless and unforgiving. The hard cap crash and the heavily subsidized NFL Raiders await the Knights in 2020. The hard salary cap from the 2004-05 lockout will probably equalize the Knights before the next CBA is rubber stamped in 2022.

The NHL is very balanced competitively because of the hard salary cap. Before the cap was imposed in 2005 the NHL was the second most unbalanced league to the deterministic dynastic/doormat driven NBA. After the imposition of the cap in 2005-06, competitive balance in the NHL has rivaled the imposed randomness of the NFL.

Unfortunately, the salary cap creates competitive balance by destroying the continuity of quality team production and engineering random mediocrity where equally bad teams are beating each other. Whatever team chemistry the Knights have created on their honeymoon will probably be systematically deconstructed by the hard salary cap in 3 to 4 seasons.

Of all the Big 4 Leagues, winning is the least economically important in the NHL in determining franchise value in either the short run or long run. It doesn’t seem really matter economically whether a team wins or loses in the NHL, unless they are in a non-traditional hockey market.

5) What would be a reasonable goal for the club to achieve in terms of annual revenue? Can the Knights’ realistically rank in the Top 10 leaguewide on a consistent basis? If the team’s success continues, when should Mr. Foley expect to recoup all of the franchise’s $500 million expansion fee?

The realistic long-run expectations for the Knights is to hang with the middle of the NHL pack with current revenue of $150 million. The value of the Knights is about $500 million, which is equal to their expansion fee.

Mr. Foley effectively paid a $500 million up price front for the rights to a Knights’ cash flow equal to a present value of $500 million over the life of the franchise. The League cartel has effectively captured all of the present value of the Knights in the expansion fee and not left much in the exchange for Mr. Foley.

The optimal expansion fee should compensate the League only for the added cost (like sharing talent) and foregone revenues from the expansion (like sharing the revenue pie). In this case the expansion fee should have been in the $300 million range, precisely because the league only shares about 20 percent of its revenue. This is probably why Vegas was the only bidder for an expansion franchise.

In the end the relatively high (exhaustive) expansion fee is probably why the League was so generous with its expansion draft. The Knights were successful by the design of the player expansion draft, but they paid for it in spades with an overpriced expansion fee that was divided equally among the other 30 owners in the League cartel.