Freedom of entry, market size, and competitive outcome: evidence from English soccer

Southern Economic Journal, July, 2007 by Babatunde Buraimo, David Forrest, Robert Simmons

1. Market Size in Sports Economics

Market size has been accorded central importance in the analysis of professional leagues. The two-team-league model of El-Hodiri and Quirk (1971), popularized in Quirk and Fort (1992) and still the framework for contemporary analysis, predicted that the larger market club would achieve a higher win-ratio. It had the incentive to hire more talent than the smaller club because greater success on the field could be more effectively converted to dollars where the customer base was bigger. In equilibrium, the superiority of the big club would be more marked, the wider the discrepancy in populations. Hence, the perceived problem of competitive imbalance in sports leagues came to be identified in the literature with the dominance of big city clubs.

Fort and Quirk (1997) and Quirk and Fort (1999), building on testimony to U.S. Congressional hearings by Roger Noll and Ira Horowitz in 1976 and by Steven Ross in 1989 and 1991, (1) argued for the breakup of U.S. major leagues to encourage new entry into large markets. More recently, Ross and Szymanski (2002, 2005) discussed introducing European-style promotion and relegation into American sports as a means to the same end. Each of these proposals is a response to the current situation where franchises confer territorial monopoly. If leagues were broken up, each of the new competing organizations would be expected to ensure a presence in each of the biggest cities. If promotion into the top level of play were permitted, entrepreneurs would be expected to be attracted by the monopoly rents of large market clubs and would invest in squads of players that could gain them entry. Either way, multiple franchises would presumably emerge in the largest metropoles, as has long been the case in open European soccer leagues. With the market divided between competing clubs, there would be more chance of even competition for championships.

Here we illuminate the debate by testing how closely playing success is linked to market size in practice. Further, we are able to test whether such a relationship exists in a long established open sports league that conforms to the European rather than American model of sport. This provides evidence on how radically the breaking of territorial monopoly in America would in fact ameliorate competitive imbalance.

In the United States, experience appears to be consistent with the notion that size matters (a lot). For example, Sandy, Sloane, and Rosentraub (2004), generalizing across the major team sports, remark that "teams that consistently win have been those with access to either the largest markets, revenue sources that are not shared with other teams, or heavily subsidized facilities" (p. 172). But despite such generalizations, there has been no direct systematic quantification of the relationship between market size and success in American sport. Impediments include that the number of clubs in each sport is small (about 30) relative to the requirements of econometric testing and that it is hard to compare market size across clubs. For example, Schmidt and Berri (2001) suggest that, in the attendance demand literature, "a common proxy for size of a team's market is the size of its metropolitan statistical area" (p. 158). They accordingly enter this in linear form in a baseball demand equation. But this is a misspecification. If one club is located in an standard metropolitan statistical area (SMSA) with twice the population of another, it cannot be considered as having double the market size. The bigger SMSA will cover a wider area, and the mean travel cost for residents to reach the stadium will be higher, implying that the ticket demand curve will not be pushed as much to the right as the population figures alone might suggest. SMSA population is, therefore, an inadequate proxy for market size.

In fact, total team revenues, not just gate revenues, are ultimately driven by local fan base as proxied by local population. Teams in European and North American leagues generally derive revenues not just from gate attendance but also from merchandise sales, sales of broadcast rights, and commercial sponsorship. (2) The potential broadcast revenues that a team can command will depend fundamentally on the fan base of the team as proxied by gate attendance. For example, in the English Premier League the biggest teams (Arsenal, Chelsea, Manchester United, and Liverpool) are shown disproportionately often in televised games and consequently earn larger broadcast revenues than smaller teams (Forrest, Simmons, and Buraimo 2005). In European soccer, teams with larger gate attendances tend to earn more merchandise revenues and larger sponsorship deals and larger broadcast revenues (despite collective selling of broadcast rights by the league as a whole; Buraimo, Simmons, and Szymanski 2006).

Hence, market size can be considered as a fundamental determinant of revenue and, therefore, team performance. In European soccer, increased market size generates a larger fan base and greater gate and other revenues, and this in turn facilitates increased budgets to spend on playing and coaching resources that help deliver improved team performance. Section 3 formalizes these relationships into a structural model for empirical estimation. In our particular study, it is notable that teams in the top tier generated substantial broadcast revenues over our sample period, teams in the second tier obtained modest broadcast revenues, and teams in the third and fourth tiers earned negligible income from televised matches (Buraimo, Simmons, and Szymanski 2006). This scaling of broadcast revenues suggests that the relationship between team performance and market size is likely to be nonlinear, and we address this point explicitly in our empirical model below.