The Oncoming Baseball Financial Apocalypse

Baseball is in a financial bubble. Not only baseball: American professional team sports in general. But the action is happening in baseball first. You might not have read about it, because it is happening in slow motion and a lot of people haven’t yet noticed. It’s going to be ugly.

Baseball clubs, and professional sports in general, broadly speaking generate revenues from three sources: stadium revenue (tickets, naming rights, concessions, etc.), merchandise sales (official team jerseys, tchotchkes, etc.), and broadcast rights. All three categories have been growing, sometimes beyond all reason–the amounts people will pay for jerseys is astonishing–but it is the third one, broadcast rights, that are the topic at hand.

Baseball broadcasts used to follow a straightforward business model. A club would sell local broadcast rights to a local television station, which would recoup the costs by selling advertising. On the national level this would be organized on the league level, selling the rights to a television network, which would sell advertising. The model was not really any different from any other TV show.

Enter the cable era. At first, little changed. The broadcast rights were still held by local stations and/or national networks. There were carried by cable systems just like those stations’ and networks’ other programming. Then came cable-only networks, including ESPN. It initially had trouble getting the rights to anything good. Early ESPN programming was a running joke (dodgeball on ESPN 8: “The Ocho”). This gradually changed, and ESPN was able to demand high carriage fees from cable systems.

Carriage fees are central to this story, so please forgive a brief digression. This all about the flow of money in the modern TV economy. Cable networks buy or produce programming and package it as a cable channel. They sell the right to carry that channel to the various local cable providers. The price is negotiated on a per-subscriber basis. For a basic cable channel this based on the entire subscriber base, while for the various premium tiers, only those who subscribe to that tier are counted. The cable provider recoups the carriage fees with individual subscription fees, so the higher the carriage fees the higher your cable bill. The cost of those obscure channels with high numbers is mere pennies, while for the more popular channels you are typically looking at a buck or so. That’s a buck or so each, so all those channels add up, and your cable bill with them.

As ESPN started getting good programming, it was able to plausibly claim to be essential. Not every subscriber cares about sports, but those who do care a lot. Cable systems came to consider ESPN a must-have, and its carriage fees rose accordingly. It now is by far the most expensive channel, at around $5.50 per subscriber per month.

Finally, we come to the regional sports networks. These arose in the late 1990s. The idea was to package sports of regional rather than national interest, meaning mostly local professional baseball and basketball and local collegiate sports. (The NFL is a different situation, with all TV broadcasts controlled by the league: a discussion for a different day.) This on its face is a perfectly sensible idea, but the reality on the ground is not one network for the region, but proliferating networks, each with their particular piece of the action. So you get stuff like the Yankee Entertainment and Sports Network (YES). Now consider a large market with multiple teams playing multiple sports, each horning in on the action. Critical to this is that they each, like ESPN, had a plausible claim to being essential programming within the region, and charging cable systems carriage fees commensurate with their essential status. A basic cable bill ends up jacked up substnatially for the various sports networks.

Let’s step back for a moment and admire the business model. It is all very well and good to create a product that people want, and have those people pay you for it. But even better is to find a way to get people to pay for your product whether they want it or not. Even the best product only appeals to a fraction of the populace. Consider how many people paid to see the new Star Wars movie. Now consider the much larger number of people who didn’t. All those people not buying the product makes any businessman sad. Find a way to make them pay, even though they don’t want your product, and our businessman will be happy.

Professional sports have a long history of getting non-fans to pay them by extorting stadium deals with local governments. These make team owners happy, bu only to a point. Local governments will accept ludicrously bad deals, but they do demand that the contracts provide for some period of years for the deal. This limits how often the owners can belly up to that trough. This makes them sad again.

With regional sports networks, we make those owners happy. The key is that the sports networks are always–Always!–part of the basic cable package. Subscribers pay for them whether they care about sports or not. And, since these channels are essential, the owners can demand premium carriage fees.

Until they can’t. Enter online streaming. Now, the television viewer who considers it critical to keep abreast of the real housewives can do this without a cable subscription. Indeed, it turns out that if you subscribe to Netflix, Hulu, and Amazon Prime you can get nearly everything, for a small fraction of what you had been paying for cable. This is an existential threat for cable providers. I suspect that their business model is doomed, and they will transition into being broadband providers. But that is a different discussion. On topic here is that “nearly” part of “nearly everything.” Baseball and other major sports are the exception. Why is this? Because the rights are locked up in sweet, sweet multi-year contracts. They aren’t available for streaming. This is absolutely essential to maintaining the sports networks’ essential status. The non-sports fans can now keep themselves informed about top chefs without paying for sports. The people who want to watch the sports still have to pay for cable.

Finally we come to SportsNet LA: the canary carcass with the coal miners standing around it. If you live in southern California you probably already know this story, but you might not if you live elsewhere. This is a regional sports network set up by the Dodgers and Time Warner in 2013. Time Warner paid the Dodgers a whopping $8.35 billion–that’s billion with a “b,” folks!–for the rights to Dodgers games over the next 25 years. Do the arithmetic and that comes out to an average of $334 million a year. You can buy yourself a couple good pitchers with that kind of do-re-mi.

Time Warner is itself a cable provider with a chunk of the local market, so partly it figured on making this up through its own subscribers’ fees. The bigger part, though, was to come from selling the rights to the other regional cable providers. It reportedly demanded multi-year contracts with carriage fees starting at $4.90 and going up from there. This would make it by far the most expensive regional sports network, and indeed second only to ESPN among all networks.

Most of the other providers balked. Time Warner has since been bought by another provider, Charter Communications, with the combined entity covering about 38% of the market. A handful of other carriers agreed to the price, but this still comes out to under half the market. The cable companies covering the rest of the region have refused to pay the carriage fees, meaning that if you live in those areas and want to watch Dodgers games you are out of luck. On the other hand, if you live in those areas and don’t want to watch Dodgers games, you can buy cable service without paying for those games. For every yin there is a yang, as my father somewhat mystifyingly used to say.

This is where it gets interesting. Games of chicken over carriage fees aren’t anything new. YES has been playing these games for years. What is different is that three years in they haven’t come to a deal. What is even more interesting is that SportsNet LA cracked, offering to reduce the fee to $3.50. This would still be high, but in line with the upper range of the other regional sports networks. Yet the other carriers have stood firm. They are unwilling even to sign a one year deal at the reduced rate. Why not? Three years in, they have taken whatever hit they are going to take from subscribers for not carrying the games. Sign a deal for one year and they are on the hook to go through that again when the carriage rate inevitably is jacked up. At the same time I suspect that they are getting a lot of positive feedback from their non-sports fan subscribers. What we have is a conflict between sports fans and non-sports fans and, for the first time, the non-fans won. The difference is that now the non-fans have options, and therefore leverage.

This is the beginning of the end of the ancien regime. Clubs and networks could force non-fans to pay only when the alternative for the non-fans was to lose the TV they wanted. The awful future the clubs and networks face is that they will have to depend on people who actually want their product. They really really don’t want that. The tip-off, if any were necessary, is that DirecTV offered to carry SportsNet LA as an a la carte add-on, charging whatever price Time Warner wanted it to. Time Warner wasn’t interested.

There is no way they can get this kind of money from just their fans. How much are fans willing to pay? Heck if I know. I doubt that anyone really does. By way of anecdatum, I cut the cord a year or two back. It wasn’t because of the three or four bucks going to the local regional sports network, but because of the total expense, coming in at around $120 a month. I realized that I could get everything anyone in the family watched through online streaming for about $20. Was I willing to pay a hundred dollars a month to be able to watch ball games on TV? No. So we have an upper limit, at least for me. Your mileage may, of course, vary. The point is that you can take whatever dollar amount they settle on, and multiply it by the number of people willing to pay it, and you will end up with less money than is coming in today.

Why haven’t we been reading about this? The SportsNet LA debacle has gotten some coverage, but it is treated as a routine story, not a sign of the impending apocalypse. Why not? I see two possibilities. The first is that I am totally full of crap and am misreading the situation. I give this about a 25% chance, but then again I am pretty much by definition the wrong person to make that assessment. More likely, I think, is that this is an apocalypse, but a slow-moving one. The Dodgers are still having truckloads of TV money backing up to the dock at their money warehouse. They can reasonably expect to continue to get these truckloads. The deal might be renegotiated at some point, but that point is not now, or even imminent. Charter Communications is taking a bath, but who cares about Charter Communications? They aren’t the ones out there signing free agents.

Where it is going to get ugly is when the various teams’ multi-year deals come up for renewal. They are going to find that their properties aren’t worth as much as formerly. Revenues will fall. Furthermore, I think they will fall hard. Yet player salary negotiations will continue unabated. The long-term trend in player salaries has been ever upward. This began in earnest in the 1970s with free agency, fueled by the value of television broadcast rights hitting high gear. The present day player contracts in the hundreds of millions are in turn fueled by regional sports network money. As this money dries up a whole lot of people are going to have to adjust how they negotiate. To add another bit of wackiness, the cable deals aren’t all going to come up at the same time. Some teams will be operating under the old regime even as others are adjusting to the new one, and how this falls out won’t necessarily follow the traditional lines of large and small market teams.

I have used the language of apocalypse, but this is mostly because it is fun. We ordinarily only have the opportunity when a good blizzard is imminent. It also is an excuse to use that awesome photo. But as the headline says, this is a baseball financial apocalypse, not a baseball apocalypse. This will not be an existential threat to baseball. This isn’t a threat to baseball having fans willing to spend. There will still be a lot of money floating around: just not as much. It will be an adjustment. It won’t even be all that painful an adjustment, in the big picture. Sure, there will be gnashing of teeth, but that will be on principle as much as anything. Who really cares if that pitcher only gets $100 million for his six year deal, instead of $150 million? I’m not even sure the pitcher really cares. Either way, he is set for life, or if he can manage to burn through $100 million and end up bankrupt, he would burn through $150 million nearly as quickly. At a certain point, this is more about keeping score than about putting bread on the table, and everyone is going to take that hit.

In the long run, I think it will be a good thing. There needs to be a minimum level of cash in the system for a sport to operate at a high competitive level. Baseball currently has far, far more than that. We are at the point where the system extorts money from the unwilling so that it can light cigars with hundred dollar bills. That can’t be healthy in the long run. Better to take the money from the willing, and settle for lighting your cigar with a twenty.

In conclusion, I have a vision of a day when the pearly gates open wide, divine light streams forth, and we can watch our local teams’ games on our computers. Do I hear an Amen?