The Captain's Blog

Earlier today, Ken Rosenthal wrote about a potential flaw in the Yankees’ plan to dip below the luxury tax threshold in 2014 (click here for a detailed breakdown, which includes estimated potential savings). According to Rosenthal, baseball’s overall financial strength is conspiring to limit the potential savings the Yankees could enjoy under the CBA’s new revenue sharing plan, and, as a result, has cast even more doubt about the wisdom of the team’s new austerity plan.

Why would the financial success of other teams negatively impact the Yankees? Such a counter-intuitive notion seems absurd, especially in a business that shares a significant percentage of revenue. However, the assertion is supported by truth. You just have to dig deep into baseball’s new collective bargaining agreement to find it.

As detailed by this blog in numerous posts (here, here, here, here and here), the Yankees’ frugalness is the result of several incentives included in the new CBA. The most obvious is the luxury tax penalty, but a subtler and potentially more lucrative mechanism is called the Market Disqualification Refund (MDR). Simply put, this scheme offers net revenue sharing payors (those who pay more into the system than they receive) a refund when two things occur: (1) the net payor is under the luxury cap threshold; and (2) large market teams earn revenue below expectations. Does that make sense? In order to truly understand how the refund works, it’s important to review the entire revenue sharing system.

Exhibit 1. Hypothetical Revenue Sharing Base Plan – 34% Contribution

Note: See Article XXIV of CBA for details about revenue sharing plan. Teams shaded in blue rank among top-15 by market size, pursuant to Attachment 26 of the CBA.
Note: Net Transfer Value is the amount sent from payors to payees.
Note: CBA sets Marlins local revenue at $100 million for 2012, but that assumption is excluded from this analysis.
Note: Local revenue data is based on 2011 Forbes total revenue estimates minus estimated $80 million central fund revenue contribution. Actual figures do not impact underlying point that is being illustrated.
Source: MLB CBA, Forbes

Baseball’s revenue sharing system begins with each team contributing 34% of their local revenue (excludes national revenue, like merchandizing and network TV contract, which is divided equally) to a pool. This is known as the Base Plan. As the chart above illustrates, each team’s contribution is added together and than divided by all 30 teams. The resultant figure is then re-allocated back to each team. However, no money actually changes hands at this point. Rather, this in only an intermediary step that precedes several more complex calculations.

After the hypothetical Base Plan calculation is done, a net transfer value (NTV) is calculated. This figure is the sum of all payments, or, more bluntly, the amount of money needed for the haves to pay off the have-nots. Once the NTV is determined, the system then calls for another hypothetical calculation. This time, another base plan is configured, but instead of 34%, each team’s contribution of local revenue is 48%. The second Base Plan exists for one purpose only: to determine a second NTV.

Exhibit 2. Hypothetical Revenue Sharing Base Plan – 48% Contribution

Note: See notes under exhibit 1.
Source: MLB CBA, Forbes

The CBA requires that the final NTV of the revenue sharing plan be equal to the amount of money that would be transferred if the base plan used a 48% rate. However, instead of simply using the higher rated base plan illustrated in Exhibit 2, the CBA adds another wrinkle, which it calls the Supplemental Plan. The value of the Supplemental Plan is the difference in the NTV of the 48% Base Plan and the 34% Base Plan (in this exercise, $254.1 million minus $180 million). Unlike the Base Plan, contributions to this second pool are not determined by a flat rate, but rather a predetermined schedule, which is known as the performance factor (the total NTV of the Supplemental Plan is multiplied by each team’s performance factor).

Exhibit 3. Hypothetical Supplemental Plan

Note: Net Transfer Value of Supplemental plan is equal to NTV of 48% plan minus 34% plan. Each team’s portion is based on NTV of Supplemental multiplied by performance factor, pursuant to Attachment 26 of the CBA. Base plan data taken from exhibit 1.
Note: See notes under exhibit 1.
Source: MLB CBA, Forbes

So, why is there a Supplemental Plan? After all, the amount of money transferred under the 34% Base Plan plus the Supplemental Plan is just about the same as would be exchanged under a 48% Base Plan. Basically, this structure seeks to proportionally assign revenue sharing responsibilities based on successful exploitation of a team’s market. So, not only do small market teams benefit, but low revenue producing teams, regardless of market size, do as well. That’s why teams like the Atlanta Braves, Washington Nationals, and Toronto Blue Jays have been revenue sharing beneficiaries, often at the expense of teams in markets much smaller than their own.

If baseball’s revenue sharing plans seems unfair, that’s because it is. After all, why should the St. Louis Cardinals subsidize other teams just because they have done good job tapping into a rabid fan base? In order to remedy some of this inequity and also encourage local revenue generation among larger market teams, the Market Disqualification Refund (MDR) was created. The way this giveback works is simple. The CBA consists of teams ranked by market size, and those who fall within the top half (excluding the Oakland Athletics, who are exempt until the team builds a new stadium) are disqualified from receiving revenue sharing payouts. Instead of paying large market teams for under performing, the disqualified payments are collected and then returned to the payors in proportion to the total amount they contributed to the revenue sharing pool (Base Plan plus Supplemental).

Exhibit 4. Hypothetical Revenue Sharing Payors

Note: Data based on exhibit 3. Only payors included.
Note: See notes under exhibit 1.
Source: MLB CBA, Forbes

Now that we know how the revenue sharing program works, we can examine the potential impact to the Yankees’ future refund. As illustrated in the table below, which includes data from the exhibits above, four top-15 market teams, as defined by the CBA, would receive a revenue sharing payout. However, under the new MDR system, those teams will increasingly lose the right to those payments, beginning with a 25% forfeiture this year and progressing to 100% by 2016.

Exhibit 5.  Hypothetical Big Market Revenue Sharing Payees

Note: Data based on exhibit 2-4. Include four top-15 market teams that were net payees under the hypothetical case study.
Note: See notes under exhibit 1.
Source: MLB CBA, Forbes

Based on the numbers below, the Yankees could receive a refund as large as $12 million in 2016, provided, of course, they can remain below the luxury tax. However, if the Braves, Blue Jays, and Nationals all enjoy enough financial success to move them from net payees to net payors, the pool of potential refunds would decrease. In fact, if all top-15 market teams became payors, there wouldn’t be any refund at all.

Exhibit 6. Potential Refund for Revenue Sharing Payors

Note: Data based on exhibit 4-5.
Note: See notes under exhibit 1.
Source: MLB CBA, Forbes

If the Yankees’ austerity plan was based solely on receiving a hefty revenue sharing refund, that assumption would be a major flaw. However, the potential competitive balance tax savings are also substantial. Besides, if other big market teams really do start pulling their weight, the Yankees would receive a larger allocation from the Base Plan pool, and perhaps be asked to carry a smaller burden in the Supplemental Plan. Granted, the Yankees would still get to enjoy these benefits even if they maintained a high payroll, but if the worst case is simply shifting the gain to another ledger, that doesn’t seem like an inherent flaw.

The CBA both encourages local revenue growth and discourages excessive payroll spending. If the Yankees can comply with the latter, they stand to be significant beneficiaries of the former. Although the numbers could shift, the success of the Yankees’ new budget plan is not contingent upon the financial performance of other teams. Rather, the final verdict will be based upon the team’s performance in the standings. Can the Yankees continue to maintain a perennial winner while adhering to a strict budget? They’d better hope so. Otherwise, the real flaw in the Yankees’ number crunching will be exposed.