Why The NBA's Claim That Teams Are Losing Money Doesn't Add Up

As the National Basketball Association braces for a possible 2017 work stoppage, commissioner Adam Silver is claiming that a "significant number" of league teams teams are losing money. Of course, we've heard this argument before.

"The financial results of the past season prove that salaries must come down. We believe that players insisting on exorbitant prices are injuring their own interests by forcing out of existence clubs which cannot be run and pay large salaries except at a personal loss"

Believe it or not, that quote didn't come from Silver's predecessor, David Stern, as a table-setter for the last NBA lockout. Instead, it came from baseball's National League—in 1879. And it encapsulates everything we've heard from professional sports leagues and owners ever since.

To wit: just a few years ago, the NBA claimed it was losing money. Never mind that it's the only league that caps individual player salaries, rookie salaries and the aggregate salaries of all players. Flash-forward to today, and the league is still crying poor, despite projected revenues of $5 billion next year.

Silver's assertion is difficult to believe.

Although Silver insists he is willing to share league financial statements with the players' union, the NBA is less willing to open its books to the general public. So while we have heard quite a bit about the $2.6 billion in aggregate free agent salaries committed to players this offseason, the league does not tell the public what its aggregate profits were this past season.

There is reason to suspect that those profits are substantial, starting with the NBA rule limiting aggregate player compensation to 50 percent of league revenue. In European soccer—where caps on payrolls and individual pay are not allowed—football teams in England pay 76% of revenue to their players. Relatively speaking, the NBA is getting its players at a substantial discount.

In addition, NBA teams receive substantial handouts from the government. According to economists Victor Matheson and Robert Baade, league franchises received $3.1 billion in stadium subsidies from 1990 to 2010. Memphis, Cleveland, New Orleans, Indianapolis, Oklahoma City and Charlotte had 100 percent of their arena costs picked up by taxpayers.

Then there's the real money: a dramatic escalation in franchise values, the billionaire team owner equivalent of seeing the value of one's home soar upward in a hot real estate market. In 2014, the Los Angeles Clippers were sold for $2 billion. Prior to this sale, Forbes.com argued the Clippers were only worth $575 million. The Clippers had only appeared in the playoffs four times from 1976 to 2012—no small feat of ineptitude in a league where more than half the teams make the postseason. Indeed, one could argue that the Clippers franchise was the least successful organization in the NBA. And yet, Steve Ballmer was willing to pay nearly four times the estimated franchise value when disgraced longtime owner Donald Sterling was forced to sell.

At the time, the Clippers' price tag was partially justified by an equally dramatic escalation in league broadcasting revenues. Not only do these revenues increase the value of NBA franchises, they also help support the idea that NBA teams must engage in an "arms race" to be financially successful—a core concept trotted out whenever league owners feel like clawing back money from their on-court workforce.

Here's the basic argument: For a team to make money in the NBA, it has to win. And teams can only win if they spend money on players. This means teams in smaller markets–who cannot afford to spend as much cash as their big market competitors–are doomed to financial failure.

There are two problems with this argument.

First, we have the implied link between revenue and wins. In a recent academic article I published with economists Michael Leeds and Peter von Allmen, we asserted that broadcasting revenues are best classified as fixed revenues—revenues that are not related to team wins. Minnesota and San Antonio receive an equal slice of the NBA's national television revenue pie, even though the latter franchise is a perennial championship contender and the former franchise is Clippers Midwest. Because fixed revenues in professional sports are now quite substantial, the link between wins and team revenue has been reduced.

Moreover, the link between payroll and wins is also quite weak in the NBA. In 2014-15, team payroll only explains about 13 percent of the variation in team wins. The Golden State Warriors, San Antonio Spurs and Atlanta Hawks all ranked in the bottom half of the league payroll rankings, yet each won more than 65 percent of their regular season games. Meanwhile, the Brooklyn Nets and New York Knicks lost more than half their games while ranking in the top 10 in payroll.

The success of the Spurs and the failure of the Knicks and Nets consistently casts doubt on the "arms race" argument. The Spurs won the NBA title in 2014 with a roster where a) the highest paid player (Tony Parker) was only paid $12.5 million and b) only Tim Duncan was a lottery pick. San Antonio found success by simply choosing productive and relatively cheap players.

In contrast, both the Knicks and Nets have decided in recent years to give money to Andrea Bargnani. In 2006, Bargnani was the first player taken in the draft. Since then, he has produced a negative quantity of wins every single year of his career. But he does score. And therefore, the decision-makers on the Knicks and Nets have both concluded that he helps.

Because NBA decision-makers tend to focus primarily on scoring totals–and not efficiency (or rebounds or turnovers)–teams consistently pay premium prices for players who do not help them win games. This is why franchises such as San Antonio can build winning teams without spending much money. It's also why the "arms race" argument is basically a myth.

But even if it wasn't a myth, the NBA shouldn't be complaining. Capitalism does not guarantee that every firm will make a profit. But professional sports leagues in North America–with caps on worker compensation, revenue-sharing and substantial subsides from government—seem designed to ensure that even very incompetent managers can find success and finish in the black whether their teams win or lose. If Silver is somehow telling the un-lawyered truth, and a number of NBA franchises are somehow, some way actually failing to make money—despite torrents of cash and rigged circumstances to make a casino owner jealous—he probably should be embarrassed to say so out loud.