To what extent does the Barclay s Premier League have oligopolistic characteristics, and if so, does this make it an oligopoly?

Transcription

1 Beall 1 To what extent does the Barclay s Premier League have oligopolistic characteristics, and if so, does this make it an oligopoly? Bob Beall I.B. Number: February 2014 Word Count: 3,235

2 Beall 2 Abstract: This report analyzes the English Premier League over the last ten to twenty years. It examines how a few clubs have been successful over this period and how this may contribute to an oligopolistic league. The essay focuses on if the English Premier League demonstrates the characteristics of an oligopoly. The Herfindahl Hirschman index (HHI), a widely used tool to determine the general market structure of an industry, is determined for the league, using the market share equivalents of Premier League clubs. This is determined by using the number of trophies each club has won over the last twenty years compared to the number of trophies available. The HHI is 2,315, well above the accepted level of an oligopoly of 1,800. Later, the league is examined using game theory and Bertrand behavior, how these concepts discourage collusion, and how this contributes to the high barriers to entry into the ranks of successful English clubs. Finally, it is determined that while the league does show some qualities of an oligopoly, such as high barriers to entry, it lacks substantial evidence of collusion, making it less of a traditional oligopoly and more of a competitive environment.

3 Beall 3 Table of Contents Abstract....2 Introduction Herfindahl Hirschman Index Firm Interaction...9 Bertrand Behavior Conclusion Works Cited... 16

4 Beall 4 The Barclay s Premier League is by far the most watched sports league on the planet, capturing over 640 million viewers every week ( The World s Most Watched League ). With such a massive audience, football has become big business in England, with billions being spent on the largest clubs in the hopes of finding success. Often, the question has arrived whether or not it is fair to have multi billion dollar firms and individuals buying these clubs and paying billions of pounds out of their own pockets to buy the best players, managers, and staff. Is it fair to have these footballing behemoths competing against teams whose budgets are a mere fraction of their own? Despite reluctance by some, foreign groups have begun to buy promising clubs which they believe will succeed with new ownership, and more importantly, new funds. Chelsea Football Club and Manchester City Football Club are prime examples of this, both being bought by foreign entities and experiencing some form of success. If spending is essential to club growth and improvement, it follows that the English Premier League will have effectively become an oligopoly, defined as an industry consisting of a few large firms (in this case, clubs) and fairly high barriers to entry, often characterized by being mutually interdependent, meaning that strategic interaction between firms may exist (Morgenson 249). If this is the case, only the few teams with limitless funds are the teams that have a chance of ultimately winning in the league. It is first necessary to define the parameters of what is being analyzed in order to be able to come to a conclusion. Money being spent on clubs is almost entirely classified as money spent on transfer fees for new players (the money a club must typically pay another club for the new player to be released from his contract), and player and staff salaries. Things such as

5 Beall 5 stadium improvements or equipment improvements will not be considered. Also, when a team is considered to have improved or succeeded. This will be measured largely by their final place in the league table at the end of a season. Major tournaments such as the F.A. Cup and the League Cup, will also be considered, as the teams in question are competing against similar, England based competition, as well as because these competitions require consistent performance over a series of games. Single game trophies such as the Carling Cup and the Community Shield will not be considered because as singles games, they do not reflect the quality of the teams involved as well as tournaments and leagues. With all of these factors being taken into consideration, it is possible to determine if the large increase in money needed to be successful has caused the Barclay s Premier League to show signs of becoming an oligopoly. Some of the best examples of Premier League clubs being bought, having millions given to them, and success following are Chelsea and Manchester City Football Clubs. These teams were bought in the last ten years by Roman Abramovich and Mansour bin Zayed Al Nahyan, respectively. Chelsea, who had been moderately successful before their purchase, was bought in Subsequently, their average transfer fees and wages increased tenfold, from about 5.7 million per season before 2003, to roughly 49.7 million per season during the next decade ( Premier League Comparisons ). The effects showed. Over the following years, they won three English league titles (2005, 2006, and 2010), four F.A. Cups (2007, 2009, 2010, and 2012), two League Cups (2005 and 2007), and most notably, the UEFA Champions League in 2012 ( Trophy Cabinet ). Manchester City has a similar, yet more recent, story. After being bought in the summer

6 Beall 6 of 2008, they also saw rapid success in the league and elsewhere. Like Chelsea, their spending was raised from about 3.5 million to over 58 million on players per year ( Premier League Comparisons ). Since this buyout, they have won the F.A. cup (2011) and the league title (2012) ( Time Line ). Manchester United is perhaps the most successful English club in the last twenty years, but interestingly, spends less than their competitors. In contrast to Chelsea and Manchester City s immense spending, Manchester United has only increased their spending from around 10 million to 21 million per season. During this time, Manchester United has won the league thirteen times, won four F.A. Cups, four League Cups, and won the UEFA Champions League twice ( Trophy Room ). Before the massive increases in spending by Chelsea and Manchester City, Manchester United spent more than both, which may have contributed to their success. In brief summary, Chelsea and Manchester City are clubs which have benefited almost immediately from an influx of capital, while Manchester United has become very successful while keeping its costs relatively low. All of these clubs have been among the top spenders in the league over the past 10 years, which also includes Liverpool and Tottenham Hotspur Football Clubs, who have also seen reasonable success in the same period, finishing high in the league and winning tournaments such as the F.A. Cup (Ambekar). Because money is such a key part of success in the modern era Premier League, it is very possible that an oligopoly has been developed. In order to become competitive, a club needs a massive amount of capital to buy the players necessary for success. This makes it extremely difficult for medium and small sized clubs in England to enter the industry, or in other words to become competitive. This high start up cost can be seen a massive barrier to entry. Unless a

7 Beall 7 small club attracts an extremely wealthy new owner, it is very difficult for them to become successful, similar to an oligopolistic or monopolistic industry. A well respected measure of how an industry is structured, even used by the U.S. Department of Justice, is called the Herfindahl Hirschman Index. This is determined by squaring the market share of all the competitors in a given market, and then taking the sum of those squares. The sum of 100 would correspond to 100 companies with 1% market share, while a sum of 10,000 would represent a pure monopoly of only one firm. If this sum is less than 1,000, then the market is considered relatively competitive, if it is between 1,000 and 1,800, the market is considered somewhat competitive, and if the sum is over 1,800, the market structure is usually considered an oligopoly (Krugman 238). Here, each club s percentage of the total trophies won (F.A. Cup, Premier League, and the League Cup) will represent their market share. European competitions are not being counted because the competition is not English, and not all of the clubs being considered participated in these tournaments. Competitions from the beginning of the Barclays Premier League (February, 1992) to the time of writing will be considered. English Trophies Won by English Clubs Club F.A. Cups Premier League Titles League Cups Total Arsenal Blackburn Rovers Chelsea Everton

8 Beall 8 Liverpool Manchester City Manchester United Portsmouth Wigan Market Share Equivalents Sum of Totals: 56 Club Market Share Equivalent Arsenal 9/56=(0.161)100=16.1% Blackburn Rovers 2/56=(0.0357)100=3.57% Chelsea 12/56=(0.214)100=21.4% Everton 1/56=(0.0179)100=1.79% Liverpool 7/56=(0.125)100=12.5% Manchester City 2/56=(0.0357)100=3.57% Manchester United 21/56=(0.375)100=37.5% Portsmouth 1/56=(0.0179)100=1.79% Wigan 1/56=(0.0179)100=1.79% Sum of Squares of Market Shares: 16.1² ² ² ² ² ² ² ² ² = 2, Given these values, the Herfindahl Hirschman Index is 2,315. This is well over the

9 Beall 9 generally accepted value for an oligopoly of 1,800, and the English Premier league can be clearly defined as such. As opposed to a manufacturer or a sales company, these firms are not trying to sell a product, per say, they are trying to sell a brand. By doing this, they increase ticket and paraphernalia sales, drive the price for television coverage up (due to an increase in demand), and demand higher sponsorship deals (because of the greater exposure clubs receive when more successful). Simplified, when clubs succeed in major tournaments, the demand for their brand increases, and therefore, so does the price for that brand. In any oligopoly, there is always a risk of collusion between the major firms in the industry. The largest firms may try to collude by fixing price or by limiting production in order to increase the profits of the few firms in the industry. This same concept could also apply to the Premier League. The large clubs, or all of the clubs in the premiership for that matter, could decide to increase ticket prices, the prices of club merchandise, or T.V. sales. This has occurred in the past; before the season, the top tier of twenty teams did collude, and broke away from the longstanding Football League and formed the Premier League in order to take advantage of a lucrative television rights deal ( History of the Premier League ). Essentially, the largest twenty firms in the industry decided to collude in order to drastically increase their revenue. It was a possibility that the dramatic increase in price would lead to less of a demand for their product. However, in this scenario, the elasticity (the demand of the product relative to the price, high elasticity causing a severe decrease in demand due to an increase in price) of the product that the clubs are trying to sell, was small enough that sales increased monumentally, while the price rose, leading to an enormous increase in revenue.

10 Beall 10 A major good that the clubs are trying to sell is the television rights to broadcast their matches. Because the competitions that these teams compete in are zero sum games with only one winner, a situation where one firm s gain results from one firm s loss, football clubs typically engage in non cooperative behavior, each club acting in its own self interest ( Zero Sum Game ). Here, each club is only interested in improving itself in order to perform better, win more tournaments, and gain more income from merchandise and sponsorships. This is called non cooperative behavior (Krugman 239). The individual clubs primarily are concerned with their own performance in the league and other tournaments. The one type of interaction that the clubs have with each other, apart from actual matches, is when they are making competing transfer bids for the same player. If similar clubs X and Y both want player Z, then this will most likely lead to a type of price competition, or Bertrand behavior (Krugman 242). For example, if club X offers ten million pounds for player Z, club Y may then respond by offering twelve million pounds. Then, club X may offer another larger sum, perhaps fifteen million pounds. This will continue until club X decides that player Z is not worth the millions that club Y is offering, and club X would rather spend the money elsewhere. For example, in 2011, a Spanish club Valencia received several offers for midfielder Juan Mata from English clubs, but ultimately sold him to Chelsea, who offered the most at 23.5 million ("Premier League England."). This competition leads to a much higher price for desirable players, forcing clubs to spend immense amounts of money to sign these players and become more successful. The result of these increased prices for the skilled players needed for success is to dramatically raise the price of success. This then raises the cost of entry into the ranks of successful clubs, creating a very high barrier to entry.

11 Beall 11 Because of this high cost, clubs attempt to become more efficient by trying to attract prospective players to their youth academies for a much smaller fee than if they were bought later on in the player s career. A great example is Jack Wilshere of Arsenal, who was signed into Arsenal s youth academy when he was nine years old, and has now begun to be a key player in the team ("Premier League England."). All clubs would save millions of pounds if they all payed the same amount for different players, but the reality is very different. Clubs tend to engage in strategic behavior when buying players. Chelsea and Manchester United are the two most successful clubs in the league over the last twenty years, and both clubs will react to how the others act. If Manchester United begins to spend more on players, it is very possible that Chelsea will spend more on players in order to stay competitive in the league. If both clubs did not increase spending, both would remain competitive, and both would retain or increase profits, based on their success. Instead of this, one club, or perhaps both, sees the possibility of the other club not spending, and then spends on new players in an attempt to gain an advantage over the other. In response the other then spends in order to prevent the other from becoming a more successful club, therefore prohibiting the other club from winning trophies and winning bigger sponsorship and television deals. This behavior is called tit for tat behavior, where each firm responds to the other s actions in order to remain competitive in the industry. This same phenomenon could also be looked at as a type of game theory. Game theory can be applied when there are two competing entities working towards the same type of goal. In this scenario, it is the biggest clubs in England competing in the same competitions. For example, if both clubs do not pay exorbitant fees for players, than both teams would make a

12 Beall 12 given amount of money. However, each different club sees that if the other invests in players (and the high fees that accompany them), they have a much higher chance of being successful. Although, being that these competitions are zero sum games, a situation where in order to succeed another firm must be damaged, the clubs are forced to both pay the record fees for players, lest they be left behind and begin to lose competitions (Wessel 338). A recent example of this is Arsenal s signing of Mesut Özil from Real Madrid. After winning the league in 2002 and 2004, Arsenal fell slightly behind their rivals, not finishing above third place in the last seven years. To remain competitive, they purchased Özil for 44 million, becoming their most expensive transfer in their history ("Premier League England"). Arsenal was forced to pay a massive transfer fee in order to remain competitive. This phenomenon can be seen on a larger level in the Premier league over the last 10 years. After the purchase of Chelsea by Roman Abramovich and his subsequent high spending at Chelsea, other clubs have seen this as a threat and have increased their own spending. In the years after the buyout, average spending in the league more than doubled as other teams were trying to remain competitive. This can be seen in the below chart shows how these fees have increased after the 2003 buyout (data taken from "Premier League England ). Given these factors, the question of whether the Barclay's Premier League in England shows characteristics of an oligopoly, and if these characteristics make it a true oligopoly can be addressed. One of the hallmarks of a traditional oligopoly is the strategic interaction between firms, often termed collusion. In the Premier League, this is present, but not in the conventional way of agreeing on set prices. Alternatively, the firms interact when buying and selling players to and from each other and from other clubs around Europe. These prominent clubs often follow

13 Beall 13 the principles of Bertrand behavior and game theory. This means that in order to remain competitive in a firm s respective industry, a firm has to take into account the actions of its competitors, and specifically how their actions affect themselves. Here, as one or more teams begin to pay more and more for top players, the other clubs take this into consideration. In order to remain competitive, they must start to pay for better players as well. While they do act strategically to ensure their own interests, there is little collusion. Another recognizable trait of oligopolies is their extremely high barriers to entry, often in the form of high start up costs. In the Premier League, because of the mentioned strategic behavior causing the ever increasing price of skilled players, combined with the fact that these competitions are zero sum games, clubs that want to be competitive are forced to pay exorbitant fees for players. This means that in order to break into the upper echelons of the league, clubs have to have a monumental amount of capital. This creates very high barriers to entry, making the Premier League more of an oligopoly.

14 Beall 14 Lastly, the widely used Herfindahl Hirschman index, used to determine how monopolistic an industry is, is well above the accepted value for an oligopoly of 1,800, having an index of 2,315. With these factors in mind, the Barclay s Premier League in England seems to be an oligopoly, but not in the traditional sense due to the non conventional industry in which it operates. Many billions of dollars are spent each year in the most viewed sports league in the world, the English Premier League. This has spurred investors from around the world to buy English football clubs, pour millions of dollars into them in the form of new players, and expect success. With Chelsea and Manchester City Football Clubs, this strategy has largely worked, as both organizations have seen success in recent years. Manchester United has proven that it is not absolutely necessary to spend these large amounts of money to find success.. Due to the nature of the industry, combined with the large sums of money needed to be successful, a Herfindahl Hirschman Index of 2,315 has been created, well above the oligopoly threshold of 1,800. As the Premier League has been determined to be at least similar to an oligopoly, issues such as collusion may appear. However, because of the zero sum game nature of the league, these issues are shortly resolved by clubs acting non cooperatively, adhering to Bertrand behavior, and competing tit for tat. This involves responding to other firms behaviors in order to prevent losses, rather than to maximize profits. Similarly, the clubs follow the principles of game theory, where two firms are competing for the same goal. Accordingly, in order to remain competitive compared to other clubs, teams are forced to buy expensive players. Many of the characteristics of an oligopoly, such as the high barriers to entry and Herfindahl Hirschman index over 1,800, are very much present. Though in contrast, one of the defining traits of an oligopoly, collusion,

15 Beall 15 tacit or otherwise, is largely absent. The only substantial instance of collusion was the formation of the modern Premier League in So while there is some evidence that the English Premier League has become an oligopoly, it has not fully made the transformation.

16 Beall 16 Works Cited Ambekar, Shantanu. "Premier League s Top Five Biggest Spenders In The Last 10 Years."Intothetopcorner.wordpress.com. Wordpress.com, 21 Dec Web. 28 Jan "History of the English Premier League." Super Sport, n.d. Web. 20 May Krugman, Paul, and Robin Wells. "Oligopoly." Economics. 2nd ed. New York: Worth, Print. "League Table." PremierLeague.com. Barclays Premier Leauge, n.d. Web. 13 Dec Morgenson, Gretchen, ed. The Capitalist's Bible. New York: Harper Business, Print. "Premier League Comparisons." Transferleague.co.uk. Transfer League, Web. 20 Dec "Premier League England." Transfermarkt.co.uk. Transfer Markt, Web. 19 Dec "Timeline." MCFC.com. Manchester City Football Club, n.d. Web. 22 May "Trophy Room." Manchester United, n.d. Web. 22 May "Trophy Cabinet." ChelseaFC.com. Chelsea Football Club, n.d. Web. 15 May Wessels, Walter J. Economics. 2nd ed. N.p.: Barron's, Print. Barron's Business Review Ser. "The World's Most Watched League." PremierLeague.com. Barclay's Premier League, n.d. Web. 3 May "Zero Sum Game." Investopedia.com. Investopedia, Web. 28 Jan