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Economics - Motives for Sport[1]

Economics - Motives for Sport[1] - W0 Baolcs of Economic Mm...

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Unformatted text preview: W0 Baolcs of Economic Mm: 1, Economics? Analysis Before beginning our discussion of the basic economic principles related to organizational motives. supply and demand. and market structures. it is important to first discuss the meaning oicconomics. To begin. we must make a distinction between finances and eco— nomics. Webster defines finances as the "management of money afFairs," Although much ofwhat we talk about in this book includes money aifairs. the termsfimznres and econome ‘ in are not synonymous. Economics is out iust talking about income statements and balv ance sheets: it also is a way ot'viewing human behavior and decision making There are many definitions of economics. Samuelson and Nordhaus “995) define it as "the study ofhow societies use scarce resources In produce valuable commodities and dis- tribute them among different people." Lipsey, Couranr. and Hagan (1999) simply say economics is the "use ofsmrce resources to satisfy un- limited human wanrs" (p. 4). A third definition. from Economic Motives of Sport Organizations Colander ([998]. describes economics as the "study of The Ftorida Martins have just finished their 2002 season. Although GM Rioh Goddard had high hopes for the season, the team only finished with a 75—57 record. in additrbn, ticketsaies were tow. and them is tatk that the team may move to another city Rich better/as that part of the reason for the team's poor performance was that the pitching staff did not live up to expectations. institutional structure through which individuals in a society coordinate their diverse wants and desires" (p. 6). Two similar elements run throughout these def— initium: (a) scarce remUrces and (in) human wants and desires. Economics addresses the question of how peo- pie make decisions about allocating scarce resources to i During the viii-season. Rich dimwrs that San Farm-m Eco satisfy human wants and desires. The economics of pitohsr John Crowder may be avaitabia in a trade that would cost 5P“ im'u‘ie‘ ”‘3 “”dt' “mm “min“: the Martins their first pidr in the upcoming 2003 draft and one of their best outfietdsrs. Crowdst; who is one at the toagtte's most popuiar players and a definite gate attraction, is agreeable to the trade: he has saidha wiit sign a tongvtsrn't contract as tong as the l. Why are scarce resources in a society distributed to sports? 2‘ How are scarce resources within the sport industry team is Hitting to meet his asking price 01520 miition per year over dim-lbw“? a years. Fitch decides to make the trade and to sign Crowdsr to a tong-term contract for the $160-mitiion asking price. Did GM Fitch Goddard make a rattbrtai decision? For example. a city collects revenues via taxes and Fees. It: budgets those revenues to support a variety ofpublic services. In a perfect world (from a city manager’s per— spective). the amount of money taiscd equals (or ex- CCEEIS) the amount of money the manager would like to spend. Unfortunately, that does not Frequentiy happen. It is generally the case that there are more places to spend the money than there is money to be spent. Economics examines the process by which city of- ficials decide how many taxes to collect, how much to spend. and how much to spend on specific items. For example. iivoters are willing to pass an increase of 1% in the sales tax, ECONOMIC MOTIVES 0F SPORT ORGANIZATIONS O 23 how will that money be allocated? Will it go to new stadiums for professional teams. new community ball fields, strcet repairs. or en- hanced education? Knowledge ofceonornie principles can help us understand this deci- sion-making process. Macroeconomics and Microeconomics The general field of economics is divided into two areas of study. Macroeconomics views an economy as a whole, focusing on economic aggregates. such as inflation rates. total investment. business cycles, and growth. The aggregates are a result of the activity of many units and markets Mimi- ermromia examines the behavior ofindivid- ual elements or markets of an economy [such as the sport industry) and how those elements interact. [1 focuses on individual decisions such as pricing policies of organie aarinns (why ticket prices go up or down) or people’s purchasing decisions (how they de- cide to buy an athletic club membership or a piece ofcxercise equipment}. The focus of this booit is a microeconomic one. We are not ignoring the fact that macroeconomic issues affect the sport industry. but the ime mediate decisions that most citizens and sport managers deal with arise from micro- economic issues. so tharwill be our focus The study of economics. particularly the study of economic decision making, is often based on the use of economic models. Eco, neurit- models are “methods ofanalyzing and explaining circumstances in the economic environmentt [They are] simplified views of reality. stared verbally. mathematically, and often graphicallyu (McCarty. 1986. p. 9). Although some students in sport manage ment may not understand how studying these abstract models will provide them with a better understanding of the sport in- dustry. the goal ofrhis book is not only to explain these basic economic principles and models but also to demonstrate how sport 24 0 THE ECONOMICS OF SPORT Learning Activities l. Return to the beginning of the chapter and reread the story about due Florida Marlins. After reading this chapter. do you believe that GM Rich Goddard made a rational decision? Which models discussed in this chapter could be used to explain Rich's decision? [5 dtcre any addi— tional information you would need before making a similar decision? 2. Roberta Sheets and Greg Reid are partners in the. Lubbock Bowling Alley. During the past year. the business earned $200,000 in business profits. The profits are split 60MB. so Roberta‘s share ofthe profits was $120.00(). whereas Greg’s share was $80,000. Although they are both happy with the profitability of the bowling alley. they are open to other options. Roberta figures that with the money she has invested in the business, she could earn about $75,000. In addition. she has a io'b opportunity with a salary of$75.000. Greg figures that he cotdd earn $40,000 investing his money elsewhere and that he could get a job earning 535.000 if he sold the bowling alley. What are the economic profits for melt owner? Given these conditions. would you expect both owners to maintain their investment in the Lubbock Bowling Alley? Why or why nor.’ 5. Spencer Sporting Goods is trying to decide between producing base- balls and producing soccer balls. It can efficiently produce only one type of ball, and whatever decision the company makes will commit them to one of the two options for the next 5 years. Company Presi- dent Anita Spencer determines that ifthe company produces baseballs, ' i it will earn profitsuf$l million, $2. million. $2 million. $3 million.and $4 million in years 1 through 5 respectively. If she decides to produce soooer balls| the company will earn 55 million. $4 million, $l million, Si million, and $500,000 in years 1 dtrough 5 respectively. Assuming _ there is no inflation and the value of the dollar' does not change over time, which option would Anita choose according to the update theory of die Firm? Would Anita’s decision be likely to change iftlte country was going through a period of high inflation and a rapid decline in the value of the dollar? 4t Lakisha Baskin is the local director of the Special Olympics. She is going over three options for this year’s big track meet. Under Option A, the organization would produce net profit: of $10,000 and 200 participants. Under Option B, the organization would produce; net profits of$5,000 and 600 participants. Under Option C. the organi- I ration would produce net profits of3-0- and 650 participants. Using the efficiency objective. which option do you think Lakisha will choose? Would her choice be likely to change ifher compensation was based entirely on participation? Why or why not? .4 management professionals can use these principles and models to make better decisions about ltey managerial problems. such as the allocation of resources. the price to charge. and the quantity to produce. Etarromir Models [t is also important that students learn how to use these economic principles and models to better understand the decisions made by sport managers and hopefully to be able to predict some oftlte decisions before they are made. This is particularly critical for sport managers when the organization under examination is a competitor. Understanding how competitors will react to changes in the organizational environment and to changes made by your organization can have a major impact on the decisions you malte on behalfofyour organization. The goal of this chapter is to begin the discussion ofbasic economic principles that will continue in chapters 3 and 4. The chapter will provide sport-related examples to help ex- plain rhe models under discussion and to show their application in sport settings. in par— ticular, this chapter will examine Ihe factors motivating managerial decision making. This will be important in helping us to better explain and predict the decisions made by man, agement. Depending on the model being used, managers are seeking to either maximize or satisfy some goal (e.g.. profits. sales, growth). The ltey, therefore, is identifying man- agement's primary goal. Once the primary goal is identified. the theory underlying each ofthese models is that managers act in a rational manner in pursuit ofrheir goal and will make the decisions they believe give them the best chance to reach this goal. in other words, managers will use rational decision making to determine how they should act in each situation. Because their decisions are rational. they can be both explained and prize dicted. For example. ifrhe goal of the WNBA'S New York Liberty is to win the most games possible and they believe most of their losses last season were related to a weak bacltcourt. we would predict that they will focus on improving their backcuurr through trades. the college draft. andior free agency. This strategy is rational because it is the best method to help them achieve their primary goal. Economic Benefits (and Cons However. determining whether the decision by the Liberty is appropriate or not will in- volve an analysis of both the potential benefits of improving the backcourt (e.g.. more wins. increased ticket sales} and the potential costs (cg, increased salary costs). ECono_ mists focus on rational decision malting as a function ofweighing benefits and costs, All choices have benefits and costs. and although some of them can be objectively evaluated (e.g.. increased sales revenue). others are more subjective [e.g.. increased morale in the city because of a successful team). Using the example discussed earlier. what are the benefits and costs ofspending the additional 1% on new stadiums versus the benefits and costs of spending it on street repairs? [n a rational model, “if relevant benefits exceed relevant costs. do it.- ifrclevant costs exceed relevant benefits. don't do it" (Colander, [993. p. H). Throughout this book. we will use the concepts of benefits and costs to explain decision making in the sport industry. ECONOMIC MOTIVES OF SPORT ORGANIZATIONS 0 25 War I: a firm? The theory ofthe firm is the basic model of business (Hirschey Bi Pappas. 1995} devel- oped by early economists to explain the behavior affirms (McGuigan St Moyer. I935). A firm “is an organiution that combines or otganizes resources for the purpose ofproduc- ing goods andlor services for sale" (Salvatore. 1993. p. 9]. Firms include sole proprietor- ships. partnerships. and. corporations (Salvatore). Firms in the sport industry range from producers ofproducts, such as Nike and Cailaway GolfCompany. to those organizations that sell products and services directly to the public. such as Foot Locker and Gold's Gym. It should be noted that although firms produce more than 80% of the goods and services in the United States. these are many organizations that are not considered firms, such as government and private nonprofit agencies (Salvatore, 1993). Many sport organizations. such as the Special Olympics and a high school athletic department. are also not firms. Their motives are quite different. Detailed discussion on these organizations will be given in a separate section. The Basie Theory of the Finn Essentially, the basic theory of the firm states that the primary goal of the firm is profit maximisation. The early versions of the theory of the firm. or the Jerry?! maximization model. suggested that ownersImanagers malte decisions they believe will lead to the maxi- misation ofshort-term profits (Sen. 1984). However. later versions ofthe model took into account that organizations are not simply focused on short-term profits. so the goal has been expanded to maximizing the owner's wealth and the long-term profits of the firm (Hirsehey 8t Pappas. 1995; Sea, 1934). In other words. ownerst'managers make decisions they believe will result in the highest present value offutute profits. Present value profits is the value nfprofits based on the current value of the dollar. For ex- ample. we know that 3100.000 earned today is worth more than $100.000 earned 10 years from now. Inflation causes the dollar value to decrease over time. Moreover. money earned today can be reinvested in the company to earn additional profits. The present value of profits takes into account that 5100.000 earned today is worth $100,000. whereas $100.000 carried 10 years from now may only be worth 550.000 in present value profits for the organization. The original and revised profit maximization models can be better understood using a sport industry example. Converse may be deciding between producing Sneaker A and Sneaker B. Sneaker A will produce 3200.000 in profits this year and 5500.000 in total present value profits. whereas Sneaker B will produce only $100,000 in profits this year. but $300,000 in total present value profits. Although the original profit maximization model would have suggested that Converse would have chosen to produce Sneaker A in order to maximize short-term profits, the revised model suggests that Converse will pro- duce Sneaker B because that will maximize the owner's wealth and will add the most to the long-term value of the firm. Obviously the revised model makes more sense for the organization and. therefore. should do a better job of predicting managerial decisions. For example. ifrhe goal was only to maximize shorteterm profits. there would be no incentive For an organization. such as 26 6 THE ECONOMICS OF SPORT Theory of the Flrm Louisville Slugger. to Spend money on research and development In order to produce betr tcr baseball bats. Research and developntent costs generally decrease short-term profits bev cause the benefits of these activities do not occur in the short term. However. we know that Louisville Slugger and other companies do spend a lot of money on research and de- velopment in order to produce better sport products, which owners and managers Irnotv will allow the company to produce a better product in the future and thereby maximise long-term profits. —-—--——-———-—.——.—__.__—___ ———-——————.___——_______— Econamlc Proms us. Business Profits Emitter: Profit: It is important at this point to distinguish between economic profits and business profits. Each year. the firm will issue an income statement that will indicate the net profit (loss) at the. bottom ofthe statement. The profit in this case is the "residual ofsales revenue minus the explicit accounting costs of doing business" (Hirschcy 8t: Pappas. I995. p. 10). or more simply put. profit is equal to revenue minus expenses, expressed in the following equation: Business Profits = Revenue . Expenses This accountant's determination of organiutional profits is referred to as the organiza- tion’s business profits. For most people. business profits is how they traditionally define profitability. Economic Profits When determining economic profits. economists also try to determine the difference benveen organizational revenues and cost. However. economists define costs more compree hensively. They recognize that the costs of producing the revenue extend beyond the costs recognized on the income statement because the owners had the option of investing their money and effort elsewhere. The return that could have been obtained from the next best investment alternative is defined as opportunitycosrs. Therefore. economic profits are equal to the business profits minus the opportunity costs. The relationship among economic prof- its. business profits, and opportunity costs is expressed in the following equation: Economic Profits = Barium Profit: - Opportunity Carts To continue investing their resources into the business, the owners must earn business profits that are at least equal to the opportunity costs. When business profits equal op- portuniry costs. the condition is defined as a normal mt: oft-mm: (Hirsehey 3e Pappas. I995). This suggests that a firm earning zero economic profits is not actually losing money. In fact, owners tanning a normal rate ofreturn are likely to continue their investe ment in the firm because there is no investment available that would result in a greater re, turn. However. ifthe organization does not earn a normal rate ofrcturn over time. owners will remove their resources and invest them elsewhere. For example. Laura Carbone is the sole proprietor ofa sporting goods store into which she has invested 3500.000 of her money. During 1999. Laura determines that her sporting goods store has earned a business profit of$100.000. Iflaura believes that the most she could have earned from investing her 5500.000 in the next best alternative would be ECONOMIC MOTIVES 0F SPORT ORGANIZATIONS 0 2T 5100.000, she is likely to maintain her investment in the sporting goods store. Although she has earned zero economic profits. she has no incentive to invest her money elsewhere because the rctutn would be the same or less. or Economic Profit: = $100,000 , 5100.000 : 30 However. ifLsura also works in the store full time. the opportunity cost is the amount of money she could have earned investing her 5500.000 in tile next best alternative piur the amount ofsalary she cottld have earned working for another organization. If Laura deter- mines that she could earn $100,000 from investing her money in the nettt best investment and could earn $75,000 by working full time someplace else. the normal rate of return necessary for her to continue owning and operating the sporting goods store would be 3175.000. [fshe consistently earns only $100,000 in business profits. we would predict that She would not continue as the owner of the store. Although accountants would say that Laura is earning a profit of$l00.000 per year in this scenario. economisls would mg- gcst that Laura would have an economic loss of 3.75.000 per year. or Economic Profits = $100,000 A $i75.000 = ($75,000) When making decisions based on a desire to maximize the long-term value ofthe firm. managers face (Britain constraints that place limitations on these decisions. These cort- srraints arise from both internal and external sources (Bridges 5c Roquemore. [996). One ofthc major internal constraints faced by all organizations is the limitation on the avail- abiliq ofmarrrm (Bridges 8c Roquemutc). Organizations never have an unlimited supply of money or personnel available to accomplish everything they want. For example. thc New York Mets may want to sign all ofthe popular players available in the freeiagent mar, ket. They believe that ifthey can sign these players, more fans will attend their games and watch their games on television. thereby maximizing the value ofthe tc-am. However. even a large-market franchise like the Mets does not have the resources available to outbid the other 29 Major League Baseball teams for all the avail...
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