The Economics of the new NBA rule changes

By: Connor Jung

If I could use one word to sum up the 2016-17 NBA regular season, it would be "lethargic". While people closest to me will point out my team (I’m a Golden State Warriors fan - deal with it) ultimately won the NBA Championship, the general product on the court this year was lacklustre. Without a record breaking MVP season from Russell Westbrook, NBA headlines were few and far between — unless you can consider Lavar Ball a headline.

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The on-court product was criticized because of highly concentrated player talent by conference, and at the team level. With NBA TV ratings falling in viewership in the first year of the new 9 year $24B NBA TV deal, I question the long term sustainability of the cap growth that we saw last season, which led to record breaking contracts.

In light of all these questions surrounding the economics of the league, the Board of Governors elected to make some changes in the effort to speed up the game. Let’s take a closer look at changes and the direct economic impact of the reduction in aggregate timeout time:

First, let's talk why timeouts are important. There has been some evidence that timeouts hurt scoring, because it disrupts the flow of the game and gives defences time to set.

Last week, the NBA announced the following changes to timeouts, thus reducing the overall time available for ads:

  1. Trade deadline moved up to 10 days before the All-Star Game

  2. 7 timeouts per game for each team (no restrictions per half) - no more 20 second timeouts

  3. All non-mandatory team timeouts are 75 seconds

  4. Each team limited to 2 timeouts after the 3 minute mark in 4th or resuming play after 2nd mandatory timeout in 4th (whichever is later)

I thought it would be fun to do a little market sizing question and find out the revenue loss from lost ad space due to reduced timeouts. It’s been awhile since I’ve done market sizing, but let’s give this a try. Let’s start with a few basic assumptions:

Let’s see the results:

The main driver for revenue loss was the reduction of mandatory timeouts from 100 seconds to 75. The purpose of the mandatory timeouts is for ad space, so ESPN and TNT will need to find other ways to squeeze in ad time while not breaking game flow.

Holding all other variables equal, the changes to timeouts will result a $64M loss for the industry and $12.7M alone for ESPN. Considering the inelastic demand for sports content, and need to watch it live, it’s reasonable that ESPN and other networks will raise ad prices to compensate for this lost ad space or find other ways to sneak advertisements into games.

There could be salary cap implications because Media revenue is actually more important than ticket revenue -- while the number of seats in an arena is fixed, potential viewership is almost unlimited. However, monetizing and policing media revenue has proven difficult for any broadcasting network due to cord-cutting, streaming substitutes or illegal retransmission.

Although the rights of broadcasters are provided for within national laws, the illegal retransmission and streaming of sports events continues to expand, especially in the online environment.

The direct relationship between NBA revenues and the salary cap allows player salaries to grow, and with the new NBA TV deal that started this year, we saw NBA salaries climb to unprecedented levels. Mike Conley was in the same company as Michael Jordan and Kobe Bryant. If the NBA cap stagnates, teams will have to be more conservative about cap spending as many teams locked up good players to great player money.

Broadcasting rights fees have been skyrocketing across all sports as live events become increasingly valuable to advertisers. Few viewers will DVR an NBA game, which means they can’t fast-forward through the commercials

While sports media and content broadcasting is a robust industry that has proven to grow continuously, its main providers seem to be at a crossroads given their current business model. With more agile technology-driven companies like Google, Hulu and Amazon, all expressing interest in sports broadcasting, companies like ESPN and TNT must offer a more cost effective, consumer centered subscription catalog or risk being overtaken in the movement to pure digital content.