The Economics of College Athletics Conference Realignment

On October 24^th, 2011, the University of Missouri Board of Curators granted Chancellor Brady Deaton the authority to leave the Big 12 to join another conference—namely the SEC.  This is a huge decision with many ramifications.  At the end of the day, this is an economic decision.  In fact, this is a classic economic decision, and here I will identify a few of the economic concepts at play.

Profit Maximization

In the competitive marketplace, firms choose the profit maximizing factors of production.  For example, a producer of garbage cans will figure out the number of garbage cans to produce in order to maximize profits.  There is a point at which producing more garbage cans will cut into the company’s profit margin.

The University of Missouri is a nonprofit organization.  However, large nonprofit organizations contain profit centers within the organization.  One area of the University may run a deficit (but serves the organization’s mission), while other areas generate surpluses.  Major (BCS) college football is a profit producer.  Thus, if the football program can bring in $19.25 million per year rather than $17.16 million per year, perhaps it would make economic sense to maximize profits by switching conferences.

However, the profit projections are much more complicated than that, and there may be a “far bigger per member share potential should the SEC renegotiate its top-tier TV rights—up to $12 million more per year.”[1]

Also at play is a large sunk cost.  A sunk cost is a cost that is independent of output (production), which cannot be recovered.  For example, if a company decides to paint its offices, the cost of paint is a sunk cost since it is a one-time payment that cannot be recovered.  In this case, the sunk cost is the Big 12 exit penalty.  The University of Missouri had obligated itself to the Big 12 in 2011 by signing a contract.  Depending on how much notice the University of Missouri gives the Big 12, this exit fee could range between $10 million and $40 million.  So let us assume that the University of Missouri determines that the sunk cost (exit fee) is $20 million, but the University can expect an additional $5 million per year in TV revenue.  All other costs and revenue being equal, this move would maximize profits after 4 years of playing in the SEC. 

The number of years of any contract is also a big issue.  The current Big 12 contract proposed reportedly would be a 6-year contract.  This may sound like a long time, but it is not relative to the contracts that other conferences have in place.  The reason the University of Missouri desires a long-term contract unveils another economic principle: moral hazard.

Moral Hazard

The moral hazard is a classic economic principle that identifies a specific problem.  The moral hazard is defined as the problem that arises when the individual has no incentive to take care.  This problem is most easily visible in the insurance industry.  Once you have auto insurance, you lose your incentive to be careful.  If you bump the wall, your insurance pays the bill—so why take care?  This moral hazard is mitigated by insurance companies when they impose deductibles or adjust monthly premiums based on your behavior.  This is a “carrot and stick” approach.  The carrot (incentive) that insurance companies offer is a reduced premium for drivers with clean driving records.  The stick (disincentive) that insurance companies impose is a deductible and an increase in premiums for drivers that cost the insurance companies money.

The current state of college athletics is rattled by a moral hazard. Instability in major conferences has created a situation where universities have lost the incentive to take care (or stick together).  Universities, in conferences such as the Big East and Big 12, are concerned that their conferences are imploding.  No school wants to be left out in the cold if the other universities in their conference leave for the SEC, ACC, Big 10, or PAC 12.  This is why the Universities of Pittsburgh and Syracuse bolted for the ACC, why West Virginia and TCU may leave for the Big 12, etc.  It seems likely that eventually stability will return to college athletic conferences.  In the meantime, conferences (including the Big East) will attempt to impose higher exit fees (sticks) while offering greater incentives to remain in-conferences in order to mitigate this moral hazard problem.

                 by Mike English, President & CEO, Missouri Council on Economic Education