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Thursday, July 05, 2007

Crazy Money

I basically ceased having a life the last couple of days and spent all my free time reading various sites and message boards as the NHL's version of a fantasy auction took place from Sunday through Wednesday.

A recurrent theme throughout the message boards and media outlets is shock at the salaries given out to players. A frequent comment is that the entire season lost to a lockout was wasted and we are back to the old NHL where the league is divided into first class and second class franchises based on revenue.

First let's address the question of "what has happened?" The salary cap in 2005-06 was $39 million and rose to $44 million last year and next season will be at $50.5 million. That is an $11.5 million increase in just two seasons. Everyone wants to know "how in the world could this be happening?" Well there are three factors that have led to this rapid escalation of the cap.

1) The initial cap was set too low (perhaps on purpose).
Under the current CBA the players are guaranteed a certain percentage of defined revenues. However, in the first season nobody knew for certain how much money the league would make so the initial cap amount was simply agreed upon by the two sides ($39 million) and written into the agreement. There are some practical and political reasons for starting out with a low cap. A low cap dramatically levels the playing field in the first post-lockout season giving more teams a chance to compete and giving fans in many cities good reason to think they are better off under the new system. From a practical perspective setting the cap too low means giving the players a substantial pay raise the following year, if you start off with a cap that is too high you face the ugly prospect of lowering the cap and making the players take a pay cut. Thus a low cap was more likely to produce happy fans and happier players (at least in year two of the CBA).

2) The Players got a collective pay raise
Under the CBA the players share of NHL revenues started out at 54% and this season it went up to 55.5% so as a group the players are receiving more dollars and a higher % of revenues. The whole point of the lockout was to establish a stable relationship between league revenues and player salaries. As an incentive for the players their share of league revenues would increase as total revenues went up.

3) The Canadian Exchange Rate
The Canadian dollar is up roughly 22% against the US dollar since the CBA was signed this is the most important factor. Why? Because the six Canadian teams accounted for nearly half of the post-lockout attendance gains. The six Canadian teams provide roughly 1/3 of all league revenues according to some press accounts. Now Canadian revenue streams appear to be growing much faster than in the US and with the shift in the exchanges rates means that they get an additional 22% boost. In fact, many outside observers suspect that the revenues produced by the US side of the NHL have been essentially flat or least stagnant post-lockout.

That means that the average US team is not seeing the same growth in revenues that the league is experiencing because that growth is heavily concentrated in a few big cities and the Canadian markets. Because the league revenue is up the cap rises even if revenues in your city are not rising all that quickly.

Ironically, many small revenue US franchises are being getting swept up in an exchange rate squeeze that caused great difficulties for small Canadian markets in the 1990s. Now the shoe is on the other foot. In the past it was small revenue Canadian teams under pressure and now it is small revenue US teams. (The big revenue US teams will still make a profit while spending up to the new higher cap).

So there is your explanation as to what has happened. The first cap was unrealistically low, the players got a collective raise and the US is on the bad side of a major exchange rate swing.

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