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Feb 6, 2019
Choose a Promotion & Relegation structure going forward
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We believe that esports should not continue to pursue franchising as its preferred league structure for the competitive scene going forward.
Franchising is an antiquated model (1800s) that is regionally bound to North America and does not foster optimal athlete and fan dynamics. Esports should follow the “promotion & relegation” structure, just like European soccer (football), which has a proven track record of creating value for investors, athletes, fans, and stakeholders.
1) Esports is global and should choose a promotion & relegation league structure for each esports game title, not the franchising model
2) The original rationale for a franchising sports model are antiquated and no longer relevant
3) Promotion & relegation fosters healthier athlete and fan development, as evidenced by soccer globally and quotes from athletic leadership
4) Protecting an investor’s capital through a franchise model is counter-intuitive because global sports leagues thrive in a promotion and relegation model.
5) Investors in esports teams & leagues will benefit greatly from a promotion & relegation model given its flexbility in an ever-changing game title landscape (case in point: Apex Legends releasing and millions of players within 48 hours).
Esports is a key tenant of the future of competitive entertainment, is inherently global (not regional), and athlete and fan development is paramount. Given that we are in the earliest days of its competitive formation, esports needs to follow a better and more flexible model than franchising.
Two video games that have franchised are the Overwatch League (OWL) and the League of Legends Championship Series (LCS).
The best model for esports going forward is to choose a promotion & relegation model across every esports game title, mimicking the success of soccer on a global scale. This competitive structure is healthier for athlete and fan development, a better fit for an ever-changing game-title landscape, has a proven track record of success globally (via soccer), and creates value for the investor’s capital exceptionally well (outperforming the NBA, NHL, and MLB).
Across traditional sports in North America (NFL, NBA, MLB, and the NHL), it is highly unlikely that these sports will transition from a franchise model to a promotion & relegation model given the entrenched investment that has built those sports to where they are today.
On the other hand, video games come and go and are therefore much more flexible to adopt optimal competitive structures each time a new game comes out. This means there are a plethora of new chances over the coming years to build the best competitive scene for the growth of each esport (i.e. each game title’s professional scene) and attract talent and investment to esports at large.
In the 19th Century, the franchise system (“closed membership”) was developed due to the long distances between cities in North America and the significant travel costs that it incurred on professional sports teams. This was not as big of an issue in Europe where shorter distances between urban areas allowed (soccer) teams to build fan bases without having to spend as much time or money traveling as the North American athletes.
In 1876, when the National League of Professional Baseball Clubs was established, the founders decided to make the league a “closed membership” where each owner had local rights and protection from other teams entering their market.
With the ability to monopolize local fan bases, the National League of Professional Baseball Clubs (now the MLB) was able to attract investors who saw a clearer path to operational feasibility given the revenue it would take to cover the high travel costs across the North American continent.
In 1800, it took 3 days to travel ~250 miles. By 1930 (see maps below), it took only 3 days to travel 2,500 miles. What took 3 weeks in 1857 (~20 years before the baseball franchise league started) took only 3 days in 1930. Nevertheless, even though the time and financial cost of travel was improving at a quick rate across the United States, sports leagues continued to franchise (NHL, NFL, NBA).
Following suit with what baseball established in the 19th Century, the rest of the leagues in North America were founded under the same sports franchising structure:
MLB (1876) > NHL (1917) > NFL (1920) > NBA (1946) > MLS (1993)
Let’s address the 3 key factors for why baseball started with franchising, which set a trend for the rest of the North American sports leagues:
1) Travel Costs: this rational around covering travel expenses and protecting investor capital into a brand new league certainly made sense at the time (late 19th Century), but in 2019 we now have faster and affordable cars, trains, and planes. The infrastructure we have today makes this early reason for franchising irrelevant.
2) Local Rights: in 2019, fans are drastically “location agnostic” and transient than ever before. Because of this and the technology advances in the past 20 years, fans can now cheer on their favorite teams remotely from anywhere in the world (this is especially true of esports today). This means that having “local rights” is less pertinent, as evidenced by the success of soccer teams in Europe who follow a promotion & relegation structure without local protection rights.
3) The “New League” factor: for baseball, they had to convince owners, families, and investors to buy into something quite novel at the time. Looking back at baseball, its first organized play was in New York City in 1845, only 3 decades before the league came together in 1876. Similarly, esports is a relatively new category of competitive entertainment (only about 3-4 decades old) and the recent franchising of the OWL (Overwatch) and LCS (League of Legends) certainly fits into the “new league” category. However, future video games have the chance to adjust course instead of repeating the trend like the other sports leagues did in North America in the 20th Century.
Advocates of franchising (primarily NA investors) claim that franchising protects their investment better than promotion & relegation. This is primarily due to the dynamic of their team potentially being relegated to lower leagues of play, thus creating a possible scenario for a dramatic devaluation of their team investment from one season to the next.
Yes, this is of course a risk, yet the opposite is also true: they could invest in a team that could get promoted, thus drastically improving the valuation of their investment.
While every team and league is a bit unique, we did some research to explore the following thesis:
Sport leagues that follow promotion & relegation create value for an investor’s capital just as well (if not better) than leagues that are franchised.
Our approach: we looked at the average valuation (by year) of the top 10 most valuable teams in each sports league (source: Forbes). We focused on comparing European soccer to the North American franchise leagues (NFL, NBA, MLB, NHL, MLS). We specifically looked at the years of 2013–2018 (note: we have data further back than 2013 yet not for each and every league across the board, hence why we cut it off at 2013)
As shown above, European soccer teams have consistently been worth more than every franchise league except for the NFL since 2013 (on an absolute USD basis).
Looking back at 2013, the European soccer teams ($1.6B) were actually worth more than the NFL teams ($1.5B). All of the European soccer teams compete in leagues that operate under promotion & relegation.
The reason for the dramatic jump in NFL valuations from 2013 to 2014 was due to the $27 billion media rights deal that was struck in 2011. This began the distribution of “nearly $7 billion in media money starting in 2014” to all of the teams, which amounted to “more than $200 million per team every year before one ticket, beer or jersey [was] sold.”
The below chart compares the EU teams to the NFL going back 10 years:
Conclusion: franchise leagues do not inherently create value for an investor better than a promotion & relegation league. In fact, a case could be made that franchising actually restricts the investor’s upside for their professional team’s value, as showcased by the lagging valuations of the MLS ($300M avg) and NHL ($1B avg).
To set the stage for the next comparison, note that the above valuations are absolute (in USD), meaning that they do not take into account any other factors besides currency conversion (USD, EUR, GBP, etc).
Looking further into the valuations of the European soccer teams, the teams that comprise the top 10 come from countries that have a lower GDP per capita than the United States (where the North American leagues are largely based).
If a significant portion of a team’s value comes from its local fan base and nationwide media outlets, then it would make sense to adjust their “actual” valuation to account for the lower purchasing power of the professional team’s home country population.
We chose to use GDP Per Capita to make this comparison, as showcased below for 2017 (which we used for 2018 valuation adjustments since that data isn’t available yet). The weighted average for the top 10 European soccer teams was 38% below the U.S. GDP per capita. You will also notice that we included the European Union GDP per capita (29% below the United States)
The below chart shows the following for the Top 10 EU soccer teams:
> Team Valuations: Adjusted for the Weighted Average GDP Per Capita by Country (per year) for the top 10 EU soccer teams
> Team Valuations: Adj. for the European Union GDP per capita (per year)
> Team Valuations: Absolute in USD
We acknowledge that such an aggressive adjustment may be a bit inflated, given that these top European soccer teams have fans globally. However, their “actual value” is likely within this range, making it within reach of (or surpassing) the most valuable sports league in the world: the NFL ($3.3B average for the top 10 teams). That said, the Super Bowl last weekend just had its lowest rating since 2009, perhaps indicating an inflection point for a league that is full of issues including an older demographic, fewer kids playing football, and concussions.
If you adjust for GDP Per Capita, the EU soccer teams actually have outperformed the NFL over the past 10 years.
In conclusion, this GDP Per Capita analysis further supports our position that promotion & relegation leagues do an excellent job of creating value for an investor’s capital over the long term.
North American sports owners have shown that they are very comfortable owning sports teams in leagues that operate under a promotion & relegation structure.
“U.S. investors invested recently in Crystal Palace and Swansea City in England, clubs for which relegation is a clear and present danger, so the idea that there is no appetite among potential American investors for that kind of risk just doesn’t ring true to me.” — Dan Jones, head of the Sport Business Group at Deloitte
Below is a sample list of investors who own teams “across the pond”:
The United States is the largest economy in the world ($19 trillion USD), ranks 3rd in population (324 million people), yet ranks 25th in soccer.
In a promotion & relegation system, there is always something at stake. Even if the team knows they won’t make the playoffs, they are still competing to ensure they don’t get relegated to a lower league. This increases the intensity of competition throughout the entire season, which is something that leagues in North America certainly don’t always embody.
Near the end of a season in the North American franchise leagues, there’s actually incentive to do WORSE in order to have a better pick in the draft next season. This type of competitive structure is unhealthy for athlete development as well as fan engagement.
Below are a few quotes from prominent coaches who agree:
“The most successful soccer leagues are based on competition. And that’s what’s probably missing in U.S.soccer. There is no motivation for teams to invest in quality because you can’t move from the third division to the second or from the second to the first. We believe the increase in quality can be achieved from the bottom up, with teams investing in quality and we believe right now it’s not really happening.” -Riccardo Silva, Miami FC Coach (MLS)
“I would like to see promotion-relegation because I think it just raises the stakes and gives so much hope to some of these smaller clubs.” — Jesse Marsch, Red Bulls Head Coach (MLS)
“This thrill of the relegation battle is non-existent in the U.S. league. The risk for club investors to all of a sudden play in the second league would be too high. But the sporting side would benefit from it. Our players from Europe know that. That furthers our national team. Something is at stake week in, week out. Be it at the top or at the bottom, you always have to perform.” — Jurgen Klinsmann, US National Soccer Team Coach
In esports, new games and titles are being released constantly. With so many new entrants, consumer tastes, and a fluid consumer base, asking investors to spend an exorbitant amount upfront for a franchise fee is no longer necessary or viable. To keep up with an ever-evolving landscape, a more flexible structure for the evolution of the competitive scene needs to be adopted: promotion & relegation.
Here are a few actionable ideas and suggestions:
After doing the research here to flesh out our theory about franchise vs. promotion & relegation leagues, we believe promotion & relegation is the best way forward for the development of esports globally.
1) The rationale for franchising is antiquated and no longer pertinent
2) Esports is global, making promotion & relegation the best model to follow
3) Promotion & relegation creates value for an investor’s capital just as well (if not better) than franchising
4) Esports fans and athletes would both benefit from a healthier competitive structure supported by promotion & relegation
5) Video gaming is not as fixed as traditional sports, we have the opportunity to fix this with new titles (e.g. Apex Legends)
6) Established games that have showed “staying power” (CS:GO, Dota2, CoD, Super Smash, etc) should not pursue franchising for the benefit of their fans, players, and investors
Given that new video games come out every 6–12 months that take the world by storm we have many chances to get this right. The OWL and LCS have helped graduate esports to the next level of league infrastructure development but the franchise model is not the best way forward.
In esports, let’s pursue promotion & relegation.
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