Building resiliency: businesses plan for all types of scenarios--busy season, slow season, economic slowdowns, etc.--but what are the unique characteristics of the business of sports, where the key ingredient, talent, is somewhat unpredictable? Financial Executive and Financial Executives Research Foundation asked several involved in the business how they manage.

With the current focus on excessive executive compensation, consider a business where more than 50 percent of revenues are paid out for compensation--and not for those in the C-suite, but to employees. Imagine a business where the owners aren't likely to receive annual returns on their investment, and may only realize a return upon selling the business--likely many years down the road. Would you invest in this kind of business?

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For many sports franchise owners in North America, the answer is a resounding "yes." A series of interviews with executives in the sports industry reveal that despite the glamour and glitz, the business of sports is tougher than one would think.

It's a business where the product you work hard to deliver is your team's performance--and yet you can't guarantee that all the players will even make it to the end of the season. You can spend tons of money on a star recruit, only to lose him to an injury. Short-term injuries are largely planned for, but debilitating season-ending or, worse, yet, career-loss injuries are high-risk variables.

It's a unique business where its asset value is the franchise itself. It's part of a universe of a limited number of franchises--all four major pro sports total 122 franchises, with 30 teams each in basketball, baseball and hockey and 32 in football--and the value is determined by the amount the last franchise sold for.

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And, talk about keeping customers. For sports teams, the customers are primarily fans, who love winners, and will often defect when the team is down. Yet, legends are made with a team like baseball's Boston Red Sox, whose fans patiently waited 86 years for a national baseball championship! Sponsors, too, will pay big for contracts with winning franchises. Indeed, the finance guys in this article know well the best time to talk about long-term contracts is when their team is on a winning streak.

Established in 1967 as the Dallas Chaparrals, the San Antonio Spurs of the National Basketball Association (NBA), have been enjoying a sweet run for about the past 15 years "We don't know what it's like to have a team that hasn't won," says Rick Pych, the executive vice president/finance, corporate development, who has been with the Spurs since 1993.

He says his team has been fortunate. Since David Robinson (who has since retired) started playing in 1989, the team has had only one losing season, and that's when Robinson suffered a back injury and missed most of the season. But, good fortune came again when the team missed the playoffs that year, got a lottery pick in 1997 and netted Tim Duncan. They have been back on a roll ever since.

Avoid the Unforced Error

Ask Pych about the most unpredictable aspect of his business, and without missing a beat, he says, "Tim Duncan (pictured, left) getting hurt and not being able to play again."

"We can't afford to make mistakes in player decisions in such a small market," Pych continues. "With us, planning is everything. We have a rolling five-year planning cycle that begins with our player roster." Any change in the team's overall health will dramatically change its financial success. "Short-term injuries you can deal with, but, when a player has a career-ending injury and you're not in a position to replace that person, there's really no provision to acquire another franchise player. You may have to start rebuilding your team at that point."

Rebuild is exactly what the now 40-year-old Pittsburgh Penguins did, as it's just completed a six-year rebuild. "We needed a major correction in the economics of our business," says President and CFO Ken Sawyer. When the National Hockey League (NHL) lockout occurred in 2004, lasting nine months, he says, "We planned for it, but nonetheless, we took our lumps, financially." It is apparently paying off, as it has allowed the team to revamp its roster.

"The more successful you are, the harder it is to sustain because better teams get later draft picks. We had a talented team, but there was no [salary] cap--we just couldn't compete. So, we made a decision to let go of players--which impacted revenue. However, in the last four years, we drafted first or second overall." Now, he says, "we have the best young talent and a great run ahead of us. That's how you protect the pipeline."

The collective bargaining agreement, along with a salary cap (results of the lockout) has made a difference for the Penguins (owned by former hockey Hall of Fame member Mario Lemieux, one of two general partners). The first season back was the team's best revenue year ever. "We led the league in the growth of ticket sales," says Sawyer, conceding it was also partly due to the Penguins signing the sports' "latest and greatest," Sidney Crosby. "Our fans were there--they were pent up."

At the time of this interview, the Penguins were selling out every night and hadn't lost in their past 13 games. "You just have to have a winning team," says Sawyer, who was previously the NHL's CFO. He's been with the Penguins since 1999.

The Nashville Predators--a 1998 expansion team--is also one of the top-performing teams. But Ed Lang, the CFO and executive vice president of Finance & Administration, still worries about consistency. "Because we're a newer team, performance can be a bit more unpredictable." The team, owned by Craig and Helen Leiopold, a family member of the manufacturer S.C. Johnson & Son, is the 27th franchise of the NHL's 30 teams. On paper, Lang says, "a team may seem to be the best in the NHL, but for some reason it may not gel."

The sports business is a very emotional business, opines Lang, adding that when the team is winning, people are knocking at your door--both ticket buyers and sponsors. Of this year, he says, "We're having a great season, and that is translating into increased sponsorship interest and ticket sales." He noted a recent call from a major retailer that previously said it doesn't do sports sponsorships. Now, it wants to do something with the Predators!

However, he knows there will be leaner times, so in order to manage the risk, he's advising his sales staff to write long-term sponsorship contracts, even giving better financial terms to stretch contracts out to three-to-five years.

Sawyer also stresses the importance of obtaining this type of longer-term "contractually obligated income," particularly when a team is hot. Though sales and sponsorships don't match up identically with performance--there is a lag--one follows the other. "If you have a very good product, you'll find that you're going to have great attendance, great revenues."

He's quick to note that fortunes can change quickly. "You're dealing with individuals, not machines. You spend a great deal on certain players and you don't know whether they're going to perform below, at or above what you expect for that amount [spent over several years]." Even drafting is unpredictable; a player recruited at 18 may not show talent until the age of 22 or 23.

Also unpredictable, says Sawyer, is coaching--"a very demanding job, and you don't know whether the players stop listening to their coach." Players are motivated by different coaches, and the dynamics are different with younger players versus veterans. Bottom line, he warns, "avoid the unforced error"--such as taking an enormous risk on one player, by entering into a long-term contract, and don't be overly optimistic.

The Expectations and ROI 

The four major sports leagues--basketball, hockey, baseball and football--operate quite similarly. Each team is an independent company that holds an equal share of and vote in governing the league in which it is a member. The league governs how the game is conducted and negotiates national and union contracts. Each team is owned by a partnership or a sole proprietor, or, in a few cases, a larger corporation. Most are private entities, and just a few have gone public.

Revenues are derived primarily from ticket sales (season, daily and group--with season the largest share) and broadcasting rights. Additional revenues come from sponsorships, licensing and several other ancillary sources. Though percentage breakdowns differ with each team and each sport, what Sawyer describes as gate receipts--ticket sales, concessions and parking--typically provide more than 50 percent. Also, some teams are involved in arena ownership and/or management, another source of income.

After the money comes in, it goes out, and in sports franchises, often more goes out than comes in. Most of the expense is for player compensation; another big chunk goes for coaching, league dues, marketing costs and overhead. The leagues have salary caps that govern the maximum teams can spend on talent.

The NHL salary cap, currently at $44 million per team, equates to about 55 percent and 65 percent (including minor league players) of the Penguins' and Predators' revenues, respectively.

For the Spurs, Pych says about two-thirds of total expenses are in some way or other player-related. In comparison to the NHL "hard" cap, the NBA cap is "softer," providing exceptions where teams can pay above the salary cap for individuals that have been in the league more than three years. Thus, Pych notes, teams have paid upwards of $100 million in salaries for their rosters.

After all the expenses, what's left? Sometimes, not much. Because of the limited supply of talent--even more so for some states that only have one major sports team--Sawyer says it's difficult to obtain the kind of returns or earnings per share achieved in other industries. "In our business, over time, it is very hard to have much of a return based solely on income. It's typically asset-driven. "Indeed, quips Sawyer, there are times when he thinks he's working for a non-profit.

In addition to asset value, an important metric for the Spurs is costs per win--which is then aggregated to determine total wins at season end so that it can be compared to total player costs. Though some teams may have a successful record, Pych notes the on-court performance may pale in comparison to the financial cost of that success. Debt-to-asset ratio is another common metric--particularly since the leagues have rules that prevent any one team from having more than a certain level of unsecured debt.

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Teams aspire to be in the playoffs. Pych says he keeps separate financials for the playoffs, and, as in many sports, "that's really where you can make some money. Your player cost is fixed for the season, [so] it doesn't cost more. If we are not having to pay another dollar of salary in the playoffs, your most significant hard cost has just disappeared."

But, even if a team does make the cut, it could still be a struggle. Lang notes the Predators--which have been in the playoffs the last two years--almost need to make it to either the 3rd or 4th round in order to either break even or make money. "It's a risky proposition," he says."

That said, owners are in it for the long haul and don't expect distributions until they are ready to sell. Even then, it's not straightforward to determine how much a team's value grows year after year. "That's a hard thing to measure," Lang argues. "The traditional cash flow models that are used in valuation get thrown out the window because of the operating losses that many teams generate." The easiest way to determine value is through comparison to recent transactions.

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Until they do sell, however, owners are often willing to lose money each year they own the franchise, as long as the asset value is growing. And Lang has been the finance guy watching the asset grow, as he's been with the team since its inception in 1998.

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The Broad Perspective

It's apparent that owners are "in the game" for reasons other than making money. Whether they like the notoriety, are altruists or just have a passion for sports, Sawyer likens ownership to being part of a public trust and says owners typically own a team as part of a larger portfolio. "[They've] made [their] money and now [they] want to enjoy it."

This appreciation of the game is shared with the fans. The Spurs' current ownership began in 1993 when 19 individuals and companies invested primarily out of a concern that the team was going somewhere else.

"It goes back to the scarcity issue, and they did this more as good corporate citizens or individuals, as opposed to any burning desire to own a sports franchise," says Pych. He explains that the NBA has evolved over the past 20-30 years, transforming the game into entertainment--adding mascots, music, dancers and promotional events to enrich the experience. Pych believes that this focus on fans and community is rewarded by their loyalty.

"We want to make sure that we have players that are good people with good character that our fans are proud to have not only as players on the court, but as citizens and representatives of the San Antonio community." Eventually, he adds, when the day comes when the Spurs are not one of the top teams in the league, having this community tie will be important.

Possibly, it is this intangible benefit that is taken for granted when just looking at the dollars and cents of sports. "We're a small business, in terms of revenues, but we have an enormous impact on the region we serve, compared to any other company of similar size," says Sawyer. "There's nothing that coalesces a community [like] a winning sports team. It's fun to be part of that."

RELATED ARTICLE: New for the PGA Tour: The PlayOffs

Time was when golf was the only major sport not to have playoffs. That's not so anymore. Starting this year, the PGA Tour has launched the FedEx Cup, a season-long competition in which top professional golfers earn points by playing January through mid-August. Then the top 144 players in the standings enter into four playoff events. The PGA Tour regular season--which previously ran from January to November--now ends in mid-August; playoffs run through mid-September.

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"We think that this is going to be very exciting for fans and great from a television standpoint," says Ron Price, CFO of the PGA Tour. "In the final event, there'll be 30 guys competing for the top prize, which is $10 million."

In creating this new approach for golf, the PGA Tour is seeking what all major-league sports teams seek: more fans, sponsor money, buzz, media coverage, collateral sales.

A distinction for professional golf, however, is that PGA Tour events contribute to charities, so the more it earns, the more it gives. Dating back to 1938, events have contributed over $1 billion to more than 2,000 charities. The Tour has no "official" charity, as funds are distributed by the local communities of organizations than host events.

Almost 40 Years Old

The Ponte Vedra Beach, Fla.-based PGA Tour was formed in 1968, when it split off from the PGA of America (PGA of America is comprised of teaching pros). It is a 501 (c)6, tax-exempt organization with about 500-600 touring pro golfers who, through competitive standards, earn the right to membership. The organization provides members with competitive opportunities and benefits all financially, with prize money as well as a substantial pension fund. Price says it has the best retirement plan in professional sports. The Tour's Policy Board determines the amounts players can earn through prize money, retirement plan contributions and other player benefits.

Indeed, Price says the way they (and their board) "measure the success of our business is based upon the level of net financial benefits that are generated for players to compete for"--through tournaments, retirement plan contributions and other member benefits.

The Tour produces approximately 110 events yearly in three groups that offer more than $340 million in prize money. The PGA Tour (which includes the four majors: the Masters, U.S. Open, British Open and PGA Championship) features the most competitive players and garners on-site and television viewers worldwide; the Champions Tour showcases the most accomplished pros over age 50; and the Nationwide Tour provides a proving ground for future stars.

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The organization's revenue is generated from two main sources: the core business of operating tournaments produces significant amounts of broadcast revenues (television and cable) and from payments received from host organizations. Also, the PGA Tour operates 12 events itself, and other revenues come from supporting businesses, such as Tournament Players Clubs (such as the flagship club at Ponte Vedra Beach, home of the Players Championship); a production company (PGA Tour Productions); a retail licensing group, a corporate licensing group and title sponsors (in addition to marketing partners).

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The tours repeat a "traditional" schedule that has been in place a long time, with few changes. Price notes that the PGA Tour recently entered into new long-term contracts with television partners (events are now covered on NBC and CBS and the Golf Channel on cable), tournament co-sponsors and title sponsors. As such, he views the core Tour business as being secure over the contract term, adding that the PGA works very hard to secure the main components of the business cycle over a long period of time.

Price explains that this cycle starts with the tournament schedule over a six-year period. (A new cycle just started this year.) This process involves much hard work--dealing with networks, title sponsors and more. "We know that the success of us being able to do this again down the road is going to depend on how well our tournaments perform, how exciting the game is [and] how our TV ratings perform." So, as soon as one cycle is complete, he says, "we start working very hard on the next cycle."

Most unpredictable, he says, are the supporting businesses, with "an unpredictable element with regard to our Players Clubs," which can be impacted by the economy. And, of course, weather can be an issue for the tournaments.

So, what's the impact of the "Tiger-economics" factor in Tour events when Tiger Woods is playing? Price concedes there is a "spike in the TV coverage and tournament revenues when he [Woods] competes." However, he's quick to add: "The way we look at our business is that we have a lot of good players out there, and anyone on the PGA Tour can win. These guys are that good."

CHERYL GRAZIANO, CPA ([e-mail]), is Vice President-Research and Operations, Financial Executives Research Foundation and ELLEN M. HEFFES ([e-mail])