The NBA season has started. It will be extremely boring. The Miami Heat will win all of their games (well, except for the one they already lost…) and won’t lose any postseason game, making them the most dominating NBA team ever. Not!
The hype about LeBron James’ switch to Florida and the other players the Heat brought in (Chris Bosh) or extended their contract with (Dwyane Wade)was incredible earlier this year. But even though Miami is the biggest favorite to win the title this season, there are other teams that are also having good chances. Take the defending champions, the L.A. Lakers, Orlando Magic or Boston Celtic, etc.
In their season previews, officials and players from these franchises were quite optimistic, mentioned their great team composition, their team spirit and the fact that they don’t have to deal with the pressure of being the big favorites.
The season will tell which view will be right. If we take the MLB as an example: The “best team money can buy”, the New York Yankees, did not win the World Series this year. Then again, they did last year.
Not only because of the LeBron James deal, many complain about the high amounts of money spent for “buying” players in sports – anywhere from the Heat to the Yankees to Real Madrid.
From an ethical perspective, this complaint may be correct. Economically, it’s not. In my opinion, the market for sport stars is one of the best working liberalized markets in the world.
In order to analyze this market, the key question is how to judge if a salary or transfer fee is fair or not. Basic rule here is (as anywhere) that as long as a player adds more value than he costs, it is a good deal. But how much value does a LeBron James add?
If the Heat wouldn’t have LeBron on board, they would certainly not start their matches with four players on the court. Therefore, the comparison is always a relative one. It’s not “how much value does LeBron James add?”, but “how much more value does LeBron James add than the next best small forward the Heat would start instead?” (the next best opportunity).
Some of this value can be calculated rather easily, like e.g. profits from sales of his shirts in the merchandising stores. Some are a bit more difficult, like e.g. profits from sales of additional season tickets prior to the first season, some are extremely complicated, like all profits that are linked to the success of the team.
Those franchises that are doing the best job at judging these factors will probably be the most successful financially on the long run.
Factors like salary caps, etc. make this game even more interesting, but don’t change it completely: In European soccer for example, where there are no salary caps, the existing financial structure strongly favors those clubs that are successful on the pitch, e.g. due to revenues from highly lucrative UEFA Champions League or revenues based on the strengths of the brands which is based on TV appearances. So it’s no surprise that clubs like Real Madrid that are really good at judging the value calculation and prediction are among those with the highest operational profits even though they have some of the highest pay rolls in the game, in Madrid’s case with two of the five most expensive players in the world playing there (Christiano Ronaldo with a salary of 13 million Euros per year and Kaká, 10 million).
Therefore, I cannot conclude good players are too expensive. Yet, examples like the Yankees, Manchester United or Chelsea F.C. show that they’re not too cheap either.
It’s a fair market with some more and some less skilled participants.
So how about good players in your team, i.e. your company? I think the market for labor in management is different from sports in two regards:
First, the availability of good alternatives seems to be better than in sports. If one manager is gone, it seems easy to replace her adequately. In sports teams that does often not seem to be the case. If a key player is gone, not always does the replacement player deliver what the key player delivered.
Second, the ratio of overall value created by a person relative to her salary is a lot higher than in sports. While a sports star earns millions for creating millions in value, a manager often earns only small fractions of what can be earned in sports, yet may have responsibilities in the multi million Dollar/ Euro range.
The relationship between these two is clear and in line with what I explained before: The market is long, so the salaries a company has to pay are relatively low.
But is this true?
With all the ongoing discussions on the “war for talent”, I would guess that the market is not as long as many think.
I believe there’s a great opportunity, and only very few see it today:
The leverage quality differences in management have is obviously huge, as the value created by each manager compared to the salary is high. If that is true, why not a) hire more qualified people and b) pay more than others to attract the best people available?
Both ideas seem to be completely out of the picture in most companies. For the past decades, companies were trying to reduce personnel wherever possible, also in management positions. Life went on, those that were left in the companies prioritized their activities and continued their work. However, this leads to more and more value adding activities being dropped or delayed. One more person tackling these activities would easily create many times more value than she would cost. And in contrast to sports the number of players on your team is not limited.
The same applies for paying above market prices for people on certain positions (and salary is just one part of it; creating a great work environment, offering trainings, etc. all cost money but make the position attractive to potential position holders or the people that are already on the position). The point is: Compared to the value most managers create, a few thousand Euros or Dollars more invested is negligible, but bringing someone in who creates 20% more value at only 20% more cost is a great deal if the leverage factor of value created compared to salary is 10, 20 or even 30.
These ideas are very simple but many will tell you they don’t make sense because we all got trained to think this way. But these approaches are forward oriented and one of the easiest way to gain a competitive edge. Times have changed and it’s time for us to change our way of thinking. In labor markets that are heating up, less is not more anymore.