Short Term Gain, Long Term Pain

Post lockout the trend for NHL teams has been to sign players to long term contracts. The inherent risks in signing a player to a long term deal include:

• Injury
• Underperformance
• Unforeseen market downturn – where the market in question (for our purposes the NHL) sees an unexpected decline in revenues or unexpected increase in costs. It is important to note that this has to be an unexpected change or the decline should be budgeted for in all decisions.

Here we will only focus on the effects of the third issue, unforeseen market downturn. Generally speaking the costs for NHL teams outside of player contracts remain fairly constant in real dollars, or put another way are expected to rise with the rate of inflation. Player Salaries, however, do not rise at the rate of inflation like the other costs of running an NHL franchise (this is why the NHLPA insisted that as the revenues of NHL clubs increased, the salary cap (which is a percentage of league revenues) also increases from 54% of league revenues to 55% and then 56% depending on how high league revenues go). Unexpected increases in costs which are unrelated to player salaries are not a problem that will hurt NHL teams if the economy takes a nosedive (which probably just happened) because they are flexible enough to account for lower revenue streams.

Therefore the biggest risk to both the economic feasibility of the NHL and of each individual franchise lies in having player costs which are too high and impossible to get rid of. Given this, it is safer for teams, especially in times of economic recession, to sign players to short term contracts so as to reduce their amount of risk.

Since the NHL operates under a cap, and we will assume for the sake of this argument that this will not change (economists are nothing without good assumptions anyways), player salaries should not become burdensome enough to risk the stability of franchises, at least not directly, but they could very well hurt the competitiveness of teams if they have players signed to long term deals and the revenues of the league turn south and the salary cap declines in value. There are several reasons for which the NHL could see a decline in revenues over the next few years, and as soon as this coming summer when they analyze league revenues again. The two most noteworthy reasons are listed here:

General market downturn: The NHL, as it is an entertainment good, is susceptible to recessions more than essential goods are. As average income decreases the amount of dollars spent on essential goods (food, housing, healthcare, etc) will experience declines which are much less severe than those experienced by any business which produces a product which is non-essential. All sports are subjected to this effect, and all should be affected, but the NHL is in rough shape relative to the other major sports in North America. The television deals which the NBA, NFL, and MLB have are worth much more than those which the NHL currently has. Since television deals are typically revenue streams which are signed for multiple years their revenue is known for all years until the contract expires, it is a much more stable and predictable revenue stream than gate revenues. Since the NHL relies so heavily on gate revenues their revenues will be hardest hit by any economic recession.

The value of the Canadian Dollar: Don’t quote me on this (general rule: don’t quote me ever, you’ll only get me in trouble) but if I recall correctly all six of the Canadian NHL teams were in the top 10 in league revenues last year. League revenues are counted in US dollars, as are player salaries. Last year (2007 calendar year) the Canadian Dollar reached exchange rates as high as 1.036 USD. The yearly average exchange rate was roughly 0.92 USD for 2007. This was an increase over the 2006 years average (roughly 0.88 USD) and the 2005 average exchange rate of roughly 0.82 USD. Currently the Canadian dollar is worth 0.846 USD, which is the lowest since November, 2005. Just looking at the change in value relative to 2007 (the Canadian Dollar remained high until very recently when it declined sharply to its current levels so the 2007 average is fairly close to the average for the 2007/2008 NHL season) the Canadian Dollar has seen a devaluation of 9%. The Canadian government wishes to keep the exchange rate lower than it was last year to help its export industry, at least that’s what I surmised from watching the leaders’ debate, so I don’t think we can expect any drastic increases in the value of the Canadian Dollar in the near future. So if no other factors came into play the value of the Canadian dollar would mean a decline in the revenues of Canadian teams by about 10%. Six of your highest revenue franchises losing ten percent of their revenues before the puck is dropped amounts to a serious problem if you’re a team which expected the NHL cap number to stay where it is, or even increase through the next couple of years.

We have seen many players signed to long term deals and for the most part these deals haven’t been albatrosses like they would have been if the cap had not risen every year since the lockout. When it takes four years for the cap ceiling to grow from 39M to 56M there will be a considerable amount of dollars available to unrestricted free agents. If it wasn’t for this rise we would probably be talking about how difficult it was for the Rangers to shore up their defense given the signings of Gomez and Drury.

This is a situation which probably won’t get too much consideration until summer comes around, but we’re already seeing a bit of hesitation by NHL teams to sign players to the types of deals we’ve seen over the last few years. For instance, Daniel Alfredsson has still not signed an extension in Ottawa, although I can only speculate as to why that might be, I would guess that the economy and uncertainty as to what the cap will look like might play into that. I for one am very curious to see what kind of money teams throw at Marian Hossa this summer or what kind of money Gaborik signs for. Keep in mind that if the salary cap does go down the Oilers could have serious trouble bringing back Garon, Grebeshkov, and Brodziak without having to cut loose other players.