Tuesday, August 28, 2007

Superstar effect

Economist Sherwin Rosen observed how the big stars of soccer and major league baseball, commanded huge salaries and other remuneration. He tried to explain as to why a small number of people earn the lion's share of remuneration and dominate the fields in which they engage. This has commonly been referred to as the "winner-takes-all" effect. Such markets are common in film and music industries, and is increasingly taking over the market for CEOs, financial managers, media personalities etc.

"Winner-take-all markets have proliferated in part because technology has greatly extended the power and reach of the planet's most gifted performers....Now that most music we listen to is pre-recorded...the world's best tenor can be literally everywhere at once.” Alan B. Krueger's studies of the concept of the "superstar" in popular music indicate that "the top 5% of revenue generators took in 62% of concert revenue in 1982 and 84% in 2003", as demand for "superstar" performers increased.

Now, I can understand Tiger Woods or Roger Federer or Michael Schumacher or Justin Gatlin commanding huge salaries or appearance fees. They all participate in individual sporting events, where success is easily measured. But how does one explain the huge salaries paid to football or major league baseball stars? Surely a Thierry Henry or Zinadine Zidane or Barry Bonds or Alex Rodriguez or Roger Clemens are not ten times better than their teammate who earn ten times less. So what explains this differential?

For one, both in football and major league baseball, superstar players often get recruited to boost the image and the hype surrounding the team, which attracts more spectators. By bringing in more people to watch the team, the superstar commands a larger audience than his mere mortal team mates. This higher audience naturally translates into greater revenues at the trunstiles, thereby justifying the massive premiums given to superstars. But this however does not explain the disproportionately high salaries paid to these super stars.

These superstar players have a more important attraction for the good teams. There is very little difference between the major contenders in any league. This means that the teams are on the lookout for anything that gives them the tiniest of edges, that places them ahead of the leading pack. Superstar players often provide that critical edge for these teams, and hence become very valuable for the team. In fact, they even become the difference between winning and losing for these teams. An economist would say that the superstar player has a much higher Marginal Benefit than any ordinary player. Sherwin Rosen therefore observes that "small differences in talent at the top of the distribution will translate into large differences in revenue."

Marginal Benefit of a good or a service refers to the incremental utility or benefit obtained for every additional unit of the good or service consumed. Generally, the Marginal Benefit of goods decreases with every additional unit, which explains the Goosens' First Law of diminishing marginal utility. But the superstar provides the critical tipping point, in terms of performance potential, that would mark a team out from its competitors. Therefore his Marginal Utility for the team becomes very high and higher than that of any of his team mates, and the salary reflects this premium.

1 comment:

Mark said...

Surely a Thierry Henry or Zinadine Zidane or Barry Bonds or Alex Rodriguez or Roger Clemens are not ten times better than their teammate who earn ten times less.

Actually, the weaker players may have a negative impact on the team's chances of winning or none at all. In that case Zinadine Zidane is an infinite number of times better player than Joe Blow to have on your football team.