The argument for franchising in the LCS—and esports as a whole

The biggest esports league in the world may soon go through a radical change. And lots of fans aren’t happy about it.

Since its inception, the LCS—Riot Games’ premier League of Legends tournament—has used a promotion and relegation system similar to most European soccer leagues. Each season, Riot has employed some variation of relegation where the bottom teams are forced to compete with the top two teams in the Challenger league to avoid being demoted.

Riot will soon look to franchise the LCS, however, granting a permanent slot to some teams and doing away with relegation forever, according to a report last month. While the esports community is drawn to the prospect of amateur teams that can challenge professional teams, franchising would put an end to that. But while the community may not be happy about this, what they haven’t recognized is that the relegation model has created an ecosystem favoring player wage inflation, disparity in competitiveness, and a growing economic bubble.

The LCS teams

Although most fans may not concern themselves with how much money a team makes, they often care for the wellbeing of players on teams. Obviously the financial success of a team corresponds directly with its ability to pay its players and increase their salaries. In this instance, the relegation model was not sustainable for the LCS owners, and consequently its players.

Consider that between a five-man roster, one coach, a fully furnished gaming house, sports psychologist, gym membership, team chef, and support staff it costs a million dollars to fund a team for a year—and that is a low estimate. How does a team turn a profit with a $1 million in expenses?

Riot provides funds for each team to pay their players and coach a minimum of $12,500 each, per split. This helps cover the costs of these individuals, but not completely. With it included, we can assume that before prize winnings, IP distribution or anything else, Riot pays for roughly 15 percent of the average team’s expenses. So where is the rest of the money coming from? The answer is sponsorships.

The cycle

Unlike the NFL, NHL, EPL or any similar league, participating teams in the LCS are given a license to participate, but retain no ownership of the league. There is no existing revenue share on issues like broadcasting and league sponsorship revenues,

Keep in mind that for an average team in an average league, the primary source of revenue is always broadcasting rights. According to Deloitte, a leading accounting firm, the broadcasting rights from the English Premier League were projected to make up approximately 60 percent of the league’s revenue in 2016/17.

The NBA currently brings in $2.66 billion per year from its national TV deal. That number does not include local TV or radio deals and it represents nearly half of the league’s revenue. Other sources of revenue for traditional sports teams include ticket sales, suite sales, concession sales and a few other streams that are not available to an LCS team. In turn, LCS teams are heavily dependent on sponsorship revenues.

The above chart, taken from Deloitte’s financial forecast for soccer teams, indicates the sources of revenue for Manchester United, Champions League clubs, Europa League clubs, and all other clubs. Of particular importance is the “Commercial” intake for every team but Manchester United and the UCL clubs. Here, commercial revenue encompasses sponsorships. Teams subject to relegation in the Premier League bring in less than 12 percent of their revenue from sponsors.

What is obvious from the graph is that the lower you place in the Premier League, the less likely you are to bring in substantial sponsorship revenues. Not surprisingly, the lower the sponsorship revenue, the lower the matchday revenue. The worse the team is, the less people watch. Unfortunately, the above conclusion is also a catch-22 because the less that people watch, the less money the teams have to spend on players. The less money the teams have to spend on players, the worse the team is. The worse the team is the less likely it is that sponsors will be affiliated with a team that might face relegation and less viewership. This conclusion cannot be reached for non-relegation leagues.

As of March 2016, some of the best teams in basketball had the lowest brand valuations and some of the worst teams in basketball had the highest brand valuations, according to a Forbes article published last year. While brand valuations obviously account for merchandising, IP licensing, and other things, it is generally a good indicator of sponsorships as well. Even though they finished in last place in the Western Conference, the Lakers brand was valued at $546 million, good for the highest in the league. Despite finishing in the top three of their conferences, the Raptors and Spurs had brand valuations closer to the middle of the pack.

An article on sponsorship.com detailing the 2014 season listed the Kansas City Royals, Pittsburgh Pirates, and Oakland Athletics as “below average” in terms of sponsorship revenues. All three of those teams qualified for the playoffs. The Royals were one game away from winning the World Series.

The difference in revenue between models is likely attributable to the potential for bad teams to build up a successful brand and fanbase over a period of time by unconditionally remaining in the league. Bearing in mind that for an LCS team sponsorships are the primary source of revenue, it should come as no surprise that some teams struggle mightily. It is very difficult for new teams to amass a large enough fanbase to convince sponsors to fund their operation; much less within one split. The result is the less well known teams run their businesses with little-to-no revenues to fund their huge expenses. At the end of the day, it becomes even more difficult for them to field a competitive team without taking on additional investors.

That conclusion is also cemented by the above chart. Unsurprisingly, the top six spending teams, all teams that spent above the league average, finished in the top six of the league’s standings. In this particular year, the average wage costs for the top six premier league teams was £110 million more than the average salary for every other team. While relegation obviously makes games more interesting to watch, since there is more at stake, it seems that due to the wealth inequality the same teams are more likely to win each year.

Since the Premier League’s inception in 1992, only 6 teams have won the title. In that same time period 5 teams have won La Liga and 6 teams have won the Bundesliga. In a “franchised” model 13 teams have won the Stanley Cup and the World Series and, 14 teams have won the Super Bowl.

In fact, there was recently an outcry among Premier League teams about the lack of economic and on-field parity between teams. A few years ago the teams jointly agreed to limit the amount that could be spent compared to the revenue they brought in. UEFA, the governing soccer body, introduced Financial Fair Play regulations to prevent clubs from spending above their means and to stamp out “financial doping.” Before this limitation was imposed, the Premier League teams collectively lost £205 million in 2011-2012, according to The Guardian. Since 2013/14 only 30 percent of revenue increases were consumed by wage growth whereas in the five years leading up to 2012/13 that number was closer to 99 percent. Still, as demonstrated by the above chart, teams closer to the lower end of the table spent a higher percentage of their revenues on wage costs. Prior to the regulations being imposed, that number often exceeded 100 percent. The result was massive wage inflation, similar to that which is being seen right now in the LCS.

For LCS teams without diversification in other games which offer other revenue streams, the threat of relegation is a threat to the very business itself. At the very least, sponsors will be more inclined to reduce their payments since there will be less eyes on their product. Since that is one of the few revenue streams teams use, it may be equivalent to killing the business. Teams recognize the risk to their primary money maker and in turn expend more money than they have, just as the Premier League teams had, competing with their fellow teams seeking to avoid relegation to ensure their business can continue. They fund the esports wage bubble and pay for it by taking on wealthy investors, some of whom treat their esports team as a new marketing expense for their professional sports franchises. While additional broadcasting revenue would certainly be helpful in the short term, without a cap on spending or a means to curtail the competition to avoid relegation the bottom line will not change. Player salaries will continue to be inflated while teams continue to lose money.

Riot’s move to franchise the NA LCS is a direct response to the instability threatening teams. Teams have responded positively and clearly have endorsed this franchise model. In that regard it is the correct response. The hope is that over time this model will become endemic to the industry and replace the unstable relegation model.