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— Norbert Lou

When Operating Leverage Creates Negotiating Leverage

I’ve been enjoying the US Open tennis tournament, now in its final match not too far from where I write. It’s clear that the quality of play is the best it has ever been, as is the sheer commercial success of the sport.

From time to time, the question of how to allocate the spoils of this commercial success has come up, most notably the question of whether women should receive equal prize money as men (currently all Grand Slam tournaments award equal prize money). One of the announcers raised the issue during the US Open, and Facebook did a poll. ESPN recently aired a documentary about Venus Williams’ successful effort to get Wimbledon to award equal prize money.

Last year Gilles Simon, a French player, asserted that men should receive more prize money, on the theory that they play more sets and that ticket prices for their matches are higher, which translates into more revenue (Ticket receipts and the sale of TV rights are two of the main sources of revenue for the tournaments, along with on-site sponsorships (eg those two Mercedes Benz logos on either side of the net that I’m staring at right now), merchandise, and food and beverage. By the way, when you’re comparing different types of revenue streams, often the best way to compare apples to apples is actually to compare apples to oranges: If I owned a tennis tournament, I would place ticket revenues, TV rights revenues, sponsorship revenues, and gross profits from merchandise and food and beverage on equal footing. Sorry, topic for another post. I’ll close this parenthetical now.). The women counter that their game is just as exciting, and that equal prize money is a matter of equal rights and fairness.

The rhetoric goes back and forth endlessly in a kind of low-level cold war, which is a good clue that the rhetoric does not really matter. In football, a wise man once said, you are what your record said you are. In negotiation, you are what your leverage says you are—and it turns out that women have a lot of it. They have a public relations advantage. They have a strong ally in the millions of female fans who follow the game. And last but not least, they have operating leverage on their side.

Both men and women benefit from running both of their tournaments at the same time and place. It helps to coordinate scheduling. It helps to concentrate the public’s attention. And finally, it allows both sides to share the large fixed costs of running a two-week tournament, most of which the men would have to shoulder on their own if they played separately from the women. From a pure dollars and sense standpoint, therefore, the men benefit greatly from the high-margin revenues the women bring in, even if on some level the men bring in more of the total dollars than the women.

You see a similar phenomenon from time in the hedge fund world, another industry in which high fixed costs relative to variable costs create a lot of operating leverage. Two partners join forces to form a fund on equal terms, and their fortunes prosper. Over the years it becomes clear that one of the partners is adding more value than the other. Resentment ensues, and the harder-working partner is tempted to file for divorce. He soon realizes, however, that if his partner leaves, he will take with him some portion of the fund’s assets under management. The problem is that given operating leverage, a small portion of the fund’s overall AUM can produce a large portion of the fund’s profits. It may then be rational for the harder-working partner to keep the partnership together and split that marginal revenue 50/50.

In tennis, ultimately, you can resolve the question of equal prize money by looking at the bigger picture. Tennis is the only big-money sport in which women enjoy equal fame and stature as men. This parity is part of the sport’s brand, and represents a competitive advantage in its efforts to attract fan attention and the advertising money that follows in its wake. This competitive advantage should be nurtured, and a universe in which women are seen as true equals is much more nurturing than one in which they are seen as second-class citizens and the subject remains a thorn in the side of the sport. Over time, nurturing the brand in this way will attract new fans and maintain the pricing power of the revenue streams, and in the grand scheme of things, those two factors will dominate everything else.