REACTING TO A POTENTIAL RIVAL’S SUBSTANTIAL PRICE DECREASE: THE CASE OF THE ULTIMATE FIGHTING CHAMPIONSHIP A THESIS Presented to The Faculty of the Department of Economics and Business The Colorado College In Partial Fulfillment of the Requirements for the Degree Bachelor of Arts By Brendan Michael Quinn May 2014 REACTING TO A POTENTIAL RIVAL’S SUBSTANTIAL PRICE DECREASE: THE CASE OF THE ULTIMATE FIGHTING CHAMPIONSHIP Brendan Michael Quinn May 2014 Economics Abstract This thesis measures the degree of substitutability in consumption between televised mixed martial arts competition presented by the Ultimate Fighting Championship (UFC) and professional wrestling presented by World Wrestling Entertainment (WWE) in order to estimate the potential impact on UFC’s revenues after WWE’s announcement of a change in its pay-per-view model that dramatically decreases prices. Using a variety of control variables, the seemingly unrelated regression model finds significant substitutability in consumption between the products offered by each company as well as decreasing revenues for UFC as time goes on. This thesis then analyzes WWE’s decision to offer a far less expensive digital subscription service and UFC’s decision to continue using the traditional pay-per-view model. KEYWORDS: (Pay-Per-View, Digital Subscription Services, Mixed Martial Arts, Ultimate Fighting Championship, Professional Wrestling, World Wrestling Entertainment, Income Effect, Substitution Effect, Game Theory) ON MY HONOR, I HAVE NEITHER GIVEN NOR RECEIVED UNAUTHORIZED AID ON THIS THESIS Signature TABLE OF CONTENTS ABSTRACT ii 1 INTRODUCTION 1 2 THEORY 9 2.1 Substitution Effect vs. Income Effect…........................................................ 9 2.2 Introducing Game Theory.............................................................................. 12 3 LITERATURE REVIEW 16 3.1 Tainsky, Salaga and Santos (2013)………………………………………… 16 3.2 Watanabe (2012)…………………………………………………………… 17 4 METHODOLOGY 20 4.1 Data Selection……………………………………………………………… 20 4.2 Seemingly Unrelated Regression Model…………………………………… 28 4.3 Summary Statistics…………………………………………………………. 29 5 RESULTS 31 6 CONCLUSION 37 APPENDIX 40 SOURCES CONSULTED 42 LIST OF TABLES 4.1 UFC Pay-Per-View Summary Statistics (2005-2013)……………………... 29 4.2 WWE Pay-Per-View Summary Statistics (2005-2013)……………………. 30 5.1 Seemingly Unrelated Regression Results………………………………...... 31 5.2 ln(UFC PPV Revenue) as Dependent Variable…………………………….. 31 5.3 ln(WWE PPV Revenue) as Dependent Variable…………………………… 32 Variable Descriptions………………………………………………………. 40 LIST OF FIGURES 2.1 Zero Substitutability; WWE Price Decrease………...………………………. 11 2.2 Perfect Substitutability; WWE Price Decrease.…………………………….. 11 2.3 WWE vs. UFC Decision Tree: Network or Pay-Per-View…………………. 13 5.1 Graph of UFC Revenue Per Event Trend Line ……………………………... 33 (February 4, 2006–October 19, 2013) CHAPTER I INTRODUCTION The Ultimate Fighting Championship (UFC) is the world’s largest mixed martial arts promotion. Their main line of business involves staging events featuring several bouts, or “fights,” between competitors from varying weight classes practicing a wide variety of martial arts disciplines. Their main line of revenue comes through airing certain events on pay-per-view. UFC airs anywhere from twelve to sixteen of their events through pay-per-view per year, and each event is priced at $45. Since debuting in 1993, UFC has gone through a number of important changes. First and foremost, the entire sport of mixed martial arts has transformed from a “no holds barred” type of competition with very little regulation and very low safety standards to one which is regulated in all forty-nine states and emphasizes the importance of rules which promote fighter safety. Senator John McCain famously labelled the sport “human cockfighting” during his nationwide campaign in the late 1990’s to ban the sport throughout the country (Silverman, 1998). Furthermore, early mixed martial arts events (including UFC) featured “freak show” type fights such as those between two fighters of drastically different sizes as well as experience; today, all competitors compete with others in their own weight class, and fighters are generally matched up with those of similar skill level. These changes have allowed mixed martial arts to become better 1 appreciated for the athleticism and competition involved, whereas many once criticized the earlier UFC shows for being a grotesque form of entertainment. Even Senator McCain has told UFC star Jon Jones that he would purchase the upcoming UFC 172 event, which Jones will be headlining (Raimondi, 2014). The business of the UFC likewise evolved along with the sport. After several years of being in danger of ending due to financial troubles and scrutiny from politicians and regulators, the UFC found its first major success with its reality show, The Ultimate Fighter, in 2005, and built enormous momentum both in the number of pay-per-views it sold for each event and in its effort to become recognized as a “mainstream” sport. In addition to being discussed seriously on shows such as SportsCenter, UFC also burst into the mainstream when one of its fighters, Roger Huerta, became the first mixed martial artist to grace the cover of Sports Illustrated in May 2007 (Al-Shatti, 2013). In July 2009, the UFC aired its most successful event ever when UFC 100 sold over 1.6 million pay-per-views (Meltzer, 2009). 2011 saw the UFC begin a seven-year broadcast deal with Fox Sports to air certain events live for free on Fox as well as Fox Sports 1. Throughout this time, the UFC became recognized as the premier mixed martial arts organization throughout this country and the whole world, buying off several smaller promotions along the way and consistently featuring the most skilled roster of professional fighters from around the world. Over the past few years, however, the UFC’s momentum has stalled. 2010 was the company’s most successful in terms of total pay-per-view buys, as well as the number of buys per event. The company sold over nine million pay-per-views that year. In 2011, they sold about 6.8 million, and in 2012 they sold about 5.9 million. Journalists and fans 2 of the sport have come up with many possible explanations. Some say the company has failed to create stars that fans will pay to see while the biggest stars of yesteryear have retired or fallen from their prime. Others suggest that the company has cannibalized its own product by airing more and more free events on television through their Fox Sports partnership, diluting the value of pay-per-view cards by pushing certain stars onto free TV (Doyel, 2013). One suggestion that is growing in popularity is that the pay-per-view business model is a dying one, as fans of the sport are becoming less willing to spend a hefty sum of money for a one-off event. This suggestion has drawn countless comparisons between the UFC and one of its rivals in the pay-per-view industry, World Wrestling Entertainment (WWE) (Meltzer, 2014a). While both are major presences in the pay-per-view industry, WWE offers a different product than what UFC offers. While UFC is undoubtedly a sporting promotion, those in charge of WWE prefer to call their product “sports entertainment,” with an emphasis on “entertainment.” Many people, including UFC President Dana White, suggest that the UFC and WWE are not rivals at all (Hall, 2014). These people first note that the UFC stages legitimate sporting contests with no writers or storylines, whereas WWE provides more of a weekly “soap opera” based around the staged performance known as professional wrestling. White has stated that he believes there is a much larger crossover between mixed martial arts and boxing than there is with professional wrestling. Still, many contend that there is enough of a crossover to consider the two companies rivals. Dave Meltzer (2012) of Yahoo! Sports wrote, “The closest business model to UFC is that of World Wrestling Entertainment” in an article about compensation for UFC’s fighters. He insists in the article that the UFC is 3 “structured completely differently from the big four team sports” and “also structured differently than boxing.” Meltzer also defends against those who, like Dana White, believe WWE’s “scripted” environment make all similarities between WWE and UFC irrelevant: “While some will argue WWE is a form of performance art and not a real athletic competition – and thus the performers don’t deserve as much money – the dollars WWE derives from its performers, who take a legitimate physical pounding, is every bit as green as those which UFC makes.” Like the UFC, WWE also airs pay-per-view events about once per month for a similar price. Although there are other mixed martial arts companies that are certainly in competition with UFC, none are close to as big as WWE. Likewise, while there are other professional wrestling companies that try to compete with WWE, none are nearly as big as UFC. For these reasons, it is not stretching the truth to acknowledge a rivalry between the two companies. Unlike the UFC, WWE’s success through the pay-per-view market revolves around selling matches between competitors using compelling, fabricated storylines on its weekly cable television shows; the UFC must convince fans to purchase their events by advertising the sport itself and the legitimate mixed martial arts credentials of its competitors. Another major difference is that WWE has the luxury of reusing its major stars for just about every pay-per-view they air, whereas individual UFC fighters typically never compete more than three times per year. Thus, the company must more carefully choose when their most popular competitors should appear on particular events throughout the year. UFC fighters are also much more prone to injuries that make scheduling even more difficult for the UFC. One planned event, UFC 151, had to be cancelled entirely when a main-event championship contender, Dan Henderson, had to pull out of the event due to injury, and 4 the reigning champion, Jon Jones, refused to fight someone else on short notice (McNeil, 2012).