Zach Arnold of Fightopinion.com  has been making a series of comments regarding the economic downturn and the state of the UFC.

There is no doubt that the major sports are being affected by the economic downturn. However the real reason why the UFC appears immune to the current recession, is not due to their economic viability, but in fact due to their status as niche sport and subsequent business model.

In order to understand why the UFC has been spared, it is first necessary to understand why and how the other major sports are being affected by the recession.

The current recession is a result of an over-leveraged, highly interconnected global economy. The major U.S. sports leagues are feeling the pain due to similar problems, an over-leveraged business model that is too interconnected to the industries that are collapsing. Thus all the major sports are feeling retractions.

There are four main revenue streams that sports depend upon; merchandise, sponsorships, advertisements and ticket sales. With Americans cutting down on discretionary spending merchandise sales have dropped across the board.

The NFL, NBA, NHL and MLB all depend on advertisements and sponsorships to generate large sources of revenue. The credit crisis has literally frozen millions of dollars of revenue from banks, insurance companies and other businesses that used to invest heavily in the business of sports. For instance, these industries were once willing to cough up millions of dollars for naming rights to stadiums. Recently Jerry Jones spent over a billion dollars on the new stadium, a stadium that has yet to find a suitor to buy the naming rights.

The lack of credit prevents corporations from taking loans to sign the lucrative sponsorship deals with franchises or leagues. For instance, companies cannot take out large loans to sign a contract with the NFL to be the exclusive partner, such as Coors being the official beer of the NFL.

The economic crisis is even worse when you consider that basic advertisements are drying up. Electronic companies, a major source of commercials due to HD televisions, are hemorrhaging money (Circuit City was the first to go bankrupt). Even the videogame industry is losing money as publisher after publisher closes its doors. Some are arguing that the videogame business model will be overhauled.

Another aspect of the advertisement crisis is the auto industry’s pain. Automobile commercials make up a major portion of sport advertisements. There are of course the bailouts for the Detroit automakers. But the crisis isn’t centralized to just Detroit. Car sales have dropped by more than 50% since the downturn began in 2008. This cuts into the German and Japanese auto industries as well. All auto companies have responded by tightening their belts, which results in fewer commercials that generate less revenue for the leagues and teams.

The second issue that is hurting the major sports is their operating costs. This comes in two folds, team costs in the form of player and coaching salaries and operating costs such as running stadium. For the NBA and MLB, they have been dealing with bloated player salaries for some time. This has crippled smaller market teams, which can’t become competitive due to giant contracts for mediocre to average players. If the smaller market teams can’t put out a quality product, ticket sales drop in a market with little discretionary spending. While great players are continuing to get paid, see Albert Haynesworth’s contract, average players throughout the sporting world are receiving direct cutbacks.

The second issue facing many major sports franchises, is new multi-million, state of the art stadiums that need to be profitable. These stadiums have lost revenue in naming rights, personal seat licenses, luxury boxes etc. In an effort to lower costs many NFL franchises have begun laying off front office employees.

Which brings me to the third issue facing major sports, their direct revenue stream, ticket sales. The business model that the major sports have created is dependent on cheap credit and large quantities of money. Personal seat licenses, luxury boxes, courtside sets, diamond seats --where teams make most of their money and pay off stadiums-- all require exuberate amounts of money. Businesses that were willing to fork over cash for a status symbol, filled these high premium seats. With the long duration of seasons for hockey, baseball and basketball, the value of such high priced luxuries is completely unnecessary.

[Side note: I have read contradictory information regarding hockey. Some reports say that the NHL will undergo a contraction losing several teams. Other news coming out of Toronto is that the lockout of 2004 helped slim down operating costs, creating a more economically viable model, thus the league as a whole is fine. On the other hand one has to take what the leaders of a business are saying with a grain of salt. For instance, the NBA is saying the same thing but Bill Simmons laid out the major economic shortfalls that are now facing the Association.]

With the economy and businesses in free fall many individuals and companies are backing out of their contracts to fill luxury boxes, diamond seats, court side seats etc. in order to save money. When fans and companies start scaling back spending it directly cuts into a franchises revenue stream through all the complicated mechanisms that were created to increase profits. (Ironically overly complex financial mechanism is what got Wall Street, the banks and the housing market into this mess). Indeed the ticket structure of the major sports may have been built on a foundation of sand that has now evaporated as cheap, easily available credit has all but disappeared.

It is at this point that the where the UFC holds an advantage over the other major sports, and that is their existence within a niche market. While the UFC has been expanding out of their niche, their business model is not as heavily dependent on the above described revenue sources like the other major sports. This has allowed the smaller, more adaptable MMA promotion to post economic gains and expansions while everyone else is retracting.

The situation is analogous to biological speciation. A species that has evolved to exploit a specific resource cache is said to exist within an ecological niche. When, the rest of the ecosystem suffers a shock, with the exception of the niche, then that species ends up becoming more prominent while other species undergoing shocks lead to population reductions or extinction.

For those of you who aren’t science dorks, think of it this way. Your manufacturing business depends on only one type of raw material, your competitors, while more successful, need a variety of raw materials. Suddenly there is a systemic shock reducing the availability of all raw materials except yours. Suddenly you are sitting pretty, while your competitors are scrambling to stay afloat.

The UFC business model is focused around pay-per view events and live gates. Lorenzo Fertitta has described it as the center of the UFC ‘wheel’, with everything else being derived from that.

Since the sport is still relatively new, the UFC was never dependent upon lucrative advertising contracts and sponsorship deals. While they have recently added Fulltiltpoker and Budweiser as advertising partners, their economic viability is not dependent on a continual reinvestment of advertising dollars in the form of commercials and sponsorship deals.
 
With regards to ticket and PPV sales the UFC benefits from their loyal niche fan base, and diversity of markets. UFC fans are more than willing to get together to pay for a fifty-dollar pay-per view event (five friends make the cost $10 not a bad deal). Since the UFC jumps from market to market, while maintaining a base in Las Vegas, it allows them to draw upon different markets to drive ticket sales. Vegas is the base for major fights, while Columbus and Montreal represent strong markets that receive a single event once a year.

It will be interesting to see if Vegas can remain a stable base of operation considering it is ground zero for the housing bubble. However the UFC has responded to this development by saving their best cards for their base. UFC 91, 92, 94, 98 and 100 are all high caliber events featuring title fights and their best fighters.

Of course key to this mobile business model is putting on a quality product. UFC 96 only had a gate of $1.8 million, almost half of what UFC 68 did, and did not sell out the Nationwide Arena. Currently there is no word regarding pay-per view buys.

The UFC is also able to keep operating costs low. Just compare the salaries of the varying tiers of athletes within the UFC to the other major sports and it is a shock. Andre Frazier, a NFL special-teamer, received a $1.7 million over two years. The equivalent would be Chris Lytle’s $14,000 to show for a fight. The payment model is obviously different, but there is still a remarkable difference between the salaries. Since the UFC doesn’t own any tangible assets, like a stadium, that further reduces their operating costs.

Overall we shouldn’t be shocked that the UFC has been able to weather economic storm with little issues (however $20 tickets in Nashville could be viewed as bad news). The UFC, and MMA as a whole, status as a niche sport and unique business model, is the direct reason for their economic viability in such a destructive time.