Sunday, December 17, 2006

Mad Mavens Make Mark Masticating Money Matters: MLB As Perfect Market  

Money and the practice of using it in organizational operations is overvalued -- managers tend to spend too much time focusing on it both in daily work and as one of many important tools that shape our means and ends.

I'm not suggesting managers ignore it. I think that in an unpredictable and apparently chaotic world, too many people embrace money because it's measurable (unless Arthur Andersen gets their mitts on it). And so, given our national obsession over money and its movement, and given that the concept of free markets is a faith with more adherents than any other denomination in the U.S., it's shocking that so many people were shocked at the post-World Series surge in the salaries of players being signed.

They felt teams were spending "too much" money, some argued there was across the board overpayment. Others, like the San Francisco Chronicle's John Shea, argue salaries for top tier players weren't "too much" but that those for ordinary contributors were. He was so torqued about it, he suggested (perhaps only hyperbolically) the owners should engage in collusion to dampen salaries.

It is, of course, sort of naïve to sit outside an almost perfect model of a "market" and snipe at it because conditions make investment choices rise or fall sharply. Sometimes when I'm giving a presentation or workshop, people will ask why I think baseball embodies an almost perfect representation of a market model against which to test theories about investment. They also ask why baseball instead of football or basketball. Here are a few of the key points I cite:

  • It's a closed system.
  • The surest path to success is to deploy a successful product (winning is, in the general case, the most effective way to icnrease team revenues).
  • Information is as close to perfectly available as it is in any line of endeavor.
  • Change is implicit to the system -- on the field and off it -- and so states are rarely steady, and
  • There are no Soviet-style salary caps as there are in football or basketball.

Anyway, Shea's whingeing was among the most intelligently argued. Abridged, his 12/10 essay highlighted these points.

Mad money  -- John Shea -- SF Chronicle, December 10

Bring back collusion. It might be the only way to put the clamps on baseball owners. It's illegal, but some fans might think the money teams are throwing at so-so players is a crime, too. {SNIP}

The most outrageous activity at the winter meetings involved teams' continued willingness to pay non-star players superstar money. Especially starting pitchers. {SNIP}

Before the winter meetings, the Phillies gave Adam Eaton three years for $24.5 million, significantly upping the market for middle-of-the-rotation pitchers, who now are paid like aces. Eaton has a 4.40 career ERA, and last season it was 5.12 when he went 7-4 in 13 starts for Texas.

Suddenly, agents clearly had the upper hand. With Eaton setting the pace and only Barry Zito and Jason Schmidt listed at the upper tier of starters, lesser pitchers became more valuable. At the meetings, the Cubs gave Ted Lilly four years and $40 million, and the suddenly generous Royals gave Gil Meche (11-8 last season) five years and $55 million.

Lilly, maybe. Though he's a .504 career pitcher (59-58), he is left-handed and won 15 games last season. But Meche? Five years? If Meche deserves five, Zito deserves 10. In the next five years, if Meche repeats his production from the past five years, he'll average nine wins a season. With the Royals, that might be stretching it. Meche never threw 200 innings in a season, and he averaged fewer than six innings per start last season. And four walks per nine innings. He's nothing special, but he gets $11 million annually. {SNIP}

This year's attendance was a record 76 million and revenues topped $5 billion, thanks in large part to record-breaking broadcast contracts and new internet ventures becoming gold mines. Team values averaged $376 million, Forbes estimated a year ago, and profiting owners signed off on a new labor agreement two months before the deadline.

Now they're willing to pay top dollar for not-so-top talent. {SNIP}

More overspending is coming. Jason Marquis (6.02 ERA, a league-high 35 homers allowed for the Cardinals, who left him off the World Series roster) just agreed to a three-year, $21 million deal with the Cubs, and Jeff Suppan, Miguel Batista and Tomo Ohka should be next. Mark Mulder, coming off shoulder surgery, might not be healthy until midseason, but that won't stop a team from writing an enormous check.

Schmidt benefited from the mayhem and joined the Dodgers for three years and $47 million, and Andy Pettitte (coming off a 14-13 season) cashed in on a one-year deal for $16 million with the Yankees. Zito might be making a million bucks for every day he watches the market from afar.{SNIP}

Owners make more money. Players make more money. And haven't you heard? Ticket prices are way up, too.

Salaries are up, but are they "too much"? Uh, no. They're more than we're used to. Expectations we "too low", much as most operations beyond baseball chose to believe oil prices would stay below $50/bbl after the occupation of Iraq. (I do have to push back on Shea's ticket prices assertion, by the way; I'll gather data and post on that later -- he may be right, but I think he's not, and that ticket prices are not up more than inflation).

Imagine an auction where the average past price for the objects was $100. People come to the auction with a fixed amount of money. What gets bid as a norm?

Now imagine the same situation, but every bidder who attends gets given an extra $15 as they enter the door, like the infusion of revenues baseball teams got since the last free agent bidding period. Now what gets bid as a norm? Of course.

Roll in the eternal competitiveness of baseball teams and the fairly open reporting/information around salaries, and the market becomes fairly efficient overall. (How efficient? How about seven different Champions in the last seven years?) Since players make the most difference to the success of teams (in wins and money, among other measures), most of the windfall (perhaps all) will get plowed back into talent acquisition. Many teams with a need to win now (terrible ones like the embarrassing KC Royals, as well as packaged-to-be-sold ones like the Chicago Cubs, as well as relentlessly urgent ones like the Red Sox) may try to pour more into picking up major leaguers and their salaries, while others with less urgency might shift more pelf to scouting and development. But either way, the Talent Is The Product, so the incremental income will most likely go to Talent. 

When Wins/Payroll$ is the factor that brings fans to the stadia and their ears to radio broadcasts and to stores to buy logowear, teams will trend that way.

Put more money in a closed system where the competitors truly want to win, investors invest more. Simply paying cash dividends to the owners won't increase competitiveness.

This errant mismatch of expectations and changed circumstances is a bane to change-resistant management groups beyond baseball. I already cited the widely-held (and clearly infeasible) delusion that oil prices would stay below $50. But beyond Southwest Airlines and Halliburton, I haven't heard of any big businesses that bet heavily on rising fuel prices after the occupation.

The most comfortable projection for change is a smooth, slow evolutionary direction -- but it's not the most likely. Mass broadcast media such as television & radio have built up models in top of assumptions of continued attention, even as they were fading. They are doing a better job of planning now, but they suffered a long disconnect between their expectations and the shift of the market.

In a competitive endeavor, managers have to step away from the way they feel about money and focus on it as a tool among others.  I know and have worked a lot with managers who won't pay a staffer more than they themselves are getting paid...on principle. They just won't do it, even if the situation calls for it, and emotional block to success. Baseball, of course, doesn't mess with that. Most players make more than most managers or GMs, and even some owners. That's the effect of a pretty efficient market on salaries. The reporters hate it...the older ones can remember when player salaries were pretty much in line with top reporter/columnist salaries (and I think this in part fuels the media frenzy over player salaries -- certainly the canard Shea rolls out about ticket prices doesn't effect him since he is unlikely to buy many tickets himself). Beyond baseball, in the truly capitalist part fo the economy, privately owned entrepreneurial organizations, it's pretty common for some of the staff to take home more than the owner (in part the owner is building equity, which staff doesn't get, as in baseball). 

But to Shea and his less rational supporters I say: Sometimes prices aren't "too high"; it's that sometimes expectations are "too low" relative to a shifted market.

NOTE: This is an elaboration of a small point I made within a multi-writer effort for Maury Brown's project, "What's Right and Wrong with Major League Baseball", which is seriously worth reading in its entirety.

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