On Friday, November 22, GSABR members Preston Barclay, Kyle Franco, Camden Hu, Nik Oza, and Xavier Weisenreider competed in SABR President Vince Gennaro’s Diamond Dollars Case Competition against twelve other schools at NYU in New York City. The case involved the forecasting of the free agent contracts of catcher Brian McCann and pitcher Ubaldo Jimenez by forecasting the players’ future production and other factors inherent to the free agent market, particularly the attachment of a qualifying offer on the two players, which would result in the loss of a draft pick for the signing team. The article below is part 1 of a series on the team’s research over a five day span from Sunday, November 17 until the competition.
With the advent of the digital age of television programming, sports remain the final frontier for marketers to target live audiences. As a result, advertisers throw exorbitant sums of money to cable networks to reach viewers spanning a variety of demographics. The biggest winner? The leagues that fetch lucrative offers from the major television networks like CBS, NBC, FOX, ESPN, etc. and teams with local broadcast networks. Despite failing to pay his team, Georgetown alum Frank McCourt sold the Los Angeles Dodgers for a massive profit due in part to the expiration of their local television contract, leading to an inflated franchise valuation with rumored television contract offers exceeding $4 billion.
$4 billion? It might make sense that teams prosper from the new digital television age where appointment viewing quickly trends into the past, but the valuation remains absurd, right? Fears of a television bubble continue to increase with the threat of potential government intervention on the practice of bundling as well as additional mediums of viewing like Netflix entering the marketplace. Bundling in the television business involves the distribution of components of cable bills to all of the channels provided to consumers in packages, even if some channels remain seldom watched; viewers cannot freely choose the specific channels they desire without receiving other stations as well. As more people turn to the likes of Netflix and other selective alternatives, bundling may cease to exist, and networks may not be able to pay the extreme prices to secure television rights deals.
But for now, the “sports cable bubble” has yet to burst, and money continues to pour into teams with expiring rights deals. At the same time, however, MLB teams also depend on intrinsic market factors to supply other forms of revenue, such as ticket, concession, and apparel sales. As evidenced in the 2008 financial crisis, fans with reduced disposable income limit their discretionary purchases, inevitably harming Major League Baseball clubs.
But why should the casual fan care? Although multi-millionaires run these clubs, the franchises also function as businesses that need profits to enable the possibility of further investment. In other words, teams will only spend what they make – greater profits (usually) means more money invested in payroll to improve the product on the field.
Contracts continue to inflate in Major League Baseball, with each offseason’s free agents the primary benefactor after the league recently placed restrictions on the amount of money teams can spend on the draft and international free agency. For MLB franchises, examining the trajectory of revenue growth will enable clubs to project their spending for free agents with respect to current market factors. With teams able to spend more, the question is how much will it increase?
Unfortunately, MLB franchises (and most other sports organizations) remain privately held companies and thus do not open their books to the public. As a result, to calculate the prosperity of organizations, we must do so without revenue totals, arguably the best measure to calculate company and industry growth given its consistent incorporation of all streams of monetary gain. While profits can vary greatly due to operational practices, revenue measures the business the company receives, and interest in the product, which provide reasonable expectations for future business.
Regardless, without revenue we need to rely on the next best publicly available measure – team payrolls. Although teams fail to invest all of their profits directly into the payroll of the team, it nonetheless serves as a viable barometer for the financial health of a franchise and the league as a whole. By examining the recent history of league payrolls, we can have a better idea of just how much teams might spend in the future.
Cot’s Baseball Contracts provides industry-acclaimed quality information on every team’s payroll dating to the beginning of the new millennium. For the sake of incorporating the data most relevant to today yet a wide enough range to account for variable market factors, I utilized the previous ten years of data for each team to arrive at league totals to calculate league-wide growth rates between each year before taking an aggregate average. While one could also examine inflation rates in the market and its impact on the baseball markets, many of those effects would likely be reflected in the approach discussed above.
Overall, the average growth rate over the ten-year period was 5.08%. Obviously during the time period, however, the nation (and world) dealt with arguably the most significant financial crisis since the Great Depression. If we eliminate the 2008-09 offseason from the calculation, the average growth rate jumps to 5.83%, and if we further eliminate the 2010-11 offseason (a dip in the economy after a brief recession, before continuing expansion), our growth rate arrives at 6.45%. Given that the economy appears to be at a peak in its expansion, the possibility for a recession in the near future remains a possibility. Conservatively, establishing a growth rate of 5.50% for each of the next five years appears to be reasonable given the past ten years of data, the past, present, and future economic climate, and the reality of increased television revenue now and into the future.
Free Agent Expenditures and Individual Team Ramifications
Of course, expecting every team to spend exactly 5.50% more each year on their payroll would be foolish. For every Los Angeles Dodgers roster makeover more than doubling their payroll from 2012 to 2013, others like the Miami Marlins will sell off many of their expensive assets to cut costs. Likewise, to a lesser extent, teams may experience moderate improvements or losses on their payrolls, depending on their individual circumstances, such as performance. On the whole, however, one should expect that the overall market will continue to grow at a rate close to the projected 5.50% and therefore, so shall the free agent market.
Although in theory such a correlation may be assumed, the data does not necessarily reflect the concept. In reference to data compiled by Lewie Pollis in his article How Much Does a Win Really Cost? on Beyond the Box Score, league-wide free agent sums are incredibly variable, though ultimately register an average growth rate similar to league payroll, at 4.85%.
Likewise, while the correlation of free agent expenditures as a percent of league payroll is not particularly strong, given an R-squared value of 0.41, it nevertheless remains significant enough to conclude that our projected growth rate is reliable enough to predict league free agent expenditures in future seasons.
Ultimately, the study above enables us to develop a sense of the free agent market this offseason. While many other variables need to be addressed, particularly the free agents that hit the market this season compared to previous seasons, the projected growth rate of 5.50% demonstrates a baseline for what to expect this offseason. We will be able to utilize the growth rate in future calculations, particularly dollars spent on the free agent market per theorized win, also known as $/WAR. Stay tuned for later insight on projections for such figures from GSABR.
Chart at top courtesy of the Washington Post
Georgetown University Class of 2014