Baseball's Bear Market? Why 'Caution' is the Keyword This Winter
Free agents are just waiting for that first shoe to drop. Once one mega-contract is signed, others will surely follow. Or at least, that's the optimistic tone agents are trying to set, amidst all sorts of negative indicators.
The New York Times ran a piece last week that noted how slowly the free agent market was moving, relative to the past five offseasons. The obvious assumption is that the economy is forcing teams to be more cautious, and that the players could be in for a rough winter.
I touched on this a bit on Squawking Baseball on Monday. The Times' data, in itself, isn't overly convincing; the sample sizes are too small to have any real meaning, and these types of dead periods happen at some point in every offseason. But with that said, this is the behavior we would expect in this type of economic atmosphere.
To see how this dynamic plays out, it's important to consider how teams value players to begin with. If you remember back to Econ 101, companies will hire employees up until the point when marginal revenue equals marginal cost. So if the A's project that Rafael Furcal will bring them $15 million in additional revenue next season, they should be willing to pay him up to $15 million. This number is his marginal revenue product (MRP).
Sounds simple enough, but a player's MRP is tied to many different factors. The most obvious, of course, is the player's production. In our hypothetical, the A's could project that Furcal is worth five additional wins, and each of those wins is worth $3 million, making his MRP $15 million.
But what if the A's, worried about the economic climate, decided to do a whole new set of revenue forecasts for 2009, and found that ticket sales were likely to take a huge hit? Or that demand for playoff tickets (should the team get that far) would be much lighter than normal, resulting in lower prices? All of a sudden, the rewards of winning 5 more games and possibly reaching the playoffs are much smaller. This, in turn, means that Furcal's marginal value to the team is much less, so his MRP (or the salary the team would have been willing to pay him) goes down as well.
It's unlikely that MLB, as a whole, will see a decline in revenue next year (I've actually been very bullish on this front). But there is obviously a tremendous amount of uncertainty, which generally (and rightfully) should lead individual teams to set very conservative revenue projections, and therefore very conservative budgets.
Bud Selig has gone out of his way to make sure the owners and general managers realize all of this. During the last recession, which began in 2001, baseball revenues stagnated. The teams, used to double-digit growth, kept adding on expenses accordingly. The result was almost disastrous, with the Devil Rays and Tigers reportedly almost missing payroll.
Scott Boras has a different take, of course, citing teams' record profits and large cash positions. "I always look at baseball revenues, and in the last seven years they have gone from $3 billion to $6.5 billion," he said. "If baseball revenues drop off, that's something we'll look at, but if there is a drop-off, it is not going to be dramatic."
He continues, ""You can't say just because one sector is bad, all others are as well. Baseball is doing very, very well."
In a lot of ways, he's right. But it's also his job to be optimistic, and he's not taking into account the most fundamental aspect of the market: budgets are set based on next year's projections, not last year's performance. And there will be a tremendous amount of uncertainty, if not overt negativity, priced into teams' budgets.
That uncertainty lies in several areas of each team's operations. Taking a closer look, we can break it down by the major sources of revenue. Depending on the team's market, competitiveness, and brand loyalty, certain factors will be more pressing than others (i.e. the Pirates should be very concerned about almost all of them, while the Yankees just need to sell their last luxury suite):
1) Season ticket sales. This should be a pretty tough market for season tickets, relative to years past. The financial crisis hit in mid-September, and the economic news isn't likely to get better before Opening Day. That means teams will be facing constant headwinds, as consumers will be less likely to spend on expensive, discretionary goods such as season ticket packages. Teams will probably have to rely more on corporations, which will be much harder in certain places than others (think Detroit).
2) Individual game tickets / gameday-related sales (concessions, parking, etc.). These are linked, obviously, since the more tickets a team sells, the more concessions they will sell, as well. Teams often have a tipping point during the season, where fans either come in droves because the team is competitive, or stay away because the team is out of the race. In a good economy, a bad team may still be able to draw fans in August and September, since consumers have cash to spend. But in this current atmosphere, bad teams could set multi-year lows in attendance.
3) Luxury suite sales. Most of these should be sold by now. For those still left, it will no doubt be a tough atmosphere. But the supply is so small, teams should still be able to sell out, even if they have to lower prices a bit. This won't be a tremendous hit for a team's overall revenue intake.
4) Corporate sponsorships. Corporate sales vary tremendously, team to team. Some may have most of their inventory locked up in long term deals. Others may have several partners up for renewal, which isn't the best situation to be in right now (especially if one of those partners is General Motors). For those that have inventory available, most new deals are closed between January and Opening Day. There may have to be discounts in order, but, much like with luxury suites, most teams shouldn't see a huge year-over-year decline.
5) National media contracts. These are fixed for next season.
6) Local media contracts. Like the national media contracts, most (if not all) teams are already set with their local media contracts. Teams that own their RSN, or sell their own radio advertising, may see some declines. But cable, especially, is a pretty good place to be right now, since the networks are paid subscriber fees by the operators.
7) Merchandise. This is squarely in the consumer realm, so that's not good. If there's any way to efficiently boost merchandise sales in 2009, it's to do it virally through MLB.com. I've often advocated taking down MLB.com's pay-walls, opening up the video vault that sits in downtown Manhattan, and building an incredible online content collection. This would make MLB.com an even better destination site than it is today, and in the process create tons of new advertising inventory that MLB could either sell, or use to push its own products.
8) Revenue sharing. Imagine trying to set a budget for next year, when much of your income relies on the performance of others. For a big market team, this means possibly writing a larger check, even in the face of declining revenues. For a small market team, it means having no control over a huge chunk of earnings. Of all the unknowns going into 2009, this may be the biggest one.
Given all that, it's no wonder general managers are being cautious. In the past, when they could count on year-over-year growth, long-term contracts weren't quite as risky. Derek Lowe's four-year, $36 million deal seemed terribly expensive in January of '05. But after four years of massive industry-wide expansion, it looks downright cheap. (Don't think Paul DePodesta thought about that back then?)
On the flipside, long-term contracts that were signed in the late '90s and early '00s were considered albatrosses by 2003. When Alex Rodriguez was traded to the Yankees, few could have imagined that he would even consider opting out (let alone get an even bigger deal) just four years later.
In good times, multi-year deals are calculated risks. In bad times, they're fireable offenses. No GM wants to be stuck with bad contracts and a shrinking budget.
So what are the likely results? The teams with some breathing room, like the Yankees and Red Sox, will keep taking calculated risks. The top tier of players (CC Sabathia, Mark Teixeira) should get very nice deals. But the great majority of the small- and mid-market teams will be extremely conservative, and that will bring down overall demand (and salaries) for the rest of the players on the market.
In particular, look for long-term deals to be shorter than most people are expecting. No GM wants to be collared with bad contracts in this environment, and the smart ones (of which there are more now than ever before) will be extremely careful.
In all, not such a rosy outlook. But it's really more of a call for conservatism by Selig (and Paul Volcker, apparently), reminding teams of the legitimate pain many of them went through during the previous downturn. Given the magnitude of this recession compared to the last one, expect the teams to heed the advice.
Shawn Hoffman writes about business and baseball at Squawking Baseball. In real life, he is a principal in web startup Veritocracy.