Strasburg, The Nats, and Game Theory
Last night, the big news around the baseball world was the Nationals coming to an agreement with Stephen Strasburg, the most touted college pitcher in perhaps the history of the draft. For those still waking up, Strasburg signed a foul-year deal worth $15.1 million, making him the richest draftee ever, but falling far short of the $50 million figure agent Scott Boras tossed around at the time of the draft.
Last night's 11th hour dealings were an interesting study in game theory, with super-agent Scott Boras, matching wits with Nationals owner Ted Lerner, team president Stan Kasten, and GM Mike Rizzo. Oh yeah, and Stephen Strasburg himself also had a say in the process. The baseball world watched intently last night because while both parties had a lot to gain from making a deal, both had much more to lose by not signing. Strasburg had a powerful incentive to sign, because if he did not, he would have to sit a year, risking injury or regression, just to be back in the same situation a year later. The Nationals of course, had an incentive not to let a can't miss prospect that the franchise so desperately needs to slip through their fingertips.
In fact, both sides were likely miles apart on the value of the contract....but not in the way you might think. For the Nationals, the value of the wins Strasburg will produce may be $30-$40 million dollars, at least as valued by the WSJ and Biz of Baseball. If they pay more than that theoretical "break-even" dollar amount, that means they could get those wins more cheaply elsewhere. If they pay less, they'll be getting a bargain.
Strasburg also had a break-even point, except his was determined by the amount of money he could likely get the following year, if he decided to sit out the season. Of course this has to factor in any depreciation that might occur, due to injury and the decreased leverage he'll have the following year if he decides to sit. When factoring the uncertainty and the risk, plus the fact that the young man wants to play big league baseball, a guess for his break-even point would probably be somewhere around $11 million. Anything more than that would be gravy, while anything less and he would be hurting himself by signing rather than holding out and re-entering the draft next year.
Graphing the intersection of these two (admittedly hypothetical) value curves, we see that the both sides should have been willing to do a deal valued anywhere between $11-$35 million. While the lines intersect where each side gets an equal gain from the deal at about $23 million, any deal struck within that range should have be acceptable. So why did the negotiations come down to 11:59 last night? Well, each wanted to get the best deal of course. When the possible value acceptable deals ranges so widely, it's hard to come to an agreement - after all there is big difference between $11 million and $35 million, and while both sides would theoretically gain with a deal anywhere in that range, neither side wants to be seen as chumps.
Of course, using those break-even points, the final deal, at $15.1 million, was far more advantageous to the Nationals than Strasburg. Why? For one, I mentioned that the Nationals would be getting a bargain at anything less than a $35 million dollar deal. But, in the MLB draft, teams are accustomed to getting big bargains. That is why having high draft picks is a good thing - the draft is a place where you can sign valuable players for less than you could elsewhere. If teams paid market value according to their projected Wins Above Replacement, there would be no advantage to having high draft picks or even drafting many players at all.
Second, the deal does not occur in a vacuum. The Nationals are aware that their negotiations with Strasburg will affect how other players negotiate with them in the future. If the Nats broke down and gave Strasburg a $30 million deal, this might be worthwhile in the short-term, but they would also raise the expectations for every other high profile player they picked in the future (including a likely Bryce Harper selection next year, which will almost assuredly entail the same type of negotiations as this year's drama with Strasburg). When this is factored in, the true break-even point for the Nationals is lowered considerably.
Strasburg, on the other hand does not have this same kind of recurring scenario. At most, Strasburg will be back at the bargaining table with the Nats one or two more times, and those will be under completely different pretenses since he will by then be eligible for either arbitration or free agency. As a result, Strasburg's break-even point isn't changed much by the possibility of future deals (Boras, on the other hand does have an incentive to draw a hard-line and raise the break-even point since he will be back at the same bargaining table many times - however, as the player, Strasburg has the final say).
Third, the way the negotiations are structured gives the Nationals an advantage. With a firm deadline imposed by MLB, the parties must come to an agreement by a specific time. Since it is the team that offers the player the contract, and not the other way around, this gives teams the final leverage to push the value of the contract towards the player's break-even point. For instance, the team can tender a "final offer" to the player before the deadline and refuse to entertain other scenarios. With the clocking ticking and the offer on the table, it is Strasburg, not the Nationals, who must decide in the final moments whether or not the deal is satisfactory. And, if that deal is worth more than Strasburg's break-even point, he'll sign it. The Nationals, knowing this, can offer a deal worth slightly higher than his break-even point, and he should still sign.
Of course, if there is no deal on the table, and the team is still listening and cowing to Boras' demands at 11:55, the Nats lose a lot of their leverage. In fact, under the game-theory principle of eliminating options, it might have been a good idea for the Nats brass to take a mid-August jaunt to a remote, unreachable island in the Pacific, or an expedition to cellphone-towerless Antarctica. By giving Boras a contract, saying "take it or leave it, see you later" and truly being unreachable at the deadline, the Nationals would eliminate the possibility of extending a higher offer, thus putting the onus on Boras and Strasburg to accept the the Nats offer or go without.
As it turns out, the Nationals didn't have to go to the South Pole or the Moon to sign Strasburg to a very reasonable deal. Considering that virtually every scout projects him as a future #1 starter and someone who can immediately step into a major league rotation and produce, the Nationals came away with a bargain. If Strasburg's value was truly $35 million, the Nationals just saved $20 million over the price they would have had to pay for getting those wins elsewhere. Here in DC, having watched the Nationals bungle move after move, I was pleasantly surprised that Washington seemed to handle the negotiations very well, signing the new face of the franchise with 77 seconds to spare, and putting them in good position to sign Bryce Harper to a similar deal the following year.
Now that the anticipation of the deal is over, the anticipation of Strasburg's first major league start begins....