The economic downturn has hit many industries hard, including the sports industry. This has led to a noticeable decline in free agent salaries, particularly for Major League Baseball. I had a chance to sit down with Vince Gennaro, a noted baseball analyst who serves as a consultant for several MLB teams. With an MBA from the University of Chicago and a 20-year career at PepsiCo, Vince Gennaro has a great understanding of the economy and how it affects baseball. Vince’s book Diamond Dollars was a groundbreaking book that was one of the first to look at the economics of baseball. Vince has also had some of his work featured on THT in the past. I talked with Vince to inquire as to how Major League Baseball has been affected by the present economic circumstances.
Please note that this interview was originally conducted during the offseason and a past version was first published in the Northwestern Business Review (NBR). NBR, a quarterly business-oriented magazine, seeks to engage Northwestern students and other business-minded individuals through a variety of content that highlights captivating trends, innovative technology and business practices. NBR provides insight as to how business influences and shapes our collegiate community as the ultimate resource for future business leaders. NBR is a product group of ISBE, the Institute for Student Business Education.
THT: In general, how would you say the economy has been affecting free agent salaries?
Vince Gennaro: Using my free agent valuation model, I compared this year’s free agent deals versus what they would have gotten last in last year’s market. After adjusting for the quality of the player, pitcher compensation (average annual value) was down about 12 percent while position players were down 5 percent. Over the last five years, the compound annual growth is around 12 percent, so it’s essentially been a reversal, particularly for relief pitchers. I think a lot of this has to do with the economy. I think teams are nervous about corporate sponsorship dollars and season ticket renewal rates, which are down significantly in some markets. With unemployment rates very high and the housing market in the tank, there are some huge risks out there so I think teams are being understandably conservative. However, the new stadiums in New York are an entirely different story. Even with many unsold premium seats, the Yankees’ revenues will escalate dramatically this year and they put those dollars to work in the free agent market with their high-profile acquisitions. Their actions have served to support the market, particularly at the high end.
THT: Have certain types of players been hurt more than others?
VG: My sense is that you’re seeing much more of a focus on defense. I think players who are predominantly offensive contributors are getting more accurately valued than in the past. Teams have come to appreciate the defensive contributions a player makes (or fails to make). My model valued Abreu at $8 million per year—a long way from his contract last year with the Yankees and much closer to his deal this year with the Angels. I had Adam Dunn valued at $11 million. There is a “supply” issue as well. If you look at the mix of the free agent class, it was very heavy with relief pitchers. I think some relievers have paid the price because of this. The market for starting pitching held up very well, particularly top of the rotation guys. The fact that the Yankees were active in that segment of the market help support prices.
THT: Does the economy make losing worse? For example, will it be harder than normal to draw fans if a team starts out playing poorly?
VG: Absolutely. Think of a team’s win-loss record as its barometer of “product quality.” In tough economic times fans are going to be less willing to support poor quality. I think in this difficult economy a team’s win-curve—the relationship between a team’s revenues and its on-field performance—has a steeper slope. There will be a bigger revenue penalty for losing. I could make the case that winning is more important in this economy. For teams that fall out of contention, I do think this reality will encourage them to deal players and shed salary earlier in the season than in the past.
THT: The Mets and Yankees will be opening up new stadiums this year. Will the economy impact this in any way?
VG: I think the long-term impact is that the Yankees have moved their chips to the middle of the table because of their ticket prices. They’ve raised the stakes of winning vs. losing. They need to reach the postseason, at a minimum, to sustain this pricing. They’ve developed a two-tier pricing structure. You can get in the ballpark for $25 but you’ll have to pay $325 a game to get 15 rows from the infield. So what they’ve done is make themselves extremely vulnerable to both the economic downturn and the team’s on-field performance.
THT: Oakland has been traditionally known as a small-market team. How have they been able to be so aggressive this past offseason?
VG: I think they’ve made an effort to return to competitiveness quickly as they try to resolve their stadium situation. Billy Beane does an excellent job of managing the peaks and valleys of the competitive cycle, intervening to make the valley more shallow and shorter. Part of that approach is to act as a portfolio manager buying and selling playing assets based on valuations. His acquisitions are less about what the A’s need, from a position standpoint, and more about arbitraging value. His acquisition of Holliday is a perfect example. It wasn’t important if Holliday fit into the A’s plans. It was important that he acquired an asset in the last year of his contract, that the Mets, Red Sox and a few other teams might covet by mid-year. The risk he took on was whether or not Holliday could make the transition to the AL and away from Coors Field. I think the price for Holliday was worth the risk. Acquiring Holliday should ultimately shorten the A’s track back to competitiveness.
THT: Do you think the trend with free agent salaries will continue in next year’s offseason?
VG: One of the things we haven’t talked about is contract length. I’ve always believed that the bigger issue is in the area of contract length (rather than average annual value of contracts). Historically, most multi-year contracts are twice as long as they should be, given the AAV of the deals. One of the things we have seen is risk mitigation by teams shortening their contracts. This is a trend that we’ve seen over the last couple of years, but it accelerated in 2009. I would expect it to continue. I think we’ll see it be more difficult for anything other than the top players to get lengthy, long term deals. Historically, one of the reasons teams were okay with contract length, was that the risk factor, especially with regard to injuries, was somewhat offset by the inflation rate in the free agent market. What we’ve seen now is a shock to the system, if you can’t count on the inflation rate, you need to find a way to offset the injury risk factor. One way to do that is with shorter contracts.
THT: Will the economy change how teams trade players during the year? For example, will teams that get off to a bad start be more willing to trade their more expensive players?
VG: I think teams that are not in contention will be more aggressive in terms of looking to deal players. I really think it will be a buyer’s market and I would expect teams to start shopping players earlier, leading to more transactions in June. There’s very little financial upside in being a 74-win team vs. a 70-win team. Yet a player who might be able to push a team into the postseason may hold the key to unlocking a $30 million revenue stream. It’s always interesting to watch how playing assets get reallocated mid-year to situations where they have the highest return. There are a few teams that have publicly said that they’re stashing some dollars in order to become an acquirer in July. They should be able to make some key additions at a reasonable price.
THT: How do you think the economy will affect how teams draft and deal with international signings this year?
VG: I would expect teams to continue to be relatively aggressive in these areas. With the downturn in the economy putting revenue pressure on many teams, these low cost sources of talent are even more important to the long term health of low revenue teams. Teams know that taking a pass on the draft by not stepping up and signing draftees, or pulling back from signing international prospects can set them back a couple of years in their quest to become or maintain competitiveness.
THT: If you were the Washington Nationals, how would you approach negotiations with Stephen Strasburg (assuming they will select him)?
VG: First, they can’t afford to not select him. Having the first pick this year is like a super lotto ticket. It’s not a free ticket, but there’s great value in the pick due to the upside that Strasburg presents. The good news is the Nats still have the leverage in these negotiations, although I’m sure Boras will come up with several angles that will shift some of it back to the player. Rationally, even with a conservative set of assumptions the Nats could easily justify a $20 million signing bonus, but I’m sure they’re hoping to pay a $10 to $15 million bonus. If we use a conservative assumption that Strasburg has a 50 percent chance of being a No. 3 starter ($130 million over the next six years, as valued by the free agent market) and a 50 percent chance of being a complete bust (no value) and never contributing at the major league level, that translates into a $65 million of value in the free agent market. Even if Strasburg becomes a Super 2, the $65 million of value will cost about $27 million. Even if we use a high discount rate—the triple C bond rate—to reflect the risk associated with a prospect that has never thrown a professional pitch, you can comfortably justify a $20 million signing bonus.
THT: Ultimately, what do you think Strasburg will sign for? How much do you think he would be able to receive if he was available as a free agent?
VG: It’s hard to say what Strasburg will ultimately sign for. It probably has more to do with the individuals involved than with the underlying economics of the situation. Perhaps, the Nats will commit $15 to $20 million guaranteed to him to get the deal done. If Strasburg were truly a free agent, I could envision at least one team giving him at least Kyle Lohse money (four yrs at $41 million).