Silva’s contract, free agency, my general economic pessimism

DMZ · January 6, 2008 at 3:11 pm · Filed Under General baseball 

The Silva contract has brought up again the question of whether any free agent signing is a bargain in a world where free agent contracts are ever-increasing. I’ll call this the Washburn Effect: today’s overpayment is tomorrow’s good deal. One of the arguments I’ve had here with Tom Tango is that his valuation of a contract’s worth is based on a formula that, to vastly oversimplify, goes

year N expected contribution * value of that contribution in the year N market

for each year of the deal. It assumes that salaries will continue to inflate as we’ve seen the last couple of years over the value of every deal, and so it hinges on whether you think that MLB revenues can continue to grow at 10% year over year for the foreseeable future. Many people believe they can, and I disagree with the certainty of those assumptions entirely and to a lesser extent, about what we should expect of the next few years.

I see two things I see stopping that escalation.

First, as we’ve argued many times here with different players, there’s often a similar skillset available for very little money. A team can sign Silva to a massive deal or find a reasonable facsimile on the minor league free agent market for $1m or so. That price isn’t increasing with the price of free agents. At the same time, we’re slowly seeing a replacement of more traditional major league front offices with smarter personnel who understand replacement value. They’re going to take the cheap option. If nothing else, that’s going to reduce the number of bidders for guys like Silva. Certainly, it doesn’t take many to keep the prices high, but even in the next few years we should start seeing the effects — and even ownership groups who don’t get it will start asking difficult questions about why they’re paying so much for so little. Just moving Texas from dumb to smart takes a huge spender on bad FAs (Chan Ho Park!) out of the market.

That may not have a huge effect, though. The larger is economic. Major league sports are entertainment, and while they have a loyal audience, in a larger sense they compete for dollars with movies, concerts, bowling alleys, nights on the town, and so on. And their sales of super-high-revenue luxury suites depends on the local corporate economy.

You can take your economic indicator of choice against MLB payroll or revenue in the post-collusion era and you’ll see they’re pretty tightly bound (I ran payroll against the price of the S&P 500 since 1989 and it came out at .86, which is amazing considering there are labor issues included). The error I see everyone making is that they’re looking at the last couple of years and seeing MLB developing new sources of revenue, especially in the web subscription money, and drawing a straight line out forever.

And that’s where I part ways. We can’t assume the economy’s going to go up, up, up. If it doesn’t, revenues don’t go up and payrolls don’t go up, and the whole model falls apart. I can’t think of any mature entertainment business – really, any major discretionary spending category – that can sustain 10% year over year growth through an economic downturn.

To our current situation specifically — we’re seeing the real estate market decline, severely so in many parts of the country. The immediate fall out’s been in the mortgage markets, affecting liquidity, credit, taking down hedge funds, and a huge increase in the number of foreclosures. Now, whether you think it’s all going to bottom out later this year and be hunky-dory from there out (it won’t) or what, you can already see some effects. People who feel less wealthy cut back on spending, and you can watch Applebee’s and Chili’s and Whateveree’s revenues taking the hit already.

I’m no economist, but if national real estate values are headed back to 2000 levels, however slowly, it’s going to be painful and tough, and between people spending less and the banking industry trying to ride the whole thing out, baseball’s revenues won’t be going up 10% year over year the whole time.

And if that doesn’t happen, today’s overpriced contract becomes tomorrow’s overpriced contract.

I don’t think the economy’s going to do well over the next couple of years. Now, you’re free to disagree, but none of us can know for certain the direction it’ll take. Maybe we’ll all be happily serving new robot overlords in a money-free economy by the time Silva’s contract expires. If it does, and salaries stagnate, today’s free agent mistakes are still going to look bad. If the free agent market gets more rational, they look even worse.

Arguing that Silva’s deal is okay because the market’s going to continue to go up forever is at least making a set of assumptions that aren’t tenable, and certainly aren’t knowable with that degree of confidence. Washburn’s contract may look decent now, in the same way getting into a house in a booming market in 2004 might have. That doesn’t mean that deal didn’t involve risk — or that you’d be right to not take that risk again in 2007.


35 Responses to “Silva’s contract, free agency, my general economic pessimism”

  1. Colm on January 6th, 2008 4:23 pm

    Written like a boy with an MBA.
    (Does DMZ have an MBA? That’d be quite a collection of letters.)

    I’m inclinded to agree with the thrust of your post, Derek.
    1. One cannot use the foolishness of others to justify one’s own foolishness.
    2. Nobody should assume that a bunch of well-paid, high-profile, and somewhat accountable baseball executives will continue to behave utterly foolishly.

    The Washburn contract still sucks; the Silva contract just sucks harder.

  2. rcc on January 6th, 2008 4:28 pm

    Well done….because I agree with your analysis, but also because I think people should be wary of any analysis that assumes things will go in a straight line.

    For example, the spot price of gold just reached its previous all time high that was last seen in 1980. Since 1980 the price had gone down, but not in a straight line, and now back up again after 27 years….also not in a straight line. Baseball revenues may or may not go up, but I would not bet that the market will make Silvas contract look any better later.

    If one looks at the last thread, and its many interesting comments, I would ask which business model is best suited to going forward in an uncertain future…the A’s, or the M’s?

  3. Roger on January 6th, 2008 6:06 pm

    (Actually, gold isn’t at it’s “all time high” if you factor inflation into account. In 1980, a dollar was worth about twice what it is today, so gold really needs to reach $1600 an ounce for those folks who bought it in 1980 to even get their original money back. It would have to be $2000 an ounce to realize even modest 5% gains.)

    There is only so high you can price a decent ticket before people find other things to do. And if really bad economic times hit, I’m not sure folks will really enjoy hearing about players making in minutes what they can’t make in a year. When the economy is good, those things seem less important.

  4. bedir on January 6th, 2008 7:23 pm

    DMZ, how to baseball’s expansion on the world stage fit into this? I mean, sure the US economy might be headed down, but with MLB International just getting humming, the teams will still have expanding revenue to exploit.

  5. Mike Snow on January 6th, 2008 7:30 pm

    I’m reasonably confident that baseball’s international revenues are still just a drop in the bucket, and even exponential growth there wouldn’t cover more than a fraction of any decline in North American revenues. There’s only so much you can get out of a market without actually placing a franchise in that market.

  6. bedir on January 6th, 2008 7:37 pm

    Have you looked at the TV contracts for the EPL?

  7. awolfgang on January 6th, 2008 7:45 pm

    I Love This Website!

  8. yellowmoth on January 6th, 2008 8:12 pm

    Fascinating analysis that this lurking economist had to smile at. The housing market analogy is spot-on. Even the most ignorant speculator doesn’t price themselves out of the market. I echo the comments of 7. Keep up the good work fellas.

  9. terry on January 6th, 2008 8:21 pm

    Energy prices have to be factored into things that will drag on the economy… I’ve got an unscientific assay I call the Walmart Parking test. Here in the midwest, when gas prices are below $3, I have to park at least 50 yards from the entrance during dinner time. As soon as gas hits the $3 mark though, I can get a spot right in front of the door.

    Also, sooner or later people are going to stop using their credit cards and decide “roh, roh-retter rart raying rem roff”….

  10. Typical Idiot Fan on January 6th, 2008 8:26 pm

    Have contracts been done this way for quite some time? I noticed that backloading contracts has become more frequent.

    I don’t know if the luxury tax will help curb the ridiculous player salaries, but I haven’t noticed a lot of teams scrambling to push the “salary cap” either.

    One thing that would make baseball’s life easier would be non guaranteed money like the NFL has. It would make pro-rated signing bonuses bigger, but annual salaries could be nixed at a percentage of cost. Bud Selig wont ever do it, but one of these days I hope he uses his commissioner’s powers to kill the next Mike Hampton contract before it’s finished.

  11. Typical Idiot Fan on January 6th, 2008 8:28 pm

    Re 9,

    Energy is definately a concern. LL had a great thread about energy use, cost, global climate changes, and whatnot. With the US econmy projected to be in a recession for a time, all these costs will start to add up.

  12. Mere Tantalisers on January 6th, 2008 8:42 pm

    I agree that the infinite growth that these contracts count on is unlikely in any environment, much less the current one. Really, I think its the big problem with WW Rostow’s model for a society’s development on which the modern US brand of capitralism is based… but that’s a whole other discussion.

    What I want to know is, Derek, do you take into consideration here the artifical devaluation of the dollar? I I doubt its worth will fall two-fold over the length of a Silva contract, but a 20% dip is totally reasonable. While the revenue of a franchise may remain constant over these five years in, say, euros or pounds, its dollar value will continue to rise driven by both modest growth and the controlled inflation being used to close our trade gap.

  13. Dave on January 6th, 2008 9:29 pm

    The wild card in all of this is MLB Advanced Media, the internet arm of major league baseball. Because of their rapid growth, including the success of, there are some estimates that MLBAM could be valued at somewhere in the $5 billion range.

    If MLB decided to spin off MLBAM and offered an IPO, it’s likely that each team would reap a windfall in the hundreds of millions of dollars. It’s quite possible that the Florida Marlins share of MLBAM is actually worth more than the franchise itself.

    Of course, no one knows how this will play out. Will MLB spin off MLBAM? I don’t know, and I don’t think anyone outside of MLB knows either. And that’s a big piece of information, honestly.

    But, also, the next time you here a team complaining that they’re losing money, remember that they’re totally and utterly full of crap – you would have struggled to find a better investment than buying an MLB team in the past five years. They’ve all made money hand over fist.

  14. hub on January 6th, 2008 10:28 pm

    So how long until Japanese Free-Agents start demanding their contracts in Yen?

  15. Uncle Ted on January 6th, 2008 11:38 pm

    This is really compelling. That said, it seems to me (and my evidence is really quite anecdotal and limited at that) that baseball free agent salaries haven’t followed the economy very closely. When the tech bubble burst in 2000 I don’t believe there was a decline or even a flattening of free agent salaries (please correct me if i’m wrong). I’d be curious to see data from the late 1970’s. I think though that the fact that teams are catching on to the inefficiencies in the baseball market will have a much greater effect towards lowering free agent salaries, and my hunch is that in the next 4 years the baseball market will be much more efficient than it is currently, and Silva’s contract might look pretty bad.

  16. MedicineHat on January 6th, 2008 11:52 pm

    As the authors have repeatedly told us, attendance doesn’t mean much in the way of team spending/profit & Loss. In addition, the economic landscape has changed a couple times over the ast X years and yet salaries continue to rise. As long as there is unrestricted free agency, internet/cable TV money coming in, salaries will rise.

  17. Uncle Ted on January 7th, 2008 12:12 am

    I found a link to a listing of average baseball salaries from 69-00. The only sustained period of stagnation is from 93-96, a time when the economy was “hopping”. The late seventies saw a period of pretty fast growth with salaries more than doubling from 76-79. 2001-2003 saw substantive though not astonishing increases, 2004 saw a decline. Anyway, I’m not sure if average salary is the best way to do this.

  18. Andren on January 7th, 2008 12:23 am

    Bought gold as a hedge against inflation in 2005 and thanks to Helicopter Bernanke it’s done much more than hedge. A lot of people I know are beginning to increase from the standard 5 to 10% of their portfolios with precious metals because of this very reason. Not to mention we are just beginning to see the effects of the ‘credit crunch’ as it’s been called.

    I’m confident that the FO is aware of the potential devaluation of the dollar and is making decisions accordingly.

  19. DMZ on January 7th, 2008 1:46 am

    Baseball payroll pre-free agency is worthless as a measure. You also want to discard the collusion years.

    Much of the difference, as I noted in the post, comes from labor issues: a strike/lock-out means the game makes dramatically less money that year, and that shows in revenues and thus money spent on payroll.

    I used total MLB payroll, btw. Though I realize now I could go back and tweak my math. But anyway.

  20. Willmore on January 7th, 2008 2:01 am

    There’s an assumption that Baseball is like any other business. It’s not.

    For one, it’s a monopoly that dictates its own rules, there is no supply and demand, because the only supply and demand is self-generated. Second, people generally don’t stop going to baseball games simply because the economy isn’t doing well, they don’t stop watching games on TV, or buying merchandise. Between 2001 and 2003 there was a recession because of the Dot Com crash and the 9/11 attacks, but did baseball suffer one iota? No, it kept growing. The only thing that could stop its growth is MLB itself, via a strike or a lockout. Speaking of the 2001-2003 recession, A-Rod signed during that time-frame. There was a recession in the late 80s-early 90s, I’d be interested to see what effect it had on the contracts, I doubt it had much, in fact I think Barry signed his mega-deal during that time.

    The MLB business is so convoluted that trying to make sense of it is simply impossible without actually knowing cent by cent how they make their money.

    But in the end, it comes down to the following: do you think the Mariners will suffer some catastrophic financial breakdown in the next 4 years? No, because they’ve already sold the TV rights for that time-frame, they’ve already forecast ticket sales for next year and have a +-10% idea of the ticket sales in the next 3 years. They would not break the bank on any player. Whether the deal is bargain is not really relevant, because if I can build a contender for 120 million dollars, while Oakland can build the exact same team for 40 million, what difference does it make to us, the fans? We’re not the ones overspending, but as long as the product is competitive, I’m fine with it.

    Would I want a smarter GM running the show, of course, would I want to give a Shapiro or a Beane 100+ mil to work with and see what they make of it? Yes, but we don’t have them, and what we have is the best we can expect for this year. And in those circumstances, I don’t see the point in debating a contract that is clearly overpriced. The reason is simple, Silva never was the pitcher to take us to the postseason. And I think that Bavasi knows it. Bavasi thinks that Silva is one of the pieces to help us win in 2007-2009, we might disagree with him, but that’s what he thinks. However, he doesn’t think Sivla is the piece, for that he needs to trade for a front line starter. If he succeeds, he’ll have a contending team, if he doesn’t, he won’t. So, I expect Bavasi to break the bank, but end up with Santana or Bedard, even if that means Jones and other top prospects.

    What really interests me, is if he still has the support of the executives to pull off such a trade.

  21. vj on January 7th, 2008 2:41 am

    I have been following Tangotiger’s thread on this offseason’s signings a bit. Say what you will about the assumptions that he bases his formula on but it seems to match the thinking of front offices quite well. Silva still is overpaid even by Tom’s standards.

  22. Wishhiker on January 7th, 2008 6:24 am

    Aren’t 2 of those recent revenue sources a one time thing (Montreal/Washington sale) and a once every 4 years thing (WBC)?

  23. eternal on January 7th, 2008 8:28 am

    I highly doubt MLBAM would pull in a $5 Billion valuation. You’re talking facebook valuations and the only thing MLBAM is very successful at is handling the MLB online situation. I highly doubt they make money on any of their other customers. The live in a very specialized world with currently, very limited appeal to other businesses seeking these type services.

  24. tangotiger on January 7th, 2008 9:12 am

    eternal/23: Most people would disagree with you.

    Dave/13 is right. MLBAM is a huge deal.


    Team payroll, franchise valuations, and MLB revenues, have increased at an annualized 10% rate, if you look at the last 20 and last 10 years, and probably last 5 years.

    I expect all three of those to continue the 10% rate. In any case, MLB teams expect that, since what they are paying out for free agents has those implied assumptions. (Otherwise, my free agent tracker would be wrong.)

  25. tangotiger on January 7th, 2008 9:30 am

    Ok, I’m looking now, for the 1990-2007 time periods.

    1990-2007: implies a 10%
    1996-2007: implies a 9%
    2003-2007: implied a 4%
    2006-2007: 6.5%

    So, it depends where you grab your boundaries, obviously.

    So, 8% might be a more reasonable figure.

    Franchise valuations are alot more stable. Using the same time periods as above:
    1990-2007: implies a 6%
    1996-2007: implies a 9%
    2003-2007: implied a 8%
    2006-2007: 12%

    Again, 8% might be more reasonable.

    It’s important to note that team valuations are somewhat inversely proportional to player salaries. After all, if you can reduce your expenses, while keeping the same quality and revenue, your profit margin will go up.

    They seem to hover around 8%.

    Working against the players is that there’s more revenue sharing (meaning less likely for a team to see increased revenue for increased performance… since that revenue will be siphoned off).

    Working against the players is MLBAM which is pure revenue sharing.

    Working for players is that owners treat the extra capital appreciation as a bonus, and might give it to players.

  26. JLC on January 7th, 2008 10:51 am

    The problem Uncle Ted (#15) that the Fed has in comparison to 2001 and the 70s, is that Greenscam had the capacity to lower the Fed Funds Rate and pump up credit (artificially, which created the real estate bubble), which Bernanke does not have now. So it’s tough to compare the two timeframes. In the 2001 timeframe, by pumping up credit, the Fed could thus lead the economy by devaluing the dollar. Bernanke has much less range to work with, and already the dollar has broken down below a many years important resistance level at .80. I always track it here:

    This time it appears that the OTC derivative market is pushing the Fed, perhaps causing enormous deflation while the Fed has no choice to follow, and thus inflating as it goes. We may be looking at extended stagflation, and in this case, you just may see a prolonged period of consumer’s tightening their belts and not spending like a crazy 8 year old in a toy store as in 2001.

    Commodities are the place to be and out of dollar based assets. I’m sorry to say, but the M’s won’t be getting much $ from me this year as I have positioned my assets in a defensive strategy (been doing this since 2002). Last year, they got some $ from me as a fan, but sadly, that is something that has to be sacrificed as this economy continues to unwind.

  27. Evan on January 7th, 2008 10:55 am

    Derek’s right throughout this piece.

    I’m not as pessimistic about the US economy as he is (though, given the state of the US economy, why are the presidential candidates spending so little time discussing it?), but a little economic pressure is all baseball needs to get smarter and stop wasting money on guys like Silva, and find new and better ways to share revenue (like MLBAM).

  28. bionicjim on January 7th, 2008 12:28 pm

    I’m intrigued by Derek’s postulation of a near-future robot-overlord dynasty with the elimination of money from the economy. What would the economy look like and how could the Ms benefit on the new capital? The Japanese and technology industry influences in the Ms front-office may have a plan…

    Or is this just Derek’s SF future history he developed in writing class this summer?

  29. heyoka on January 7th, 2008 12:45 pm

    It’s fun to read a post connecting the outside world to the inside world of baseball.

    Derek, you’ve mentioned real estate as an economic ill, but that’s only a piece of the whole recession puzzle. Declining public infrastructure, climate change, military expenditure, and peak oil are all going to put huge strains on the economy that could see our real wages fall, but this leads to an interesting (baseball) point.

    The value of the dollar.

    Inflation is on the rise due to higher gas prices and the way our economy is currently structured – requires lots of oil. (Huge trade deficit could factor in.)
    But the contracts that baseball players are given are assigned fixed costs. If inflation were to skyrocket to something nasty like 20%, then the cost of Carlos Silva will decrease with each year to the point he is being paid about 60% less by the end of it. Maybe in 10 years the league minimum will be the equivalent of a current teacher’s salary. 🙂

    Hopefully I’m exagerating…..

  30. pdb on January 7th, 2008 2:07 pm

    Of course, no one knows how this will play out. Will MLB spin off MLBAM?

    If by “spin off”, you mean “take public”, I would guess not – if MLB were to take MLBAM public via an IPO, baseball would have to open its books for the government and the world to see how it runs its business. I’m a bit skeptical that MLB would ever want that kind of financial transparency.

  31. Typical Idiot Fan on January 7th, 2008 2:20 pm

    tangotiger said:
    Working against the players is that there’s more revenue sharing (meaning less likely for a team to see increased revenue for increased performance… since that revenue will be siphoned off).

    That’s a scary thought. What’s the incentive for a team to win if they’re getting more money from revenue sharing and standing pat then from being competitive?

    If more teams do end up going the way of the Cleveland Indians, you could end up with teams making absolute shitloads of money on teams with payrolls ~70 million. Any team can field a team with that kind of money, and then pocket the insane amounts of profit for the owners. 10 years ago, a 70 million dollar payroll was for only top end franchises like the Yankees. Now, it’s “frugal”. The worst part is, you can do that and not even bother fielding a winning team and make a ton.

    So what’s the incentive to win? The fanbase getting antsy? Jeff Loria has proven that fanbase anger doesn’t freaking matter.

    Working for players is that owners treat the extra capital appreciation as a bonus, and might give it to players.

    I almost choked on my Coca-Cola. Unless the Players Association steps up and demands it, it wont happen.

  32. scareduck on January 7th, 2008 3:24 pm

    The Blue Jays have had a very real advantage in recent years with the run-up of the Canadian dollar. My guess is that this will continue.

    Energy prices will be THE dominant factor in any discussion of future economic circumstances.

  33. scareduck on January 7th, 2008 3:56 pm

    Re #26: what the Fed seems to miss (again and again) is that this is a solvency crisis, not a liquidity crisis.

  34. John D. on January 7th, 2008 7:27 pm

    An example of Derek’s caution that prosperous times aren’t always here.
    I went to some games at Fenway in the late forties .
    The place was always full.
    In the mid-fifties, one could buy a general admission ticket, and sit almost anywhere that he/she wanted.

  35. tangotiger on January 8th, 2008 7:50 am

    Idiot/31: when teams get a quick bonus, it would not be atypical for them to use that as extra money to sign free agents. So, it wouldn’t surprise me that teams dish out the money too quickly.

    Also note that if revenue sharing makes it so that a smaller and smaller percentage goes to players, players will negotiate or strike on the issue. Selig has admitted to revenues exceeding 6 billion, and yet the average team payroll is under 100 million (under 3 billion total). Having under 50% of your revenue to payroll is something that the NFL does. The NBA and NHL have a system set up so that 55% or so goes to players.

    It’s possible that players will agree to payroll and salary caps, if they can force a 55% level. Otherwise, as MLBAM becomes the equivalent of NFL/Cable, player salariess will not keep pace.


    As for the general theme, of course there will be ebbs and flows. This happens in MLB and in every industry. I’ve shown the numbers above. But in terms of long-term trends, the business of baseball will outpace inflation by a good margin, be it at 8% or 10% or whatnot.

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