With MLB revenues increasing, clubs are taking more risks with contract amounts, and
more importantly, lengths
As we roll up on the start of the 2014 MLB regular season, the inevitable questions begin to surface as to who has done the most to improve themselves in the offseason. Predictions are made as to who will make the postseason (a difficult, if not silly endeavor), that none the less makes for great fodder at barstools and water coolers.
Those that wish to assign praise or blame around the amount of years and total dollars assigned to multi-year extensions have their work cut out for them. It’s not that this facet has changed dramatically from the days when baseball became a professional endeavor, rather that the needed adjustments in the overall view of what a “good” or “bad” contract is changing as revenues ebb and flow.
Baseball is seeing a dramatic escalation in revenues due to national and local media rights deals. That has allowed more risk taking. Here’s why what looks crazy may not be crazy in the overall.
#10 - Growth in Overall Revenues Has Made MLB an $8 Billion+ Industry
When accounting for the growth of media rights, along with attendance growth, and other revenue streams, when accounting for inflation Major League Baseball has seen gross revenues grow 274 percent since 1995. As we reported here first on Forbes, MLB’s gross revenues for 2013 surpassed $8 billion for the first time. While there are haves and have nots of varying degrees, this steady growth in revenues is giving owners belief that “taking a chance” can be for everyone.
#9 – AAV and the Luxury Tax
With the influx in revenues, those clubs looking to wrap up talent to multi-year extensions have more flexibility than ever before. The problem is in the allocation of salary to individual player resources.
If we look the current trend for top-tier veteran free agents, what we’re seeing is an escalation in contract length, as well as increased overall total contract value. This is partially due to clubs looking to keep the annual average value (AAV) within reasonable limits along with the other players on the roster to prevent bumping into the Luxury Tax threshold. By spreading out the total dollars over years, the larger sums can be met while still allow some level of flexibility. Of course, this comes with it’s own set of risks as we’ll see later when performance wanes.
#8 - While Mega-Deals Remain, the Cost of Player Salaries Are 47% of Revenues
While fans will shake their heads at what appears eye-popping contracts, the amount paid out to players in contracts takes up less than 50 percent of the total revenues coming into the league. According to The Associated Press, $3,767,445,277 was spent this past season on player salaries, including benefits and extended benefits. That reflects only 40-man roster compensation and does not include signing bonuses for minor league contracts, such as players in the Rule 4 draft, and international free agents. Still, that amount accounts for just 47 percent of the total revenues coming into the league (and remember, the league would only say that revenues came at above $8 billion, but not higher than $8.5 billion, meaning the percentage could be less). As to how this occurs, there’s certainly clubs like the Houston Astros that are doing a radical rebuilding process that saw total player payroll for 2013 below $30 million, but there’s a larger reason. For most all players in the first 3 seasons of an MLB career, clubs only need pay them at least the league minimum salary, which this past season was $490,000. After that, the majority of the players will see 3 years of being in salary arbitration where player performance is compared to like players and their salaries. While there is a sizable increase between the first 3 years to salary arbitration, there is still some level of control with the salary arbitration system. Imagine if players like Clayton Kershaw or Mike Trout were, instead, instantly free agents. How much more would they be earning now?
#7 - With Extra Money, the Free Agent Pool is Thinning, Thus Driving Up Demand
The system that is seen as the most sound in baseball is to develop players through the draft and shrewd trades, and then selectively offer the best talent extensions before they hit free agency. Fifteen years or so ago, the small revenue clubs bemoaned that they couldn’t sign the extensions, and lost talent they had developed to free agency. Now, more and more clubs are signing young core talent.
In doing so, you get a classic “supply and demand” dilemma for those that wish to tap free agents. As fewer players hit the free agent market, so demand for them goes up… as do the salaries and the contract lengths. For those that wish to make a move in free agency, doing so with the cream of the crop means busting open pocketbooks, and be willing to do so for many years to one player resource.
#6 - Annual Contact Escalation
One game general managers in MLB like to play is “It Might Look Crazy Now, But Not in A Few Years.” That is to say that there is constant market escalation. As other free agents sign deals, the market changes upwards. Throw in rate of inflation, and GMs and agents for the player will factor in adjustments. Where it gets interesting is the fuzziness of the free agent market. What the sides try to do is work out a way in which annual escalation is factored in, with the player and agent erring on the side that anything from injury to performance decline can factor in, and the owner and GM thinking that what may look high now will look “low” in the future. Of course not all contracts see the same amount or slight increases to account for market escalation in each year of a multi-year agreement. Some clubs do what is called “front loading” (more salary in the beginning years that then tapper off at the end) or more commonly, “back loading” (think of balloon payments on your home mortgage). The plan that most often leads clubs to get into back loaded contracts is that they either A) don’t have payroll flexibility due to other player payroll obligations, or; B) the hope that signing a star free agent will get the team into the postseason (and hopefully a World Series win) in which case new revenues will flow in. The latter is a dangerous game of “robbing Paul to pay Peter” but it’s done. The most notable example was when Jerry Colangelo owned the Arizona Diamondbacks. The practice yielded a 2001 World Series Championship but it hamstrung the organization with bloated contracts for years after he left as fans became fickle when sustained trips to the postseason dried up.
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#5 - Massive Revenue Influx Causing Clubs to Eat Salary at the End of Long Contracts
While clubs are seeing high amounts of revenues, they still flow in at a rate that does not allow them to bust the bank each and every season. With the exception of the Yankees, Red Sox, Angels, Tigers, and Dodgers, no clubs have broken through MLB’s soft cap. The threshold, this past season that was $178 million. For every dollar that clubs spent over that, they are taxed percentage of that dollar with a Competitive Balance Tax, or as it’s more commonly known as the Luxury Tax. If you do it in consecutive years, the tax rate climbs. The aforementioned Yankees have broken the Luxury Tax every season since it was implemented and with it, their tax rate was a whopping 50 percent this year, and with it, paid $28,113,945 in Luxury Tax.
Few clubs used to be able to approach this, but with the revenue influx, it’s becoming possible to reach the Luxury Tax threshold. To avoid it, or allow for salary to be spread to others, while contract dollars for individual seasons, the contract lengths are what have become extraordinary. Consider the following that shows current age; age at end of contract; salary, and; projected WAR (Wins Above Replacement), a metric that assigns value to a player in terms of how many wins they are worth to a team. Note how each of these players see declines in performance often times as salary is escalating (values via FanGraphs)
(Current age 38, Age at contract end 42) – Owed (2014:$25M, 2015:$21M, 2016:$20M, 2017:$20M), WAR (2014: 0.9, 2015: -0.1, 2016: -0.1, 2017:-0.2)
(Current age 33, Age at contract end 40) – Owned (2014: $23M, 2015: $24M, 2016: $25M, 2017: $26M, 2018: $27M, 2019: $28M, 2020: $29M, 2021: $30M), WAR (2014: 1.4, 2015: 0.9, 2016: 0.3, 2017: -0.2, 2018: -0.8 2019-21: no projections that far out)
(Current age 32, Age at contract end 35) Owed (2014: $15M, 2015: $23M, 2016: $30M, 2017: $30M), WAR (2014: 1.5, 2015: 1.1, 2016: 0.6, 2017: 0.2)
This seems to fly in the face of conventional wisdom. Salary is increasing as performance declines instead of the other way around. This seems like a poor investment, and in reality, it is. But, what’s occurring is that by spreading contract dollars out to get flexibility to spend on other players, keeping total dollar allocation reasonable for each season to prevent being hit with the Luxury Tax, and having extra revenues to spend, many clubs are clearly saying, “We’ll hope that adding a star player now will pay dividends early in the contract, and write the decline years off as a sunk cost.” This, of course, is a dangerous game to play. No one can reasonably think that Albert Pujols will be generating high-powered offense at age 40 and a salary of $30 million. What the Angels had to think is that a player of that caliber would get them to a World Series win early in the contract, which in turn generates more revenues, which in turn makes Pujols an expendable item later in his contract. To date, the gamble hasn’t paid off. With Rodriguez (specter of PED scandal, and injuries), and Hamilton (injuries and performance decline), the issue is the same: performance value declines and rarely increases over time with veteran free agents, yet salary escalates when you’d prefer to pay less.
#4 The Robinson Cano Deal with the Mariners Is Not “Crazy”
With all the aforementioned details, you have to re-evaluate contracts, and a good example of that is the one that former Yankees second baseman Robinson Cano just signed with the Seattle Mariners. The deal is worth $240 million over ten years. Here’s why the deal isn’t crazy, yet risky.
For one, the Mariners are in nearly perfect financial shape to do such a deal. They are debt free, and just got done purchasing the majority interest in ROOT Sports NW. Up until the Cano signing the only major payroll obligation past 2014 was to All-Star Felix Hernandez.
There’s other reasons the signing of that magnitude has some logic.
Mariners attendance has basically been cut in half over the last 10 years. Last season the club ranked 25th out of 30 in attendance, and second to last behind only the Indians in terms of percentage of ballpark filled (45.4% of capacity).
Cano’s former home is New York, baseball’s largest market, and therefore has much more national visibility and marketing power that was afforded being in Yankee pinstripes. For the Mariners to entice Cano to Seattle where media coverage is low, the team hasn’t been winning, and the crowds in the stands have been light, you’re going to have to overcompensate to get a player of that caliber.
Cano is 31 and will be 41 at contract end. Here’s how his contract breaks down:
2014: $24M, 2015: $24M, 2016: $24M, 2017: $24M, 2018: $24M, 2019: $24M, 2020: $24M, 2021: $24M, 2022: $24M, 2023: $24M
Here’s one aspect where “crazy” is at least somewhat reasonable. While he gets salary that is in line with the aforementioned star free agents, the annual salary remains flat over the life of the contract. It does not account for market inflation, where Pujols’ does. Projections for production on the field fair better than those we’ve compared. Here’s Cano’s project WAR:
2014: 4.5, 2015: 4.2, 2016: 3.9, 2017: 3.5, 2018: 3.0 (2019-23 no projections that far out)
The issue with the Mariners is not that the Cano deal is necessarily crazy… if there’s more in the works for them. This offseason, they added Corey Hart (missed all of last season due to knee surgery) and Logan Morrison in a trade with the Miami Marlins. Morrison went .236/.321/.387 in 2013, down from seasons prior. The Mariners are hoping both will rebound, but there’s no guarantee. So, for the Cano deal to make more sense than some marketing ploy to get fans in the seats, they will need to continue to spend–not only this offseason, but in following years–and hope their prospects develop.
#3 - Gambling, Cost Certainty and Risk Aversion
None of this is to say it’s not gambling. It’s risky; often very much so. But the flow of money and players tied up for multiple years does something that owners and CFOs love: it gives them cost certainty. That ability to have known costs allows one to make planned moves that can be a gamble, but as revenues increase, your ability to absorb potential mistakes becomes greater, which in turn fuels owners to gamble further.
#2 – Placing More Value On Young Talent And The Service Clock
While there will always be a want for free agent talent, more and more we’re seeing clubs make their investments up-front with developed prospects. As clubs do so, the battle that Marvin Miller brought to the table in 1974 becomes more prominent: the Service clock.
There is always an intense focus by the media and fans around veteran signings and extensions, but little is being focused on how much money is being placed on prospects. As an example, over $1 billion in total contract dollars were spent on this year’s class of salary arbitration eligible players.
The Astros and prospect George Springer created a bit of a stir when he turned down a 7-year, $23 million offer in Sept. of last year that would have had him under control through 6 years that included all salary arbitration eligibility, plus one year of free agency. When he rejected the offer, the Astros moved him back into the minors.
The move begged the question: if he was good enough for the Majors then, why is he not after he turned down the deal? The answer centers on player service time and when they hit salary arbitration eligibility.
Back to Marvin Miller and when this process started… the percentage of players that have more than 2 years of service, but less than 3 year (Super 2) that are salary arbitration eligible has undulated over the years. In 1991 the top players by service time that were in-between 2 and 3 years of MLST was 17 percent. That has increased to 22 percent in the most recent labor agreement that ends in 2016. The MLBPA is likely to seek yet another increase in the percentage of Super 2 players arguing that clubs are holding back Major League talent strictly because in doing so they keep a player from entering salary arbitration earlier.
#1 - What is certain is this…
All 30 owners in Major League Baseball have the capacity to be players in the free agent space. They need to pick and choose when it makes sense to, as they say, “drop the hammer” but it can be done if the team is close enough to getting into the playoffs. The key difference is that there will always be economic disparity. Big markets with higher revenues to work with can sustain winning, and absorb mistakes easier. That’s where the real story is: not that every team in MLB doesn’t have a chance of winning a World Series, but rather than the windows of opportunity are smaller, or larger, across the league.
Maury Brown is the Founder and President of the Business of Sports Network, which includes The Biz of Baseball, The Biz of Football, The Biz of Basketball and The Biz of Hockey. He writes for Baseball Prospectus and is a contributor to Forbes. He is available as a freelance writer. Brown's full bio is here. He looks forward to your comments via email and can be contacted here.
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