December 4, 2006

The Ledger Domain

Why the Free Spending?

by Maury Brown

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Why?

At the end of a particularly difficult college philosophy course, a professor warned the students of the difficult final that would be approaching them. "It will count greatly toward your grade," he noted. As the day of the test arrived, a tense air filled the classroom as the test was passed amongst the students. "You have the entire class to answer the final. Now, turn over your paper and begin." When the paper was turned over, there was simply one question… Why?

Many of the students filled pages espousing what they thought was great philosophical wisdom, but when the time came to receive their grades, all had been awarded grades by the professor that were barely passing, or below. One score that ranked higher than the rest of the class so perplexed the other students as to cause jaws to drop. The answer granted the higher score simply read, "Why not?"

The point of this little fable is that sometimes the answer is far easier than it may appear. While making a case for why we've seen high salaries and contract lengths this offseason may not be as simple, the evolution of baseball as a business tells us a lot about why these changes are occurring. As for just how high the market is compared to last off-season, Nate Silver calculated that the market is "up approximately 70% higher versus last season."

Silver also added, "Now, that number might decline a bit once some bit pieces sign later in the cycle. On the other hand, we haven't yet experienced the nightmare that will be Barry Zito's contract.

"Things also appear to be a bit less non-linear than in years past. In other words, this is not really a stars-and-scrubs market. There are some bad contracts for top-tier talent, but there are also a lot of bad contracts for middle-tier talent (Wolf, Eaton, Nomar, etc.)."

I'll try to answer the eternal question today.

MLB's New National Television Contract

At the All-Star game this past season, MLB, ESPN, Fox, and Turner Sports announced that a new national television broadcasting agreement had been brokered. The deal that starts in 2007 lasts for seven years, and will end in 2013. The deal comes with a hefty amount of revenue attached to it: in excess of $3 billion over its duration.

Along with other facets of MLB's business landscape, the TV deal certainly primed the pump for what is now occurring. While the television deal by itself may not have been a catalyst for the free spending we're now seeing, it certainly is one of the key ingredients in the mix. Given the fact that MLB is set to make approximately $5.2 billion in revenues this year alone, the TV deal gave owners more to be giddy about.

MLBAM Continues to be a Cash Cow

Interestingly, MLB continues to talk of creating a television network, which would put them in the same position as the NFL and NBA. The reason that they haven't done so yet is due to the substantial revenues that are pulled in from MLB Advanced Media (MLBAM).

As it currently stands, MLBAM, which includes the very popular MLB.com and other internet holdings, accounts for 6% of MLB's total revenues, or roughly $312 million this year alone. This is one of the recently centralized aspects of MLB, and therefore the owners split the majority of the money 30 ways. That gives all the clubs around $10 million of MLBAM-related revenue to play with.

The CBA Arrives Early

One of the biggest reasons for free spending this off-season is that management and the players agreed early on a new collective bargaining agreement that will last for five years, ending in 2011. With MLB's financial landscape so secure since the labor peace that has held since the agreement of August of 2001, owners and players alike can predict much of the same moving forward; MLB revenues grew at an astonishing 11% over the life of the 2002-2006 CBA.

The new CBA further incentivizes clubs to grow revenue through changes in the revenue sharing aspect of the agreement, and therefore, owners are banking that MLB will continue this explosive growth. While the national economy does play a role in this issue, some analysts predict that MLB revenues will continue to grow at somewhere between 8% to 10% over the life of this new agreement.

Other Factors Set the Table for Free Spending

To add to the TV deal, MLBAM growth, and the new CBA, take in the following:

• MLB's International Fixation. As mentioned, MLB does not currently have a MLB Network due to worry that its creation would cannibalize MLBAM. Still, MLB is charging hard at promoting the game internationally, with plans to play regular season games in Europe, and also possibly in China before the Olympics. International revenues only make up 2% of MLB's total revenues, so clearly this is an untapped resource.
• New Stadiums. The Nationals, Mets, Yankees, and Athletics will all be unveiling new stadiums over the next few years. With the new stadiums comes increased revenues, which are then shared with the other clubs.
• The Value of MLB.com as a Public Offering. While it may have been a trial balloon, MLB came close to putting MLB.com up as an initial public offering on Wall Street. The value was projected at $3 billion at the time. While MLB has said that it would like to continue to control MLB.com, the value of this centralized holding certainly has to be something sitting in the back of the minds of many owners.

Parity Sets the Table

Parity plays a role in this dynamic as well. With seven teams in as many years winning the World Series, clubs are more likely to think they have a better shot at getting to a World Series. Stan Kasten, the president of the Washington Nationals, sees the World Series as an obvious siren song.

"The only thing I can point to as a theory, is with so much more perceived parity, so many teams still in the chase in September, and an 83-win team in the Cardinals winning it all, there are more teams believing they are only that one or two final piece away," Kasten said. "That's ultimately what motivates everyone, and one of them will be right. All the rest will be wrong."

How the Tribune Co. Raised the Bar

With all of the aforementioned factors in place, the offseason market has been set, not by the Yankees or Red Sox as has been the case in many years in the past, but by the Chicago Cubs.

The Cubs have already signed (or re-signed) five players this offseason. When the contracts are added up, they could total anywhere from $231 million to $237 million (Aramis Ramirez, $75 million, five-year contract; Kerry Wood, $1.75 million, one-year contract that with incentives could be $6 million; Mark DeRosa, $13 million, three-year contract; Henry Blanco, $5.25 million, two-year contract; Alfonso Soriano, $136 million, eight-year contract). Of all of these, the Ramirez and Soriano contracts have done the most to set into motion the market we are at today.

As I wrote earlier, the Tribune Co.--ergo the Cubs--are for sale. With the Ramirez and Soriano contracts backloaded, the indication is that the Tribune Co. wants to make a final run at a World Series, and the salary dollars at the end of the longer contracts will become the responsibility of the new owners when they take over the Cubs.

The Cubs are not exclusively to blame for market values we are seeing. Certainly the signing of mid-level players such as former Cub Juan Pierre (signed by the Dodgers to a five-year, $44 million contract) and former Cub Gary Matthews, Jr. (signed by the Angels to a five-year, $50 million contract) have set the bar higher across the board as well.

Making Sense of the "Why?"

As I mentioned at the beginning, it's not quite as simple as, "Why Not?" but it is certainly simple to see why free spending is occurring: It's simply market driven. It is supply and demand.

"It's no different than the housing market in Toronto or any large city in North America," said Paul Godfrey, the president of the Blue Jays, in the Toronto Sun. "Everyone says it can't continue to rise. But it can. And it does. Same in baseball, we have revenues going up and a new collective bargaining agreement and everybody's feeling good about the game, and so the spiral starts again and people say salaries are out of control. I don't know what's out of control any more."

And therein lies the perfectly simple answer… What is "out of control" any more? The deals being done cannot be viewed in a vacuum. They are indicative of the time and the place and the financial well-being of MLB right now. Suddenly, Godfrey can point to the deals the Blue Jays made last season for A.J. Burnett and B.J. Ryan and say, "Everyone said, 'How can give you five-year contracts and with such large numbers like that?' One year later, if you put Ryan and Burnett on the market, they would get a whole lot more than they got last winter. All of a sudden you look at our deal and you might think we got a bargain."

Maybe. It's a relative statement that Godfrey makes, and here's why. When an AP-AOL Sports poll of 2,002 adults (including 774 baseball fans) was conducted in October of this year, 28 percent of those polled said salaries were the top problem in baseball, 21 percent said it was the high cost of attending games, and 19 percent said it was players using steroids and performance-enhancing drugs. This is a shift from the year prior, when PEDs were the number one issue for fans. The question becomes, do the large salaries impact how the baseball public views the game, or more correctly, does it impact their interest in the game to the point of not purchasing tickets or watching or listening to broadcasts? The answer is probably no. Keep this quote in mind as to why not:

Professional baseball is on the wane. Salaries must come down or the interest of the public must be increased in some way. If one or the other does not happen, bankruptcy stares every team in the face.

--Albert Spalding, in 1881

Maury Brown is an author of Baseball Prospectus. 
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