Let’s pick on Tom Hicks for a bit.
Last week we discussed the bubble that took hold in the player market in the late ‘90s and early ‘00s, and also determined that the current market still has room to grow. While there has been some tremendous work done on predicting player performance, little attention has been spent on forecasting the market. Why is this important? When dealing with long-term contracts, there are two questions a team must answer: how will this player perform, and how much will that level of play cost on the market through the life of the deal?
By 2000, MLB revenues had grown almost 140 percent over the previous decade. When the Rangers handed the keys to their castle to Alex Rodriguez, they likely expected revenues, and in turn player salaries, to keep skyrocketing at a similar rate.
But then something funny happened. In 2002, the sport narrowly avoided yet another labor stoppage. But with that hanging over everyone’s head, along with the recent economic recession, baseball’s growth came to a screeching halt. Revenues grew just two and six percent in 2002 and 2003, respectively, barely staying ahead of normal inflation.
All of a sudden, the A-Rod deal was a dud. Desperate to get out from under it, Hicks and the Rangers agreed to pay a sizable chunk of the remaining money on the contract when they traded Rodriguez to New York.
The Rangers weren’t the only team to get burned, though. As mentioned last time, from 2001 to 2003, teams simply went beyond their operating means, losing money all three years. The problem was simply a lack of foresight. Even if they couldn’t see the recession coming, they should have been more cautious due to upcoming labor issues. Instead, they continued to hand out bigger and bigger contracts, even as revenues were about to slow.
The key number in all of this is percentage of total revenues allocated to player salaries, or RAS, which we introduced last time. On an industry-wide basis, teams can safely re-invest up to about 45 percent of all operating revenues on player payrolls, and still turn solid profits. This has held true throughout the free agency era, as RAS seems to gravitate to that level (excluding the sport’s more collusive periods).
So that seems simple enough. When RAS is under 45 percent, salaries will generally rise. When it is over that mark, salaries tend to stagnate until revenues catch up.
But that statement in itself doesn’t help put a price on a specific player.
A player’s value is the marginal revenue and marginal equity he brings his team, over what they would have made without him. Hicks and his staff felt that Alex Rodriguez would add $252 million or more to the Rangers’ coffers from 2001-2010.
That thought isn’t quite as ridiculous as it seems, even in hindsight. The Rangers were essentially buying the entire athletic peak of one of the greatest players of all-time. Their shortstop the previous two seasons, sabermetric punching bag Royce Clayton, had produced 4.5 and 4.8 wins above replacement in 1999 and 2000, respectively. In his three years in Arlington, A-Rod produced an average of 13.3 wins above replacement, a staggering difference.
Despite that production, the team bled money in 2002 and 2003, losing a combined $53 million over those two seasons, according to Forbes. Although their revenues had remained virtually constant since 2000 (when they brought in a $7.4 million profit), the team’s expenses went through the roof. Chief among those lavish expenses was their superstar shortstop.
And yet with all that given, it’s not totally out of the question that the deal could have been a success for the Rangers, had things broken differently. Part of the problem, obviously, was that Texas was not a good team, and the marginal revenue of every extra win greatly increases when a team is closer to a playoff spot (since a postseason appearance is invariably worth millions of dollars).
But this is unreasonably short-term thinking, given the length of the deal. It is certainly not irrational to think that a team built around Alex Rodriguez could consistently challenge for a playoff spot. Had the Rangers been a contender for at least the majority of the contract, and perhaps even won a World Series, the deal could have been a success. Winning, or even reaching, a World Series has an enormous effect on a club’s franchise value, not to mention the added revenues of any postseason appearance.
The problem in reality was that the Rangers had simply misread the market. They were caught buying high in the midst of a salary bubble, and when industry-wide revenues stagnated, they were essentially caught with their pants down.
Analysts often point to unpredictable player performances as a reason to steer clear of big money, long-term deals. But the unpredictability of the market is perhaps an even greater reason. MLB has seen some fantastic gains in the last four years, but the sport as a whole is just barely catching up to A-Rod’s contract now, seven years in (and due to the genius of Scott Boras, just in time for him to opt out and get an even fatter deal).
Any investment in any sector has a micro component and a macro component. We’ve spent so much time analyzing player performance that we seem to have largely ignored the market aspect. Later in the week we’ll discuss some of the work that has been done, and how we can improve on it.
Feedback? Write a comment, or e-mail the author at shawn(AT)squawkingbaseball.com
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