Big Contracts and the Business of Baseball

[KJ Duke]

Reading Doughboy's Miggy post got me started here ... My main job function is to evaluate the quality, sustainability and risk of businesses, decide what they are worth, and translate that into an investment process. With baseball I can only see what's on the surface, but this is what I see ….Teams justify large contracts with a "market price" argument; of course, it starts with someone pushing the market price higher and others following suit. The latest round of salary escalation has been funded by huge TV contracts, which began with the Dodgers and is gradually rolling through the league. I think these teams are making a huge mistake.

There is a mid-sized retail chain with a philosophy of cutting prices whenever it's margins expand beyond their historical range. Early on, this blindsided investors who were unhappy that the company wasn't pushing up earnings guidance when the business was clearly performing better than expected and the stock was swiftly punished. This happened several times, but the stock always rebounded quickly after the sharp decline. Now it doesn't get punished at all when it cuts prices. Why? Investors have figured out the business model which translates to higher future sales volumes, significantly reduced competitive risk and the value of a happy and loyal customer base ...

Compare that to a typical MLB franchise, which upon achieving a revenue windfall immediately goes out and jacks up salaries, increasing its cost structure for years to come. To keep margins and growth intact they'll simply raise ticket and food/beverage prices down the road, yet again. They are the complete opposite of the retail chain above. They are systematically increasing the risk of their business and alienating their customer base. What if, instead of jacking player salaries, they instituted deep price cuts to the cost of attending games? They'd garner loyalty, which in baseball seems to be passed on by generation, they'd increase demand for their product, and they'd have a permanently lower cost structure to offset any impact of a future downturn. Players would play just as hard, and the fans would see the same players on the field league-wide.

The retail chain above is one of my favorite companies for long-term investment. The way MLB franchises are run? Not so much. They are fortunate to have monopoly power, but they are unfortunately ratcheting up the cost of attending games upon a mostly middle class customer base and passing it on in the form of huge contracts to a minute number of individuals for no apparent reason, other than stupidity, and in the process increasing their long-term business risk.

[Outlaw]

Well said... I'll add they live off the huge TV deals, but those have run their course. Cable and Satellite are bleeding customers, almost 8 million in the last 4 years, a 44% increase over the prior 4 years and with no end in sight with the Negative churn. Those leaving are saying they don't need to watch TV, they get their fixes from the internet. Internet TV like Hulu and such, that some go to, are for very specific tastes. Younger people, they got no interest in watching sports, like hockey, golf, baseball, Basketball. Only football still grabs some Young people. Some owners have figured it out, where it is all headed, by 2020, the $$$ landscape will have changed in baseball. Ticket sales these days are manipulated by MLB, using the stub hubs and such. You can get tickets to most games for 5-10 these days, far below face value. the problem is, the young people don't care and the older fandom base, most wouldn't even know how to buy a ticket on Stub Hub.

People quite frankly are turned off by spoiled nature of pro athletes and the costs, its not fun for a lot people, especially the younger folks. TV ratings are way down for live sports, in spite of what they may want people to think.
As Dough said, The Miggy deal was just like the Albert deal, they'll be paying these guys for another 8-10 years, long after they are probably retired or just pinch hitters. Ellsbury deal with the Yankees, he's nothing more than Michael Bourne, he'll be hurt more than he plays the next 7 years.... any of us would be hard pressed to come up with any deal over 5 years, thats been signed in the past 20 years that was a good deal for the player and the Team. The list of bad ones, would take hours to write.

[COZ]

Reading Doughboy's Miggy post got me started here ... My main job function is to evaluate the quality, sustainability and risk of businesses, decide what they are worth, and translate that into an investment process. With baseball I can only see what's on the surface, but this is what I see ….Teams justify large contracts with a "market price" argument; of course, it starts with someone pushing the market price higher and others following suit. The latest round of salary escalation has been funded by huge TV contracts, which began with the Dodgers and is gradually rolling through the league. I think these teams are making a huge mistake.

There is a mid-sized retail chain with a philosophy of cutting prices whenever it's margins expand beyond their historical range. Early on, this blindsided investors who were unhappy that the company wasn't pushing up earnings guidance when the business was clearly performing better than expected and the stock was swiftly punished. This happened several times, but the stock always rebounded quickly after the sharp decline. Now it doesn't get punished at all when it cuts prices. Why? Investors have figured out the business model which translates to higher future sales volumes, significantly reduced competitive risk and the value of a happy and loyal customer base ...

Compare that to a typical MLB franchise, which upon achieving a revenue windfall immediately goes out and jacks up salaries, increasing its cost structure for years to come. To keep margins and growth intact they'll simply raise ticket and food/beverage prices down the road, yet again. They are the complete opposite of the retail chain above. They are systematically increasing the risk of their business and alienating their customer base. What if, instead of jacking player salaries, they instituted deep price cuts to the cost of attending games? They'd garner loyalty, which in baseball seems to be passed on by generation, they'd increase demand for their product, and they'd have a permanently lower cost structure to offset any impact of a future downturn. Players would play just as hard, and the fans would see the same players on the field league-wide.

The retail chain above is one of my favorite companies for long-term investment. The way MLB franchises are run? Not so much. They are fortunate to have monopoly power, but they are unfortunately ratcheting up the cost of attending games upon a mostly middle class customer base and passing it on in the form of huge contracts to a minute number of individuals for no apparent reason, other than stupidity, and in the process increasing their long-term business risk.

Interesting angle and well-written. Enjoyed it. Spot on in my opinion. Do tell which Retail Chain it is you reference. investing minds..I mean inquiring minds...want to know....

COZ

[TOXIC ASSETS]

Good write up! This is why I continue to watch these boards, for stuff like this. I wouldn't say baseball is hurting, attendance is just as strong as ever, and I'm guessing that if the drain on cable subscribers continues, sports will find a way to adapt - moving more content to high speed internet, etc. However maybe we are due for a correction in some of the salaries being paid out. Another wild card in the whole thing -- Sports Gambling - if that becomes legalized in more places, it could be a good thing.

Regarding the retail chain -- not sure who it is, but I can tell you it's NOT J.C. Penney -- the 'Street' is trying to sell a 'turnaround' story to Ma and Pa America. It's not happening!

[Daveclum]

Just going by what I heard on tv. But, salaries as a percentage of revenue are the lowest in many years. Also it is a bit naive to think lower salaries would result in lower ticket or munchie prices. I am a firm believer that the owners will charge whatever the market will allow.

[Glenneration X]

I am a firm believer that the owners will charge whatever the market will allow.

Bingo. We have no one to blame for the current state of ticket prices, parking, a damn $10 hot dog and $20 beer at the game but ourselves because we keep buying them.

[DOUGHBOYS]

We need Bill Veeck.
The era of the Maverick owner is over. Now, Major League teams are owned by billionaires who leave the fiscal matters in the hands of others with no imaginations.
All 30 teams, whether high or low payrolled, seem to try to charge top dollar, while 'doing us favors' with 'dollar hot dog night' or all you can eat tickets.

Nobody goes to Tampa games. If a team is screaming for change, it would be the Rays.
If Veeck owned Tampa, he would play the cards that were dealt to him.
He would offer half price senior citizen tickets.
Run shuttles to the ball parks to make it more accessible for the many seniors that live in his area.
Hell, Veeck would probably feature shuffleboard tourneys at the stadium if it made his customers happy and got them to the ball park.

Cleveland has the lowest attendance in baseball right now.
Folks say that they are hardest hit by the economy.
Veeck would have had them bring an unemployment check stub, good for half off ticket and concession prices.
Or he would have given away a 'free lunch' of a hot dog, chips, and soda on purchase of ticket.
Or made $2 dollar tickets available in the outfield for those struggling with Cleveland's economy.

The 'showman' part of Major League Baseball is a bygone era.
The imagination is gone.
Major League Baseball runs their business like Disneyland. The in-game is to try to suck as much money from the consumer as possible.
It's too bad.

[Edwards Kings]

A huckster like Veeck? I do not know. Did the St. Louis Brown's really draw enough to make it a successful franchise? No. The last year in St. Louis, they drew on average 3,860 per game, lost 100 and finished 46 out of first. Veeck was forced out and the Browns went to Baltimore.

To sum it all up, despite the gimmics, Veeck came up short...



Yes. You knew that was where I was heading.

Personally, the fan bases are different. The Yankee fans want winners at all cost and they do not seem to worry much about talent being home-grown. The cheepo Braves seem to build from within (as well as evidently having a hidden financial interest in Dr. Andrews thriving practice), but it seems to work pretty good as the fans love Freeman, Gattis, Simmons, Heyward and Kimbrel.

Some will contest that the merchandizing and other perks of having long-term contracts on players who will be albatrosses by the end of their agreements outweight the negatives. I do not know. Long term, substainable success both on the field and the income statement seems to come from avoiding huge, long term contracts on mature players. I wish the Braves had remembered that last year....

[Glenneration X]

Some will contest that the merchandizing and other perks of having long-term contracts on players who will be albatrosses by the end of their agreements outweight the negatives.

We should ask the Phils how that's worked out.

[DOUGHBOYS]

A incredibly short-sighted view of Veeck, who did set attendance records while with the White Sox.
Not every move is a success, Wayne.
I think about that as I watch the Braves 2B and CF.

Getting back on track, I think the Braves would charge high prices for tickets and concessions, whether they signed all those players or not.
Major League teams know no different.

[The Mighty Men]

Interesting angle and well-written. Enjoyed it. Spot on in my opinion. Do tell which Retail Chain it is you reference. investing minds..I mean inquiring minds...want to know....

COZ

C'mon, Coz, you are a professional, too. You know you have to pay for intel like that!

[KJ Duke]

Also it is a bit naive to think lower salaries would result in lower ticket or munchie prices. I am a firm believer that the owners will charge whatever the market will allow.

Dave, that is exactly what they are doing, my point is what they should be doing. The higher broadcast revenue created an opportunity to maintain margins AND make the game more accessible, build the fan base, sell out games, breed loyalty and make baseball a relative entertainment bargain ... all of those things would be good for the sustainability and long-term value of the franchise. It takes a management group with foresight to do those things. MLB franchises don't appear to have that, they do exactly as you say - charge what the market will bear. They are playing the short game.

[KJ Duke]

Interesting angle and well-written. Enjoyed it. Spot on in my opinion. Do tell which Retail Chain it is you reference. investing minds..I mean inquiring minds...want to know....

COZ

C'mon, Coz, you are a professional, too. You know you have to pay for intel like that!

Thanks Coz. I can't give the appearance of making a recommendation on a public forum per my compliance rules; if I could the timing may not be ideal anyway. But, if I had to buy one company that I couldn't touch for at least 10 years, this would be high on my list. The founders previously originated a retail concept which was copied by others and later merged into one of them to become Costco. The new concept was refined several years after that merger. If you happen to figure it out, please don't post it.

[DOUGHBOYS]

Some will contest that the merchandizing and other perks of having long-term contracts on players who will be albatrosses by the end of their agreements outweight the negatives.

We should ask the Phils how that's worked out.

Just two years ago, the Phils were attracting over 44,000 fannies in their seats.
This year, 29,000.
The 15,000 lost customers per game, is equal to how many fans, on average, that come to watch the Cleveland Indians each regular season game.
Mis-management of their team has reflected in lesser customers through their turnstiles.
And still, Ruben Amaro keeps his job.
I do not get baseball economics at all.

[Edwards Kings]

Not every move is a success, Wayne.

Agreed. Most of my most successful movements are short lived and confined to the "library" as I read the morning sports page (yes, I still get a hard copy newspaper!).

I think about that as I watch the Braves 2B and CF.

Please do not make me think about them. I just ate.

If the goal is to somehow induce MLB management to be more fan friendly, I certainly agree. Perhaps the major difference between now and then is corporate ownership (bottom line oriented, less committed to the community, faceless and removed). Strange though that we should maybe think that the game would be better off with the likes of Charlie Comiskey at the helm.

[Daveclum]

KJ for the most part I agree. I don't think I have agreed with any MLB decisions since the great experiment the DH. But, I have had this discussion with top Mlb people in Manhattan. They point to all time revenues. The huge success of Mlb. Com. And that is their argument. Also they will tell you that if you are not picky about your seat you can take a family to the park quite cheaply. I think I paid more taking my family to the movies last monday.

[Fourslot40]

Interesting angle and well-written. Enjoyed it. Spot on in my opinion. Do tell which Retail Chain it is you reference. investing minds..I mean inquiring minds...want to know....

COZ

C'mon, Coz, you are a professional, too. You know you have to pay for intel like that!

For the fun of it... I guess "The Gap"?

[EWeaver]

Baseball is a monopoly. It's run as such. Talent and innovation are low across the board. Yes, businesses in competitive industries are better managed - they have to be or they go out of business.

Billy Beane gets books and movies made about him for appropriating ideas propagated by a night shift security guard at a pork cannery in the 1980s. That is how far behind the exec "talent" is in baseball...use the cannery guard's ideas a decade later to great result.

The owners are accountable to nobody. I highly doubt that Ilitch considers miggy's contract a mistake, just as a for example. Lord Ilitch of Fiefdom Detroit will be dead when Miggy's contract turns ugly. Ilitch doesn't give a shit. Dumbrowski, who answers to Ilitich, will be retired, and was probably just doing what he was told..."Keep Miggy happy while I'm still breathing. Text my assistant when it's done." From DET owner/mgmt side, nobody made a mistake or did anything stupid. They did what they wanted to do, probably exactly. Now, us normal-ish, non-billionaire, not-team-owing baseball fans KNOW Miggy's contract is bad and stupid and a million other negative things, but "the rules" don't run in ownership's direction.

I give a lot of credit to HOU for *trying* to change this. I think they will succeed and in a decade, we will be reading articles about how they pushed MLB forward and became the template for the "modern" front office run by actual professionals with a solid plan AND a level of consideration for baseball fans.

[DOUGHBOYS]

Blame Wayne ...But allow me to go off subject here. Then you boys can go back to baseball economics.

I love the Eddie Gaedel story. Gaedel is the little fellow pictured in Wayne's post.
Veeck has worked secretly with Gaedel before installing him in a game. He taught him to crouch down in his stance, so that he only had a two-three inch strike zone.
Gaedel eschewed the crouch when entering the batters box and took a 'Joe DiMaggio stance'.
The golden rule set down by Veeck for Gaedel was not swinging. He had taken out an insurance policy on Gaedel, but knew that if the stunt resulted in Gaedel getting hurt, that the ramifications would be dire.

Gaedel worked as a riveter in World War II. His diminutive size allowed him to crawl inside plane wings to do his handiwork.
After the war, his dwarfdom would pay the bills. He would be a mascot, salesman, or clown it up at events.
Veeck snuck Gaedel on the Browns roster on a Friday afternoon, knowing the league would not thoroughly check players till Monday.
Gaedel popped out of a cake between games of the doubleheader in which he 'batted'.
When approaching the plate, the umpire called for the Manager of the Browns. Veeck had already furnished the official roster for him, and the umpire pointed to the batters box.
The catcher went out to the pitcher, he said, amusingly, "I'd keep the ball low if I were you."
The first two pitches were thrown hard. Both high.
The last two were batting practice pitches. Also high.
Gaedel bowed twice on his walk down to first base. He was given a standing ovation as he was replaced by a pinch runner.

Most funny to me was the aftermath. Veeck was called into the league offices. He was accused of making a mockery of the game. He was told that his antics were not appreciated and threats followed. They then told him that Gaedel's contract would be voided.
Veeck seemed to be prepared for this moment. With a straight face and acting upset over the void contract, he made a threat of his own.
He threatened that he would request an official ruling as to whether Phil Rizzuto was a short player or a tall dwarf.

[Edwards Kings]

Blame Wayne

Get in line behind my wife, my kids, the cat, my sisters-in-law, boss, President Barak Obama....

Great story, Dan. The first fantasy league I was ever in had a team called the "Eddie Gaedel's".

Needless to say, they finished short in the standings....

[Jeff Erickson]

Also it is a bit naive to think lower salaries would result in lower ticket or munchie prices. I am a firm believer that the owners will charge whatever the market will allow.

Dave, that is exactly what they are doing, my point is what they should be doing. The higher broadcast revenue created an opportunity to maintain margins AND make the game more accessible, build the fan base, sell out games, breed loyalty and make baseball a relative entertainment bargain ... all of those things would be good for the sustainability and long-term value of the franchise. It takes a management group with foresight to do those things. MLB franchises don't appear to have that, they do exactly as you say - charge what the market will bear. They are playing the short game.

Amen - and because it's a monopoly, there's a lot of peer pressure for all the franchises to continue the short game. We can't have one outfit embarrassing the others, after all. This has a whole "too big to fail" vibe to it.

[Outlaw]

Also it is a bit naive to think lower salaries would result in lower ticket or munchie prices. I am a firm believer that the owners will charge whatever the market will allow.

Dave, that is exactly what they are doing, my point is what they should be doing. The higher broadcast revenue created an opportunity to maintain margins AND make the game more accessible, build the fan base, sell out games, breed loyalty and make baseball a relative entertainment bargain ... all of those things would be good for the sustainability and long-term value of the franchise. It takes a management group with foresight to do those things. MLB franchises don't appear to have that, they do exactly as you say - charge what the market will bear. They are playing the short game.

Amen - and because it's a monopoly, there's a lot of peer pressure for all the franchises to continue the short game. We can't have one outfit embarrassing the others, after all. This has a whole "too big to fail" vibe to it.

Numbers never lie...When the $$$ problem becomes too big of an issue, salaries will be driven down. I think it has already started the past 2-3 years. The locking up of young players for 5-7 years at "affordable" contracts, Free agents having tough time getting deals, The debacle contracts of Pujols, Hamilton, Miggy, Arod, and now probably Cano is showing that players 30 or older, should not get more than 5 years and not 8-10 for 200 million. Not for nothing but Cano looks lost, his swing isn't even the same. The truly superstar young talents like Trout, they'll do OK, but it will happen at a much younger age and for less dollars. Trouts new contract caused a lot of uproar, because most writers, players, agents felt he signed for too cheap. I tend to think his advisors saw the storm ahead and said lets get something done now before that storm hits. That Trout deal ensures that a player like Harper will not get anymore than Trout.

It certainly will be interesting to see how it all unfolds over the next 10 years.

[Outlaw]

Great article that touches on everyones views who posted a response to KJ's observations..

http://www.businessweek.com/printer/art ... ll-dynasty

[Outlaw]

KJ should like this one.

http://www.sloansportsconference.com/wp ... rrency.pdf

[KJ Duke]

Being successful from a competitive standpoint and/or generating record revenues say nothing about long-term sustainability, just means they're doing well today. I would attribute this far to more to baseball's monopoly status, along with existing demographic and social trends, than management effectiveness.