April 9, 2002
The Daily Prospectus
The Daily Prospectus: Sunk Costs
One of the points we've been pounding for years is the concept of sunk costs. In baseball, it refers to the amount of a guaranteed contract yet to be paid. The money is committed, and must be paid to a player regardless of whether he's playing or not.
Throughout the free-agent era, teams got themselves into bad contracts with players whose performance immediately went south. Flops cost their teams millions of dollars while providing virtually no performance. However, the standard practice was to carry the player until his contract expired, in the hopes of getting something for the money.
This was a double whammy: not only were teams out the money spent, but they were also often being hurt on the field as a player performed at a replacement level or worse. Beyond that, these commitments led teams to stifle the development of better players while waiting for the free agent to right himself, or even to trade promising young talent blocked by the albatross.
The thought process is wrong. Teams need to extricate themselves from the idea that they have to try and keep a player whose performance doesn't warrant a roster spot, regardless of his salary. Of late, the idea has gained some momentum, and in just the last week, there's been a flood of good decisions by teams making roster moves based on talent, not contracts. It's not easy to pay a man millions of dollars to not play for you, but some teams have stepped up and made the tough calls:
It's important to note that the cost in each case isn't the money remaining on the contract, but the price of the replacement. The Pirates were paying Bell regardless; the only additional cost they incur is that of his replacement on the roster (Rob Mackowiak, in this case). In general, the marginal cost of the decision to release a player with a bad contract is $200,000--the minimum salary, and generally what the replacement player will earn.
In baseball terms, $200,000 is nothing, certainly not a barrier to a decision. No, what keeps teams from releasing players owed money is the idea that to do so would be a waste, that they need to get something back from that investment. Often, though, it's hopeless, and the best thing to do is accept that the contract is a sunk cost and ignore it in the decision-making process.
As the Dodgers, Royals, and Pirates demonstrate, this concept is taking greater hold in front offices. Each of those teams is better for their decision.