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October 25, 2009

The Biz Beat

Another Chilly Winter?

by Shawn Hoffman

What's the free-agent market going to be like this winter? A buyer's market, or a seller's? I can honestly say that I have no idea, and any team executive who gives you a more definitive answer is probably either hoping or hedging.

Remember this time last fall, when the world was imploding on itself? Lehman Brothers had collapsed, and was about to take the entire financial system down with it until the federal government stepped in. Meanwhile, you couldn't get a credit card or a home loan unless you were Mark Cuban, and companies were firing thousands of people just to make sure they could survive. Yeah, that was fun.

But as scared as everybody was, it actually made a lot of decisions easier: in a normal recession, it's hard to decide if or when to cut costs. But in the Great Recession, it was simply a race to the bottom, as companies rushed to slash inventories and lay off anybody that wasn't absolutely critical. As such, it also made business in 2009 pretty predictable: it was going to suck.

But going into next year, that sense of certainty is gone. (Although at the very least, we know the world isn't going to end, which is a step up from last October.) Perhaps, more than any year in recent history, 2010 is proving to be extremely tough to predict. Are we in for a V-shaped recovery? One that's U-shaped? A double-dip recession, like the one in the early 1980s? Ask five different people, you might get five different answers—and none with any real conviction.

This is crucially important to baseball's free-agent market, probably even more so than the actual players available. Teams set their budgets based on forward-looking revenue projections, which can lean heavily on the general economic outlook. I walked through this last December on Baseball Analysts:

[C]ompanies will hire employees up until the point when marginal revenue equals marginal cost. So if the A's project that Rafael Furcal will bring them $15 million in additional revenue next season, they should be willing to pay him up to $15 million. This number is his marginal revenue product (MRP)...

But what if the A's, worried about the economic climate, decided to do a whole new set of revenue forecasts for 2009, and found that ticket sales were likely to take a huge hit? Or that demand for playoff tickets (should the team get that far) would be much lighter than normal, resulting in lower prices? All of a sudden, the rewards of winning five more games and possibly reaching the playoffs are much smaller. This, in turn, means that Furcal's marginal value to the team is much less, so his MRP (or the salary the team would have been willing to pay him) goes down as well.