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April 27, 2011

Ahead in the Count

Expanded Playoffs, Expanded Salaries

by Matt Swartz

Bud Selig recently admitted that owners and players are likely to reach an agreement to add two teams to the post-season schedule for 2012, allowing an extra wild-card match-up of one or three games to precede the divisional round. This measure may seem like it would result in extra cash for owners—in fact, that has been widely cited as the reason for its inception—but perhaps counterintuitively, it will likely fatten players’ wallets far more.

The size of baseball players’ salaries often come as a shock to people who don't follow sports regularly. Guaranteed contracts worth hundreds of millions of dollars at the high end and league-wide average annual values of three to four million dollars provoke jealousy, disbelief, and heated debates about fairness. The most common response that educated fans can provide as a counterpoint is that Major League Baseball raked in $7 billion in revenue in 2010, which makes it reasonable for the on-field performers to aspire to $3 billion in earnings.

Players did not always garner such a large piece of the revenue pie. Most fans know that before the advent of free agency in the 1970s, player salaries were a pittance when compared with the large sums that clubs generated, but even after the Seitz decision, players did not immediately earn the shares that they have in recent years. In the late 1980s and early 1990s, players earned only about 30 percent of league revenues, but from the mid-1990s through the present day they have taken in roughly 50 percent, and sometimes more.

That change can be traced to a dramatic increase in the monetary value of players. A large contributing factor to this explosion in player value was the introduction of the wild card and a third division winner in each league. More playoff teams meant more playoff games for which tickets could be sold, as well as higher television revenues, but players didn’t simply get paid a share of those proceeds for the sake of equity—the pre-free-agency era debunked that idealistic notion. Players began to get paid hand over fist because of the extra revenue they were bringing in, just like workers in any other profession. Better players get paid more upon reaching free agency because they generate more money for clubs, who bid up salaries in order to get their hands on that extra money. The more wins a player adds, the more money he makes.

The changes to the playoff structure after 1993 made the value of a win higher to teams that actually spent on free agents. It was not simply that more teams made the playoffs—it was that more teams were in the playoff race and more teams were able to see a potential windfall of cash from adding another win to their records. The dollar value of a win is not the same to all teams—it is much higher for those on the playoff bubble, which is why 58 percent of free-agent dollars this offseason were doled out by teams with 86 wins or more in 2010 (despite the Nationals mistakenly categorizing themselves as “competitive” and lowering the ratio). The expected revenue that comes from adding a player is higher than it was before the wild-card era, and teams have bid up player salaries in response.

The value of a win stands to rise still higher if MLB adds an extra playoff round, since there will be more teams on the playoff bubble to bid up salaries of free agents to a level commensurate with the expected revenue gain. With more teams in competitive positions, this additional value will probably be allocated to the players, and I believe that player salaries will increase even more than total revenue as a result.

Consider the marginal effect of a win, which is highest when it makes the difference between reaching the playoffs and not reaching the playoffs. The median gap between the wild-card winner and the wild-card runner-up over the past 15 years was 3.5 wins. As a result, the odds of one game making the difference have been quite high.

By comparison, the average gap between the teams in second and third place in the wild-card standings during the same period was only two games. With those teams even closer to the promised land, the odds of a single game making the difference will spike even higher. Only 27 percent of wild cards in the last 15 years have been decided by a single game, but the second- and third-place finishers have been a single game apart 43 percent of the time.

The main reason for this discrepancy is that the American League wild card has gone to the AL East runner-up in 12 of 16 years. The NL wild-card winners have actually had a median margin of victory of just two wins, while the AL wild-card winners have had a median margin of victory of six wins. This has diminished the value of extra wins to American League teams, but with a second wild-card spot in play, teams in the AL Central and AL West won't necessarily have to outdo an AL East team to secure a playoff berth, which will lead to fiercer competition in auctions for free-agent talent.

Furthermore, the value of a win to AL East teams will increase as well. Since finishing in second place has not led to much lower odds of bringing home a championship (and its associated revenue) than finishing in first place has, the value of a win has not been as high for teams that were likely to get the wild card if they failed to win the division (I’m looking at you, Red Sox and Yankees). Having to play an extra playoff round would change that equation, prompting the beasts of the East to try to add enough wins to ensure a division title.

As teams grasp the benefit of adding players who could potentially improve their playoff chances, as well as the increased cost of letting such players go, bidding on free agents will intensify. With such a sharp increase in the percentage chance of one game meaning the difference between going home and going to October, there is no reason to assume that the total increase in player salaries would be less than the total increase in league revenue stemming from the expanded playoffs.

If the odds of a team finishing one game out of the playoffs come October were to increase from 5.5 to 6.0 percent (a fairly reasonable estimate, if not a conservative one), and approximately one third of the marginal value of a win is attributable to increased playoff odds (also reasonable, if not conservative), then player salaries could be expected to rise by three percent for free agents, which would represent an increase of about $50 million overall. On the other hand, even if MLB added a best-of-three series (which would average 2.5 games in length) to each league, and each game generated an average of $5 million, then total revenue would go up by only $25 million, half of my estimated increase in player salaries.

The players may be asking for concessions in exchange for this extra revenue opportunity, but it is the owners who should be compensated. Although the owners stand to benefit from increased revenue, players will benefit more from an increase in the marginal value of a win, which should wipe out the owners’ potential profits, and then some. Perhaps the owners should ask for more regular-season games instead.

Matt Swartz is an author of Baseball Prospectus. 
Click here to see Matt's other articles. You can contact Matt by clicking here

Related Content:  Wild Card,  The Who,  Salaries,  Second Wild Card

18 comments have been left for this article. (Click to hide comments)

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Randy Brown
(189)

Somewhere in the MLB offices in New York, an intern is cleaning coffee from a computer screen after Bud Selig read this article and did a spit-take.

Apr 27, 2011 06:11 AM
rating: 4
 
mafrth77

I wonder if the revenue generated by 2 home games in the wild-card round will actually make winning the division a losing proposition,financially speaking.

Apr 27, 2011 06:21 AM
rating: 0
 
BP staff member Matt Swartz
BP staff

I played around with this one, but I think it's still better to ensure the longer series.

The expected number of games in a 3-, 5-, and 7-game series are: 2.5, 4.125, and 5.8125.

So you're expected number of playoff games as a wild card is 6.74 if you're in a wild card matchup and 8.48 games if you get a first-round bye directly. Definitely an interesting idea, though.

Apr 27, 2011 10:15 AM
 
drawbb

I'm sorry, I don't even understand what your argument is here. Care to elaborate?

Apr 29, 2011 21:09 PM
rating: 0
 
metfanaaron2001

Articles like this are why I won´t give up my BP subscription. BP actually tries to give (does give)objective analysis; too much sportswriting these days is either about jumping on the bandwagon (ex., ¨Bud likes the new playoffs, so let´s sell it to the fans¨) or trying generate storylines in a vacuum (ex., ¨I'm bored, let's start an Albert Pujols trade rumor¨).

Most of the coverage of the expanded playoffs debate takes it for granted that a. this is going to make baseball better and more exciting and b. this is inevitable.

As a Mets fan, I know how much having an extra wild card would have benefited them a few years ago and I STILL think its a terrible idea.

Apr 27, 2011 06:28 AM
rating: 6
 
Luke in MN

I'm not buying. On the one hand, a win will be worth more in the sense that making the playoffs will be a matter of degrees and there will be more potential revenue to chase. But to some degree that will be offset because you won't need to win as many games to make the playoffs. As you approach 100% playoff participation, the value of regular-season wins necessarily declines as you go. (see, e.g., the NBA) So the Yankees have to worry more about being second-best in the AL East, but they have to worry less about being third-best.

On a more basic level, the amount an owner is willing to spend on a player win is necessarily a function of how much that win will return to the owner. If a player win is worth $6 million to an owner, it's *worth* $6 million to an owner. If spending more on players causes owners to earn less, spending more on players is exactly what the owners won't do. You're saying both (1) that there will be more revenue in the collective pot due to the extra playoff games BUT (2) the extra playoff games will cause the owners to spend in a way so that they actually lose out on that money and then some. "Conservative" estimates aside, I find that very unlikely.

Apr 27, 2011 07:15 AM
rating: 2
 
BP staff member Matt Swartz
BP staff

I'm not saying that going to 100% playoff participation will raise the marginal revenue. I'm saying that going from 27% to 33% will raise the marginal revenue, and specifically given how the league is currently set up.

You're right that I'm saying that there will be more revenue in the collective pot, but that owners will end up with less of it. It follows logically from the economic concept that you're talking about. I'll give you a perfect example

Suppose that the MLB says that any team that doesn't make the playoffs for five years in a row loses their revenue sharing. Let's say this makes fans excited, increases ticket sales. But as a result of the larger increase in marginal revenue per win to the Pirates, they now spend more. The revenue goes up, but the Pirates spend more money than the expected revenue increase. Contrived, yes, but it makes the same point.

In this case, the odds of one game making the difference goes up from about 27% to about 43%. As a result, the marginal revenue of a win is higher to a lot of teams, and they bid up salaries. It follows logically from rationally acting owners who simply have higher estimates of expected marginal revenue from spending across the board. The key here is understanding the auction nature of this market.

Apr 27, 2011 07:30 AM
 
Luke in MN

"the marginal revenue of a win is higher to a lot of teams, and they bid up salaries"

Right, but I still don't understand why they would bid up salaries in a way that's not commensurate with the expected extra marginal revenue a win will add. Why would they? By your own argument, they'll lose money if they do.

The Pirates in your example may suffer from that system, but that's only because the benefits of the system flow to good teams and the punishment falls disproportionately on the bad teams. In the aggregate, the point holds: teams under your hypo would on average see increased revenue per win, and they would spend on wins in a way that's in proportion to (but less than) that expected added revenue.

(I wonder if, as you add up the numbers, the key thing your model is missing is that if regular-season games matter more--basically the premise of your argument--than the owners will make more money on regular-season games too.)

Apr 27, 2011 08:33 AM
rating: 0
 
BP staff member Matt Swartz
BP staff

They don't necessarily spend up to their marginal revenue right now. Other teams bid them up as high as they're willing to go. But as more teams bid, they're more likely to spend closer to the marginal revenue and end up with the same chance of making the playoffs.

The laws you're talking about implicitly assume that they would make the same amount of money if they sat on their hands. They wouldn't. Teams on the margin will spend more, and compete in bidding more.

Also, the wild card/division winner issue in the AL East also comes into play for years with only two good teams in that division. Being the better of those two teams didn't used to matter but when your playoff odds as a wild card are cut in half relative to now, winning that division matters more.

I don't know if you can assume owners will make more on regular seasons games proportionally just because they matter more. Maybe attendance goes up a little, but I doubt it would be commensurate with the playoff gains.

Apr 27, 2011 08:43 AM
 
Luke in MN

"The laws you're talking about implicitly assume that they would make the same amount of money if they sat on their hands. They wouldn't. Teams on the margin will spend more, and compete in bidding more."

I'm just saying that teams will spend more if it's profitable to spend more and sit on their hands if it's profitable to sit on their hands. But you're saying teams will spend more on player salaries after the expansion even if it's not profitable to spend more. That's what I don't get. Ok, salaries will be bid up higher. But before or after the playoff expansion, why would anyone bid an amount on a player that they expect will be more than what that player will provide in return?

Apr 27, 2011 11:23 AM
rating: 0
 
BP staff member Matt Swartz
BP staff

That's not what I'm saying. What I'm saying is that in situations where they are willing to spend $10 million, they used to only have to spend $8 million to win the auction, but now someone will bid them up $9 million. They will still make money but the increased competition makes it harder to get a player for much more than their marginal revenue.

Not only that, when other teams spend less in general, there is less need to keep spending to ensure a playoff spot, but this may make it harder to continue to do so.

Apr 27, 2011 11:26 AM
 
BP staff member Matt Swartz
BP staff

And regardless, it seems that you are undoubtedly convinced in general that you expect the players to be the beneficiaries. You're just not sold on my belief that the owners may actually keep less money. But you would agree that if these playoffs generated $25 million more in revenue that player salaries will go up at least around $25 million, right?

Apr 27, 2011 11:28 AM
 
BP staff member Mike Fast
BP staff

Very interesting article, Matt.

Apr 27, 2011 09:57 AM
 
devine

Nice work. Does playoff revenue currently go into the revenue-sharing pot? And if so, would this also create more incentive for teams with little hope of competing to try what the Marlins and Pirates were trying for a while, and stay completely out of the FA market completely, tank the season and pocket the bigger rev-sharing check?

Apr 27, 2011 12:11 PM
rating: 0
 
ncooke

Isn't your example of marginal revenue only adding the incremental revenue for those additional three games, though? Even if the owners lose money for those three games, the hope would be that more fans show up all through August and September because more teams are on the bubble. In that case, the three game playoff is a loss leader (loss trailer?) to get more sales during the regular season. The true marginal revenue starts showing up sometime in August, not on October 1.

Apr 27, 2011 12:40 PM
rating: 0
 
BP staff member Matt Swartz
BP staff

A fair point. Generally teams spend more than the direct playoff revenue. That extra revenue will be part of what the players get too, though, in the sense that they will be paid for the marginal revenue of wins. Whenever you add revenue associated with winning, the players will get that. So the net result here may be closer to neutral for owners, except for the bidding issue I mentioned earlier in the comments. So maybe it's not $50MM vs. $25MM but $50MM vs. $40MM. Something like that. Good call.

Apr 27, 2011 12:59 PM
 
jswede

after reading this, and then following your exchange with Luke, it seems to me that you put in place a number of assumptions to start off with that took me quite a while to shake. Now that I have, I'm not sure I can necessarily agree with your thesis.

Expanding the playoff picture, and keeping all else equal, would be a boon to owners in aggregate, as at least another, say, 6-10 teams will stay in the playoff picture longer, and sell more seats later into the season.

You're assuming that more teams than not decide to chase these playoff spots, and that the 'cost of chasing' is equal or greater than resulting revenue. I'm not saying that is wrong, but I don't see anything proving it right. I have nothing to hang my hat on.

What I would and could hang my hat on is Luke common sense approach that the owners, by and large, are good businessmen and would spend up to where it's profitable to do so.

The reason, if I may offer opinion, why the teams with 86+ wins spend more, is that they could spend to begin with, and that's why they have 86+ wins. They are large market, and have in many cases have owners with egos that risk spending past profitability.

As you expand into the next tier - the 6-12 "new entrants" now vying for spots 9-12 in the proposed playoff structure - you're seeing less large market, less ego and more business oriented owners. I think it's a dubious assumption to say these teams will be 'chasing' these revenues past what makes sense.

Further, in this part of the MLB pack, a mid-pack AL team is likely to realize their chances of knocking off Texas, NYY, and BOS, then Philly are quite low. I'd guess many would be content with sitting back and enjoying the revenue of a playoff race that usually ended in early July, now going into late Aug...

Apr 27, 2011 20:09 PM
rating: 0
 
BP staff member Matt Swartz
BP staff

I don't think you correctly interpreted my point, so I'll try to make it clearer. I don't think they will spend past rationality. I think they will be rational-- that is my point. As a result, I think they will spend as much as the expected increase in revenue.

The expected increase in revenue, however, is NOT fixed, and the expected cost of talent is not either.

The expected increase in revenue is based largely on the probability of spending putting a team in the playoff spot, something that has been shown many teams here and other places. Since teams have been tighter packed, that probability will go up, which will make the expected revenue of spending go up for teams on the margin, causing them to bid more on wins.

You say that teams with 86+ wins will now have the option of spending more but you think they can choose to stand still. But that assumes is it equally easy to reach 86 wins. No one can realistically reach 86 wins without free agent talent, something I've shown before (look through archives for: Service Time Contracts and Wins, Part I and II), which means that if there are more bidders for that talent, the cost of that will go up. In other words, THE OPTION TO STAY PUT AT 86 WINS IS NOT AVAILABLE IF PLAYERS COST MORE. Another example, if there was no longer a luxury tax or draft pick compensation, the Yankees would spend more on the players that mid-market teams have been able to acquire in their pursuit of 86 wins-- making this cost more.

The assumptions you're making assume constant prices of labor, a common assumption in perfectly competitive markets with many buyers and sellers of labor-- that has nothing to do with baseball.

The odds of winning a playoff series is not so different than 50%, so they won't really treat that as different than before.

Apr 28, 2011 04:23 AM
 
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