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Friday, February 17, 2006

BUSINESS OF BASEBALL Q&A

Vince Gennaro is a consultant whose research and analysis focuses on the business and economics of baseball. His analysis has appeared in The New York Times and The Sporting News. Vince was gracious enough to answer the following questions based on his recent series of articles for Hardball Times.

1. Johnny Damon has a long history and a strong list of comparable players, so I don’t feel the Sox or NY evaluated J.D’s future on-field production differently. Both clubs won 95 games last season and should be in the postseason hunt again in 2006. So do you feel NY’s better offer was primarily based on their disparity in marginal revenue over the Sox?

A: My estimates show that over the same 5-win range (91st through 95th win), the Yankees would have a modest revenue advantage totaling about $1 million per year. However, there’s an interesting dynamic in a situation where a team helps itself while hurting its main competitor. The value differential actually increases, because NY is elevating their probabilities of reaching the playoffs by weakening their chief competitor. (I wrote a more detailed analysis of this effect, which will appear in a soon-to-be-released publication The 2006 Red Sox Annual, published by Maple Street Press, due out in the next month or so). I believe there are different mindsets in Boston and New York. I feel that NY asked the question, “is Damon worth his asking price?”, and concluded “yes”, or more accurately, “close enough”. In Boston it is more likely they asked the question, “is that the most effective way to spend $12–$13 million per year?”, and concluded that they could purchase more runs scored and runs prevented in a more efficient manner, elsewhere. There is one other possibility…the Sox may have a better handle on some of the health problems that limited Damon (particularly defensively) last year, and they are convinced that he’s headed for a dramatic decline. The Yankees, on the other hand, are notorious for buying based on peak-career performance (ala Kevin Brown, et. al)

2. What are your thoughts on Curt Schilling’s World Series winning vesting option? Could have the Sox earned enough in 2004 to cover the cost of the option or $13 million?

A: My understanding is that the $13 million was not a “bonus” per se, but rather the vesting of a $13 million option for the 2007 season. I suspect that by 2007, $13 million may be a premium price for what Schilling may deliver, but only by several million dollars. To the question of what did the 2004 World Championship yield for the Red Sox – I estimate the 2004 postseason triggered a revenue stream with a net present value of about $45-$50 million. It comes in the form of “pricing power” (ability to raised ticket prices, parking, concessions, etc.), and the halo of the Championship will buy the team additional months/years with sellout crowds, should the win column falter a bit.

3. Does a vertical integrated club - owning a cable channel to distribute your MLB team’s games - lead them to integrate your type of marginal revenue analysis more than other organizations?

A: One of the key elements of my modeling efforts is to make the distinction of who owns the broadcast network transparent. I aggregate my estimate of YES and NESN into the team’s revenue stream as if they were selling broadcast rights at market prices. I wouldn’t say that a team is more (or less) likely to impute the value, based on whether they’re vertically integrated. However, I would say that the vertically integrated clubs have a more fluid pass-through of revenues, meaning that revenues vary more directly with winning and losing. Instead of the “normal” situation of signing a contract with a broadcast entity with fixed terms, the vertically integrated teams see the upside (and downside) in ad revenues from winning (or losing) more directly. It seems like these clubs would have a greater economic motivation to improve, as the increased revenues should pass-through, rather than end up in the pocket of the broadcaster.

4. Since both the Pirates and Royals are unlikely to contend and bring in additional revenue, the signings of Burntiz, Randa, Dessens, Elarton, and Sanders would appear to be poor investments in 2006. But do you think clubs need to make some investments, over most winters, to keep customer interest and sustain their marginal revenue potential?

A: You raise an interesting question. It gets at the distinction between managing a short-term profit and loss statement vs. building the long-term equity of a team. On a pure P&L basis, a 70-win team (or 56, in the case of KC) will have a difficult time justifying major free agent signings. The Pirates’ and Royals’ thought process might be, “we need to show our fan base that we’re serious about winning”. While it is important to protect the value of the team as a “brand”, I think bringing in pricey free agents is a very expensive marketing and PR ploy. Ideally a team that is not blessed with the economic base of the Yanks, Red Sox, Cubs and a few others, would build to say, an 85-win team through a strong player development system. At that point, they could enter the free agent market and bid with the “big boys”, as their chase for the postseason would justify some free agent salary demands. Also, let’s not ignore the possibility that the Pirates’ brass sees themselves as an 85-win ballclub, which caught some bad breaks last year, and this year’s signings are, in fact, the last piece of the puzzle.

Follow up: It appears that the Marlins are following your ideal strategy, but they may find themselves with attendance numbers similar to 2002’s 10,000 per game this coming year. Even after their 2003 W.S. win, they only averaged 22,000 paying customers in 2004 and 2005, which keeps them in the bottom quarter with the aforementioned K.C. and Pitt. Perhaps, this is one instance that a team really does need a new stadium. Do you think that the Marlins should have tried to have a 500 club in 2006? Do you feel that a future postseason Marlins team, in say three years, can regain the paying customers that will likely find other entertainment in 2006? And if so, will 22,000 fannies be enough to keep MLB in 17th largest media market?

The Marlins have placed themselves in a difficult situation. They have drawn a line in the sand and have publicly tied the stadium issue to a "stay vs. go" scenario. Clearly they have devalued the Florida Marlins "brand" with their open threats to leave town. Part of being a fan (as we know all to well) is making an emotional commitment to a team. In order for that to happen, the Marlins need to make a commitment to the local fans. Since the Marlins have one foot in South Florida and one foot TBD, I don't think building a .500 team would yield the returns it might have yielded two or three years ago. In the short term, they need to provide their fans with some answers and commitments about where they'll play. Until they do so their attendance levels at various win total should continue to slide.

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