With the Dodgers’ new lucrative television deal they have gone on a money-spending spree that has replaced them at the top of the ladder for highest payroll for the coming season, displacing the New York Yankees for the first time since 1998.  But how did they decide exactly how much they should spend?  The answer is a conglomeration of decisions, but it’s really not hard to understand when properly thought about with logic.  Of course there’s some ambiguity to these decisions, but we can piece together the thoughts that determined the process.  Understanding this will help you to understand exactly why teams spend how they do.  A point of note is that you might want to consider reading one of my former posts, A Simple Economic Reality: Realizing That Winning Is Worth More To Different Teams

before diving into this one for a solid background.  I wont repeat what I said there for obvious reasons.

Point 1: Winning Pennants and Wild Cards In Itself Is Extremely Profitable

Let’s take a moment and realize what winning a pennant or wild card does for your team.  First of all, let’s start with attendance.  If games matter in September, do you believe that more people are likely to show up?  Of course.  Let’s take for example the 2011 and 2012 Reds.  Coming off a postseason appearance in 2010, the Reds had strong expectations for the coming year.  They’d ultimately end up 3rd in the NL Central with a 79-83 record.  2012 was a different story, as they finished 97-65 advancing to the playoffs to lose to the eventual champion San Francisco Giants.  In fact, the Reds actually had their best regular season attendance numbers in 2012 since the opening of Great American BallPark.

In games 70-81 that were played in Cincinnati in 2011, the Reds averaged an attendance of 24,762 fans per game.  In 2012, in games 70-81 the Reds averaged an attendance of 26,769 fans per game.  We could perhaps chalk that up a little to perhaps some better weather outside, more desirable game times, more desirable opponents, or even better ticket prices / different ticket deals, true.

But what about the postseason?  They were able to play five games against the Giants, three of those at home.  In those three home games they received attendance of 44,501, 44,375, and 44,142 for a total of 133,018 extra tickets.  Realizing the actual cost per ticket is difficult, but we all know that postseason pricing is inherently more expensive.  The Reds ticket prices ranged from $35 to $150.  Going with an underestimate of say, $60 per ticket (weighted more towards the cheaper portion since we know that’s where most tickets are), that’s $6,650,900.  In those two games in San Francisco there was a total of 86,997 patrons, worth $4,349,850.  Now, to recalculate here real quick:

15% of paid receipts for all postseason games are given to the Commissioner’s Office (which here totals $1,650,113), while the remaining 85% turns into:

60% of the paid attendance from the first three games of the division series is contributed to the player’s pool: $5,610,383.

That leaves a total of $3,740,255 to be split between the two teams (it’s 60-40 in favor of the home team).  In the case of the Reds home games, the 40% that they kept was $2,261,306.  60% of that was $1,356,784.  You get the point for the 40% gained from the Giants games.  In short, after giving myself a headache doing some math, playing the five postseason games gave the Reds roughly $2M in extra ticket revenue.

But of course it doesn’t stop there.  Those 133,018 tickets also bought concessions at the stadium.  If we were to assume that say, they each spent $10 on concessions at the stadium, that’s $1,330,180.  Of course I just made up that number as I can’t find reliable information on how much they make per game in concessions, but as baseball fans I’m sure we can all find that number relatively reasonable.

We can then throw in merchandise.  I would feel confident saying it went up during postseason play, but for simplicity let’s assume that it averaged out to $1 per fan.  That’s another $133,018.

Finally, we have advertising profits.  We have an extra five games showing the ads in the stadium.  No, I don’t have the figures on these, but as we can all logically come to the conclusion of, these games are probably higher watched than regular season games and thus they can charge a higher premium for any signage located throughout the park that will be shown on national channels such as TBS.  Or, if you believe that they simply include this in the price at the beginning of the year and not on a game-by-game basis, if there is the expectation of success in the season they can charge a higher initial price for sign placement at the beginning of the year since the promoters know there’s a higher chance of them being seen nationally.

What’s the total?  Honestly, I’m not positive and I won’t pretend I am, but can you at least see the possibility of just five playoff games being the addition of $5M in revenue?  But of course that isn’t it…

Point 2: Winning Makes Everyone’s Job Easier

Know what people like to see?  A winning team.  Why?  Because winning is an enjoyable experience.  Losing isn’t.  Convincing a potential customer that they should buy season tickets is a lot easier when they have the expectation that the team is going to be better.  Looking at businesses that buy suites at stadiums, they know that their customer is likely to have a more enjoyable experience if the team is doing well too and are more likely to buy the suites.  I’d also argue that having a customer surrounded by “happy people” because their team is winning probably makes it easier to complete a deal, but that’s getting a bit too abstract for even me admittedly.

When people have the expectation that the team is going to win, they are more likely to want to attend games.  If they are more likely to want to attend games, then it takes less effort on the ticket sales’ group to actually sell the tickets.  Know what this means?  One of two things occurs: since it’s easier to sell the tickets, teams should theoretically not need as much staff or, at the very least, need to invest in as many “schemes” to get people out to the park.  This also means that they have less incentives to offer coupons or “deals” to get people out since demand for the tickets is high already.  Alternatively, the team can raise its ticket prices to compensate for the increase in demand and retain the same methods of selling tickets.  In either case, whether reducing costs or increasing gross profit, there is an increase in the bottom line.  Now I’m not saying that every team does that, but it’s what every team should do.

It’s also much easier to sell advertising inside the stadium and it should again follow the same rule: either decrease the amount of people trying to sell the advertising (as there needs to be less cold calls / visiting of clients) or increase the prices to compensate for the increase in demand.

Finally, when was the last time you heard about a manager being fired after winning a pennant?  The likelihood is very slim.  The same goes for General Manager, President, and the rest of the upper management staff.  As such, there are no needs to go into the process of finding new candidates and interviewing them.  This eliminates hiring/firing costs.  It also eliminates the cost of dealing with publicity.  Finally, it allows the General Manager, since he had no threat of being fired, as well as the upper staff, to start investigative work for the coming season earlier, perhaps resulting in more informed decisions.

Point 3: Winning Creates Intangibles

It would be impossible to quantify the exact amounts that winning creates.  Consider when you go to a stadium and you see their pennants hung along the rooftop – why do you think they do that?  Perhaps because it adds a level of credibility to the team that people internally recognize when they go to see their team.  Consider how many times you’ve heard the phrase in advertising “see your reigning championship ____ defend their title in the coming season, order your tickets today!”  Winning plays a role in marketing that they probably wouldn’t utilize if they didn’t believe it had a positive effect.

Ultimately, winning also creates loyalty to the team.  It’s easier to cheer for a team that you know has a chance to win.  If we are to think of a team as an extension of ourselves where we get to say “ha, I beat you” when talking to your friend / person you have never met, it’s a nice feeling when you know you at least have a shot of being able to say those words (either verbally or non-verbally).  Just think of how many times you’ve heard a Yankees fan say “27 rings” whenever pushed into a corner – they are reminding you that “hey, my team has been constantly better than yours no matter what you say, so take that.”

Loyalty results in a plethora of things: from season tickets to merchandise sales.  I couldn’t even begin to fathom how to quantify this, but can you imagine that it’s difficult not to assume that say, the Pirates’ merchandise sales over the last ten years is significantly lower than a comparative market’s team?  It just seems logical.

The Real Point: Teams Can (And Sometimes Should) Spend Up To The Point Where Their Gains Reach Their Costs

I know I’ve rambled for quite a bit up to this point, but I promise I’m reaching my point.  To illustrate my concept, let’s go with an example.  Assume that you and your friend are running lemonade stands side-by-side.  Let’s assume for some reason that the maximum and minimum price you both have agreed to set on your lemonade is 25 cents.  Now, how can you convince people to buy your lemonade over your friends if you can not compete on price?

If you can’t compete on price, the only alternative are things difficult to quantify (marketing for example) or quality of the product.  Let’s say that me, being the savvy lemonade business-man that I am, go and buy some of the finest sugar for my lemonade and advertise it as such.  Sure, my lemonade now had a higher cost to make, but I have taken all of the rational consumers away from my friend and to me as my product is better and at the same cost.  Realizing my move, my friend copies my strategy, forcing us to split customers.  Understanding that it worked before, I go and buy the best lemons and again take the customers away from my competitor while increasing my base price.  My competitor copies.  Soon we would both have the best ingredients and are identical while having both decreased our profit margins.

But there are two important points here.  Say if the finest lemons would have increased my costs of every cup of lemonade over 25 cents – would I have bought the best lemons?  Of course not, as I would be running a net loss on every cup sold.  Assuming my friend is rational, he also would have not bought those lemons.  As we can see here from this example, people that are for profit will only sell a product as long as they are making a profit, a seemingly obvious conclusion.

So the same applies for baseball.  Is it possible for any team to spend a billion dollars this year to compete and dramatically increase their chances of winning a division?  Of course, but the sales made from doing such a task will definitely not outweigh the costs.  Therefore, we have a simple principle:

Principle 1: A Team Will Spend, At Maximum, The Amount it Intends to Gain In Sales (Tangibles and Intangibles)

But we all know that teams don’t actually do that.  Why?  Because they don’t need to spend that much in order to have a legitimate shot.  For simplicity’s sake, let’s assume there are two teams.  These two teams are exactly identical in every way.  They are in the same division and the only two teams in the division.  Thus, both teams, as of this moment, would end in a repetitive tie at the end of the season in this simple world.  But we’ve already listed above the reasons for winning.  Thus, it would seem to make sense that each of the teams would like to become marginally better than the other.  Do they need to be 100% times better than their opponent?  No, of course not – they only need to be .0000000001% better than their opponent.  Thus, if spending a little extra gets them that percentage, they will probably more than reap back the benefits by being included in postseason play.

If the gains in this simplified example from reaching postseason play were say, $100, they the team should be willing to spend up to $99.99 to gain the percentage difference in beating their opponent as it would be an increase in profit.  Now, if it only costs them $1 to be marginally better than their opponent, there’s no reason to spend the $99.99.  Following?

Principle 2: A Team Should Spend the Minimum Necessary In The Process of Reaching the Playoffs

As you can see from my above example, it’d be more beneficial to the team to spend $1 to reach the playoffs than $99.99 as the profit is bigger.  This is why teams don’t spend the maximum amount they could spend while still being profitable – they are trying to reap the surplus.  Understanding how teams spend in the context of their competition is a discussion for another time and a large function of game theory, which I’ll definitely post on in the future.  Keep an eye out for it if you’re interested.

But if you’ve followed my discussion here, than you’ve come to the ultimate realization that I wanted to make.  Here it is:

Ultimate Principle: Teams That Potentially Could Gain the Most Profit From Winning (Which Are Usually Bigger Markets) Will Spend More Than Their Competition As The Line That Intersects Their Gains With Their Costs is Simply Higher Than Their Opponent’s Line.

Say the MLB suddenly becomes two teams: the Milwaukee Brewers and the New York Yankees.  The Brewers gain $100M in profits when they win if they were to field a team that cost $0.  The Yankees gain $150M in profits when they win if they were to field a team that costs $0.  Thus, the Brewers could spend up to $100M while the Yankees could spend up to $150M.  If baseball was determined purely by who had more money to spend to attract the best players, the Yankees would win every single game as they could spend up to $150M while the Brewers could, at most, spent $100M.  Assuming the Yankees were rational and the players were as well, they could offer each of the best players just an extra penny to play on their team and reap all the benefits while maximizing their profits.  This would result in a profit of roughly $50M per game.

 

Final Thoughts

Luckily, baseball isn’t a game that is purely determined by how much money you spend.  But let’s not pretend it isn’t a very large factor – there’s a reason the Yankees and Red Sox have largely maintained competitiveness for so long now.  Hopefully you can walk away now with an understanding of why teams spend so much money to achieve victory.  In a future article I’ll go into detail on how they decide exactly how much to spend given imperfect information and so forth.  But that’s for another day…

 

Baseball Rethought.

-Steve