Tuesday, January 10, 2012

The True Cost of Luxury

An interesting thing happens when a big market team decides to overpay for a free agent. It starts a cycle in which the team has to continue paying for the same mistake over and over again. This is....the more painful, yet unwritten luxury tax. Often, these factors are glossed over because these teams can use their seemingly unlimited resources to cover their tracks, but once a team is labeled as a "free agent big spender" the following problems blossom immediately:

1) By injecting money into your own division with a free agent signing, you are elevating the playing field for all of your competitors and forcing them to spend big.
This is seemingly unavoidable if you want to be successful, but each free agent signing makes the cost of future acquisitions and the cost of a win more expensive moving forward. This hike in cost moving forward occurs regardless of whether or not your big time free agent acquisition produces like you expected him to. For example, the signings of Albert Pujols and C.J. Wilson were obviously very expensive, but if the Rangers then signed Prince Fielder and/or Yu Darvish to counter...a large portion of the value to the Angels was just lost. To further this point, if any of the players involved underachieves, the result is a huge cost AND a net loss in performance relative to your competitors.

2) Farewell to the home town discount.
Every team has core players, and these players expect to be treated as such. Therefore, when a core player sees his team lure a free agent to town with a big contract, he sees this as the floor for his own negotiations (assuming relative talent). Teams such as Tampa or Oakland do have a small amount of leverage in that, they can point to the books and say, "If you wish to stay, here is the highest amount we can reasonably pay you." Although this is a false ceiling, it does tend to ground negotiations and forces the player to weigh their drive to achieve a big contract against staying in a place they enjoy. If the player leaves, small market club can often absorb the PR backlash since the public knows of the club's financial limitations. This is even sometimes directed back at the player with accusations of greed. Without this false ceiling, the club ALWAYS loses the PR battle. For example, no one in their right mind would pay Jeter as much as his most recent contract was worth. However, the Yankees were stuck between fans romanticizing Jeter's past performance and Jeter's knowledge of their endless revenue streams. This same factor assisted in pushing Nomar Garciaparra out the door in 2004 because the Red Sox payroll was going sky-high, just as Nomar's performance was in decline. The reports were that the sides weren't close on an extension, so the Sox rightfully opted to make a trade to bring in Orlando Cabrera.

3) Relativity.
Again touching on the Yankees, any free agent pitcher will certainly have New York's history of spending in mind. Negotiations from the player's perspective will certainly open with a favorable comparison. Starting pitcher? "Well I'm THIS much better than AJ Burnett, and you gave him 5 years and 86.5 million. Let's start at 5 years and $110 million" Mediocre relief pitcher? "Well I'm about the same as your ineffective reliever Rafael Soriano, so I'll just take the 3 years, 30 million." Eek. You can see how that adds up quickly.

These three problems never wear off, and they actually accelerate over time. The value of each dollar spent decreases each offseason, because agents and players alike study these trends and use them to their advantage. This is the reason that Scott Boras and Dan Lozano intentionally draw the Phillies, Red Sox, Cubs or Yankees into every single negotiation. These agents have recognized that for these teams to get a dollar's worth of production, they are required to pay their client closer to $1.50.

Editor's note: I'm wondering if the restraint shown by the Yankees and Red Sox so far this offseason are cursory attempts to break this cycle. Contrarily, the Phillies' offseason spending thus far has shown this inflation pretty vividly (Overpay for an incumbent shortstop? check. Dramatically overpay for a closer? check.)

1 comment:

  1. I think the yankees still have a few moves left this offseason, but we'll see.