As I’m sure you’ve seen in other places around the internet, Robinson Cano’s pending 10 year, $240 million contract has been drawing a lot of comparisons to past free agent contracts. One of the more common comparisons is with the 10 year, $254 million contract the Angels gave to Albert Pujols in 2012. Another is the 10 year, $252 million contract the Rangers gave to Alex Rodriguez in 2001. They’re easy comparisons to make. Similar number of years, similar number of dollars. They’re also misleading. Here are two much more accurate comparisons:
2012: Prince Fielder 9 years, $214 million
1999: Kevin Brown 7 years, $105 million
Let me guess, I lost you with the Kevin Brown comp. Bear with me.
The value of money is not static. You’ve heard this before. It’s called inflation. A dollar today will not buy you as much as it did fifty years ago. It will buy even less fifty years from now. Basically, inflation is defined as a rise in the cost of goods over time. In the U.S, the price of goods has risen, on average, about 2.2% per year from 2001 until now. That means that each year, that dollar in your wallet or purse is worth about 2.2% less than it was the year before.
In baseball, the cost of player contracts is also inflating. We know this intuitively, maybe even concretely for some folks. Maybe you've seen a chart that shows how the average player salary has grown over time. Perhaps you intuited it when reading about the rising cost of wins.
Perhaps the best place to see this rise is in the amount of money that teams spend on payroll each year. Here’s a chart that shows the cumulative payroll of all thirty baseball teams from 1998 through 2013:
Payrolls jumped enormously around the turn of the millennium, but since 2001 the cost of players has inflated by an average of about 4.28% each year. That’s considerably more than the 2.2% that you and I experienced over the same period of time.
Payrolls are growing fast because the business of baseball is booming. According to an article published by The Biz of Baseball, MLB revenue exploded from $2.5 billion in 1998 to $7 billion in 2010. Yahoo reported late last year that total revenue was $7.5 billion in 2012. Starting next year, a new group of national TV contracts will take effect. Along with new regional contracts, some are estimating MLB’s revenue could reach $9 billion in 2014. That’s a lot. If you throw out the large jumps from 1999 to 2001, MLB's pot of money has grown 7% each year and looks to continue to do so in the near future.
In contrast, our pot of money, the GDP of the United States, has only grown by 3.78% over the same timeframe.
That means in our world, revenue grows by about 3.78% per year and our costs rise by 2.2%. However, in a MLB executive’s world, their revenue grows by about 7% each year and their player costs by 4.28%. If you feel like player salaries have grown outrageously large over the past few years, this is a reason why. The world of MLB is simply growing a lot faster than ours. Our perspective is skewed.
Before we bring this back to Cano's contract, let’s discuss a tool that will help us do some analysis. This tool is called present value. Present value is the lump sum value of a contract in today’s financial terms by adjusting all of that contract’s payments by the interest rate that affects them. Cross-eyed? Investopedia has a good explanation on their website. If you prefer to stay here, however, I’ll give you a quick example.
Let’s say you go to your neighbor and offer to clean his driveway each spring for the next ten years. Your neighbor likes the idea and offers to pay you $10 each year to do so. You now have a contract with your neighbor for ten years and $100 to be paid out in $10 installments each year.
Because of inflation, next year when you clean the driveway and receive your first check, that check will be worth 2.2% less than it would've been if you'd received it today. In other words, adjusting for inflation, your $10 check will only be worth $9.78 relative to today. Two years from now, your check will have a relative value of only $9.57. On and on it goes until your last check ten years from now will have a relative value of only $8.04. Sum up the relative value of all ten checks, and you’ll find your contract is only worth $88.89, today, after adjusting for inflation.
This $88.89 is the present value of the contract.
Because present value is a single dollar amount adjusted for a single moment in time, it is possible to use it to compare cash flows from different places and different periods of time. Have a payment obligation of, say, a player contract and a revenue stream of, say, jersey and ticket sales? Estimating a present value for each and comparing them is a budgeting tool that you could use to plan your finances in the near future. This is one of the many types of tools a MLB executive would use when they’re trying to decide how valuable a free agent is to them.
I used present values for something different. I used them to compare free agent contracts from the last fifteen years with one another.
For each contract, I calculated its present value on the date it was signed using the 4.28% inflation rate that player salaries rise each year. I then adjusted that value to put it terms of today using the cumulative payroll in the chart above as a crude CPI. Cross-eyed again? Basically, I put all contracts in the financial terms of this off-season.
The PV column shows that contracts’ present value inflation adjusted for today. Again, this is inflation from the seat of a baseball CEO, not yours or mine. The rightmost columns show what that contract would then look like if it were signed this off-season. All dollar values are in millions.
This table gives a better perspective on how large Cano’s contract actually is compared to others in the recent past. It’s huge, no doubt, but it’s probably not quite the financial albatross it seems to be. It’s certainly nowhere near the burden that Rodriguez's contract was to the Rangers in 2001.
For a contract to have the same financial impact today, it would have to be for 10 years and $421 million dollars. It was that, stinking, huge compared to payroll that year. That dwarfs what the Mariners are going to give Cano.
Instead, it's more accurate to say the Mariners valued the opportunity to sign Robinson Cano about as much as the Dodgers did the opportunity to sign Kevin Brown in 1999 and the Tigers did Prince Fielder just two years ago. Lots of money, yes, but not without precedent.