Inning 6: The Pro Sports Labor Market

Top sports stars are earning more money than top surgeons, and average ballplayers are signing multi-million dollar contracts. Has the world gone mad?

Well, believe it or not, the sports labor market is not as crazy as it seems. Team owners who shell out big bucks for superstars are acting rationally. (Whether or not they always spend their money wisely is another question.)

And superstars, who make more in one month than many fans earn in a lifetime, are sometimes underpaid. Inning 6 looks at why.

A. Is Anyone Worth That Much Money?

The hometown team has just signed its star pitcher to a six-year, multi-bazillion dollar contract. He is a top talent, a great box office draw, and, by all accounts, a nice young man who signs autographs with a smile.

But no matter how you look at it, the young ace is making a lot of money for throwing a baseball. And there is no guarantee that he will ever deliver a World Series championship to the town’s long-suffering fans.

In the world of modern professional sports, there’s only one guarantee: Next season another superstar will sign an even fatter contract. . . .

Why do pro athletes make so much money?

The answer, once again, is related to supply and demand. Only this time, it’s supply and demand in the labor market. Players are selling their skills and talents; team owners are the prospective buyers.

The players’ skills and talents—their labor inputs—are in great demand. Why? Because fans are willing to pay top dollar for a chance to see the world’s best players at work, and that produces tremendous revenue for team owners.

Rule Number One in the Sports Labor Market: When it comes to salaries, no profit-oriented owner will knowingly pay more than a player is expected to generate in revenue.

James Quirk and Rodney D. Fort, authors of Pay Dirt: The Business of Professional Team Sports, explain why:

Looking at things from the point of view of any team, we can calculate the most that a profit-oriented team would pay a player; it is the amount that the player would add to the team’s revenue if he were signed. In the jargon of economists this is the player’s marginal revenue product, which we will refer to as his MRP. The player’s MRP is the most a team would pay a player because paying a player more than this would decrease team profits; on the other hand, signing a player for anything less than his MRP means that adding the player increases profits for the team.

Yes, owners and general managers sometimes misjudge a player’s talent or throw away big money on a player who isn’t right for the team. But here’s the bottom line: An owner will pay a player millions of dollars only if he or she thinks the player will bring the team even more than that in revenues.

Quirk and Fort also offer a way to identify the minimum limit on a player’s salary:

From the player’s point of view the least he would be willing to accept as a salary offer to sign with a team is what he could earn in his next-best employment opportunity. . . . [E]conomists refer to this next-highest employment value as the player’s reservation wage. If a team offers a player less than his reservation wage, the player would simply reject the offer and remain employed in his next-best opportunity.

The reservation wage for professional ballplayers changed dramatically during the 1970s when players won the right to bargain with other teams. Under the old system, one team owned a player’s contract for life and was able to dictate salaries on a take-it-or-leave-it basis. If a player didn’t like a team’s offer, he had nowhere else to go. His reservation wage—his next-best employment opportunity—was whatever he could earn outside of baseball, and for many players, that meant low-wage manual labor.

B. Five Things that Affect Salaries

The basics of the sports labor market are pretty straightforward: Owners (buyers) make salary offers based on how much revenue they think a player will add to the team. And players (sellers) make salary decisions based on what they think their talents are worth on the labor market.

But there are a few other points to keep in mind:

1. Demand for pro athletes—especially superstars—has been fairly inelastic. That’s partly because there are no readily acceptable substitutes for pro athletes. In most businesses, owners can automate certain jobs. Team owners don’t have that option. Maybe a computer can defeat a chess master, but how many computers or robots can hit a big league curveball? (And even if they could, would you really buy a season ticket to watch them do it?)

Human substitutes don’t fill the need either. Major League Baseball and the National Football League tried to end labor disputes by hiring replacement players, but the replacement product did not meet the standard of quality that fans expected from a professional team. Hardly anyone showed up for the replacement games—even after owners slashed ticket prices.

2. The decisions that buyers and sellers make will help to determine the level of market prices (or salaries). When a team owner decides to pay a small fortune to a star shortstop, you can bet that other shortstops with similar statistics will be looking for more money when contract time rolls around. Every new blockbuster contract changes the labor market.
   
   
3. The supply of players isn’t as big as it seems. There are thousands, maybe even millions, of people willing to supply their talents and skills in the sports labor market. But the number of people who even come close to possessing the required level of skill is much smaller—and they are the people that teams are actually competing for.
   
   
4. The number of buyers and sellers influences the level of competition in any market. When sports leagues expand, they also increase competition in the sports labor market. The number of teams (buyers) increases, but the number of top players (sellers) remains the same. It’s a simple equation:



League expansion =
Greater demand for players =
Stiffer competition for top talent =
Higher salaries for superstars.

5. Market size has an impact on how much a player earns. All other things being equal, players who spend their most productive years in “big markets” like New York or Los Angeles will almost always earn more than players who spend their careers in “small markets” like San Diego or Cincinnati.
   

C. Underpaid Superstars?

Sandy Koufax, one of baseball’s all-time greatest left-hand pitchers, threw four no-hitters. Photo courtesy of National Baseball Hall of Fame Library, Cooperstown, New York. Click on photo for a bigger image.

Every big money entertainment business runs on star power. Sports is no exception.

Superstars earn high salaries because they generate lots of revenue for their teams. They are the players fans pay to see—marquee players who draw spectators to games through a combination of exceptional talent and a certain “star quality” that is hard to define but easy to spot. Without them, pro sports would be less exciting and less lucrative.

Nevertheless, lots of people shake their heads over the super size of superstar salaries. And if you are one of those people, this next part will really have you talking to yourself:

If the market for professional athletes were perfectly competitive, superstars could probably earn more than they already do.

Two things prevent superstar salaries from being even higher than they are:

1. The Amateur Draft—Every year, pro teams “draft” (choose) the best college and high school athletes. The draft gives a team “exclusive rights” to a player for a certain number of years, and teams with the worst records get to choose first.

The system is intended to prevent rich teams from signing all the best young prospects. But it also prevents players from shopping around for a higher salary until after they’ve spent the required number of years with the team that drafted them.

2. The Limited Number of Buyers for a Player’s Services—The professional sports labor market has a relatively small number of buyers. In fact, it comes very close to being a monopsony market—a market with only one buyer. Players in each professional sports league have only three choices:
   
   • Sell their services to one of the teams in the league;
   
   • Play for a team in an overseas league, or;
   
   • Look for some other type of work.

If there were more leagues competing for top players, salaries might be even higher. When the American Basketball Association challenged the NBA for nine seasons during the late 1960s and early 1970s, competition for top college stars triggered a bidding war that benefited players in both leagues. Salaries went up and never came down, even after sparse crowds and lack of a national television contract forced the ABA to fold its tent.

Owners may fret over the high cost of attracting and keeping top talent, but the fact is that they are parting with their money willingly—if not always cheerfully or wisely—and they never pay more than they expect a superstar to generate in revenue.

In a sense, high salaries are a measure of how prosperous sports have become. If teams didn’t have the money, they couldn’t afford to pay as much as they do.

D. Difference between “Average” and “Median”

A kid’s game? Don’t believe it! On his way to breaking Babe Ruth’s record for career homeruns, Henry Aaron faced unimaginable stress. Photo courtesy of National Baseball Hall of Fame Library, Cooperstown, New York. Click on photo for a bigger image.

The average salary for a Major League Baseball player went from $289,000 in 1983 to $2.4 million in 2002. Not bad! No wonder so many fans think every player is a millionaire.

But the figures for median salaries tell a different story. In 1983, the median Major League Baseball salary was $207,500, and in 2002 it was $900,000.

Why the dramatic difference between average and median?

An average salary equals the total dollar amount for all player salaries divided by the number of players. A handful of huge salaries for superstars can make the average salary look very high.

Median salary numbers define the midpoint of the salary range. The 2002 median salary numbers tell us that half of all major league ballplayers earned more than $900,000 and the other half earned less.

Of course, a lot of people still believe that $900,000 is pretty good money for playing a “kid’s game.” And in a sense, they are right. Half a million dollars a year is nothing to sneeze at.

But baseball, or any other sport, is no “kid’s game” at the professional level. The stress can be crippling, the travel is punishing, and the job security is negligible.

Think your report card or job performance review is stressful? How would you feel if the morning newspaper carried a daily critique of your performance? And imagine what it’s like to make a crucial mistake while thousands of spectators gasp in horror, and millions of TV viewers throw snack food at their sets.

Maybe you think the big money would help you find a way to cope with the stress. Think again. The world of professional sports is downright Darwinian. Noted author and commentator Studs Terkel calculated that for every 70 prospects who sign a minor league baseball contract, only one makes it to the majors. And then there is always someone trying to take away the job.

E. Paying Dues and Earning Rent

Making it as a professional athlete is never a “sure thing,” even for people blessed with extraordinary talent, drive, and ambition. Baseball players in particular, spend years “paying their dues” in the minor leagues earning only a few thousand dollars a season.

The dollars-and-cents difference between the tiny salaries players earn as minor leaguers and the huge paydays they enjoy in the majors is known as economic rent. Here is another way to look at it:

• A player owns a resource—his exceptional talent.
  
  
• He is willing to supply that resource—that talent—in the minor league labor market for just a few thousand dollars a year because he hopes to make a fortune someday in the majors.
  
  
• Through a combination of skill, luck, and determination he finally makes it to the big leagues, where he signs a contract for a tremendous amount of money.
  
  
• The difference between the tiny amount he earned in the minors and the megabucks he earns in the majors is economic rent.
  
  
• He was willing to provide his resource—his talent—for a very small salary in the minor leagues. The huge salary that the major league team is now paying him to supply his talent is all gravy. In a way, economic rent is gravy.

F. Opportunity Cost and Trade-Offs: You Can’t Necessarily Have It All

• Should you spend your entertainment dollars on a game or a concert?
  
  
• Should a team spend its money on a 30-year-old star pitcher or three talented young prospects?
  
  
• A superstar is very happy playing for a small market team, and by his own admission, he is making more money than he will ever need. Should he leave to sign with a team in New York or Los Angeles, where he will make phenomenal money and pick up lucrative endorsement deals?
  

Advertisers and self-help gurus would like us to believe we can “have it all,” but, deep down, most of us know better. The size of our paychecks and the number of hours in a day force us to make trade-offs.

Opportunity cost is an economic concept that gets at the notion of trade-offs. Writer Susan Lee, in her book Susan Lee’s ABZs of Economics, defines opportunity cost as “a measure of what could have been.”

The fact that we live in a world of limited resources means we can’t “have it all.” We have to make choices. And when we choose to commit a certain amount of money, time, or resources to one thing, we leave ourselves with less to devote to something else.

If you turn down four hours of overtime because you want to go to a party, you give up four hours of overtime pay. That’s opportunity cost. You could have worked but you chose to go to the party instead. And you paid a price. You “bought” the leisure time with the overtime pay you turned down.

If a talented player decides to stay with his small market team for $8 million a year instead of jumping to a big market club for $10 million a year, the opportunity cost is easy to calculate. He’s giving up $2 million.

Tony Gwynn knew he could have made more money in L.A. or New York, but the joy and satisfaction of playing in San Diego outweighed the extra cash. Photo courtesy of the San Diego Padres. Click on photo for a bigger image.

But the cost of making a choice does not always carry an explicit price in dollars and cents. Opportunity cost may be harder to calculate for things like “personal satisfaction” and “peace of mind,” but it is no less real. If a player leaves a city where his family is happy and the fans like him, he may pay a high price, even if he makes more money with the new team. His family may hate the new city. He may not click with his new teammates. The fans may boo him the first time he goes into a slump. Any of these things could make his life miserable.

Of course, most of the time players go for the “big payday.” In that regard, they are not much different from the rest of us. But once in a while, a talented player will choose to stay with a team even though he has the chance to make more money in another market. And those players often turn out to be the happiest, best loved, and most respected of all.

G. Marginal Revenue = Marginal Cost: Breaking Up a Championship Team

A team owner who wants to make money—in fact, any profit-oriented business person—will be guided by the following principle:

Marginal Revenue = Marginal Cost (or MR= MC).

For those of you who are easily frightened by equations, let’s break this one down and look at its parts.

Marginal revenue is the extra revenue—the increase in revenue—from selling one more unit of something.

Marginal cost is the extra cost—the additional cost—of producing one more unit of something.

Look at it in sports terms:

1. You are a team owner who believes that the best way to make a profit is to field a winning team.
   
   
2. During the off-season, you spend big money on talented superstars: a pitcher, a closer, a centerfielder, and a first baseman. They are all big names—marquee players that fans will pay to see.
   
   
3. The plan seems to work. Your “hired guns” win the World Series, and attendance goes up 33 percent for the season.
   
   
4. There’s only one problem: Your team lost money on the season! Revenue went up, but not enough to cover the additional cost of hiring the superstars. The additional revenue did not equal the additional cost.
   
   
5. What does a profit-oriented owner do when marginal revenue does not equal marginal cost? Unload payroll. Sure, a team of young unknowns will lose games and draw fewer fans. But the young players will cost a lot less in salary, so the team won’t need to draw as big a crowd every night.

Florida Marlins celebrating their 1997 World Series victory. Not long afterwards, owners dismantled the team. Sports purists were disappointed but the owners had made a rational business decision. Photo courtesy of the Florida Marlins. Click on photo for a bigger image.

H. A Rising Tide: Curt Flood Challenges the Reserve System

For nearly a century, baseball’s reserve system forced players to stay with a team and accept whatever salary the owner offered. The lack of competition for star players kept salaries artificially low, which was just fine with team owners because they got to keep a larger share of revenue for themselves.

Then, in 1970, a player named Curt Flood teamed up with Marvin Miller, head of the Major League Baseball Players Association, and together they challenged baseball’s reserve system.

Few athletes have had a greater lasting impact on the world of modern sports. Curt Flood paved the way for professional athletes to exercise the same right enjoyed by every other worker in a market economy—the right to choose where he would put his talents to work.

Read his story and decide for yourself if the excesses of the present are any worse than the inequities of the past.

Submitted for your consideration:

Imagine a world in which:

• You have to spend your entire career working for the same employer even if someone else is willing to pay you a lot more; and
  
  
• Your employer can ship you off to another city and force you to work for someone else.

Sounds like a cross between slavery and indentured servitude, doesn’t it?

That’s what Curt Flood thought. Flood played centerfield for the St. Louis Cardinals, and in 1969, after 12 good seasons in St. Louis, the Cardinals traded him to Philadelphia. (He found out about the trade from a reporter who called to ask for his reaction.) For a variety of reasons, he was dead-set against making the switch.

Money wasn’t the problem. He had earned $90,000 for the 1969 season in St. Louis, and he would make a very respectable $100,000 if he played for the Phillies in 1970.

Flood’s main objection was that he did not want to be treated like a piece of property. And that is exactly what he said in a letter to the Commissioner of Baseball, Bowie Kuhn:

Dear Mr. Kuhn,

After 12 years in the major leagues, I do not feel that I am a piece of property to be bought and sold irrespective of my wishes. I believe that any system that produces that result violates my basic rights as a citizen and is inconsistent with the laws of the United States and the several states.

It is my desire to play baseball in 1970 and I am capable of playing. I have received a contract from the Philadelphia club, but I believe I have the right to consider offers from other clubs before making any decisions. I, therefore, request that you make known to all major league clubs my feelings in this matter, and advise them of my availability for the 1970 season.

Commissioner Kuhn denied the request on the grounds that the St. Louis Cardinals had a legal right to assign a player’s contract to another team—whether the player liked it or not. His decision guaranteed that there would be a showdown over baseball’s reserve system.

Backed by the Major League Baseball Players Association—the baseball equivalent of a labor union—Flood took his case to federal court and then sat out the 1970 season so he could become a free agent. (Baseball’s reserve system required a player to sit out an entire season before signing a contract with another team.)

Curt Flood. Photo courtesy of National Baseball Hall of Fame Library, Cooperstown, New York. Click on photo for a bigger image.

While his case made its way through the federal court system, he tried to make a 1971 comeback with the Washington Senators. But the year of enforced idleness had taken a toll on his skills. After only 13 games in a Washington uniform, Flood retired from baseball.

And he fared no better in court. Both the federal district court and the circuit court of appeals ruled against him, and on June 6, 1972, the United States Supreme Court upheld the lower court decisions by a vote of 5 to 3.

But Curt Flood and Players Association director Marvin Miller had taken the first step in a process that would alter the balance of economic power between owners and players. In 1975, a labor arbitrator granted free agency to pitchers Andy Messersmith and Dave McNally, and baseball’s reserve system came to an end. For better or worse, the economics of professional sports would never be the same.

I. How Free Agency Happened: A Timeline

1954—Players vote to establish the Major League Baseball Players Association. The Association is the equivalent of a players union, but it is not particularly effective in helping players to make meaningful gains. The minimum salary for ballplayers was $6,000 in 1954, and eleven years later, it would still be $6,000.

1966—The Major League Baseball Players Association (MLBPA) hires Marvin Miller as its director. Miller was the former chief economist for the United Steelworkers Union.

1968—The Players Association and team owners negotiate their first written agreement—the Basic Agreement. It raises the minimum salary to $10,000 and provides for improved pension, health, and travel benefits. Most important of all, it establishes a formal procedure for resolving grievances.

1970—Players and owners negotiate the second Basic Agreement. The minimum salary will rise, in stages, from $10,000 in 1970 to $13,500 in 1972. The Agreement also establishes a mechanism for binding impartial arbitration.

Andy Messersmith. Photo courtesy of National Baseball Hall of Fame Library, Cooperstown, New York. Click on photo for a bigger image.

1972—After a 13-day strike, players and owners reach a third Basic Agreement. (The strike is the first work stoppage in modern baseball history. But it won’t be the last. There will be a 24-day lockout in 1976, a 50-day strike in 1981, a 2-day strike in 1990, and the marathon strike of 1994 that will result in cancellation of the World Series.)

The third Basic Agreement allows the Players Association to participate in the arbitration of grievances. This is the measure that will finally finish the reserve system.

1975—When the 1974 season ends, L. A. Dodgers pitcher Andy Messersmith and Montreal Expos pitcher Dave McNally are unable to reach contract agreements with their respective teams, so the teams automatically renew the unsigned contracts.

Dave McNally. Photo courtesy of National Baseball Hall of Fame Library, Cooperstown, New York. Click on photo for a bigger image.

Messersmith and McNally complete the 1975 season, but neither of them signs a contract, and at the end of the season they declare themselves “free agents.” They argue that they are free to bargain with other teams because the owners’ right to renew an unsigned contract lasts for only one year.

But the owners disagree, claiming that they have the right to renew a player’s unsigned contract for as long as the player remains in the major leagues.

The disagreement goes to a three-member arbitration panel: the director of the Players Association, the director of the owners’ Player Relation Committee, and an arbitrator from the office of Major League Baseball. The panel rules that Messersmith and McNally are eligible to become free agents. For all intents and purposes, the reserve system is finished.

For a detailed account of how free agency happened, read A Whole Different Ballgame, by Marvin Miller.

J. How the “Reserve Clause” Got Its Name

During the 1880s, the “reserve clause” became a standard feature of every major league contract, and for the next 80 years it shaped the economics of baseball by forcing players to stay with a team for life.

But why was it called the reserve clause? Here’s the answer.

During the 1880s, baseball team owners were concerned about the economics of their game. Albert Spalding, owner of the Chicago White Stockings, sounded the alarm in 1881. “Professional baseball is on the wane,” declared Spalding. “Salaries must come down or the interest of the public must be increased in some way. If one or the other does not happen, bankruptcy stares every team in the face.”

“Salaries must come down or the interest of the public must be increased in some way If one or the other does not happen, bankruptcy stares every team in the face.” Albert Goodwill Spalding, 1881. Photo courtesy of National Baseball Hall of Fame Library, Cooperstown, New York. Click on photo for a bigger image.

Spalding’s main worry was that star players were jumping from team to team in search of more money, and in the competition to sign them, owners were driving up salaries. The salary situation was having a dual impact:

1. Marginal teams—teams that were barely managing to stay in business—could not afford to pay higher salaries; and
   
   
2. The competition for top players was costing the owners too much money and diverting a large share of revenue from the owners to the players.

Team owners decided to deal with the situation by entering into a “gentlemen’s agreement” that allowed each team to “reserve” five players for itself. The owners agreed not to raid one another’s reserve lists. And when they saw how successful the reserve system was in holding down salaries, they decided to make it a formal arrangement by adding a reserve clause to every professional ballplayer’s contract.

K. Going to Greater Lengths: How Contracts Have Changed

Contract negotiations used to be a lot like haggling over the price of a new car—only more intense. Owners and players sat across the table from one another and battled over every penny.

Management almost always had the upper hand because: 1) the reserve system prevented players from bargaining with other teams; and 2) most players lacked the negotiating skills for a head-to-head confrontation with owners and general managers.

But during the mid-1970s, the reserve system ended, and sports agents entered the picture. Contract negotiations would never again be the same.

Star players Ty Cobb and Nap Lajoie each receive a new car in 1910—back in the days when superstars didn’t already own a different car for each day of the week. Photo courtesy of National Baseball Hall of Fame Library, Cooperstown, New York. Click on photo for a bigger image.

Today, no player would dream of negotiating without an agent. And when superstars and agents get together, there’s often more at stake than money. Whether they need the money or not, top stars usually go for all they can get because a big contract is a way of “keeping score”—a way of showing how valuable they are in relation to other players.

Ditto for most agents. An agent who negotiates a fantastic deal for a high-profile star is in a better position to attract other lucrative clients: “See what I did for that guy? I can do the same for you.” And of course, salary negotiations are also a way for agents to keep score. Their professional pride is on the line every time they match wits with an owner or general manager.

Players unions have a stake in high-profile salary negotiations, too, because they don’t want to see the pay scale erode. In those rare cases when a superstar considers taking less money to stay with a small market team, chances are that the union (and the player’s agent) will pressure him not to offer the team a “hometown discount.”

Degrees of Separation

Not only has the size of player contracts changed, so has the length. Owners used to favor one-year deals because they figured a “hungry” player would try harder. Only the biggest stars had enough leverage to bargain for more. But when free agency arrived, owners began to look at multi-year contracts as a way to bring some stability to their line-ups.

Superstar perks have changed, too. Top players used to flaunt their stardom by asking for special meals or demanding a single-room when the team traveled—all of which sounds almost quaint compared to today’s star treatment. According to an article in The Wall Street Journal, contract perks in the late 1990s included private hotel suites, separate hotels, luxury boxes for family members, golf club memberships, and private jets to fly family members to games.

Are special perks and superstar salaries affecting the delicate balance between “team play” and individual concerns? Matt Bloom, an assistant professor of management, thinks it’s a definite possibility—at least in big league baseball. He looked at payrolls and performance for the period covering 1985 to 1993 and found that baseball teams with wider pay ranges did not perform as well as those with relatively equal pay structures.

He suspects that, “The costs of acquiring this year’s star may negate the benefits of hiring last year’s star.” In other words, this year’s high-priced star could go into a funk when the team pays next year’s high-priced star even more.