Finding a New Market “Inefficiency”

By Mike Musary, Special Contributor to The Catbird Seat

Teams are always searching for the new market inefficiency. With the A’s in the early 2000’s, it was on-base percentage. With the Royals of yesteryear it was building a team that was perfectly suited to winning in their home ballpark – they focused heavily on defense to improve their pitching staff and favored contact hitters that would thrive in the gaps of Kauffman stadium. The new market inefficiency I propose? Finding an owner that’s willing to invest in his or her own team!

Ok, so, that’s not really a market inefficiency. The idea of a market inefficiency is that in an environment where resources are scarce, there is some type of good or service whose “resource cost” is not at a level that is truly reflective of its true “resource worth.” So, in actuality I’m arguing that there are more resources available for teams to use to acquire talent than I am that spending more money is an actual market inefficiency. And after a long, arduous off-season of ownership-serving penny pinching, I’m going to use the White Sox as a guinea pig for my argument.

Unfortunately for fans like myself wishing to delve into the depths of major sports finances, organizational financial information is incredibly hard to come by. This is no accident. All major league teams are privately owned which means, much to my dismay, that they are not required to make their financial information public. One of the most frustrating aspects of all of this is that I don’t have all the facts when evaluating the financial health of the White Sox. This makes it easy for the organization to cry poor and say they don’t have the money for a marquee free agent like Justin Upton, when I strongly believe this not to be the case.

The best estimates of sports organizations' finances come from Forbes** and their most recent estimate for the White Sox came on the 2014 season. The 2015 estimates come out soon, and I am very excited to see what those look like for the White Sox as I strongly suspect that the White Sox will have yet again made plenty of money as an organization. Pivoting back to the data that’s available, Forbes estimated that the White Sox made $227 million in revenue with a $31.9 million operating profit for the 2014 season. That operating profit is purely money that Forbes’ is unable to attribute to any cost or expense and it is likely money that the organization has left over after all expenses and is probably divvied up amongst ownership. So we can reasonably expect that, at a bare minimum, the White Sox owners made $31.9 million on the 2014 baseball season.

However, I think that number is misleading in terms of the actual money that White Sox ownership truly makes. Having a background in insurance pricing, I’m very familiar with various forms of expense loading or profit provisions. Essentially, what I think this means for the Sox is that within the expenses that Forbes’ has accounted for lies both salaries for all of the team’s board members (the owners) as well as an additional target amount of profit, or return on investment, for those board members.

So, to take a deeper look and find where these salaries and profit provisions lie, I’m going to attempt to back out all of the expenses for the White Sox. We know that Total Expenses = Revenue minus Operating Profit which in this case is $227 - $31.9 = $195.1 million. According to Forbes, the White Sox paid out a total of $112 million in player expenses in 2014. At first glance, this number may seem to be too high as Cot’s Contract has their end of year 40-man payroll at a shade under $92.5 million, but Forbes is account for things like draft pick signing bonuses, benefits for injured players leaving the organization, etc. So after we removed the $112 million in player expenses, we can assume there's $83 million in other expenses that represent non-baseball related expenses. I know from reading snippets of the stadium agreement that the White Sox paid roughly $1.5 million in 2014 for the rights to use U.S. Cellular Field and its surrounding area - a laughable pittance in its own right relative to the total cost to build and upkeep the stadium. This takes us down to $81.5 million.

Now, because of all of the murkiness surrounding team finances, we have to make some assumptions. All of the following estimates are my own. I’ll provide the logic I used but because I really can’t get any firm numbers, there may be some inaccuracies. Anywho, let's assume that the White Sox have 800 employees that work as vendors, custodians, sales reps, equipment manager etc. within the stadium (I'm not certain about this number, it could be high, could be low) during the season. Given that the annualized minimum wage is something like $17K, let's be somewhat aggressive (in my opinion) and assume all of these employees are paid $20K a year for their services to the team. Remember, while this number may seem low, remember that expense is for 81 games a season and most of those positions are part time jobs. In total I estimate the expense for these employees is roughly $16 million. This brings our running total of unaccounted for expenses down to $65.5 Million

Looking at the Chicago White Sox website, they have 230 (I counted) front office employees that aren't also board members (Jerry Reinsdorf and Eddie Einhorn, may he rest in peace, are both officers of the White Sox, but I'm counting them elsewhere). There are 13 non-board member officers, guys like Kenny Williams, Rick Hahn, Brooks Boyer, etc. Let’s assume Kenny Williams has an annual salary of $2.5 Million, Rick Hahn has an annual salary of $1.5 Million and the 11 other members have an annual salary of $500K. The total for these 13 officers is $9.5 million and that reduces our total down to $56 million.

There are 38 people involved in major league operations. These positions range from the director of amateur scouting to the team lead physician to the direction of team travel. It’s really hard to estimate what all of these positions are worth, but let's again be aggressive and give them each a salary of $200K. Now maybe some of these people make more than this, but I would guess that this average is on the high side. I would assume most of the doctors, if not all of them, have other practices and aren’t just monopolized by the White Sox and other positions such as Jim Thome’s “a special assistant to the GM”, probably are paid much less than $200K by the White Sox. All told this becomes another $7.6 Million off of the White Sox expenses so that brings our running total down to $48.4 million.

There are also 179 other individuals within the White Sox Front Office ranks (and some of them are just former players, guys like Ron Kittle and Bo Jackson) and I'll assume an average salary of $70,000 for them. Using this CNN website, $70,000 ranks in the 63rd percentile for household income, so I would estimate that $70,000 probably ranks closer to the 80th percentile for individual income. Based on this information, I feel that the average salary presented is aggressive in nature and I do not believe that the average salary for this group of people would be more than this. Thus, this group accounts for a total of roughly $12.5 Million. This brings the running total down to $35.9 million.

Even if you think that the White Sox Spend $5 million on their organizational coaching tree, $5 million on marketing and giveaways, and another $5 million on low level scouts, team traveling, and other miscellaneous expenses, the team has a leftover amount of $20.9 million that's likely just to be allocated toward board member salaries. That’s a sizeable amount of money! So all-in-all, I believe White Sox ownership pocketed roughly $52 Million from the 2014 season. And mind you, that that was a season where the team lost 90 games on the heels of a 99 loss season and a five year playoff drought. That's ridiculous. 

AND! We shouldn’t forget that this is simply yearly cash earnings, and not return on investment. For instance, the current White Sox ownership group bought the White Sox for a meager $20 million in 1981. The White Sox are now worth nearly $1 billion in total. That’s not a bad return on investment for 35 year, no? So while ownership’s cash earnings do not seem all that (relatively speaking) impressive, they have gained oodles and oodles of money in equity and will be able to cash in for a ridiculous profit when the White Sox are sold.

AND AND! This doesn’t even include money that Reinsdorf makes through his ownership of Comcast Sports Net Chicago, of which he has a 40% stake. Reinsdorf does also own the Bulls, so for just White Sox purposes, we can problem drop that stake down to 20%. Still, as a 20% shareholder, that means millions and millions more for Reinsdorf which just adds to the large amount of money that the team ownership is getting on a yearly basis.

One of the reasons I am very interested in seeing the 2015 Forbes numbers is that Major League Baseball got a new national TV contract in 2015 that doubled every single team's national media revenue from $26 million to $52 million. So the White Sox got an extra $26 million in 2015 (relative to 2014) for doing absolutely nothing! To the White Sox credit, their team payroll did jump by roughly that amount moving from 2014 to 2015, but it still goes to show you that the White Sox have a very, very large number that’s a target profit provision for the ownership and that number really hasn’t changed.

Professional Sports Franchise owners will likely always make a lot of money. These people are the owners of the team, and unfortunately they can do whatever they want. It’s may not be fair to fans, but no one ever said it was supposed to be. I’m sure I'd have a very different tone if the White Sox were winning as a franchise, but they've been utterly despicable for a decade now, and not spending money to bring in good players this winter looks like it could end up keeping the White Sox out of the playoffs another year now! If they were making profits as a winning team, fans don't really have any room to gripe since whatever financial strategy they're using is also translating to on field success. But when a team is cheap AND losing, I think it’s within reason to critique the approach.

This is also a problem that’s not unique to the White Sox. The Cleveland Indians have made a shade under what the White Sox have in terms of operating profit over the last decade and their ownership didn’t even invest in their team this off-season. I think that’s shameful too. Almost every organization is padding its pockets with pretty ridiculous profits. So while I can sit here until I’m blue in the face and clamor on about the White Sox needing to spend more, the same can be said about almost every other organization. This phenomenon is why I’m viewing the idea owner’s spending more money is actually a market inefficiency.

If the market was efficient, then owners would spend more, players would make more, and operating profit would trickle away and the various ownership groups would be left with the provisions that they built into their own expenses which, as I’ve shown, is no small amount. But that’s not the case and for the moment it appears that significantly trimming profits is a relatively easy way to improve your franchise by a lot! The biggest, most obvious example of ownership spending into their profit margins is the Tigers, and unsurprisingly, when the team started this, they had almost immediate success with a World Series appearance in 2006. And as the Tigers “deficit spending” increased, they had a run of 8 out of 9 seasons of .500 or better baseball, 5 playoff appearances, and 4 division titles. The Tigers wanted to win, they saw that their best opportunity to win was to spend money, and guess what, they had a ton of success doing just that.

Obviously, it’s a little bit crazy to expect a team to operate like the Tigers, where they are probably losing money on a yearly basis, but if the White Sox signed Justin Upton and Ian Desmond and took the payroll up to $155 million, there’s no denying the team would be much, much better off heading into the season. And quite honestly there’s still a very good chance even at a payroll of $155 million, the White Sox would still make money for their ownership. To me, it really stings as a fan when a team is so, so, so, so close to being something great and then ownership says, nope, we can’t take this risk of losing money in the short term with no foresight of what actually winning would do to the franchise in the long term. How soon a group of people forget that the White Sox World Series win dramatically improved their revenue as a franchise for years after the appearance. The White Sox have been stuck in the doldrums for a decade and as James Fegan wrote, if this current core and the current state of the AL isn’t incentive enough for this team to spend money and climb out, then nothing likely ever will be. And that’s really, really tough to swallow as a diehard fan of the franchise.

Hopefully the White Sox just defy the odds and make the playoffs, because the ownership certainly isn’t doing the team any favors.

**An incredible amount of work goes into the Forbes’ estimates, they’re not just some random guy taking his best shot with both eyes closed. I actually contacted one of the writers for the estimates requesting a breakdown of the White Sox expenses. The writer confirmed that everything from physician’s wages to board member salaries were included in the estimates, but he said that Forbes does not disclose that breakdown to the public. My guess would be that it would get them into legal trouble with the organizations themselves. It’s unfortunate for my research, but I certainly don’t want to compromise anyone’s legal standing. At any rate, while I wouldn’t take these numbers as gospel, I would expect them to be quite accurate all things considered.