Basic Principles of Free Agent Contract Evaluation by Neil Weinberg January 14, 2016 While it’s January and many free agents have decided where they will be playing in 2016 and beyond, there are still some notable players without new teams. One thing I’m struck by each offseason is how frequently some people comment on new contracts without a good grasp of how teams and players settle on a term of years and dollars. In particular, it’s common to hear these comments from pundits and fans who aren’t quite as plugged into the game as regular readers of sites like FanGraphs. So for the new reader, or the old one looking to explain the finer points to their friends, here are some basic principles about free agent contracts to remember when thinking about their prudence. Team Pay For Future Wins While “projections” and “WAR” are sometimes met with eye-rolling from casual fans, those complaints ought to be more about specifics than concepts. In other words, when a team goes to sign a player to a new contract, their goal is to estimate how good that player is going to be for the term of the deal. Past performance is a relevant factor, of course, but teams care about signing players who will be valuable to them next year and in the future. It’s important to remember that when we talk about these concepts at FanGraphs, we often talk about projection systems like Steamer and ZiPS and valuation models like WAR, but that doesn’t mean teams use those exact tools to make their decisions. The key point is that teams use the same concepts in making their decisions: future projection and contribution to winning. It’s entirely possible that our projections systems and WAR models aren’t very good and that teams know better when we criticize a signing, but teams are absolutely thinking about how productive a player will be in the future when the make an offer. This also brings up player aging. Again, as public analysts we might not know exactly how a player will age, but a player’s age is a very important factor in contract negotiations because it informs the probability that he produces in the future. For example, Ben Zobrist is probably better than Justin Upton at this precise moment, but Justin Upton is much younger and is likely to stay closer to his current level of performance for longer than Zobrist. As a result, a team will probably give Upton more money because the overall value he will bring will be higher, even if he’s worse to start. Inflation Matters The number one pet peeve I have in sports contract analysis is people who don’t understand the baseline values of the moment. There will be many people who criticize moves this winter because they think a given player was paid well above his ability, when in reality, the market simply pays everyone more than it once did. For example, Mike Pelfrey got $8 million a year. That sounds like a lot of money if you’re in a 2007 mindset, but $8 million is simply not that much money in 2016. Baseball is doing extremely well financially these days and player salaries are rising as a result. If anything, salary growth isn’t keeping pace with the financial health of the sport and players should be getting paid even more. It’s hard to conceptualize this if you follow sports will salary caps more closely because the ability for teams to really break the bank is restricted in those cases. Also, the average person probably hasn’t seen their own salaries increase substantially over the last few years, so your mind might not be as prepared for large increases in particular sectors. In other words, you can’t judge a contract by what players signed for three, four, or five years ago unless you make proper adjustments. It’s worth looking at Carlos Beltran’s first big deal when evaluating the Jason Heyward deal, but you have to first adjust your baseline to the 2016 salary levels. Just because a player who was much better signed a deal for $15 million a year in 2011 doesn’t mean a worse player doesn’t deserve $15 million a year in 2016. Teams Pay For Entire Contracts Another common misconception is the idea that the back ends of contracts drag down the value of a deal. Simply put, teams sign players for a total number of years and dollars and the annual salaries are only important from an accounting perspective. If you sign a player to a 5 year, $100 million contract, it does not matter if the player isn’t worth $20 million in year five. All that matters is that the player is worth $100 million over the entire life of the contract. In a basic sense, you might want to get 12 WAR from a player signed to a $100 million deal. For the deal to make sense, the player doesn’t have to be worth 2.4 WAR each year. It’s perfectly fine for the player to be worth 4, 4, 2, 2, and 0 WAR over the five seasons. In the last year of the deal, the team will be paying $20 million for a replacement level player (a guy you could replace for $500K), but it doesn’t matter because they will have gotten 4 WAR for $20 million (a massive bargain) in each of the first two seasons. It’s like an interest free loan from player to team. Teams known that players will decline over the life of most contracts. In year one they will be getting more value for their money and in year five they will be getting less, but they only care about getting good value overall. All agreements look bad if you only focus on the part of the deal that benefits the other side. Teams get value on the front end of deals and players get value on the back end. This works because teams care more about money in the short run, as they have to think about having available cash for other players, while players don’t mind waiting to receive their full sum because most people won’t notice the difference in quality of life from having $20 million today and $80 million later versus $100 million now. This isn’t to say that we, as analysts, will always get the contract values right. Sometimes teams know more about a player than we do, but it’s important to remember that while contracts are paid out pretty evenly over the years, teams do not expect performance to be distributed the same way. Dollars Per WAR ($/WAR) is About Alternatives In a lot of our contract analysis, we use something called $/WAR. Sometimes that gets ridiculed as an overly simplistic and meaningless metric we use because we are the kind of fans who like thinking about teams as puzzles rather than as athletic opponents who like to win. But I think it’s important to state what is implied when $/WAR is used. $/WAR is basically a measurement of how much teams are paying for players on the free agent market according to how many wins they will add over replacement level players. Right now, we think teams are paying about $8 million per every WAR they add to their roster. For example, a 2 WAR player signed for three years would theoretically provide his team with 6 WAR, so a team might want to pay him anything up to $48 million. If the team pays less than $8 million for each expected WAR, we call this a “good deal” and if they pay more, we say they “overpaid.” There are a couple of important things to know about this type of analysis that is easy to miss because we tend not to spell them out over and over again. First, that $/WAR of $8 million is an average number we estimate based on all players and some basic projections. It’s not perfect. Neither are our estimates of player performance. Something might look like an overpay to us simply because we misjudge a player’s talent. Second, each team has different incentives to spend on players. A team that is very close to a playoff berth might be incentivized to overspend because that specific, extra couple of wins could be a giant deal. But most importantly, $/WAR is not an end in and of itself. I think sometimes people think we treat it that way because we don’t explain why it’s so important each and every time we cite it. There is no prize for being the team that spends its money most efficiently on the free agent market. If you sign a bunch of 1 WAR guys for $6 million per year, you’re going to get a lot of good marks on $/WAR, but your team probably won’t win a lot of games. Rather, $/WAR analysis is about alternatives. If you overspend on your left fielder, you have less money available to spend on your second baseman. We don’t care if teams set fire to a pile of money, we care about them burning that money if it means they can’t afford to do something else and it hurts their overall success. Think of it this way, your team needs two corner outfielders and you have $25 million in yearly salary available to sign both. Roughly speaking, that will buy you 3 total WAR. If you sign a 2 WAR outfielder for $20 million, you are getting a good player for slightly more money than he’s worth. That leaves you with $5 million to spend on the other guy, and that $5 million will only buy you a 0.6 WAR outfielder. That means you have 2.6 WAR for $25 million. That’s an inefficient use of your money based on what teams are paying players on average. This doesn’t matter if you have an unlimited amount of money because you could just sign the best available guy at each spot and wind up with the best team, but if you have a fixed budget, making deals for market or below-market rates means that you have money left over to spend elsewhere. If you have one spot to fill, a 1 WAR guy for $4 million is efficient, but a 2 WAR guy for $16 million contributes to more success. The question you have to ask is if you could sign the first guy and then reinvest that $12 million in an additional player worth more than 1 WAR. It’s not about winning economics class, it’s about using the money you do have to make the best team. Spending efficiently helps you do other things that will help you win. The Others Finally, there are a couple of other things to throw into the pot. First, the luxury tax. If teams spend more than $189 million on players per year, they get taxed on the amount by which they exceed $189 million. This is a soft salary cap that deters teams from spending too much. It doesn’t mean teams won’t spend more to sign players, but it does mean that signing players once you’re past that mark gets more expensive relative to teams that are well below that level. It’s a tax that needs to be factored in, but it doesn’t get added to a player’s actual contract value. Second, the qualifying offer imposes a tax on teams that sign certain players. This needs to be considered when evaluating contracts. Yes, draft picks are not sure things, but they do come with an expected return. You wouldn’t ignore a great player just because it will cost you a pick, but the value of that pick should be factored into your evaluation of the signing. Third, opt outs have financial value. It’s unclear exactly how much, but some estimates put them at about $20 million in favor of the player. That’s not all bad for teams, as it’s a way to give a player a benefit without it counting toward the luxury tax. No matter how much it is worth, it is a commodity which has financial value. **** A lot of you might have a good grasp on these factors, but it never hurts to brush up. Teams pay for the future, baseball inflation happens faster than real inflation, we care about total value not yearly value, and $/WAR is about maximizing your money.