Table of Contents

Monday, August 03, 2009

Understanding Surplus Value

Play's to firstJoey Votto is not only the Reds' best player, but also one of their cheapest players. Image by phillenium1979 via Flickr

In the Rolen trade analysis, I spent much of my time evaluating "surplus value" in my assessments of the players involved. This is not the first time I've posted about this, though perhaps it's the highest profile case of this sort. It is, however, becoming a more mainstream approach to analyzing trades (see, for example, Sky's Trade Value Calculator). I thought I'd take a stab at explaining this concept, and how it has been extended to prospect valuation.

The core of it is understanding the connection between player value and payroll.

The major league minimum this year is $400k. You need 25 guys on your team (assuming no injuries, etc...), which means the minimum possible payroll in MLB right now is $10 million ($400k * 25). How well would such a team perform? Well, if you use that $10 million exclusively on free agents, you're not going to get very good players--mostly guys who can't get a job anywhere else, minor league free agents, etc. Those guys are essentially the definition of replacement players, and we generally assume a team full of replacement players will play around 0.350 ball, which amounts to 57 wins per season (you'll see other figures around the 'net--which one you choose doesn't change what I'm about to do qualitatively).

On the other side of the coin are the New York Yankees, who began this season with a $201 million payroll. From other work, we know that each win above replacement cost roughly $4.5 million in last offseason's free agent market. Therefore, if the extra $191 million they're spending above the minimum was invested in free agent salaries, they could reasonably expect to win $191/$4.5 = 42 extra wins above the minimum 57, or 97 wins (for what it's worth, the Yankees are on pace for 99 wins). :)

But take the Tampa Bay Rays. They began the year with a $63 million payroll. That's just $53 million over the minimum payroll. If you invested that extra money in free agents, and filled in the rest with replacement players, you'd expect they'd win another $53/$4.5 = 12 extra wins. That would equal 69 total wins. But they're on pace for 91 wins. How?

The answer, of course, is that their team is not made up of free agents. It is made up of a lot of quality, young players making far less than they would had they signed as free agents. For the first three seasons of a player's career in the major leagues, they make at or close to the league minimum. For the next three seasons after that, they are eligible for arbitration and get raises, but for a variety of reasons still get paid well below what they would as a free agent. As a result, for the first six years of a player's career, they will make less than a free agent regardless of their performance on the field.

Most teams operate under a fairly set budget. The median opening day payroll was about $81 million this year. So if a team has that budget, and spend it all on free agents, you'd expect them to win around 57+16 = 73 games. In order to win more games, teams have to have players who produce value above their salaries. For example, this year, Joey Votto has produced ~2.5 wins above replacement (worth $11.3 million on free agent market), but is making just over league minimum. If you fill your team with those kinds of players instead of replacement players, and still spend $71 million on free agents, you'll obviously win a lot more games.

That's what we're talking about when we talk about surplus value. It's the extra value a player provides above what their salary would bring on the free agent market. The keys to winning, at the club level, is 1) to spend money for good players, and 2) to get players who produce value above what their salary would predict. Most teams can't get by on #1 alone, and the easiest way to do #2 is to get young players making "slave" wages.

This is also what makes prospects valuable commodities. Prospects generally have no or minimal MLB playing time, which means that their "owners" get them for six full seasons when they will make below free-agent market rates. So, the short of it is that if you figure out how much surplus value a typical prospect type provides their team during the first six years (including assessments of how often they provide any value to their team at all--many, of course do not), that gives you a good indication of how much value to assign prospects of that type.

In Zach Stewart's case, I pegged him (as many others do) as a class-B pitching prospect. Pitchers of this sort tend to provide the equivalent of $7.3 million in surplus value over their first six seasons. Another way to think of that is that it's a total of ~1.6 wins above replacement over their first six years (only 0.3 WAR/season). Not particularly inspiring, maybe, but it reflects the fact that many class-B pitching prospects do not pan out for one reason or another. But some do, some provide a little value, and some provide a ton of value. The $7.3 million total is the typical amount of surplus value you can hope to get from such a pitcher.

Anyway, this became rather long. But if anyone made it this far, I hope it helped clarify the underpinnings of this kind of trade analysis.