I recently finished my junior year at North Dakota State University. Taking a class called "Economics of Entrepreneurship", I was surprised at how many parallels I could draw between entrepreneurial theory and sports. For my end-of-semester research paper, I wrote about how baseball front offices have exhibited entrepreneurial tendencies in recent years. You can find the paper below.
Abstract
While a firm, all-encompassing theory of the entrepreneur has not yet been properly developed, we have come to understand and agree on at least one thing: Entrepreneurs utilize knowledge or methods that the rest of the industry has not caught on to in order to make a profit for themselves or their firm. In this paper, I will develop an economic system in the terms of Major League Baseball, demonstrate that team general managers are the key agents in this system, and expand on how some of them have been entrepreneurs in their position in order to profit (win games) since the turn of the century. This research was inspired in part by Dorene Ciletti’s 2012 paper “Sports Entrepreneurship: A Theoretical Approach”, which concludes that “the uniqueness of sport and its entrepreneurial nature provide an opportunity to examine it within the context of entrepreneurship.”
Baseball’s Economic Framework
In order to demonstrate how entrepreneurial theory relates to MLB general managers, we first need to identify the economic framework within which they are working. Major League Baseball is unique in the major American sports leagues in that there is no established salary cap. This means that, theoretically, each team is allowed to spend unlimited money on salary for the players, which makes it essentially a free market. This is in stark contrast to the NFL, where each team has a very firm cap on salaries that is determined by a collective bargaining agreement. While MLB does have a luxury tax on team salaries above a certain amount, this is but a small annoyance to team owners who are already willing to spend over $200 million on their players. Therefore, “resources” (players, for our purposes) most often go to whichever team is willing to bid the highest when they become free agents. Due to this, combined with the fact that not all owners are willing to spend the same amount of money, there is not just room, but also incentive for general managers (who assemble the team by signing players) to act in entrepreneurial ways.
Let’s dive deeper into that little qualifier: not all owners are willing to spend the same amount of money. While MLB allows teams to spend as much money on player salaries as they desire, and this paper will be more concerned with wins than actual business profits, not all team owners have the same amount of money, nor do all teams generate the same amount of revenue. More wins don’t necessarily result in dollars made, even if there is a correlation between wins and dollars spent (see Chart A). Revenue has to do with a lot of things, chief among which is market size. The larger the market, the more people are buying tickets and merchandise from the team, the more money the team makes. The more people who want to watch the games from home, the more money the team makes off of their regional television deal. However, stingier owners can find themselves also stuck in a vicious cycle. As illustrated by Colin Santos Regan in his 2012 paper “The price of efficiency: examining the effects of payroll efficiency on Major League Baseball attendance”, common payroll efficiency strategies, such as employing younger, lesser-known players, leads to lower game attendance and thus lower economic revenues even if the team is successful. Even this does not prevent some owners from setting low budget constraints. The bottom line is, even though there are next to no league-wide spending restrictions, some owners will set budgets for the general manager that are significantly lower or higher than other teams. The general managers for the highest few have the luxury to simply bid the highest for proven commodity players; general managers on teams that are lower on the payroll ladder need to utilize entrepreneurial creativity. It is very easy to connect the dots from Hayek “Competition as a Discovery Procedure” (2002) to a low budget-constrained general manager. The baseball market is very clearly competitive, and those with the best labor will field a team (product) that out-competes the others. Therefore, when a firm is unable to compete for the “known” best labor, new discoveries must be made to allow them to exploit labor market inefficiencies. In simpler terms, they don’t have an easy path to signing players who are widely considered to be among the best in the league, so they need to get creative.
In this MLB economic system that we’re developing, a team would be considered as a “firm”. Each team is essentially a large and diverse company that is competing with the other teams for wins. This means that, for our purposes, wins are “profits”. Within the firm, the team owners function such as a company owner or president would function; they set budget constraints under which the firm, and general managers, operate. The general manager is the key “decision-maker” in the firm. While they don’t technically own the firm, as an entrepreneur as developed by Frank Knight in Risk, Uncertainty, and Profit (1964) does, the general managers are granted stewardship of the team- that is, they have been granted the authority to make most of the decisions for the firm, but must work within some constraints that are set by the owner. In this capacity, some general managers will act entrepreneurial and some will act more as a standard manager within the firm. This arrangement means that they have the power to use entrepreneurial judgment to build a profitable product (winning team). Judgment, as defined by Foss and Klein in Organizing Entrepreneurial Judgment: A New Approach to the Firm (2012), is “residual, controlling decision-making about resources deployed to achieve some objectives.” While it actually shows some amount of entrepreneurial judgment on the part of the owners to hire these general managers to make the major decisions about how to run the team, the general managers are then given the responsibility of “residual, controlling decision-making about resources deployed to achieve some objectives”. If they are unable to use their judgment to obtain above-normal “profits” (wins) after a certain amount of years, the general manager will be fired and a new one will be hired.
Beneath the general manager, there is the manager, whom he hires, and players, whom he acquires. The manager acts much in the way an economic manager acts- he oversees the use of the resources that the general manager has acquired for him. Nowadays, the manager will often get hired because he is willing to implement the general manager’s team-building vision. Managers do have the authority to act entrepreneurially with the resource allocation (player use), but that’s not quite as economically interesting as the entrepreneurial strategies that are employed by the general manager. At the bottom level, the players are the “resources” that teams employ in order to build a “product”- the on-field team. The players are acquired either through free agency (they can sign with whoever will have them, often go to highest bidder), by a trade (best offer for the team they are currently employed by usually wins), or through the amateur draft (the right to sign newly eligible players get picked one at a time, with the worst team from the previous year going first). If this product is good, it will be “profitable”, meaning that they will win an above-average number of games.
Now, let’s move away from the draft and trades for a while and look deeper into free agency. How is the price set for players in free agency?
Salaries for players who have reached free agency are comparative. Teams will look at the player’s age, position, and prior production. His prior production will be analyzed using baseball statistics, which have been around in some capacity for over 100 years. Many of the same ones were used to evaluate players since the very beginning, before one of our later case studies came along and changed that (to a degree). After taking these three things into account, a general manager and his aides will find comparisons for the player and see what they signed for. If Player A and Player B were the same age and played the same position when they hit free agency, but Player B has better statistics, Player B will get paid more. There are some aberrations, as teams will sometimes overpay for a player simply because they really want that particular player and need to overpay in order to sign him, but in most cases the contracts follow simple comparative rules. The same thing basically applies to trades as well, except trades involve spending “resources”, rather than money, to obtain the new “resource”. So, taking all that into account, how are general managers who have relatively low budget constraints able to put together a profitable product (winning team)?
The Age of the Entrepreneur GM
The entrepreneur general manager has popped up in some form at a few different times in baseball history. Take Branch Rickey of the 1940’s Brooklyn Dodgers for example- while he may have had the motivation to sign the first African-American to a Major League team due to moral reasons, he certainly also recognized that African-American ballplayers were a huge untapped pool of resources that teams, like the Dodgers, could use to win games. On a side note, this particular case is quite similar to the “Bootleggers and Baptists” theory put forth by Bruce Yandle (1983); however, in this case, Rickey was both the bootlegger and the Baptist.
Moving forward; the entrepreneur general manager has existed at times in MLB history. However, since the turn of the century, it has almost become a prerequisite that the general manager have entrepreneurial ideas about how to build a team- that is how prevalent it has become. This is the Age of the Entrepreneur GM, and there’s a general format that we can identify by studying these general managers.
First of all, most entrepreneur general managers take over a team that has some issue holding it back from success. The team may be hampered by a low budget constraint- the owner isn’t willing to spend enough money in order to get players who are wanted by teams who are willing to pay more. Another problem may be years upon years of poor player development. The cheapest way to build a profitable team is to develop young players that the team drafts into good, useful resources. If a team has been struggling to develop good players for years, they will always need to be paying for the top-dollar free agents in order to compete. This often requires a full system overhaul. There are some cases where the entrepreneur general manager simply finds a better way to do something, even if the team wasn’t particularly struggling in the first place, but these are the exception to the rule.
The next step is for the general manager to identify or become aware of a market inefficiency. I say “become aware of” because it is often not actually the general manager who initially identifies the market inefficiency, but an advisor. These advisors are often analytics experts, or may have some knowledge of biomechanics that helps them identify how a “resource” could be tweaked to make it more useful. I liken these advisors and the general managers to Steve Wozniak and Steve Jobs- Jobs identified that Wozniak was someone who would be able to help him achieve great things with his engineering prowess. Jobs exhibited entrepreneurial judgment in choosing to work with Wozniak, even if the entrepreneurial discoveries that followed weren’t strictly Jobs’ ideas.
These market inefficiencies are quite often related to performance evaluation. The groupthink of the league will overvalue certain statistics and undervalue others, so a smart general manager can take advantage of this by properly valuing them. Sometimes, teams even find new ways to quantify a part of a player’s performance that was known to have an effect, but could previously not be measured. There still isn’t a statistic that fully and accurately quantifies a player’s defense.
The inefficiencies may also have to do with how the “resources” are employed. General managers may develop theories about strategy or technique that may help a team’s or player’s performance when implemented. Recently, we’ve seen examples of this with the implementation of extreme defensive shifts and the launch angle revolution.
The third and final step is then for the general manager to use their judgment to alter the firm’s infrastructure in order to exploit the identified market inefficiency. First of all, the general manager needs to hire managers and coaches who will buy into any strategy or technique changes that the GM intends to implement. In the case of undervalued players, the GM needs to hire scouts that will be able to identify these “resources”, rather than just stick to what they know. This is often-times a large obstacle to overcome for the entrepreneur general manager, as often-times scouts can be pretty set in their ways and have been with the firm for many years.
Now, let’s look at some case studies of the entrepreneur general manager. We’ll start with the first really notable entrepreneur GM, Billy Beane of the Oakland Athletics.
Case Studies
Billy Beane
Billy Beane was the first and most notable entrepreneurial GM of the current era. Hired prior to the 1998 season as the general manager of one the Oakland Athletics, Beane worked under one of the lowest budget constraints among all the teams in the league. After one unfruitful season, Beane made the decision to bring a new analyst on board- Paul DePodesta.
DePodesta influenced Beane to think of baseball in a new way. While Beane already had become aware of some newer statistical methods, due to the writings of Bill James, DePodesta got Beane to buck traditional scouting and act on these newer findings. Chief among these was that rather than batting average as the most important hitting statistic, DePodesta theorized that on-base percentage was actually a more complete picture of a batter’s value. Furthermore, Beane and DePodesta targeted players who were undervalued due to cosmetic things. Players who had good statistics but were “under-sized” or pitchers who had unconventional throwing motions were able to be had for less than the market price should be for players of their value, and the Athletics took advantage of this.
In order to take advantage of these market inefficiencies, Beane was forced to alter the organizational structure, although subtly. The old scouts that had been making decisions for a long time became less empowered, as they were stuck in the traditional thinking. This was an example of “institutional stickiness” that Beane had to overcome. As defined by Boettke, Coyne, and Leeson in “Institutional Stickiness and the New Development Economics” (2008), institutional stickiness is “the ability or inability of new institutional arrangements to take hold where they are transplanted”. With all of the old guard around, there was a fair amount of resistance to a new institutional arrangement. As a result, many of the scouts ended up leaving or being let go in the few years after DePodesta was hired. Furthermore, incumbent team manager Art Howe had to be won over- if he did not embrace Beane’s vision, he would have been let go. Following the implementation of these new principals, the Athletics were competitive for 8 consecutive years, making the playoffs 5 times. This was an astounding success for the size of their payroll, although some tried to discount the success of his new methods by citing the lack of success his team had once reaching the playoffs. In 2009, John Vrooman analyzed this claim in his paper “Theory of the Big Dance: The Playoff Payoff in Pro Sports Leagues”. Vrooman uses statistical methods to demonstrate that over a large sample size, like the MLB regular season (162 games), the statistic principals that Beane embraced should win out. However, in small playoff sample sizes, anything can happen. The events of this entrepreneurial revolution by Beane were detailed in narrative form in the 2003 book Moneyball, which inspired many think-pieces on the topic. An interesting paper (“An Economic Evaluation of the Moneyball Hypothesis”) by Jahn K. Hakes and Raymond Sauer (2006) used econometric analysis to test whether Beane really discovered and exposed the inefficiency of baseball’s labor market, or if the success was merely coincidental. They concluded “our analysis supports the hypothesis that baseball’s labor market was inefficient at the turn of the twenty-first century”, as well as positing that this inefficiency had existed for many years. Mark Fichman and Michael Fichman arrived at a similar conclusion in their 2012 paper, “From Darwin to Diamond: How Baseball and Billy Beane Arrived at Moneyball”. The two made an interesting comment that really reinforces the economic nature of baseball’s competitive market in connection to the shift of focus from batting average to on-base percentage, as facilitated by Beane and DePodesta: “The timing of this shift in managerial attention and strategy from managing hitting performance to managing on base performance is due, in part, to the value of batting average ''running down'' or being "competed away'' as all teams pursued the same strategy”. We see similar phenomena when too many firms enter similar products into a competitive market.
Neal Huntington
Neal Huntington was hired as the general manager of the Pittsburgh Pirates prior to the 2008 season. While many teams had noticed the success of the Beane-led Oakland Athletics, GM’s around the league were very slow to pick up on his strategies. However, Huntington immediately stated his intent to use advanced statistics in his quest to build a winning team. While this may be true, it took some newer entrepreneurial discoveries to make the team successful. Prior to the 2013 season, coming off 20 years of losing, Huntington relied on his new data department, headed by Dan Fox and Mike Fitzgerald, to find new advantages.
Fox and Fitzgerald, along with Huntington, made a few discoveries. The two analysts found that the pitch-framing skill of catchers was being vastly undervalued. The other two things they found had to do with resource allocation (player use), rather than undervalued players. The three men found that using defensive shifts could be extremely successful, and their pitchers should be throwing more two-seam fastballs and less four-seam fastballs.
Armed with the new knowledge, the Pirates defense and pitching improved immensely and the team made the playoffs for the first time in twenty years. The entrepreneurial revolution in Pittsburgh is detailed in the 2015 book Big Data Baseball.
Jeff Luhnow
Jeff Luhnow was hired as the general manager of the Houston Astros prior to the 2012 season. For Luhnow, it wasn’t a low budget constraint that necessitated entrepreneurial action, but a long string of losing seasons. Luhnow essentially was taking over a sinking company, and one that most free agent players would choose not to play for, even if offered a good salary. What Luhnow and his top analyst, Sig Mejdal, found, was that the market that Beane had begun correcting had now overcorrected. Statistics were valued so much that traditional scouting had become undervalued. Following this discovery, Mejdal built a player evaluation system designed to pair scouting observations, such as family history, temperament, and build, with the new wave statistical data. This, along with the franchise’s embrace of the new strategy of tanking, led the team to make strong draft picks and amateur signings, setting them up for the ultimate success 5 years later. This part of the story is covered by the 2018 book Astroball. However, in 2019 it was discovered that Luhnow had made another entrepreneurial move in the quest for wins: he supported and facilitated an elaborate illegal sign-stealing scheme in order to give the Astros batters a significant competitive advantage. While it was clearly unethical and illegal, it is an advantage of how entrepreneurship can be toxic sometimes. It was an idea that was used to gain an advantage to make more profits (win more games), so legal or not, it was a successful entrepreneurial move.
In Conclusion
In the free market system that is Major League Baseball free agency, there is room and incentive for teams to find players who are being undervalued. The key economic agents within the firm, team general managers, are incentivized to find strategies or statistics that are being undervalued within the league’s traditional groupthink in order to gain a competitive advantage. This is especially true for general managers who have to work under a relatively low budget constraint, which has been set for them by the team owner. While they are not the actual resource owners, and so differ from the traditional Knightian entrepreneur, the GM’s have been given the authority to make entrepreneurial judgments by the owner.
Bibliography
Scholarly Sources
Knight, Frank H (1964). Risk, Uncertainty, and Profit. Sentry Press: New York, New York.
Foss, N and Klein, P (2012). Organizing Entrepreneurial Judgment: A New Approach to the Firm. New York: Cambridge University Press.
Hakes, Jahn, K., and Raymond D. Sauer (2006). "An Economic Evaluation of the Moneyball Hypothesis." Journal of Economic Perspectives, 20 (3): 173-186.
Yandle, Bruce (1983). “Bootleggers and Baptists- The Education of a Regulatory Economist”. Aei Journal on Government and Society.
Boettke, Peter J, Coyne, Christopher J, and Leeson, Peter T (2008). “Institutional Stickiness and the New Development Economics.” American Journal of Economics and Sociology, 67 (2): 331-358.
Regan, Colin (2012). “The price of efficiency: examining the effects of payroll efficiency on Major League Baseball attendance.” Applied Economics Letters,19, 1007-1015.
Vrooman, John (2009). “Theory of the Big Dance: The Playoff Payoff in Pro Sports Leagues.”
Ciletti, Dorene (2012). “Sports Entrepreneurship: A Theoretical Approach.”
Hayek, F.A (2002). “Competition as a Discovery Procedure.” The Quarterly Journal of Austrian Economics 5 (3): 9-23.
Other Sources
Lewis, Michael. Moneyball: The Art of Winning an Unfair Game. New York, W.W. Norton & Company, Inc., 2003.
Reiter, Ben. Astroball: The New Way to Win It All. New York, Three Rivers Press, 2018.
Sawchik, Travis. Big Data Baseball: Math, Miracles, and the End of a 20-Year Losing Streak. New York, Flatiron Books, 2015.
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