The New Business of Baseball

How the San Diego Padres are upending a class system decades in the making.

The story starts in the summer of 2021 with the San Diego Padres returning home from a mid July road trip to open up a series against the Oakland A’s. Fresh off pre-trade deadline moves, the Padres were positioned for a playoff run with a team that already had five all stars, the most in team history. That night, 40 thousand fans packed Petco Park on a Tuesday to watch a Padres win. Fernando Tatis Jr, the 21 year old phenom and new face of baseball that had just graced the cover of MLB the Show, nearly hit a ball out of the stadium in the third inning. It was electric. I was there to see it.

A few hundred feet away from me, Bob Melvin, the A’s manager, watched from the dugout. For eleven years he’d been managing an A’s team in near obscurity in the league’s most dilapidated stadium to crowds of less than 8 thousand a night (slightly less than the Hershey Bears minor league hockey team). His team had one of the lowest payrolls in baseball. Somehow, he’d been winning though. It earned him the reputation as one of the best managers in baseball. Within five months, he’d be managing the Padres. In an unusual turn of events that made little business or competitive sense, the A’s let him out of his contract. They felt they owed it to Bob to give him something they knew he wanted.

A’s General Manager David Frost on his decision to simply let Melvin out of his contract with no compensation: 

“He (Melvin) made reference to the series with us in July (at Petco Park in San Diego), the atmosphere, the ballpark. They’ve done an outstanding job in San Diego giving themselves a chance to compete every year. I think it’ll be great for him to have those resources at his disposal.”

Hearing this, a long time Padres fan struggles to understand what bizarre world they’ve stumbled into. No team has lost more baseball games over the last 50 years than the Padres. They are one of only two teams founded before 1970 without a World Series title. The stadium over the years has been consistently packed with Dodger Blue when the rivals from up the interstate came to town. To hear that the Padres, of all teams, are a hot destination for talent is the thing of fantasy for a fan base now down to one major sports franchise since the Chargers departure in 2017. Something has clearly changed.

It started in the winter of 2019 when the Padres actually won the top free agent on the market when they signed Manny Machado to a $300 million contract, at the time, the largest contract in the history of American professional sports. They’ve since gone on a player driven spending spree that has seen them sign more blockbuster, long term contracts than any team in baseball over the last four years. More than the Yankees. More than the Dodgers. And the world has questions about how this is working. Not just baseball questions; business questions.

The Padres, who have historically had a payroll in the bottom third of the majors playing in a market in the bottom third of the majors, have signed mega star after mega star in the last four years to long term contracts. As a result, their team payroll has ballooned from an average of 18th highest in the league over the last 25 years to third highest. And they’ve done it with long term contracts that pay players into their 30s and 40s, obligating them to a high level of talent payroll for the long haul. And while there’s certainly a study on whether or not this will work to win a championship to come (beating the Mets and Dodgers in the playoffs last year certainly shows early promise), the true study of the time that transcends not just baseball but even sports, is how to think about how the Padres have upended a business structure over a century in the making. And whether or not it’s sustainable. 

To get to that, there’s some things we need to understand about how the business of baseball works. There are 30 teams. Each team is owned by a private ownership team or individual. The financial outcomes of each team is the responsibilities of that ownership team. And while there is a revenue sharing agreement between the franchises that’s a bit murky, there is a massive gap in the revenue of the most valuable franchises and the least valued franchises. And there is no salary cap for player salaries which means there are also massive gaps between the largest and smallest salary payrolls.

For frame of reference, the NFL, which has a salary cap, has a gap of 25% between the highest and lowest payrolls that often has different teams at the top and bottom each year based on episodic contract expirations. The gap between the top and bottom payrolls in Major League Baseball, on the other hand, is 700%. You read that right. Moreover, the top and bottom teams have been the same for decades. According to Forbes, the total valuations of the teams in the different sports show a similar pattern. The NFL top valued Dallas Cowboys are a little over twice as valuable as the bottom Detroit Lions. In baseball, the Yankees are six times more valuable than the Marlins. And the rankings haven’t moved around in decades. Which means the MLB no salary cap, free market system has resulted in a staunch class system in baseball. So when the Padres show up, seemingly overnight, with the third highest payroll in baseball, it actually is unheard of.

Colorado Rockies owner Dick Monfort, who’s team historically has lived in the same economic neighborhood as the Padres, isn’t a fan.

"That puts a lot of pressure (on us)," Monfort said. "But it's not just the Padres, it's the Mets, it's the Phillies. This has been an interesting year.

"What the Padres are doing, I don't 100% agree with, though I know that our fans probably agree with it. We'll see how it works out.

So what exactly are Peter Seidler and the Padres ownership team trying to do? Surely there’s a reason why the economics of baseball have formed the deep grooves in how the product on the field materializes relative to the market size and wealth of the franchises. It’s possible the Seidler team is simply irrational fan ownership. But it’s also possible (likely) that we’re seeing a shift in the economics of baseball and a broader asset management focus formed by historically lower interest rate environments that teams like the Padres, Mets and Phillies have recognized and are trying to win first market mover advantage. That the pecking order would still be frozen as it is, is at least as unbelievable that it could change. George Steinbrenner bought the Yankees for $8 million 50 years ago and built the team through double digit interest rate environments. The local market and near term bottom line was everything. The world is quite different today. And so perhaps the mechanics of the baseball business could be too.

When we think about MLB baseball franchises, it’s important to realize that the modern sports franchise is an asset to the ownership teams and not their business. The days of family run ball clubs aimed at generating nightly income at the gate are mostly over. The business of modern sports owners, for the most part, is not baseball. It’s asset management. And through that lens, what the Padres are trying to do starts to make a little more sense. For most of the near past low interest rate environment years, it’s been far more important for asset managers to focus on increased valuations than income as new money has mostly been free if you have valuable assets (like an MLB franchise). And so revenue generation has mattered more and the bottom line has mattered less. What’s true of tech start ups in 2019 was true of baseball teams. The Yankees lost 40 million dollars last season. And they weren’t alone. Only three of the top ten valued MLB franchises turned a profit last year. And they don’t care. Because when we look at how franchise values grew over the last decade, we start to understand why anyone would ever invest in owning a baseball team.

As much as people like to bemoan the slow pace of the game and the relative growth of the NFL, it’s pretty clear that Major League Baseball is alive and well. In fact, it’s booming. The exit from the pandemic shortened, zero attendance season was faster than expected. Sponsorship revenue is increasing substantially. In 1985, the first year I remember watching the World Series, there were 21 total potential playoff games in four markets. Now there are over 60 in 14 markets. That means that Fox, TBS and ESPN are shelling out huge amounts of money for the rights to broadcast those playoff games. Starting in 2022, every single MLB team started receiving $60 million dollars in revenue from national TV deals. On top of that, new streaming deals with Apple and Amazon, which will only grow, are adding even more national level broadcasting revenue into the mix. The benefit for being in the club of MLB baseball teams has never been higher. And the outlook has never been better. Which means valuations of MLB baseball teams have and will continue to grow.

Since 2011, MLB franchises have seen valuations grow at an average of $112M annually. For the top third, that average is over $200M annual growth. For the middle third, that average drops to $80M. The bottom third comes in just below $50M. Which means the business of baseball enables a franchise to roll out of bed and realize about $100M in annual revenue and between $50M and $100M of asset valuation increase without selling a single ticket. The Oakland A’s presently have a total team payroll of about $40M. The team is worth $1.1B and has grown at a rate of about $50M annually. It’s pretty clear that with the growth of overall MLB revenues and the growth in team valuations, there’s little excuse to have a $40M payroll. Or even a payroll under $100M. Yet nine teams have one. And we should rightfully shame them at least a bit for really not caring about winning. But it also means there is tremendous opportunity to at least try to move from the bottom tier of growth to the top. And the windfall in that is far more than the potential salary costs of players. It’s not close.

So what separates the goods from the greats? And what is the risk is to try to get there for the Padres? As I write this, as per Forbes, Seidler and team own a franchise that they bought 10 years ago for $600M that is now worth $1.2B. They’ve doubled their investment. And they’ve made some income along the way since the team was in the black for a good portion of their ownership time. But the Padres roster payroll is in the stratosphere with the likes of teams worth four and five times what they are. And, while it’s fun to beat up on guys like Rockies owner Dick Monfort for questioning their methods, he asks a fair question. How is this going to work out? Especially since Seidler and team are actually the least rich owners personally of all the MLB ownership teams. We can’t just explain it away by saying they’re willing to blow their money on trying to win like we can with Mets owner Steve Cohen (also an portfolio manager in his day job by the way).  

Here’s where things get interesting. There’s a few variables that come into play that really separate the truly rich of MLB from the rest of the field. The first is ticket, box and seat prices. And the second is local television contract values. Those are two things that you really can’t get to the elite level if you don’t solve one of two things. The first is that it really helps if you have a big market. It’s not the end all and be all, but it’s like starting with a lead. But it’s definitely a lead that can be blown. Especially when you consider that the biggest markets have more than one team in the same city. Market alone isn’t enough. If you don’t have a large market, you can make quite a bit of valuation from having a strong brand. If you’ve got both, you’re the Yankees and Dodgers. If you have neither, you’re the Oakland A’s. And there’s really only one way to develop a brand in baseball. And contrary to popular narrative, it’s not by winning championships.

29 teams fail every year. The Yankees have won one this century. The Dodgers haven’t won one during a full season since the Reagan administration. But both teams are worth five times what the Padres are. The Yankees and Dodgers brand doesn’t come from championships. The Yankees brand is Ruth, Dimagio, Mantle, Reggie Jackson, Derek Jeter, Mariano and Aaron Judge. The Dodgers are Koufax, Robinson, Drysdale, Betts and Kershaw. A brand in baseball comes from stars. Every team plays 162 games. The best teams win 12% more than the worst over time 25 years. Yet some are worth five times what others are. The chicken or the egg question that the Padres are betting on materializes. Are the big teams worth more because they get more stars? Or do the big teams get more stars because they’re worth more?

Let’s put that aside for a second to dispatch some noise in the system. There’s a common perception that there are teams that win with small payrolls and have a blueprint for success without having to compete dollar for dollar with the titans of team wealth. And that smaller market teams like the Padres should follow it if they’re smart. The teams that pop into mind are the Tampa Bay Rays and of course Bob Melvin’s Oakland A’s. The Kansas City Royals even won a World Series in 2015 as a small market team. When we look at the details though, that narrative begins to fall apart. 

The Royals actually had a pretty high pay roll in 2015 in the top half of the league. They’ve since fire saled that roster and drifted off into nearly a decade of obscurity. The Oakland A’s figured out how to win enough to make it into the playoff regularly. But they won two playoff series in 25 years. The Rays are as close as one can really come to competing consistently at a high level with a low payroll. But when you peel back the onion on them, they’ve made it past the division series in the playoffs once in 25 years if we discount the bonkers 60 game Covid year (and I do). Low payroll means no household name stars. And no household name stars means a glass ceiling of squeaking into the playoffs and getting bounced quickly by the titans of the league.

But isn’t it good business to do more with less? Well, actually it isn’t. The Rays, Royals and A’s are valued 29th, 28th and 27th respectively in MLB. And their ownership teams have seen their investments grow at the bottom quarter of MLB franchises. Moneyball, as it’s called, isn’t making anyone money. And it’s not drawing fans. If you take all of the MLB financial data and all of the MLB performance data and plug it into a single database (I did), you see some Occam's Razor-like patterns.

The teams with the highest valuations have the highest payrolls. And the teams with the highest payrolls have the most playoff series wins this century. And the teams with the most playoff series wins make the most money at the gate of their stadiums and charge the most for their TV contracts. And then you start to see what Seidler and team are trying to do.

This story started in July of 2021. But it ends today. As I write this, the news has broken that the Padres  just extended their star Manny Machado another 11 years. He’s going to be a Padre until he’s 41.

That makes three of the Padres top stars now signed into their 40s. And one, who is 23, signed into his mid 30s. Seidler and team want stars that are not just stars. They want stars who are Padres stars. They want players that get statues and have 500 home run tours and 3000 hit watches. They want Hall of Famers they will name streets after. The current Padres all time home run leader is Nate Colbert, who was a fine ballplayer. But if you’re not a baseball nut, I bet you’ve never heard of him. You can’t charge what the Yankees do for a club box if no one outside of San Diego can tell you who the greatest slugger the team has ever had is.

The Padres are in the bottom four of ticket prices in MLB right now. For the first time in team history, they had to stop selling season tickets this year because they’re sold out. San Diego isn’t really a small market. It’s Southern California. There is no shortage of money here. If you build it, someone’s going to pay to see it. But you have to build it. You just have to think of them as an asset. Not a baseball team. Clearly Peter Seidler and team are.

How exactly they’re going to make the economics work in the short term is a good question. They’re making a pretty huge bet here. No that it will bring a championship to San Diego. That they can turn San Diego baseball into a brand. And that brand will turn the Padres into a top tier valued franchise. They’ve got an amazing stadium. They’ve got the scenery. And they’ve got the city entirely to themselves since the Chargers left. And now they’ve got some of the best talent in baseball locked up until the 2030s. It’s fair to be skeptical. Baseball is may be emerging from the gilded age of professional sports. But it was there for a long time. The teams at the top are the Vanderbilts and the Morgans and the Rockefellers. And the system has not been set up for them to be joined by others. Ever. But someone somewhere has to give it a run. 

Why not the Padres?