Tuesday, September 26, 2006

Innovation and Diffusion in Baseball

Managerial innovation often involves the use of new ideas that allow a firm to produce at a lower cost than rival firms and, in turn, earn higher profits. Yet, as word of profitable innovation diffuses, other firms will mimic the innovator until prices adjust and the innovator's initial cost advantage disappears. The labor market for baseball players at the turn of the 21st century offers an example of managerial innovation and diffusion. The innovator, according to Michael Lewis's Moneyball, was the Oakland Athletics headed by general manager (GM) Billy Beane. Beane was the first GM to make use of an idea that was formerly relegated to the realm of baseball stat geeks: the notion that on-base percentage is a much more important indicator of batting performance than baseball managers realized.

Let's assume that professional baseball teams earn more revenue when they win more games. In this case, profit-maximizing baseball teams will strive to maximize the production of wins while keeping the team payroll as low as possible. Winning requires scoring more runs than the opponent. We can think of batters as the run producers. A batter's value to a team is tied to his ability to produce runs and, by extension, wins.

Like any other productive resource, economic theory suggests batters should be paid according to their marginal productivity: that is, the amount their talents contribute to runs scored by the team. Of course, there is no way to measure this amount precisely. So summary statistics, such as batting average (the player's hits divided by at-bats), slugging percentage (the player's total bases divided by at-bats), and on-base percentage (the number of times a player reaches base divided by plate appearances) must be used. GMs must decide how to value each of the various batting attributes so as to acquire batters capable of scoring runs and winning games.

In a recent journal article, economists Jahn Hakes and Raymond Sauer (founder of The Sports Economist blog) show that, at the turn of the 21st century, player pay did not adequately reflect the contribution of on-base percentage to winning games. That is, in paying batters, GMs paid too little for on-base percentage and probably paid too much for other, somewhat less important attributes. Oakland's managerial innovation--emphasizing on-base percentage in the evaluation of prospective batters--exploited the inefficiencies in baseball's labor market and allowed Oakland to acquire players with high on-base percentages at a relatively low cost. As a result, the A's built a series of playoff contending teams but spent much less on payroll than clubs with a similar number of wins. Read the first few pages and the concluding remarks of the Hakes and Sauer article to find out more about the Oakland innovation and how its diffusion changed the labor market for ball-players.

1. According to pages 3 and 4 of the paper, what do batting average, slugging percentage, and on-base percentage measure? Compared to batting average, what additional information about a hitter's productivity does slugging percentage capture? What about on-base percentage? According to the authors, which measure, on-base percentage or slugging percentage, has a bigger impact on wins?

2. What do the authors conclude about the diffusion of Oakland's managerial innovation? Had the value that GMs placed on on-base percentage changed by the time Lewis's Moneyball was published?

3. Steven Levitt, co-author of Freakonomics, criticized Moneyball for over-emphasizing the role of batting and under-emphasizing the role of pitching in Oakland's recent success. Levitt argued that pitching generated most of the A's success. Remember, winning requires scoring more runs than the opponent. Part of a team's success in out-scoring opponents comes from the ability of its pitchers to keep the other team from scoring runs. During the 2000-2004 period, Oakland found a way to acquire inexpensive but productive offense and managed to assemble a stellar pitching staff. Do you think Oakland's offensive innovation helped free up the resources needed to acquire pitching talent?

4. What can the labor market for baseball players tell us about the labor market for corporate executives? Might boards of large corporations mis-price leadership attributes when they determine executive compensation? That is, do corporate boards overvalue certain characteristics of business leaders and undervalue other, potentially more important indicators of competence?

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  • At 9:02 AM, January 18, 2007, Blogger Christopher said…

    One of the most interesting conclusions in Moneyball, which is especially apparent in the Afterword in the paperback, is the lingering inefficiencies in the market.

    Many baseball teams refuse to admit that Beane's technique is more logical and more efficient. By embracing an inefficient and irrational scheme for valuing players, it leaves plenty of opportunities for Beane-like managers to exploit market inefficiency.


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