Contextualizing The Qualifying Offer System

At base, the qualifying offer system provides a mechanism that allows teams to allocate resources elsewhere while still obtaining the services of certain desirable, established ballplayers. Those players, in turn, sacrifice a portion of the contractual guarantees they would otherwise obtain in an unqualified market. In effect, the system taxes the prospective earnings of certain players who are (or soon will be) free agents.

For more background on the function of the qualifying offer system, see Avoiding The Qualifying Offer, by MLBTR's Tim Dierkes.

The impact of the qualifying offer system has come under much scrutiny over its first two offseasons of implementation. Some have argued that it unfairly penalizes the above-average but non-superstar players that are made a QO (which, if declined, requires another club signing that player to give up its best non-protected draft pick and the accompanying bonus pool money). Others claim that it allows such players a fair chance to sign a substantial contract, pointing to the offer's value (last year, $13.3MM; this year, $14.1MM). A range of arguments also claims that the system perversely favors larger-market clubs.

But before considering such criticisms (and potential reformulations of the system), it is worthwhile to put the system in its broader context, and to consider carefully how it serves (or disserves) its various actual or potential purposes. While it seems exceedingly unlikely that changes will be made before the current CBA is expired and replaced in December of 2016, the topic deserves consideration and debate leading up to that point. In approaching the issue, it is worth looking carefully at both the money at play and where the various risks, benefits, and incentives fall.

A. Overall Market Impact

How much money — in both real and baseball terms — is at stake here? Dave Cameron of Fangraphs posited recently that a 3x valuation of a draft pick's slot value is a good approximation for that pick's value. In other words, a team considering gaining or losing a draft choice would factor that amount in when assessing the potential impact of signing a player (or allowing that player to sign elsewhere). For the 2013 amateur draft, slot values rose by 8.2%, according to Jim Callis of Baseball America. I will assume both a 3x slot value in reaching a market rate, as well as a like 8.2% increase for the upcoming 2014 draft. (Note: because slots shift with every move impacting the draft, the resulting numbers will not be perfectly precise, but should nevertheless easily qualify as accurate for our purposes.)

In 2012-13, six players declined qualifying offers and changed teams. According to River Ave. Blues, teams sacrificed the 17th, 22nd, 28th, 29th, 42nd, and 70th picks, while other clubs picked up the 28th through 33rd selections. 

In 2013-14, to date, nine players have declined qualifying offers and changed teams. (Two QO-declining players have yet to sign.) Again, according to River Ave. Blues, teams have sacrificed the 17th, 18th, 21st, 26th, 44th, 48th, and 54th choices, while other teams gained the 28th through 34th pick. In addition, the Yankees both earned and sacrificed two supplemental first round choices. Because they finished with the worst record among clubs to have earned a supplemental pick, they would have stood to gain the first two of those picks.

Add up the slot values, and apply the 3x multiplier, and these are the results: In 2012-13, teams sacrificed a total value of $27.51MM ($4.585MM per player) and gained $29.33MM ($4.889MM per player). In 2013-14, to date, teams have sacrified a total value of $48.90MM ($5.433MM per player) and gained $48.85MM ($5.428MM per player). The 8.2% assumed increase in draft slot bonuses fairly well accounts for the rise in per-player figures, with the increase in overall impact coming otherwise from the increased use of qualifying offers.

QO pick value

It is worth putting these numbers up against the overall free agent spend to gauge their magnitude. I recently broke down free agent spending trends, including numbers for the 2012-13 period and the 2013-14 period to date. In the 2012-13 free agent period, clubs committed just over $1.463B in total via free agency, while this year's spending has now topped $2B (it was at $1.88B as of that post). Thus, the net draft value transferred through the qualifying offer system has been around 2% to 2.5% of the total open-market spend over the last two years. 

That, surely, is a relatively minimal savings for MLB teams on the whole. When considering the full gamut of ways in which teams invest money into players — including free agency, extensions, the draft, and international signings — the money saved (i.e., allowed to be re-allocated) makes up a meager portion of the aggregate. Of course, it is worth wondering the extent to which the prospect of a future qualifying offer also transfers savings and leverage to teams negotiating extensions with players close to hitting free agency. This is impossible to calculate, but nevertheless does also transfer value to individual teams and savings to the league as a whole, as against current MLB players.

B. Impact On Individual Teams

On an individualized basis, teams assessing whether to make a qualifying offer, or whether to sign a player bound by draft compensation, have ample flexibility to value the choices at stake and decide whether and how to factor them into their decision. 

Generally, a team making a qualifying offer to a player obviously reaps a substantial, albeit variable, benefit (in addition to having the right to choose whether or not to make the offer). It may ultimately retain that player at a one-year rate which, in theory, is at or below that player's market value. Or, it may instead receive a supplemental draft choice that lands between the first and second rounds of the draft. (It has been suggested that a team can sign a player that declined a QO at a lower rate than can other clubs, but that is not entirely true: once the offer has been declined, a re-signing effectively entails the sacrifice of a draft choice that, as explained below, comes with roughly the same value as the choices given up by other teams.)

A team signing a player that declined a qualifying offer, on the other hand, theoretically ends up in a neutral position, because it can discount its offer by the value it places on the pick that it sacrifices. While draft picks move as they are added and subtracted, teams have a very clear idea of what they are giving up in future value, and can apply their own valuations (including the tradeoff of present and future, and the actual slate of available draftees) to reach a discount.

As noted above, teams that are considering extensions of current players — especially, those close to reaching free agency — can also utilize the threat of a QO (implicit or otherwise) to achieve leverage. That may mean little in negotiations with superstars, but could have a sizeable impact on talks with "merely" above-average players. The possibility of a qualifying offer adds to and even enhances the risks of injury or performance decline already present to an above-average free agent-to-be, which could result in savings to current teams. This factor is, perhaps, enhanced in the situations of older or defensively-limited players who could be looking at short-term contracts after their walk years, even if they put up good numbers.

C. Impact On Players Subject (Or Potentially Subject) To Qualifying Offer

Meanwhile, for players, those issued a QO are subject to the whims of their team and other circumstances outside of their control. The take-it-or-leave-it offer is presented at the team's initiative, before the market even opens. (This year, for instance, Ubaldo Jimenez came with draft compensation; Matt Garza and A.J. Burnett did not.)

Further, the cost of the small reduction in overall spending falls squarely on the shoulders of the small number of players who are made a qualifying offer: their market value is decreased by whatever amount prospective teams choose to discount for the lost pick. And that burden is not shared by any other stake-holders (other players, the league, teams).

One line of sentiment says that some players over-value themselves by rejecting the QO. (No player has yet accepted one.) Even if the offer is an arguably fair price for one year of a certain player's services, however, that does not end the matter. It is quite difficult to reach free agency through service time, let alone to do so at an optimal point in time. Players that do naturally seek to maximize their overall guarantee, often choosing a longer contract with a lower average annual value to avoid the risks inherent in suiting up for another season before securing a future commitment. As Ubaldo Jimenez recently explained it: "I knew that I would have a better offer than the qualifying offer. Or at the very least, I wasn't as much worried about the annual salary, I was more concerned with having the long-term security."

For those that decline the qualifying offer and test the market, the resulting tie to draft compensation can be a significant drain. Though it is often suggested that the downside of the QO system lands solely on the more marginal players that receive an offer, that may be true only in relative terms. We do not know whether, say, Robinson Cano would have garnered a $245MM (rather than a $240MM) guarantee from the Mariners without an offer. But it is likely that the impact of a lost pick was factored in on some level.  While the effect is a relative drop in the bucket for top-dollar free agents, it appears nonetheless.

(This is not to suggest that the team would have any focus on the loss of the draft pick in negotiating with a star-level player; rather, the value of the lost pick would be baked into the valuations that the team uses in setting internal parameters before entering negotiations. As Blue Jays GM Alex Anthopoulos has explained, for example, "there's still value" even for picks after the first round, "and you still build that into an offer." Of course, teams may still be willing to go past those valuations to land premier free agents, and/or effectively adjust their internal valuation of a pick downward based on their present roster construction and expected point on the win curve.)

More importantly, though, it is clear that non-superstars take the largest proportional impact. That is made obvious by Nelson Cruz, who recently became the first QO-declining player to sign a deal worth less than the qualifying offer itself, with his one-year, $8MM contract falling over $6MM shy of the $14.1MM he could have taken before the start of free agency. (Previously, the least guaranteed money in a deal to a player who declined a qualifying offer was Adam LaRoche, who signed for two years and $24MM last year after declining the one-year, $13.3MM QO.)  

Indeed, the greatest risk for a player may lie not in the possibility that they will see a reduction in their earnings to compensate for the value of a lost pick, but in the impact on that player's overall market. Some teams may decide that they will not sacrifice their draft pick in a given year at all, for any number of reasons. Others may decide that, whatever the theoretical value of the pick, organizational needs dictate that they not cede the choice unless they are signing a player of a certain, higher order. Some clubs may simply put a greater internal value on the draft choice than that suggested by Cameron.

Whatever the case, teams clearly do not take lost picks lightly. "You hear people say, 'Well, what if the [drafted] player doesn't make it,'" Brewers GM Dough Melvin has said"That's not the sole purpose of a draft pick. You can use those picks for trades. … I'm glad we have Kyle [Lohse], but don't tell me that about overrated draft picks. Their asset value is huge." The net effect, in all likelihood, is often to take away some teams that would be potential suitors and, perhaps, to limit the willingness of some others to offer multiple years.

This could explain, in part, how a player like Ervin Santana ended up taking a one-year pact (at the precise value of the qualifying offer) just to get in camp before the end of the spring. This kind of situation is not unprecedented even without draft pick implications — for instance, Edwin Jackson signed a $11MM pillow contract with the Nationals the year before the QO system went into effect, and did not cost the Nats a pick (he was a Type B free agent under the old system). Like Jackson, Santana had multi-year offers, apparently at about the price achieved last year by Kyle Lohse. But Santana was unwilling to sign for three years at a total value roughly equivalent to two years of qualifying offers, as was Lohse, and was apparently unable to translate relatively strong demand into a fourth year.

The point here is not that the QO in and of itself prevented Santana from achieving the four or five-year deal he was hypothetically entitled to. Rather, it is that, for the reasons just noted above, the qualifying offer played a role in dampening his market and reducing his leverage to pry away more years at a strong average annual value. And that, in turn, makes for an even greater potential increase in the proportion of the burden borne by a limited class of players. 

Then, there are the soon-to-be free agents facing the possibility of a market hampered by the burden of draft compensation. As noted above, their leverage is surely reduced by the prospect of carrying that added cost, especially if always-shifting demand turns out to be less than robust. And the qualifying offer introduces risk to the player through the unpredictability of its effects, especially since the system drastically skews the market (through the protection of some draft picks and the fact that teams signing multiple compensation free agents sacrifice increasingly less valuable choices.) Indeed, players like Justin Masterson and Chase Headley have reportedly seen their current teams insert the qualifying offer into extension talks.

D. Conclusion

With this understanding of the broad parameters of the function of the qualifying offer system, the question becomes one of purposes. What does the system hope to accomplish, and hope to avoid? And how well has it done? I will suggest an approach to those questions in a second post.

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