The Power of Competition

by Russ Roberts on May 1, 2007

in Competition

In a number of recent posts, there have been comments questioning whether "the market will solve all problems," or whether competition works as advertised. In my post on the myth of clutch hitting, K. Williams wrote:

All these baseball people, who spend all of their lives presumably
thinking about the game and about ways to improve their own performance
and the performance of their players and (if they’re in management)
about what creates real value on the field, and they all have an
essentially false view of something as fundamental as clutch hitting.

Why is it, again, that we’re supposed to believe that competition ensures that people will make optimal decisions?

A similar complaint has been made about the insights of Billy Beane, the GM of the Oakland A’s who discovered that players who walk a lot, all other things held equal, are undervalued in the market for baseball talent. How could this insight go undiscovered for so long? Why do some teams still ignore on-base percentage?

My claim is that baseball, while competitive (in the everyday sense of the word), is not a very good testing ground for the power of competition as economists use the term. It’s not a very good measure of how competition works in markets even though there is a "market" for baseball players in the everyday sense of the word.

The biggest problem with generalizing from baseball to the rest of the economy is that if you do a lousy job in baseball, you still make a lot of money. That is hard to do in most markets. In most markets, if you fail to keep up with your competitors, if you use outdated technology, if you fail to please the customer, you don’t just make less money than your competitors. You go out of business.

In baseball, you can have an inept owner who hires an inept general manager, who signs inept players (or who doesn’t  bother signing ept ones), who fails to spend sufficient money on the fundamental assets necessary to excel, who signs players who do the little things and the big things badly, who neglects the team’s farm system. You can perform poorly, year after year and you can not only survive, you can thrive.

Since 1998, the Kansas City Royals have been horrible. They have won more games than they’ve lost only once in that span. The other years, they’ve been dreadful. They’ve lost 100 games or more four times since 1998. Yet according to Forbes, the value of the franchise doubled between 1998 and 2005.

Even though the Royals are terrible, the Yankees can’t drop them from their schedule. Despite fielding a mediocre team, when the Yankees or the Red Sox come to town, the Royals draw a nice crowd. Even though the Royals are terrible, the owner keeps the team. Can a different owner buy him out the way he would if another asset weren’t used to its full potential? It’s possible but it’s not easy. There are only 30 baseball teams. If an owner sells he can’t just buy another one. So the non-monetary thrills of owning a team can’t be easily replaced. As long as an owner gets sufficient non-monetary thrills from being an owner, he will rationally turn down lucrative offers.

The other owners would prefer a more profitable franchise in Kansas City, but not too profitable. They would prefer better attendance when the Royals come to their parks but they are happy that the Royals are not a threat to win the pennant. So there is little incentive for the other owners to force out the owner in Kansas City for performing so badly. The owners almost never force out a mediocre owner who doesn’t try very hard. Having a few of those is tolerable.

So while baseball has competition in the sense that teams play each other and keep score and while baseball keeps precise measures of relative performance (called the standings), baseball is not competitive in the traditional economic sense. There is no free entry or exit. Excellence is rewarded (as long as it is relative excellence) but mediocrity is not punished.

In such a world, it is not surprising that the best strategic ideas can take a while to be adopted by baseball teams. It is not surprising that racism can persist for years in the explicit form of a color line and it is not surprising that even after Jackie Robinson, teams can be slow to sign African-Americans.

In the competitive world of sports, you can indulge your preferences for hiring a pleasant fellow as a general manager rather than a smart one. You can indulge your preference for hiring someone with your skin color. And you can indulge your preference for hiring someone who is not much of a risk-taker. In fact, a risk-taker is a bit scary.

After a while, if enough of the other teams start signing African-Americans or using better decision-making heuristics or starting a baseball academy in the Dominican Republic, the costs of your inadequate strategies might get so costly that you join the new ways of doing things.

But I don’t think you want to argue that because baseball teams forgo profit by using crummy heuristics for what makes a good player or a good team or a successful strategy, that markets don’t work very well.

Contrast the market for baseball players or baseball strategies with the market for restaurants. Consider the following insight from a former student of mine, Steve Daley. Every town in America over a certain size (50,000, maybe) has a Chinese restaurant. There’s no Chinese Restaurant Czar to allocate Chinese talent to towns and cities all over America. The profit motive is sufficient. A town with more than 50,000 people but no Chinese restaurant is a forgone profit opportunity. Somehow, word gets around. And a town of 150,000 people with only one Chinese restaurant or attracts others. If a Chinese restaurant is badly run, it usually goes out of business and another one opens that does a better job. And in bigger cities, the standard for what is badly run is more demanding because there are even more competitors both in the Chinese niche but also outside of it, competing with the Chinese restaurants.

Finally, consider my local grocery store in a prosperous Maryland suburb outside of DC. I went in there the other day and the shelves in the soft drink section were half empty. It’s not the first time I’ve noticed this. You’re out of root beer I told the cashier. Oh, she replied, we can’t do anything about that. They just show up when they show up, she explained. I suggested that she might want to tell the manager to ask them to show up more often. She shrugged.

There’s are only two grocery stores in my neighborhood (both owned by Giant) and both are run poorly relative to other grocery stores in my experience. A failure of markets to serve customers? My guess is that it’s a lot harder to open a new grocery in my neighborhood compared to other neighborhoods—a combination of various zoning regulations

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{ 20 comments }

David May 1, 2007 at 1:14 pm

The constraints placed on behavior have a lot to do with those limits not only institutionally imposed, but environmentally as well. Ned Colletti, for example, thought that it would be appropriate to sign Juan Pierre because he needed a center fielder. Given zone rating statistics (which JC Bradbury has trashed before), one would trust Pierre's center field coverage.

Still, the only other options for center field were to attempt to re-sign JD Drew and give him more money, try Soriano in center (and the Cubs have since moved him to left), Gary Matthews Jr (ha!), Dave Roberts, make a trade (creating more holes), or just let Matt Kemp or Jason Repko play there. Now, the last couple options would likely have been better, but one couldn't be certain. Colletti is very risk-averse, and he'd rather have the guy who could play 162 and be pretty dependable (though one can certainly argue what you can depend on him for).

Kinney May 1, 2007 at 2:11 pm

How would you rate European soccer leagues competitiveness where the possiblity of being relegated is present?

Chris O'Leary May 1, 2007 at 2:19 pm

I don't think it makes sense to compare baseball relative to itself (e.g. from team to team).

This is because baseball is largely a closed system. Much like the Washington Generals (the foils of the Harlem Globe Trotters), the KC Royals could be playing the role of Professional Patsies (whether they admit it or not). The advent of revenue sharing has made this Professional Patsy role increasingly lucrative.

Instead, to really understand baseball and the idea of competition you have to compare MLB to the NFL, the NHL, WWE, Hollywood, and other entertainment entities.

John Payne May 1, 2007 at 3:08 pm

I think you're vastly underestimating the number of Chinese restaurants in America. For instance, my hometown has fewer than 20,000 people, but there are four Chinese restaurants there. Of course, this only makes your case stronger.

caveat bettor May 1, 2007 at 3:08 pm

There are lots of considerations in the MLB market, following on from the the prescient Chris O'Leary. Revenues and team payrolls can range from the Marlins to the Yankees, where the latter boasts 7 times the former. ARod, Jeter and Giambi each get paid what 20 Marlins players get paid on aggregate.

But the Yankees never seem to win 7 times the games of the Marlins (or Royals). How 'bout them apples?

Ray G May 1, 2007 at 7:08 pm

An "authentic" MLB jersey costs something like $210, $260 with your name and choice of number.

I haven't looked into this, but I do know basically how the league is run, and so I think it's safe to assume that the same co-op kind of deals dictate the sales of MLB merchandise.

So the only reason I can imagine that they would charge that much money for a jersey is that everyone has to get their seemingly fair share. Only problem, with everyone demanding X amount, the shirts now cost so much, that there is no way that they sell enough for it to truly be a lucrative sideline.

Simply put, the demand for such an item is too elastic .

Point being is that very poor business practices abound, even outside of the clubhouse. I can only assume it is because of the co-op like arrangements they have. Without such arrangements, we would no doubt have fewer teams, but we would very likely have better teams for less money, and we could get an "authentic" jersey for about $60.

Dave D May 1, 2007 at 10:57 pm

Speaking as a former Royals fan, who has been on strike since the last time the players walked out, we need to define the market. The real competition isn't between baseball teams, it is the competition for the entertainment dollar. Baseball competes with football in the fall, basketball in the spring, and movies, TV, videogames, and minor league baseball in the summer.

I seem to recall a statistic that the annual take from the Yankee's radio contract is worth more than the combined payrolls of all of the small-market teams. The Royals may be little more than a AAAA team for the big media-owned teams, but it isn't their fault that they can't generate enough revenue to complete at the same level. But apparently that doesn’t matter, they can still produce enough revenue from to cover their costs, and the Yankee’s need teams to play.

The NFL understands this, and shares revenue as a way to make sure that all teams are competitive, resulting in making the entire league more entertaining, and profitable. Total profits to major league baseball might be greater if all of the teams could compete for talent on a more equal basis. But, I’d suspect that the big market teams, might be worth less, so that won’t happen, and I remain on strike (into the 12th year).

Python May 1, 2007 at 11:01 pm

John Payne,

Not to go off on a tangent, but the professor (nor the person he quoted) made no estimate of how many Chinese restaurants there are in the US. Consider the statement: "Every city in the United States that has over 1 million people has at least one female."

Stephen Samild May 2, 2007 at 12:11 am

So basically, baseball is like government!

Russell Nelson May 2, 2007 at 3:11 am

Why has nobody yet caught the silliest thing K. Williams said? "Why [should we] believe that competition ensures that people will make optimal decisions?" The answer is that competition does NOT ensure that people will make optimal decisions. It just ensures that people will make better decisions than anybody else in their situation. That's the same reason why it's doubtful that a J. Random will make better decisions than a CEO of a firm. Competition doesn't ensure perfection. It doesn't even ensure wisdom. It just ensures that the most foolish decision-makers have their resources taken away from them.

David P. Graf May 2, 2007 at 8:06 am

As a long-suffering CUBS fan, I'd be interested to see if economics could shed any light on their long record of futility.

REW May 2, 2007 at 8:24 am

A contrast to the KC Royals example is the ownership of the Dallas Mavs by Mark Cuban. In a short tenure he has attempted to bring competitive forces to the league, and he has been treated in a slightly hostile way by the league and other owners.

David Z May 2, 2007 at 8:32 am

"Why has nobody yet caught the silliest thing K. Williams said? "Why [should we] believe that competition ensures that people will make optimal decisions?"

I caught it in an earlier post. Competition doesn't cause better decisions, it merely *allows* for different decisions to be made, which previously were not permitted for some reason or another. Whether the new possibilities are better, is purely subjective.

steve May 2, 2007 at 10:08 am

Baseball is entertainment. As long as people enjoy going to a game or watching it on TV, the team can be economically successful, whether it wins or loses. The same is true in the rest of the entertainment industry. As long as the public enjoys going to see an entertainer, it doesn't matter how bad he is, any more than it matters how bad the team is. In short, the measure of success for a team (from as financial point of view) is not winning, but whether the team generates enough interest to be considered worth watching. Therefore, parallels with most of the business world are misconceived.

HC May 2, 2007 at 10:32 am

Yes, MLB does compete with the NFL and therefore should work to maximize the entire league's entertainment value; but, no, I don't think a Communist salary-cap system is optimal. Rather, I'd favor a more competitive system similar to European Soccer where teams are free to move freely between markets and perpetually poor teams are relegated to lower leagues. This will keep the product dynamic and interesting rather than the stale, homogenous product that the NFL puts out (yes, the NFL is thriving now but I think it will eventually lose it luster just as the NBA did). Also, NY can support 3 teams- why shouldn't KC be able to move to NY to compete down some of the Yankees power. Even better, let's say MLB mandates that they aren't allowed to take the Royals brand out of KC so, if the D-Rays owner is optimistic on the KC market he can move his team there and call them The Royals. Competition between cities and within them will make the game more exciting. Football has no competition between cities- nobody in Indianapolis thought of the SuperBowl as Indy beating Chicago, they thought the Colt beat the Bears; but I guarantee St.Louis thought of the WS as St.L beating Detroit.

sup? May 2, 2007 at 12:26 pm

There's a more simple explanation. Nobody I know of takes the position that competition leads to perfect decision making. Rather, it is the system that, based on its incentives and relative to all other known systems, creates the best odds of quality decision making.

m phillip baudrand May 2, 2007 at 1:12 pm

Baseball is entertainment as David K stated. People watch bad t.v. shows and go to lame movies all the time and have a great time doing it. My suggestion (as I've stated on my blog): move the fences in. Make centerfield 350 feet and left and right 275 feet. When Miguel Cairo hits 50 homers in a year, then you'll see the stadiums packed every night.

David Peterson May 2, 2007 at 1:59 pm

Great post Russell. I think also part of the problem is the word "efficient." Because of that word, some people (economists included) expect a perfect form of efficiency where prices reflect all conditions and information instantaneously. The people who see efficiency as this take any sign of less than perfect efficiency as inefficient.
Then I think there are people who mean a relative form of efficiency when they say "efficient." They don't expect perfect efficiency, just to be more efficient than alternatives could provide. For them showing inefficiencies is irrelevant unless compared to said alternatives.

Chris Poole May 3, 2007 at 9:41 pm

In the many arguments I have with the opponents of the unfettered market I have realised that I, and those who oppose markets, are talking about two different things when we use the word "market".
To the people who aren't happy with it, the market is an ideology, a set of organised and coherent arguments with designers and proponents. It is a thing, an agent, and entity. It "does this" or "fails to do that".
Taking down this straw man is a bigger battle. To me the market is just a notional space where individuals get to do what they damn well please. Where they can enjoy the freedom to be wrong, or make decisions that, added to the decisions that others may also freely make, may lead to results deemed "negative" according to the countless criteria that people use to judge the behaviour of others.
The quality of the decisions will ultimately be better because it is a much tighter feedback loop, where everyone gets to learn as fast as they can how to make good or bad decisions. But still, "good and bad" can only be meaningfully defined by the person with a stake in the outcome of the decision. (About now you have remind people what "freedom" means again – like "freedom from your definitions").
Basically opponents of the market are terrified of the consequences of everyone else being free to do what they want.
In practice there are many way in which markets are efficient, or produce outcomes that come to be recognised as generally good. But fundamentally "Markets" are not there to "maximise efficiency", or produce outcomes that help the economy or the environment.
Markets are just the lesser of two evils: the greater being all those people who think they know better, restricting the freedom of others.

triticale May 4, 2007 at 5:28 pm

I passed thru Moberly Missouri in 2000, when the population was 11,945. I ate at two differenc Chinese buffets there. The better of the two, on the edge of town, was in fact run by a Vietnamese immigrant. Again, you have underestimated the market; someone who has been there more recently will be needed to verify the competitiveness.

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