Economics of MLS Allocation Assets – Pt 2

In this one I summarize the last post’s conclusions (part 1), expand further from there, look at some data on TAM price inflation, and then draw what I believe to be a very important conclusion re: how best to use allocation money for clubs in an inflationary environment (TAM-related).

Quickly revisiting Pt 1 plus some knock-ons

In the last post I wandered through some scenarios in an attempt to understand the best and worst uses of the league’s complex fiat currencies: General Allocation Money (GAM) and Targeted Allocation Money (TAM).

I ultimately concluded that GAM and TAM are best used via the action that destroys them forever: the buying down of player salaries via centralized league funds and/or the buying down of a transfer fee for an imported player via centralized league funds. Essentially, every dollar of GAM or TAM in your possession is a way to increase your team’s competitive position relative to the rest of the league (by carrying a higher wage bill than is otherwise allowed under the league’s complex roster rules). So any transaction that sends GAM or TAM to another team within MLS rather than the aforementioned transactions which destroys/uses the GAM/TAM is a transaction that lowers your team’s potential wages relative to the rest of the league’s potential wages (all things equal). As an example, and as a first order, trading GAM/TAM assets to another MLS team in exchange for a player’s current contract with said team is at face value an inefficient way to optimize your team’s competitive position, in that you are increasing the other team’s total potential wages and decreasing your own team’s potential total wages. In the last article I posited that the only scenario in which a trade might make sense would be if the player’s current contract is “favorable” (e.g. player is good enough to make $250K/year, but is making $100K/year and has time remaining left on the contract). But ultimately, I concluded that because the market for MLS caliber players is much larger than just the sum of all current MLS players, it follows that the GAM/TAM that is sent in this scenario to acquire a favorable player contract from another MLS team could just as easy be used to “buy down” a portion of a “market value” contract for a player transferring in from overseas to where the net effect might be the same hit to the salary budget charge, with the added bonus of not increasing your opponents’ total potential wages relative to your own.

Some things I did not mention in the last article but that I think are worth mentioning:

  • The argument that the total pool of MLS caliber players is much larger than the current MLS player pool is dependent upon a team’s availability to information on players in this larger pool. Information on MLS players is naturally more available to a team than it is for foreign players in other leagues. As such, the total pool of MLS caliber players is only significantly larger to a team than the current MLS player pool if the team is willing to spend real money on scouting and analytics, things which close the information gap for MLS players vs import players. It follows that the decision point between trading GAM/TAM to another MLS team in exchange for a player you have easily available information on versus using GAM/TAM to sign a similar player from another league might come down to a tradeoff between 1) spending league money (no incremental cost to owner) accompanied by lowering your team’s wage bill relative to other teams to acquire a player and 2) spending real money (incremental cost to owner) on scouting and analytics so that the team can maintain a higher wage bill relative to other teams to acquire a player. Ultimately, this suggests club ambition and owner finances come into play as it relates to which strategy a club pursues.
  • Further, stocking one’s team with more international players than other teams have on their rosters comes at a nominal cost: a trade with another team to acquire an additional international slot (above the baseline 8). Historically these slots trade on the “open market” for somewhere in the range of $50K-$70K of allocation money but draft picks can also be used. So it should also follow that trading GAM/TAM assets to another team in exchange for additional international slots might be acceptable in that it frees a team up to not send even more GAM/TAM to other teams in exchange for players. But importantly, it might be more efficient to trade Super Draft picks instead, given the level of uncertainty involved in SuperDraft picks.
  • Additionally, MLS has some strange rules around player discovery which require a nominal amount of allocation money to exchange hands whenever a player is signed by one club but the player has been identified as a discovery player by another club. So allocation money has trade value in these situations.

Other Prickly elements of fiat currency (and thus GAM & TAM): Inflation

Because GAM and TAM are fiat currency, created out of thin air by the central MLS governing body (backed solely by the League itself for the ultimate use of increasing a team’s wage bill above preset limits), the fair market value of a dollar of TAM or GAM has the potential to act erratically, fluctuating based of the actions of the governing MLS body – principally its ability to increase or decrease the supply of TAM or GAM. This may or may not be manifesting itself at the present moment as we witnessed deal after deal at the close of the most recent MLS transfer window involve higher amounts of allocation money than we would’ve previously seen (had these amounts been as transparently reported by the league as they are today). The word on the street is that there is another round of TAM injection coming into the league, and perhaps in addition to this, an added optional TAM purchase options for clubs (spend incremental owner real dollars to acquire incremental TAM dollars used to increase team wage bill legally). And perhaps, what is only speculation by folks like me is confirmed behind closed doors by various MLS owners. If in fact, a new injection of TAM is on the horizon, and importantly, one that is larger than we’ve seen in the past, than we would expect to see some inflation in the going rate of player contracts or other MLS assets as priced in TAM.

Note: Sam Stejskal released this very good piece on TAM inflation as I was writing this piece. He tackles some really interesting wrinkles I did not pick up on, related to wages right around the max charge and inefficiencies in the market there.

Player contracts are messy and hard to value for many reasons, the least of which being we don’t have full access to the number of years left on any given deal. More significantly the fair wage valuation of a player is very subjective. But we do have some theoretically easy to value assets we can look at, to see if inflation is creeping up on allocation money.

Study: Inflation in the GAM/TAM exchange rate for International Slots / Spots

If we look at the market for International Spots, we can see an increasing trend within this season. It’s possible that this is demand-side inflation as teams MUST comply with the roster requirements as the transfer window begins to shut, but I don’t have a mental model to think through it… seems to me like unused IS spots should decline in value as the transfer window comes to an end, just as the teams who need IS spots start to really, really need them…in my mind there’s an equilibrium here, but I may not have it right. Anyhow, assuming that demand-side inflation is minimal, I thought we’d look at the available data of pure play International Spot deals to see if there’s some supply side inflation as the season has progressed. By my count there have been 15 trades involving international spots since the league started disclosing the general terms of trades between its members this year. From December 2016 until now only 7 of these have been straight swaps of international spots for allocation monies. Here they are:IntlSpotInflation

For deals done in the summer months I’ve multiplied the price of the GAM/TAM by two since the team acquiring the international spot is basically only acquiring half a season (or less) worth of it. What we find is that the price of international spots has risen as the season has kicked on. With smaller subleases going for full annual prices this summer, reflected above as increased prices in the chart. It’s a small sample size but I think it’s something. Notably, with the exception of one deal between Atlanta and NYC, these are all GAM deals, which tells us that the inflation is not due to the expiry of the assets themselves (TAM assets which have a shelf life would theoretically lose value as they approach their expiration dates (remember, they die after 4 full transfer windows and so one would expect unused TAM that’s about to expire to be given away freely at the close of a transfer window).

Again, it’s possible this is a natural demand-side phenomenon with teams *needing* to comply with the roster rules in a timely manner and the teams with unused spots sitting back and laughing at them…but again, unused Intl Slots are worth $0, so it’s difficult to prove.

What of it? The Perhaps Very Important Stuff

I suppose the next question though is, what if there’s some inflation in TAM or in GAM due to teams expecting a fresh injection of funds into the league in the coming years? Does it change the conclusions we’ve already reached regarding “good” and “bad” ways to use allocation moneys? What are the broad market impacts of said inflation?

I may have to get into this deeper next time, but I see the impact being completely different for the non-international player market compared to the international player market. There is a basically finite supply of MLS caliber non international players in MLS. Each year some of them retire, some come up through academies or through the SuperDraft — others drop to lower leagues. So my gut is that an increase in TAM injections would be highly inflationary as it relates to non-international player wages (and yes trade fees, if you want to call them that), when we talk about the final use of TAM – which is the paying down of wages and transfer fees to meet cap rules. For the international player market, I think it’s completely different. Remember, TAM & GAM aren’t ever traded outside the league – they don’t exist. They are traded within the league, or they are USED (dead). Will teams looking to buy foreign have more funds to play with (and still comply with roster rules)? Yes. But will this have a huge impact in the global market for footballers? I don’t really think so. The supply is vast. To my eye the implications of this disparity for front offices in MLS is massive. If the price in allocation moneys for a non-international player is inflating but the price in allocation moneys for paying down an international players wages is NOT, it seems obvious that there’s a market inefficiency here that can be translated into a big competitive advantage.

Columbus Crew Vacuuming Up Minnesota United’s Pennies

Let’s take one of these recent trades and use it as an example. The opening assumption here is subjective, which is that Minnesota has overpaid the Columbus Crew for Ethan Finley. Don’t get too hung up on whether you disagree with that. Let’s just follow the math. Minnesota got Finlay (on a salary of $290K a year – is he worth more than that?) in exchange for $425K of total allocation monies ($100K TAM in 2017, $250K TAM in 2018, $75K GAM in 2018) paid to Columbus. If this price reflects the inflation of non-international players denominated in TAM assets because of a looming $2M TAM injection in 2018 — and I believe it does), just think what Columbus can do with these fiat funds on the international market. Because while there’s a finite supply of mid 20s American wingers (and thus his price in TAM is inflated), for that money they can replace him with an international player on $100K more wages per year (if they get him on a free), or they can use allocation money to buy down a transfer fee for a player on similar wages. Put another way, they can sell their asset (Finlay’s player contract) in an inflated fiat currency (TAM) and purchase a better one with a stable global currency ($USD) and then use the TAM to pay down the player’s wages $ for $ (without the inflation). This seems like a bit of arbitrage to me, but please let me know if I’m missing something.

In short, in this new environment of domestic TAM inflation, not only does it continue to make sense for the most ambitiously competitive teams to spend real $ on scouting & analytics and in doing so, maximize their GAM/TAM via *using* it to pay down player salaries rather than trading GAM/TAM, but in addition, it also makes sense to SELL domestic at inflated TAM rates, to then turn around and BUY international and USE TAM to buy down the international players purchased at normal rates.

Bullet points for my working MLS front office manual for a highly ambitious club.

  • Spend GAM/TAM primarily to buy down player wages/foreign transfer fees below roster caps.
  • Do not trade GAM/TAM in exchange for MLS player contracts (lowers overall competitive ability due to relative wages)
  • To achieve the above two bullet points, real investment in scouting and analytics / recruitment departments is important to close the information gap for international player market compared to current MLS player market.
  • In inflationary TAM environment, selling non-internationals (fixed supply) for TAM makes sense to then buy internationals, using the TAM you received to buy down their wages/transfer fees below the caps. (sell high, buy low)
  • Acquiring future international slots now at nominal rates might make sense to achieve the above strategy of exploiting the two separate player markets. If you can trade draft picks to acquire these international spots, do that.

Thoughts?

 

The Economics of GAM and TAM

Trying to figure out how General Allocation Money and Targeted Allocation Money work in Major League Soccer has been an adventure for me.

MLS Salary Budget Rules Overview – skip it if you know it

MLS is a single entity owned jointly by its members – who are owners of the teams competing in the league. All the owners agree (and jointly with the MLS players union) on how much is going to be spent on players in a given season, and then the league sets the rules around roster construction and provides all the teams a specific amount of money to spend based on these rules. There are specifics and then crazy specifics, but as a general rule, it works like this: Each MLS team is made up of 28-29 players, the wages for 20 of which (the senior roster) are governed by the Salary Cap. Each of these 20 players will carry a salary cap charge between the senior minimum ($65K) and the maximum budget charge ($480K), for a total of $3.8M in salary budget. In order for a team to sign a player making more than $480K (or to sign a player by paying a fee + wages greater than $480K), while still making use of these shared League funds (i.e. not opening up the individual team owner’s pocket book), it has to use up some of its “Allocation Money” (also handed out by the League to each of its member teams based on #rules), which comes in two forms: General Allocation Money and Targeted Allocation Money.

General Allocation Money (each team receives $200K of each year +/- amounts triggered by a variety of achievements and/or other events) does not expire and generally doesn’t have any additional restrictions with it. You use it to bring your roster in line with the salary budget when it exceeds it, either for an individual player charge, or more generally for the team’s total budget.

Targeted Allocation Money is like GAM except it can only be used for players making between $480K and $1M, and it is given out in tranches (agreed to on an ad hoc basis by the league, it would seem ) which each expire after 2 transfer windows. A summary of the recent TAM injections are as follows:

  • 2015 – $500K per club
  • 2016 – $800K per club (expires at the end of 2017 season)
  • 2017 – $1.2M per club (expires at the end of 2018 season)

GAM and TAM are tradeable between MLS teams, and GAM and TAM cannot be combined together to pay down any player’s contract or transfer fee.

Importantly, if a team wants to sign a player above the max budget charge of $480K AND it doesn’t want to (or can’t) spend allocation money (GAM or TAM) to “buy the budget charge down to $480K, it can pay for the salary (or transfer fee) in excess of $480K out of its owner’s own pockets (for up to 3 players) and the player’s budget charge would remain the max of $480K. Such players are known as Designated Players. And the budget charge for a designated player can be less than $480K if a player is 23 years of age or younger.

Other Background Reading on the topic from some immortals: Doyle, Stejskal, and I will add some more here.

Edited to add: Somehow I missed linking to Jared Young’s comprehensive CAP review at AmericanSoccerAnalysis, here.

Some Takeaways

So, it’s important to point out that a team does not have to sign any designated players. They can play with “League money” only — let’s call it $5.2M ($3.8M budget + $1.4M in estimated annual allocation money). In fact, 1 of those 3 potential designated player slots costs a team that uses it $150K, which is paid to the League, and then distributed as additional GAM to all teams who do not use up all 3 designated player slots. But most importantly, in light of all of this, if a team does not “use” its allocation money, it should consider it a real economic cost, since it is already paid for. Use it or lose it. Alternatively, it can trade away its allocation monies, potentially operating on a senior roster of wages totalling as low as $3.8M. But my important takeaway from all that is that anything within the $5.2M umbrella is all “MLS Money.” There’s no way to exchange it for outside dollars, and it’s already been paid for (by the league, or by each member contributing the required annual amounts to the league, or however they settle it). To some extent it is a sunk cost. Anything above that $5.2M threshold – the DP money – is real money, real incremental dollars – real economic decisions to be made by a rational club owner.

And given that it’s included in the “MLS money” umbrella, and not in the “outside money” (or “real money”) bucket, GAM and TAM are endlessly interesting to me. I want to explore the question: what is the best (most efficient?) way for an MLS club to use GAM and TAM? As a reminder/checkpoint, here’s what you can do with GAM and TAM.

  • Trade it to another club in exchange for things such as Players, other allocation moneys, International Spots, Draft Picks, Allocation/Waiver Priority.
    • As an example, Orlando City could trade $400K of General Allocation Money and $500K of Targeted Allocation Money to Sporting Kansas City in exchange for the rights to Dom Dwyer’s contract ($680K/year salary with 1-2 years left).
  • “Buy down” a salary budget charge for a DP to below the max charge (and to no lower than $150K)
    • As an example, Atlanta United could sign Chris McCann for $570K and spend $90K of TAM to buy McCann’s budget charge down to $480K (keeping the DP tag off of him).
  • “Buy down” a salary budget charge to no less than half the original charge
  • “Buy down” a transfer fee or loan fee so that it does not count towards your salary budget (either at an individual level or a team level.
    • As an example a team could pay a $500K transfer fee to foreign club for a player on $400K/year in wages. The team could spend $500K in TAM or GAM to eliminate the transfer fee from being included in the team’s salary budget.

Fiat Money

It’s important to point out that for the purposes of understanding how GAM and TAM function in MLS, both types of asset are what’s known as “fiat currency” — currency whose value is backed solely by the entity that issues it. In other words it is Monopoly money. It is both created and destroyed by MLS. It has value to MLS teams because MLS is the league they compete in and it is used to subsidize MLS salary caps. Under no circumstances could TAM or GAM be sent to a team outside of MLS; they simply would not accept it. It doesn’t exist. When MLS creates new TAM, it simply decrees that TAM has been created and it can destroy it as well.

Since TAM and GAM are fiat, it is also true that in only 1 of the above 4 uses of allocation money, does the allocation money survive the transaction (if it is traded). If it is spent buying down salary budget charges or buying down a transfer fee, it disappears into the ether, decreasing the overall aggregate supply of allocation money in the league. Allocation money can exchange hands in MLS, but its final resting place — its ultimate purpose is to be destroyed/spent in exchange for a given MLS team being granted the ability to invest slightly more into its senior roster than otherwise is permitted. Further, TAM will even die of old age if it is not destroyed within 4 transfer windows (a 2 year shelf life).

With this in mind, I have a hunch about how allocation money is best used, and how it’s not. Let’s do some accounting homework.

Scenario Analysis

MLS Team A needs a striker, and they’re considering two potential options.

Option A:  Striker John Doe, 26 years old from the Championship in England. He can be signed by paying his current club a $1.6M transfer fee and he wants a contract worth $400K per year. To comply with MLS roster rules and not make John a designated player (i.e. not spend any outside “real money” but just “MLS money”), MLS Team A would need to spend (send to MLS HQ) $1.6M in allocation money to eliminate the transfer fee from the budget, so they can sign him and slot his $400K of wages into the $5.2M-ish MLS budget.

Option B: Striker Dom Doe, 26 years old and currently on MLS Team B’s roster. He can be traded for by paying his club $400K of GAM, $1.2M of TAM and he’s on a contract worth $400K per year. MLS Team A would need to send $1.6M of allocation money to MLS Team B, and then Dom Joe would fit into MLS Team A’s senior roster budget just fine ($400K is below the maximum MLS salary budget charge).

Assuming MLS Team A has enough cap room and allocation money to execute either option and assuming John Doe and Dom Doe are of equal talent, health, work ethic, and potential, and that both qualify as international players under MLS rules, which transaction (Option A or Option B) should MLS Team A go through with?

In my mind, the answer is clear, but this might be a controversial opinion, I’m not sure. Under both scenarios, Team A gains the striker, loses $400K of cap space, loses $1.6M of allocation money, and loses 1 free international slot. But if Team A trades for the striker with Team B, they transfer “MLS money” (fiat assets) to a competitor plus the competitor gains $400K of cap room to replace the striker), whereas if Team A buys the striker from England, Team A *uses* the MLS money– they use it up. It is destroyed. It returns to the earth from whence it came, and no other MLS teams can use it to improve their squad. See the difference? Allocation Money’s ultimate use is to be torn up into shreds in exchange for allowing a club to field a more competitive side by increasing the total wage bill without breaking the salary budget rules. You can either *just do it* and sign a player, and comply with the rules by using GAM/TAM to lower your charges, or you can transfer said GAM/TAM to an opponent in order to get your player, and that other team will replace him with A) the salary budget room they just added in his absence + B) the new allocation money which can allow them to pay his replacement even more!

So, why would Team A ever trade MLS Money to another MLS team to acquire the other team’s striker (if the global football market surely provides a supply of similar players that this hypothetical assumes) and if in doing so, they benefit the other team? I can think of one scenario that makes sense, and that’s when the other MLS team has locked up a favorable contract with said player (because MLS is a single entity, contracts do not get ripped up upon trades between its member teams). So if Dom Doe deserves to be paid $650K but he’s making $400K with MLS Team B, and since MLS is a single entity and contracts transfer between teams, MLS Team A might be willing to “pay” for the favorable contract (to get a guy worth $650K but only pay him $400K, and only take a $400K budget charge). Since MLS Team B will be shipping out a player worthy of $650K/year but is only taking a $400K budget charge, they may only be willing to part with the player if they are compensated for the fact that they will have to replace the player worthy of $650K with a player to be paid $400K (to continue compliance with MLS roster rules). So what would the value of this contract be? What might the two teams agree to as a fee? Maybe its $250K multiplied by the remaining years on the contract, maybe its $300K per year (a little extra for the hastle?).

But again, instead of doing this whole thing, can’t Team A simply sign a player from overseas who makes $650K and buy down $250K of the contract with allocation money if they need to fit him into a $400K budget hole? The result seems similar. I suppose it comes down to valuations. If you value the contract higher than the $300K they’re asking for, you do it.

In the end, MLS is unique from other American sports where trading is more frequent. In those sports , virtually the full labor market for a given sport exists under one collective bargaining agreement, and all the players you would want to sign player for teams in your league, your competitors. In MLS, you can sign a player from anywhere in the world, so there is no need to grease the wheels of other MLS teams to acquire their contracts when you can go out and sign your own. The supply of players is nearly infinite but the supply of GAM/TAM is … not, at least not yet?

OK, just going to publish this now. Let me know your thoughts please. I’m 100% certain I got some big stuff wrong in here, but how else will we figure this stuff out, except by trying.

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Late Edit after some feedback on Twitter:

Some things that have been pointed out are:

  1. To assume you’ve got an endless supply of replacement players in the global market, you have to account for the real world cost (real $ not MLS $) of hiring scouts, more of them, and better ones, and analytics departments and all sorts of other things that cost real money. Inherent in this is the admission that a player you are familiar with (by way of seeing him in MLS and knowing he can produce at this level) is more valuable than a mystery player. So the tradeoff is basically, you can spend more real world money in order to close that information gap (of a foreign playe relative to an existing MLS player) and hope to maximize your cap room / wage bill relative to the rest of the league’s wages, or you can save the real world money (don’t use it on scouting etc) and use the MLS money (by trading it) to acquire the player you have more info on.
  2. On that point, it has been suggested that a better way to phrase the argument is that by trading GAM/TAM to another MLS team you are actively shrinking your team’s wage bill relative to the wage bill of the rest of the league (all else equal, like say if you take DPs out of it, or assume everyone spends big on DPs).
  3. It was brought up that allocation money is perhaps *more* valuable for lower spending teams who do not plan to spend on DPs, which could create some interesting value disparities and therefore trade opportunities when it’s a big spender dealing with a low spender.