FanPost

Price, Cost and Value

OCC wrote article showing how many teams still use the traditional draft chart instead of the Harvard chart. You should read it, but then one should read anything OCC writes

http://www.bloggingtheboys.com/2014/4/28/5504076/2014-nfl-draft-the-trade-value-chart-is-alive-and-well

In that article, I had a rather long post [yes even longer than my typical posts]. I thought it was worth cleaning up and presenting as a fanpost. The key is that there are several words that are similar, but have different meanings.

Price and Cost

Price is the actual amount you pay. Buyers and sellers agree on a price during a deal. If they cannot agree on a price, then there is no deal.

Cost is what you have to give up and may be more or less than the price. For example, a firm may donate an item to a charity. The charity gets an item for free but the firm donating does not give up the full selling price.

The donating firm’s true cost may be only half that much as the typical selling price. In essence, they are really only donating their cost basis of the good. They are also forgoing the opportunity cost of doing something else with that good, but that is largely only theoretical in nature and never shows up on a profit/loss statement.[There is no profit realized on a good until it is sold.]

Further, the cost of an item for a manufacturing firm varies by the volume you sell. This has to do with set up cost and actual production costs. Imagine one has to set up a machine to build a widget. One has to spend some time and money doing so. Setup-cost per item varies. Once the machine is set up and ready to go, one wants to make a lot of them. Divide the cost by a lot of items and the cost per unit goes down.

That is why manufacturers like to have standardized goods. Ford was the master of this. The saying was that one could get a model T in any color you like, as long as it was black. GM made money originally by having shorter production runs [higher costs] but had different styles and folks could get what they wanted.

Then there is the cost of actually running the machine. The cost of running a machine is constant. One uses the same electricity, amount of raw materials etc.

Add the set up costs and the production costs together. So how much a item costs to make really depends on how many you make.

Value

Value is harder to understand. This is a perception that is independent of price or cost. This is what how much that item helps you, net of the pain involved.

For example, we traded away a future 7th round pick to get Cook. One does not expect much out of a 7th rounder and a future pick is worth even less.

We traded for Cook as insurance as we did not know if Costa or Kowalski would be available. As insurance, we would have loved to have never to have had to use him. Yet, we cashed in that insurance policy only 3 snaps into the season. We ultimately got 12 starts out of Cook which is outstanding value. One can hardly imagine that season without Cook at center.

In football terms, a team that trades away a player at a position that they have too many high quality players is not losing much. That is especially true if they were to have to get nothing later. We got Drew Henson for a future 3rd round pick even though he was at the time thought to be a lottery pick, because if Houston waited much longer they would have gotten nothing as he would be a FA.

Eventually we did not get much out of him, but a future 3rd round for a lottery pick is good point value on the charts. At the time, many thought we had replicated our drafting for the future rights to Herschel Walker who was playing in the USFL at the time.

Yet, Houston still made out as they took a flyer and drafted him in the sixth round. He was highly touted and thought to be an early pick if he played football but wanted to play baseball. Houston took a risk, but again what do you expect out of a 6th round pick anyhow. converting a 6th round pick into a 3rd round pick is good point value even if they had to wait some time to do so. [Future picks are almost always undervalued for points]

Pricing on Cost or Value

Often firms will sell items on a cost-plus basis. They add a small amount to their costs to give them a profit and that is the price for the item. More advanced sales forces using value as the pricing mechanism.

For example, my brother sells ball bearings – about a $3.5 item based on cost yet often can sell it for $100 of dollars.

The reason is that his firm can save the buyer a lot of money. Their bearings are easy to use as they have some special tools. They can open up a machine and replace those bearing much easier and faster. If you have a machine that when down and not operating costs the buyer $20,000 an hour, saving a little time is more important than a couple of dollars for the metal itself.

We have talked a great deal about how to optimize draft picks. Yet the key is that two teams can value a particular pick in different ways. One major reason is the player that the pick represents.

If team A really need a QB, and the player that they want is expected to be picked at 16 and team B does not want or need a QB, then they have two different ideas on what that draft pick represents. For team A, that pick represents the ability to get a particular player for team B it is just the next best player. If they value that player differently, then the pick is valued differently too.

That is why draft boards are important. Not only for the grouping of players at a particular draft round, but the gaps between the rounds.

We thought Frederick was a 2nd round evaluation. We traded down to 31 which is about as close to the 2nd round as it gets. Yet we took him in the first as we did not think we could wait under our second round.

Traditional vs Harvard charts

The traditional chart was based on actual trades in the past – what teams would trade to get another. This is similar to pricing.

The Harvard chart is based on the probability of success for each pick and as such represents value instead.

Using two different methodologies for different purposes; it is not surprising that the draft picks have different numbers associated with them.

One major cost to a team is the PR nightmare for going off the traditional chart. Further, as pointed out, the team that wants the deal more than the other loses negotiation power and that tips the price one way or the other.

Harvard charts note that early picks are less valuable and later picks more valuable than the traditional chart. Thus a team trading down from early first round picks may get less using the Harvard chart but if may get more trades that way. The pricing may be lower but the value may be higher. This opens up a gap that can be exploited.

Functions of Money

Similar to the discussion on price, cost and value are the functions of money. We have talked about how inflation changes the nominal price of goods. I talked about Romo as the six million dollar man. We can build him better after surgery.

http://www.youtube.com/watch?v=K7zNY0I5JNI

What cost $6 million in 1973 during the run of the show would cost $31.04 million in 2013.

http://www.westegg.com/inflation/infl.cgi

The main functions of money are distinguished as:

Medium of exchange

A medium of exchange is an intermediary used in trade to avoid the inconveniences of a pure barter system. In other words it makes trade easier by converting your X into a unit that we both can use instead of my Y.

Draft charts best use the concept of medium of exchange. Your draft pick is worth so many points and my pick is worth so many points lets swap, but one has to throw in more or better picks to make it approximately even. This was a way to quickly calculate a lot of information and is why the Johnson draft chart became so useful and is now considered the traditional method.

Unit of account

A standard unit of account allows meaningful interpretation of prices, costs, and profits, so that an entity can monitor its own performance and its shareholders can make sense of its past performance and have an idea of its future profitability.

We can go back and discuss past trades and see who got the best point value in the trade. Yet we can also use the Harvard chart to see who actually got the best player.

Store of value

A store of value is the function of an asset that can be saved, retrieved and exchanged at a later time, and be predictably useful when retrieved.

Those pieces of paper are easier to keep than stones, pelts, or other items of value. Today’s draft picks can be traded for future picks, but the future picks have to be one round earlier to make up for waiting just like interest on a loan.

One last idea

Many trades still occur using the traditional chart instead of the Harvard chart. That shows how well ingrained folks have become to the traditional chart. Indeed going off the chart can entail a PR nightmare.

This demonstrates a paradigm or state of mind. Shifting paradigms is hard. Yet if opens an area that a smart team can exploit. Only when a team can consistently show that exploiting this difference is a good thing will others leave their old mindset.

Another user-created commentary provided by a BTB reader.

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