Interesting Forbes article on F1 costs and changes from Liberty

Thought this was a mighty interesting article:

https://www.forbes.com/sites/csylt/2018/06/06/the-real-reason-f1s-top-teams-are-threatening-to-quit/#10292dc36355

Formula One auto racing is reaching a crossroads. The series was sold last year for $4.6 billion to investment firm Liberty Media which is transforming F1’s business model for the first time in decades. It has fuelled a revolt from Ferrari and Mercedes which will see their prize money slashed and costs capped to prevent them from boosting their spending to gain an edge on track. However this isn’t the biggest roadblock in the way of reconciliation.

F1’s high-octane valuation was driven by the business engine under its hood. Last year it had revenue of $1.8 billion which came from four key sources.

The smallest is the $273 million of revenue paid by advertizers including watch maker Rolex and the Emirates airline. Next up is corporate hospitality ticket sales which, along with other miscellaneous sources, came to $301.5 million. It is followed by $601.2 million from television broadcasters and $608.3 million that event organizers pay for the rights to host F1 races. It comes to an average of $30.4 million per race but that’s just the start.

The hosting fees typically accelerate by 5% annually due to escalators in the race promotion contracts. It has led to the biggest-payers having an annual bill north of $70 million which makes a massive dent in their bottom line.

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F1 returns to Canada this weekend under a cloud of uncertainty as its top teams have threatened to quit (Photo by Melzer/ullstein bild via Getty Images)





Unlike most sports hosts, F1 race organizers generally don't receive any of the revenue from the broadcast of their event or the advertising and official hospitality at it. That all heads to F1 itself which is owned by Liberty and listed on on the Nasdaq through a tracking stock with the ticker FWONK. It leaves the race hosts with only the revenue from ticket sales but that’s far from the end of the story.

Almost all of the races also receive funding from the local state or government as the event promotes the destination to F1’s TV audience which hit 352.3 million last year. This funding is roughly equivalent to the running costs of the race with ticket sales covering the hosting fee so that the event breaks even. However, as the hosting fee rises annually the ticket prices usually do too to compensate.


Every year since 2006, a team including this author has been collecting data about the highest and lowest ticket prices at every Grand Prix, along with the attendance from Friday to Sunday. It is a gold mine of information and is available to the public here in a report. For full disclosure, it needs to be stressed that this author was involved with compiling the report and with the data acquisition process, although the information comes directly from the race organizers, which are all independent sources.

The report is the only study of its kind and covers 573 days at 191 races. The impact of the increasing hosting fees is highlighted through the fact that in the two years to 2017 alone, the average three-day ticket price rose 8.9%, from $438 to $477.

The change was calculated by first arriving at the average price, across all races in a year, for the cheapest three-day tickets. The same was then done for the most expensive three-day tickets, and the two results were added together and divided by two to get the average for that year. The difference between the averages could then be calculated.

As ticket prices have surged, spectator numbers have reversed and the report reveals that the average three-day attendance at F1 races fell by 1.6% to 184,408 over the decade to 2017. In a bid to turn this trend around Liberty is steering F1 in a new direction which appears to be a risky maneuver.

When Liberty took the wheel of F1 it replaced Bernie Ecclestone who had been the boss of the series for nearly 40 years. His replacement was former News Corp executive Chase Carey who soon said that he hoped to add another race in the United States where there is currently only one in Austin, Texas. Carey said he was targeting “destination cities” such as Los Angeles, New York and Miami which would boost F1’s visibility in the US where it trails in popularity behind the home grown NASCAR and IndyCar series.

These cities don’t need F1 to drive tourism so there is little hope of getting state funding as is usually the case, even in Austin which contributes around $19.5 million annually to its Grand Prix according to an Associated Press report. In place of this, Liberty has created a partnership model which is due to be pioneered at a race in Miami next year.

It is expected that this will see F1 waiving the hosting fee and sharing the costs, as well as the ticket sales, with a local promoter. It is likely to anger existing race hosts as they are paying huge sums to host an event which Miami is believed to be getting for free. As Britain’s Daily Telegraph revealed, F1’s race hosts have already signalled that they aren’t prepared to continue paying their current rates. Miami’s cut-price deal is likely to inflame them further and that isn’t the only risk.

As we have reported, F1 could end up making a loss on Miami as the promoter carries the risk in the race hosting model. There is no guarantee how many tickets will be sold and this uncertainty could send both F1 and the teams into a spin.

F1’s biggest single cost is the payment of prize money to the teams which is equivalent to 68% of its underlying profit and came to $919 million last year. They have become dependent on it.

As we have reported, the teams’ latest financial statements show that they have $2.6 billion of combined costs so the prize money covered 35% of that. Our research shows that it is the largest single revenue generator for the teams followed by 33% from sponsorship, contributions from owners at 15%, the sale of engines and technology providing 6% and the remainder coming from miscellaneous sources.

Forward-planning is the key to keeping the teams’ wheels turning. One of the teams’ biggest costs is research and development with four-time champions Red Bull Racing alone spending $120.1 million (£97.6 million) in 2016. R&D is largely directed at the design of the cars which is done the year before they race. So in order for the teams to budget it is crucial for them to know how much money they will have at their disposal. Their sponsorship contracts are usually multi-year with equal payments and, as the table below shows, they have previously been able to bank on the prize money rising every year which aided their forecasts. Not any more.

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F1's prize money payments reversed in Liberty's first year at the wheel

Since Liberty got into the driving seat it has boosted F1’s costs by 12.1% to $427 million last year as shown by the table below. It has re-branded the series, launched a series of street demonstrations, moved F1 to a plush new headquarters in London, England, and doubled the headcount, as we revealed.

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F1's costs accelerated last year as Liberty moved the series into a plush new office and doubled its headcount

These cost drivers are also gambles as they have yet to pay off. It doesn’t stop there as Liberty has also failed to sign any big ticket sponsors but has lost deals as we reported. It led to revenue reversing by 0.7% last year which is clear from the table below.

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A loss of sponsorship fuelled a fall in revenue in 2017

 

The increase in costs coupled with the reduction in revenue has driven up the red ink. Last year F1 burned up a $37 million operating loss, down from a $47 million profit in 2016. In turn, the teams’ prize money has crashed as it is based on a share of F1’s profits.

Not being able to bank on prize money increasing makes it harder for the teams to forecast and this problem is magnified by the the new business model for races. Hosting fees currently bring in the biggest chunk of the teams’ prize money and replacing that with a share of ticket sales increases uncertainty as it is hard to predict how big the crowds will be.

The more races that follow this new model, the greater the gamble will be for the teams and F1. It affects bigger teams more than the minnows as they have more money at stake so their owners need a greater level of certainty over the revenue before committing to back the outfit.

It explains why Toto Wolff, boss of the Mercedes F1 team, recently said “fees were one of the three key revenue generators in the old Bernie Formula One business model. And he was exceptional at these deals. I’m not sure that is sustainable...Maybe that one pillar (hosting fees) is going to be difficult to maintain on the levels we have seen before. We have to grow in other areas, we have to grow broadcast deals and digital revenue and monetize alternative revenue streams.”

Liberty has a radical solution to boost the teams’ visibility and make it easier for their owners to commit. It involves introducing a cap on budgets in 2021 when the teams’ current contracts come to an end. In addition, the prize money bonuses that the top teams currently receive are due to be spread more evenly between the field with Ferrari being one of the biggest losers.

The Italian team currently gets a guaranteed $92.2 million before a single race begins but this would be cut by half under Liberty’s plans. Understandably, it has fuelled frustration, as has the budget cap because the top teams would have to make massive layoffs and it would prevent them from spending more in a bid to gain an advantage on track.

Ferrari and McLaren have threatened to leave F1 if the rules are introduced but this is one crash that could still be avoided. A simpler solution, which leads to less uncertainty, could be right under Liberty’s nose.


It could be argued that the real roadblock in the way of modernizing F1’s business model isn’t that the teams’ costs are out of control but their revenue is. If they had less at their disposal it would keep budgets in check more naturally. There is no doubt that $919 million is an exorbitant sum to receive just for getting 20 cars around 21 tracks. It is especially hard to justify when NASCAR pays its teams just 25% of the fee from its TV deal with NBC and Fox which are believed to be paying a combined $820 million annually.

If the teams’ share of F1’s profits was reduced from 68% to around 40% it would free up $378 million which could be passed to the race promoters either to directly reduce the amount they pay or, better still, to be used as a discount fund to reduce their fee depending on how many spectators attend their event. The greater the number of spectators, the lower the cost of the race would be.

As the race hosting fees currently generate $608.3 million this discount would reduce them by 62% which in turn would drive down ticket prices. There would be no danger of fans turning away from F1 then.

As things currently stand this would put the teams under tremendous pressure as it would wipe out $378 million of their revenue but a budget cap could address that and it is understood that Liberty will introduce that anyway so this wouldn’t be a major change to its plans.

It is easy for the teams to complain about getting less prize money because Liberty has boosted F1’s spending on gambles. However, it would be much harder for them to find fault with a redistribution of that revenue to the promoters and ultimately the fans.

Liberty’s share of the spoils would be identical as although it would receive less from the race hosts the amount it pays the teams in prize money would be reduced by exactly the same amount. Based on last year’s financial performance the teams would get a total of $541 million in prize money which is still a gigantic sum by anyone’s standards and that’s before taking into account income from sponsorship and other sources. Half a billion Dollars alone should be more than enough to get 20 cars around 21 tracks and a budget cap would ensure that they could all be sustainable with it.

The big difference over Liberty’s current plans is that it would also secure the future of all the races without having to resort to giving away ‘free’ events like Miami which make it harder for the teams to forecast their budgets. The biggest winners would be the fans as it would put the brakes on the rising ticket prices. Unless Liberty takes steps to address that F1 could still be on track for a crash even if it manages to swerve around a collision with the teams.