Features - Insight

JANUARY 5, 2006

Formula 1 funding - how does it work?


Many people, even in the sport, do not really understand how Formula 1 racing is funded. It is a complicated business and very different from the way in which other sports work. It has its advantages and its disadvantages.

Many people, even in the sport, do not really understand how Formula 1 racing is funded. It is a complicated business and very different from the way in which other sports work. It has its advantages and its disadvantages.

The traditional sports marketing model is that the holders of the rights to a sport control events which have a value to television broadcasters. The TV companies bid for the right to broadcast the events. Broadcasters package and promote the events for their audiences and hope that advertisers will pay premium prices for the time available during the coverage of these high rating events. Advertising rates for the Super Bowl, the Olympics and World Cup soccer matches are extraordinary. Last year's Super Bowl, for example, had rates of $2.4m for a 30-second slot. There were 60 slots and so the network made $144m from the one broadcast. In addition to that Ameriquest Mortgage paid $15m to sponsor the intermission, featuring rock star Paul McCartney.

Substantial profits mean that the TV companies can afford to invest more in paying for the rights. The thing that complicates the business is the need for venues. The rights holder has to negotiate deals for venues: either paying them or being paid by them, depending on the popularity of the sport. The International Olympic Committee, which has a very bankable business in the Olympic Games, can demand huge investment from cities bidding for the Games. These cities feel their bids are justified to promote local economic growth, build up tourism or improve the image of the city.

There are many different motivations.

In smaller sports the involvement of the venues is more complicated. Sometimes the teams involved will own their own stadium - notably in soccer, baseball and so on. Other venues are owned by local governments. Facility management is an industry in its own right with venues bidding for events and making money by selling tickets, merchandise, food and beverages, naming rights and so on.

There are times also when venues are rented out to promoters, who create their own events, negotiate TV deals, sign up sponsors and attract big name contestants with good prize money. This is widespread in boxing and in motor racing is seen with the Race of Champions event in Paris.

The key driver in the sports marketing business is that the activity involved is of interest to the largest number of people possible. This attracts the money and the rest follows.

It is what happens to that money that makes the difference between the different sports.

In Formula 1 the rights holder is the international automobile federation, which in French is called the Federation Internationale de l'Automobile. It is known as the FIA as a result of the French name.

The FIA decided a few years ago that it did not wish to deal with all the comlicated issues involved in the commercial exploitation of the sport. It therefore negotiated a 100-year lease of the rights to a private company in Britain. There is a complex structure of companies but in general terms this is the known as the Formula One group. It is important that one distinguishes between Formula 1 and Formula One because one is the name by which the sport is best known and the other is the company involved. They are not synonymous on all occasions. Nor does the Formula One group own every company with the words Formula One in their names.

The Formula One group is currently in the process of being sold with three banks getting rid of their shareholdings and a venture capital company called CVC buying control. This company will have Bernie Ecclestone as a minor shareholder. Ecclestone is the man who set up the system in the 1980s and 1990s before he began selling off shares in the business to cash in on his success. He remains a key player because he invented the system and because he has enormous influence over those involved.

Ecclestone thus controls the rights to the sport but his organisation does not exploit all of them because it is simply not a big enough organization. Like the FIA, Ecclestone was not interested in exploiting all the rights. So, in an effort to maximise his profits and minimise his costs, Ecclestone did a deal with another private company called Allsport Management in Geneva. This is run by former journalist Paddy McNally and leases the rights to sell trackside signage, title sponsorships, VIP entertainment, official supplier programmes and various other bits and pieces from the Formula One Group. In exchange McNally pays Formula One Management an annual fee of around $50m. McNally makes probably twice that, perhaps more.

Formula One however retains the other rights, notably the TV deals and negotiates with the teams and with the venues. Formula 1 is so popular that venues have to pay - just as in the case of the Olympic Games. In addition to that they have to meet stringent (and expensive) standards and have to sacrifice many of the traditional sources of income for venues. In most cases, for example, they are not allowed to sell their own signage. They pay a minimum of $13m a year and the contracts seem to include annual increase of 10%. All the circuits have available to recoup these costs are the ticket sales, which explains why F1 tickets can be very expensive. One way around the problem is to expand the capacity of the stadiums, which is sometimes possible but requires a big investment. However this means that the venues can lower the ticket prices and pull in more people. Unfortunately, for this to work there needss to be enough demand - and that is not always the case.

The result of all this is that some venues do not make profits and, in a lot of cases, they need the support of local government money to survive. The local authorities generally seem to feel that the Grands Prix are good for them and that it is worth the money they have to invest.

The Formula 1 teams fund most of their activities with sponsorships, partnerships and revenues from merchandising. However an important source of income is also the payment made to the teams by the Formula One group. There is an agreement in place between the teams, the Formula One group and the FIA. This is called the Concorde Agreement and this is a legally-binding contract which covers all areas of the sport. This details all the various divisions of powers, money and responsibilities but it is confidential.

One of the drawbacks of this system is that the sport gives off an image of being overly secretive and not fully transparent and that has had the effect - along with tobacco money - of driving away some big sponsors and financial institutions that might otherwise be involved if the sport had a more wholesome image.

The payments to the teams are secret but they are based to some extent on performance and to some extent on how important the teams are for the sport. Most of the teams do not really understand why they are being paid the sums they are being paid but they do not ask questions. There is friction because some teams feel that the teams should all get the same money and that there should be no special deals for teams like Ferrari, which reputedly is deemed to be more important that other teams and so gets more cash.

Once it has paid its bills, the Formula One keeps the rest of the money, which makes it a hugely successful business but this success has created problems because the teams, being the actors in the drama, believe that they should get more of the money.

It is a fair point and the negotiation process for a more equitable deal has been ongoing for some time with threats of a`rival championship and so on.

The other big weakness of the system is that the FIA member clubs do not benefit much from the success of Formula 1. The lease fee paid by the Formula One group was a one-time payment - although there are believed to be some annual recurring costs as well. The money - which was only around $350m - went into a foundation which funds research programmes for the FIA but the many millions that the sport generates are not filtering through to the sport to grassroots level as happens in other sports. This means that there is no investment in the sport at lower levels and also means that poor countries have no real chance to ever build up a motor racing infrastructure. They cannot even afford to pay for a local rally series, a kart track or a scholarship scheme for a talented youngster. This is a source of discontent amongst some of the clubs but to date no-one has seriously challenged the logic of the deal nor the power of the current FIA leadership.

Despite these flaws, Formula 1 is hugely successful and has created probably 200 or more millionaires over the last 25 years. It has made Ecclestone a multibillionaire and it continues to go from strength to strength. The various parties involved push and shove and whine and gripe and perhaps there are better ways for the sport to be structured but things are not about to change in a short period of time.

Perhaps when some of the current personalities involved have moved on there will be reform but until they do they will be fighting as they always have done.