Spending

Spending cap heralds return to profitability for F1 teams

Changes to F1’s business model have helped teams become more financially self-sufficient. © Clive Mason – Formula 1 via Getty Images

The profitability of Formula 1 teams is traditionally summed up in a joke attributed to American Nascar driver Junior Johnson: “The best way to make a small fortune in racing is to start with a big one”.

Historically, the most successful teams – particularly Ferrari, but recently also Red Bull and Mercedes – have had to spend lavishly to stay at or near the front of the grid. In recent years, more than $400 million could be spent in a season.

And, over the past decade, at least four of the 10 teams on the grid have struggled financially, including McLaren, who “spent everything we had and then part in our desire to get back to the front of scene,” according to Chief Executive Zak Brown.

But those days of endless spending seem to be coming to an end – along with the long history of teams going through a season cutting corners, paying salaries late or not at all, bringing in uncompetitive “pay drivers” for their ability to bring in money. , and, in the not-too-distant past, receiving mid-season bailouts from former F1 ringmaster Bernie Ecclestone.

Now, under Liberty Media ownership, the sport has made some changes. Increased revenue from television contracts and racing promoters helped create a $700 million prize pool to be shared among the 10 teams, in addition to sponsorship deals.

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But the most critical new development was the introduction last year of a mandatory cap on most (but not all) team spend categories: starting at $145 million in 2021, dropping to $140 million. this year and $135 million in 2023.

“A lot of teams didn’t need to be profitable because their owners saw it as part of a global investment that paid off for the business,” said Stefano Domenicali, managing director of Formula One Group. “But, to drive the growth of our business, it is essential to maintain the financial viability of our key stakeholders, which means controlling costs while increasing revenues.”

Domenicali, who was a team principal at Ferrari between 2008 and 2014, says the impact of the cost cap is already visible in teams’ balance sheets. “Despite the Covid situation, last year was the first where we did not receive any requests for deposits from the teams”, he specifies.

“As a business proposition, Formula 1 is very stable and solid – all teams can make money. We have never had so many partners investing in the sport, either directly with us or with the teams. And we see the level of return on investment increasing as we expand into new markets such as the United States.”

Domenicali also says the benefits of the cost cap are visible in the narrowing performance gaps between different cars. “All the teams had scored points after five races, which had never happened before in the history of Formula 1,” he said, arguing that this not only means more prize money for all the teams, but also helps them negotiate better sponsorship deals. .

Even teams that were among F1’s big spenders see the value of the cost cap.

“This has prevented billionaire team owners from spending more on wages than others,” says Toto Wolff, team principal and shareholder of eight-time constructors’ champion Mercedes. “Escalating costs made teams unsustainable, which meant Formula 1 was not attractive to potential new entrants.

Toto Wolff, team principal and CEO of the Mercedes team © AFP via Getty Images

“Today investors know you can’t spend more than $140 million and neither can Mercedes and Ferrari. Meanwhile, Ebit [earnings before interest and taxes] of F1 is growing, and the teams are taking around 70%. Even the lowest-ranked team will receive between $75 million and $80 million in TV money before signing a single money-making sponsor or driver. The most important thing for team owners is the predictability of their business case. »

It is also an important development for large teams. “We have gone from a cost center – although we have always been close to break-even due to our success – to a double-digit Ebit business,” says Wolff. “For a team owner, rather than just being a trophy investment that generates a return on marketing, it has become a profitable sports and entertainment business.”

The cost cap was long overdue, according to McLaren’s Brown. “Before, there was really no path to profitability because the sport was about who could afford to lose the most,” he says. “It’s still early days, but we’re seeing signs of how it’s starting to level the playing field. I think it will provide fans with more competitive and compelling racing across the peloton, and a better financial proposition for fans. racing teams and their shareholders.

However, this has significant implications for new entrants and the value of F1 teams. Opportunities to enter the sport through struggling sales have drastically diminished. There also doesn’t seem to be much enthusiasm among existing teams to expand the grid size to a maximum of 24 cars, not least because it would split the revenue pie in a number of ways.

“It would only make sense if a new team was accretive to the business in terms of brand image or incremental revenue,” Wolff says.

From an economic perspective, F1 teams are increasingly likely to resemble the American sports franchise model, he suggests, in terms of limited supply and demand. “Today, if you want to buy a Formula 1 team, just like an NFL or NBA team, you can’t. There simply isn’t a team to sell.

Brown says the value of an F1 franchise will increase significantly, as in other sports. “Historically, buying an F1 team came with an obligation to support it financially – the acquisition price was just a starting point,” he says.

“Now the teams have the capacity to be autonomous, for a shareholder it becomes a much more interesting franchise to own. There are only 10 of them and all are in good health. If you consider that we had a valuation of 560 million dollars and that Williams would have been sold [to Dorilton Capital] for about 150 million euros, if Chelsea Football Club is sold for 5.2 billion dollars, it certainly shows how much the growth in value [potential] there is in an F1 team under Liberty’s new ownership cost path.

F1’s Domenicali says he has never seen so much interest from investors, not only to try to create new teams, but also to take stakes in existing ones. “This means that from a financial point of view, the platform is robust enough to guarantee a return on investment.”

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