The real reason F1 will never get a budget cap

05/07/2009
NEWS STORY

Over a recent dinner in London Tony Purnell, the FIA's technical consultant, told Pitpass' business editor Chris Sylt that personnel in the FIA had scratched their heads long and hard over why the FOTA teams had been so opposed to a budget cap in F1. According to Purnell, the FIA brainstormed all manner of weird and wonderful possible reasons but in the end none seemed to stand out as being likely. After the dinner Sylt gave it some thought and soon figured out what it appears the FIA had failed to do: as ever, follow the money.

According to F1's industry report Formula Money, the average F1 team budget is currently $302.8m with the team owners putting in $160.5m and sponsorship providing $88.1m - 29% of a team's resources. The bulk of the remainder comes from prize money. A budget cap would of course completely change the dynamics of this landscape and it would in fact put the teams in a lose-lose position. They would have two options regarding sponsorship and both are equally catastrophic.

The first option is that the teams could reduce their sponsorship rates according to the decrease in budget required to run the team. Clearly it would seem strange for a sponsor, such as Marlboro, which still pays Ferrari an estimated $100m annually to continue to do so when around 60% of this amount (under the €40m cap) would fund the entire team.

The sponsors seem to expect that if a cap is ever introduced, the rates will be reduced. One prominent F1 sponsor (which is also known to believe that current F1 sponsorship rates are too high) has indicated to Sylt that it is strongly in favour of a budget cap. Indeed, apparently one of the first calls that the FIA had after announcing the cap came from sponsorship agent Zak Brown who congratulated the governing body for a move which he believed should bring sponsorship rates down to a level more accessible to sponsors. This may not be the case.

There are two severe down-sides if teams decrease their sponsorship rates. The first is that the teams would experience a huge perceived loss in brand value. Sponsors are the teams' customers - they buy its services (such as space on the car) so, for the sake of comparison, imagine what would happen to the reputation of a grand hotel, such as the Savoy or the Dorchester, if it slashed its room rates from 400 per night to 40 per night.

Currently, the average price of sponsorship on Ferrari is estimated at $13.4m per year and this high barrier to entry is part of the attraction and the mystique of partnering with the team. Only the wealthiest of brands can afford it and they requires little vetting - the rate alone does that. However, if the teams' sponsorship rates were slashed then so too would be the cachet of an F1 partnership. It has taken the top teams decades to build up, and justify these rates so they are not likely to slash them in the blink of an eye. Which brings us to the second severe down-side.

If the teams slashed their sponsorship rates under the budget cap then it would take them decades to increase them again once the cap is lifted (as it inevitably will be) when the economy improves. Sponsors would be quite happy to pay a fraction of the current going rate but they would not be so keen on returning to the previous fees once the cap was lifted. This in itself could lead to a mass exodus of sponsors and could see teams hamstrung with small business budgets (down from their current status as economic powerhouses) for decades to come.

The alternative under the budget cap would be for the teams to retain their current sponsorship rates. What a fine way to reward years of trust and support from sponsors! The cost of providing the service decreases five fold but the cost of the service to customers stays the same. If anyone wants an indication of the sponsors' reaction if this were to happen then consider the uproar from customers when the price of oil decreased dramatically over the past year but the home energy rates of some providers didn't immediately decrease. Many F1 sponsors also have wider partnerships with the teams' parent companies so the last thing they would want to do is create bad will towards them.

It seems likely that the teams would prefer to keep the rates at their current level and pocket the profit. One sponsorship expert who has also run an international racing series says "I think the majority of teams will continue to seek the maximum commercial support they can obtain. The issue is not what the teams need to raise in order to go racing but rather what the exposure, benefits of association (i.e. being a sponsor) hospitality and so forth are worth to a sponsor."

Sylt says that there is a third, outside, option for teams regarding how to deal with sponsorship under the budget cap. Currently, they use sponsorship to maximise their budgets but this obviously would not be necessary under the cap.

The amount that the team owners would need to spend to fund the entire team budget would be a fraction of what they are currently spending to fund 53% of it. Indeed, it would not be cost-effective to employ an acquisition department to get sponsors to contribute a relatively small sum which the owners could easily contribute themselves. Sponsorship currently brings in 29% of the teams' budgets and this would represent just $16m under the cap. So, depending on the cost of hiring the sponsorship acquisition staff, the teams might actually make a loss on getting sponsors.

Under the budget cap the teams would get the best return from the space by running them with no external sponsorship and just have the parent company's brand covering the entire car. Red Bull of course pretty much does this already and it would avoid the thorny consequences of dropping the sponsorship rates or keeping them the same. Sponsors could then be re-introduced to the cars' liveries (at the present rates) when the cap is lifted.

It would not be the first time that this has been suggested. Sylt says that when the car manufacturers were planning their own series several years ago they discussed running sponsor-free cars in order to give the series' own sponsors exclusivity. Payments from them would have been so high that the teams simply wouldn't have needed sponsors just as they would not them under the budget cap.

The big question is whether sponsors would hang around for years waiting to come back to the sport once the cap was lifted. There would be so many of them flooding the market that the independent F1 teams wouldn't be able to pick them all up and so the sport would most probably lose many of them if the car company-owned teams ran with only their own logos on the cars. The knock-on effect of this could be catastrophic since these sponsors buy services such as corporate hospitality tickets and trackside advertising but they would be less likely to do so if they were no longer a sponsor in the sport

One wonders why the FIA suggested the budget cap when it could have such severe consequences for the teams. However in fact it is quite understandable since the FIA is not responsible for the commercial side of F1 and functions solely as its regulator. It is prevented by law from profiting from F1's commercial rights and does not own any teams so, for these reasons its experience in these areas is naturally limited.

It is slightly harder to see why the teams never raised this as an objection to the cap but even that is not so tough to work out. The sponsors most probably expect that the rates would be cut under the cap so, for them, there would not be an issue. The last thing that the teams would want to do is suggest otherwise, particularly if there will not be a cap. And that is precisely how F1 looks set to stay.

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Published: 05/07/2009
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