The Relationship between Spending and Performance – Correlation and Causality

Introduction

The rhetoric from UEFA regarding Financial Fair Play seems to be that it is essential for the long-term health and sustainability of the game that clubs are encouraged to be responsible and ‘live within their own means’. A joint statement released last year from the European Commission and UEFA outlines that the aims of FFP are to:

●        Improve the economic and financial capability of clubs;

●        Increase transparency and credibility;

●        Improve governance standards in football;

●        Encourage clubs to operate on the basis of their own revenues;

●        Introduce more discipline and rationality in club finances;

●        Protect the integrity and smooth running of UEFA club competitions;

●        Encourage responsible spending for the long-term benefit of football;

●        Protect the long-term viability and sustainability of European club football.

Furthermore it is claimed that “These are objectives which UEFA, as governing body for football in Europe, will promote in a balanced and proportionate way, acting in accordance with all applicable legal rules and, in particular, within the framework of EU law” http://ec.europa.eu/competition/sectors/sports/joint_statement_en.pdf.

We have seen in the past that football is not immune to general European legislation, in particular we can look at the Bosman Ruling of 1995 as an indication that any infringement on general European Union Law, such as the free movement of workers, is likely to end up in the ECJ. European Union Competition Law is intended to prevent companies abusing their market power, indeed with regards to sport the European Commission states:

“Most sport cases have been handled under EU antitrust rules, which prohibit anti-competitive agreements and practices as well as abuse of a dominant position. These cases concerned revenue-generating activities connected with sport, such as media rights and ticket sales and regulatory/organisational aspects of sport” http://ec.europa.eu/competition/sectors/sports/overview_en.html.  

It is therefore perplexing that the EC appear to be fully supportive of FFP when there is strong evidence that clubs in dominant financial positions are going to benefit the most from the new regulations. Recently, Arsenal, Liverpool, Manchester United and Tottenham submitted a statement to the FA requesting tighter financial control for the Premier League in line with UEFA’s FFP regulations. It is no coincidence that these are traditionally wealthy clubs with high revenues, seeking to limit spending to a club’s self-made resources. Additional measures for the Premier League have now been passed by the narrowest of majorities meaning FFP is not just something that clubs wanting to compete in Europe should be concerned with. I among others have argued that these regulations are anything but supportive of a sustainable sporting environment as UEFA claim, primarily because they limit competition, which in the long run will be detrimental to the health of the game.

Data

The data (kindly supplied by Stefan Szymanski) comes from all four professional English leagues over a ten-year period from 2000/01 to 2009/10. The data is not complete with figures missing from a number of clubs, particularly from lower divisions, however the volume is sufficient for this analysis. The data covers Final League Positions, Revenue, Wages, Profit/Loss and I have added the additional variable Spending. I have calculated spending as a team’s revenue minus or plus their profit or loss respectively, i.e. a team with a revenue of £100 million and a profit of £10 million has only spent £90 million, whereas a team with the same revenue and a loss of £10 million has spend £110 million.

Assumptions

It is commonly thought that football clubs that spend more are likely to perform better in the long run. This is because of the logical assumption that performance is based on talent i.e. a team with more talented individuals is more likely to succeed in the long run than a team with less talented players, as well as the equally logical assumption that more talented players will cost more money to obtain (transfer fees), and maintain (wages). This is an important assumption for analysing the relationship between performance and spending.

 

Part 1 – Correlation

Correlation analysis is a statistical measure of how two variables relate to each other. I am interested in how performance compares to spending and will examine the data holistically, annually and annually by division.

Overall Relationship

The graph below shows all ninety-two teams over all ten years. I have applied a Spline Interpolation Line to the data.

 

 

The first thing you will undoubtedly notice is a sharp rise in spending from around 20^th up to 1^st demonstrating the obvious financial clout of the Premier League. For the remaining leagues there is a gradual slope as the line progresses further down, but the gradient becomes almost negligible in League 2 (Division 4). There is a clear difference in variance between Premier League team spending and the remaining three leagues, which appear much closer. For example, results from the Championship range between £2.6 million and £72 million, whilst the Premier League has a range from about £21 million to over £320 million. You can even go as far as to say that the Premier League has its own split with teams regularly finishing above 8^th exhibiting much larger spending than others. It is also interesting to note that no team has won the Premier League spending less than £100 million during this period. I have also calculated the Pearson Correlation for the entire data set and the value of 0.629 suggests a strong linear relationship between spending and performance.

Annual Relationship

To explore the annual relationship I have selected seasons 2000/01, 2004/05 and 2009/10 to provide a spread across the entire period. I have not included all years for the sake of repetition, but rest assured they all look pretty similar to these three. I have used LOESS regression as this allows us to identify an approximation using a localised trend, i.e. the calculations give higher weighting to data closer to the point in question.

 

 

 

 

 

 

 

As you can see the pattern is very similar to that already established. You will also note that lower league spending has hardly changed over the ten years whilst Premier League spending has more than quadrupled from just over £50 million to just under £220 million, using the LOESS curve. Pearson Correlation gives us 0.736, 0.606 and 0.668 for 2001, 2005 and 2010 respectively, suggesting the linear relationship has remained strong over the entire period.

 

Annual Divisional Relationship

 

Using the same seasons as above I have analysed the data for each division separately. I have left out the fourth tier due to the lack of data.

The Premier League

The graphs indicate that teams in the lower half of the league tend to be reasonably close in terms of their annual spend, whilst the top positions tend to go to teams that spend the most. Teams that appear to over perform in terms of their relative spend do so because of bumper profits i.e. Arsenal in 2001, Everton in 2005; or turn out to be one season wonders i.e. Ipswich 2001. It is clear that in the Premier League money is not sufficient to guarantee success, but it is certainly necessary for sustained competitiveness at the highest level.

Championship

The relationship in the Championship is a lot less clear. The correlation is a lot less defined than in the Premier League, however, the winners of the league in each season tends to be one of the top spenders. In the entire period the winners of the English second tier only spent below £20 million on two occasions, and on only one occasion, West Brom in 2007/08, did any winning team avoid making a loss. This raises the question of whether these successful teams would have achieved this under stricter financial restraints; a question that we are likely to see answered over the next decade of football under such conditions. The average correlation for the period was 0.451. Clearly the relationship is nowhere near that of the Premier League, however, there is still empirical evidence to suggest that money plays a pivotal role in determining success.

League 1

The English third tier, League 1, is similar to the Championship. The correlation is a lot less significant than the Premier League, yet the data shows a slight upward inflection towards the top of the league. Average linear correlation is 0.499, so again there is a case for the importance of spending for success.

Part 2 – Causality

Correlation ≠ Causation

Correlation and Causation is not the same thing. If one variable causes another then they are almost certainly correlated, but just because two variables are correlated does not mean that one necessarily causes the other.

It is difficult to claim solely from correlation analysis that spending is the key driver of performance, and unlike correlation, causality is extremely difficult to establish using statistics. However, it would take a brave individual to argue that money is not a critical factor in determining long-term success.

Spending is the most plausible determinant of performance if we accept the critical assumption that talent drives performance and that more talent costs more money. If we accept that there is a link between talent and performance, and that better players cost more money to buy (transfer fee) and to maintain (wages), it seems irrefutable that the amount of money a club spends is going to significantly shape performance.

The graph below shows the relationship between Wages and Performance.

 

 

 

The outcome is, unsurprisingly, almost identical to that between Spending and Performance. This is because wages make up the bulk of every clubs annual outgoings. It is increasingly rare for a club to spend less than 50% of their revenue on wages. Despite the lack of robust scientific control studies it seems appropriate to call the correlation between Spending and Performance a causal relationship.

Conclusion

In previous articles I have argued that competition is critical to the long-term health of the game. This is fundamentally due to the fact that football, like any other professional sport, requires fans that spend money on ‘the product’ i.e. watching games (at the ground, on T.V.) and buying merchandise. In turn, media coverage grows with fan interest, whilst worldwide interest grows with the increased media attention. The amount of money television companies are willing to pay for the rights to show games also increases with a rise in interested spectators e.g. there is a reason the Premier League has a much higher total T.V. deal than La Liga. Competition is key!

Under Financial Fair Play spending is likely to become synonymous with revenue for the vast majority, meaning performance will be somewhat restrained and predictable. The idea that FFP will secure a more viable future for the game is delusional. In the short-term the clubs making losses will inevitably spend less, and their performance is likely to suffer for it. In the long-term teams in dominant financial positions will be able to consolidate their sporting positions at the top with an ever-increasing gap that will be impossible to traverse (see my previous article discussing Sass http://journaloffootball.blogspot.co.uk/2012/10/normal-0-part3-why-ffp-is-end-of.html). Predictability will ultimately destroy consumer interest in football; perhaps not for every supporter, but the global nature of the modern game means that, financially at least, the majority of clubs will be worse off under FFP.

If it really is the European Commission’s mandate to prevent the abuse of a dominant position, then to allow, and even support UEFA’s FFP regulations is nonsensical. 

 

A Brief review of Peeters and Szymanski - Vertical restraints in soccer: Financial Fair Play and the English Premier League

Academic interest in professional sport is significant due to its unique mechanisms often requiring legislation that would seem ridiculous and untenable in any other industry. Football is at the forefront of modern sports literature, and slowly but surely the academic field is producing models and predictions about the possible effects of Financial Fair Play on European football, and this article seeks to evaluate one such contribution.

Download the article here: http://ideas.repec.org/p/ant/wpaper/2012028.html

Thomas Peeters and Stefan Szymanski sought to design a model that would demonstrate the effects of the break-even aspect of FFP on the English Premier League using data collected between 1993/4 and 2009/10, from the financial accounts of teams in the top three tiers of English football. In short their model predicts that FFP will result in lower average payrolls (for the Premier League this could be between £10 million and £16 million, or 14% to 23% of its initial level), whilst average revenues will hardly be affected (the model shows a fall of about £1.5 million which is within their standard error calculation); hence wage to turnover ratios could reduce by anywhere between 8% and 15%. They also argue that competition will be restricted by the vertical restraint of break-even.

They share the view of the majority of others that there is a strong relationship between the amount of money a team spends on wages, and the amount of games that they win. Indeed the average wage bill for the period was £16 million per season, and this number is truly eclipsed by teams in the Premier League, some of which demonstrated figures ten times larger than the average. It is this disparity that Peeters and Szymanski argue is the principle difference between FFP in European football and the salary caps that we see in North American sports. The salary cap in the NFL for example acts as one of the important mechanisms for maintaining competitive balance (alongside equal revenue distributions and an annual redistribution of talent) by fixing spending to league revenues. This is intended to limit the variance between team performances and thus promotes competition. Peeters and Szymanski point out that since FFP only limits spending of an individual club in proportion to its own resources, and these resources vary hugely in European football, no such benefit can be claimed. In effect, FFP will fix sporting performance to financial performance.

This is the conclusion from their paper:

“In this paper we have studied the impact a specific form of financial regulation on the intensity of competition in an industry. The effect of the regulation is to harden the budget constraint for a subset of firms in the industry. We show that the impact of this regulation is substantial even for those firms which are not directly affected by the regulation. Given that firms in this industry are engaged in a form of rent-seeking contest, the regulation is expected to impact almost entirely on costs, which primarily take the form of wages.

In particular, we find that had the Financial Fair Play regulations applied fully in the English Premier League in the 2009/10 season, wage to turnover ratios would have fallen by as much as 15%, which is in line with the theoretical predictions of Dietl et al (2009). As such, the FFP break-even rule will in many ways resemble a North American salary cap, although the latter applies the same spending cap to all teams. In other words, our paper shows that in this context a vertical restraint may restrict competition in exactly the same way as a horizontal agreement between competing firms. Salary caps have been justified in US courts under the theory that they promote competitive balance among the teams. On top of this, they are agreed upon in a system of collective bargaining with unions representing the players, and such agreements are exempt from antitrust. The break-even rule under FFP has not been negotiated as part of a collective bargaining agreement with unions, and furthermore such agreements are not exempt from competition law in the EU. Therefore, analysing the impact of FFP on competition in national leagues is important to assess whether it complies with EU competition law.

The rationale advanced by UEFA for its regulation is not the promotion of competitive balance, but “discipline and rationality” in club finances. Considered as a vertical restraint, this might be deemed to have pro-competitive properties if the rules help to preserve the integrity of the competition and the financial stability of the clubs. On the other hand, our results demonstrate that the break-even rule could be construed as a means to raising profitability and therefore an anti-competitive vertical restraint under EU competition law” (Pages 27 and 28).

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FFP regulations are dependant on being pro-competitive to be acceptable under EU law. If they are found to be anti-competitive it is likely that they will be severely tested in the European courts. Peeters and Szymanski state that “the 1995 Bosman judgment of the European Court of Justice had demonstrated that regulation which restricted competition in the market for players that was not backed by pro-competitive reasoning was doomed to failure under EU law. The relevant European law in the Bosman case concerned the freedom of movement of labour, but UEFA also became embroiled with the European Commission over the collective sale of broadcast rights, a competition law issue” (Page 6). I agree with Peeters and Szymanski’s assessment that FFP is vertically restrictive, and is therefore anti-competitive. However, I do not agree that revenues will remain unaffected. If competition is restricted we should see, in the long run, a reduction in supporter interest, and therefore a fall in media revenues resulting in smaller television distribution deals, and ultimately falling revenues for clubs. The overriding suggestion is, however, that FFP is doomed to failure in the long run due to its anti-competitive constraints.

Bristol City – A club in big trouble

A few days ago Bristol City announced their latest financial figures for the 2011/12 season, which showed a record loss of £14.4 million. With a new £92 million 30,000 seat stadium currently in a legal battle, some of this loss can be attributed to the continuing work at Ashton Vale. However, this isn’t really significant and even a cursory glance at the figures makes grim reading for supporters of the club.

Key Data
	2008/9	2009/10	2010/11	2011/12
League Position	10th	10th	15th	20th
Loss	£6.5m	£11.8m	£11.5m	£14.4m
Turnover	£11.7m	£11.1m	£11.9m	£11.8m
Wages	£10.2m	£13.8m	£15.9m	£18.6m
Wages to Turnover	87%	124%	134%	158%

Turnover has stagnated, wages have increased and league performance is deteriorating. When wages are greater than turnover a club should be concerned. With an extra £8.4 million going on wages now than four years ago, and no increase in turnover, it is unsurprising that the club is spending more than one and a half times its turnover on players. They should be even more concerned when this meteoric rise in wages does not lead to an improvement in on the pitch performance. Currently, Bristol City find themselves 22^nd in Championship and in a relegation battle, one that they managed to win last year. So what does the future hold for Bristol City?

If they survive

Remaining in the Championship means complying with break-even regulations: http://www.football-league.co.uk/page/FLExplainedDetail/0,,10794~2748246,00.html 

Championship teams voted 21-3 in favour of break-even constraints, much like the UEFA system, and below is how it will work.

Football League Financial Fair Play Framework – Permitted Losses
	2011/12	2012/13	2013/14	2014/15	2015/16
Acceptable Deviation	£4m	£4m	£3m	£3m	£2m
Shareholder Equity Investment	£8m	£6m	£5m	£3m	£3m
Total Permitted Losses Allowed	£12m	£10m	£8m	£6m	£5m

In the first reporting period 2011/12 (the accounts just published) clubs are allowed to make a total loss of £12 million as long as owners/shareholders fund at least £8 million of that loss. The numbers then reduce over a five-year period until the total permitted loss reaches £5 million, which will remain in place for subsequent seasons. Bristol city have already failed in this respect with their accounts showing a loss of £14.4 million (even when new stadium expenditure and youth development costs are deducted this figure is likely to remain above £12 million). Luckily, the Football League does not intend to sanction clubs until 2014/15 to allow clubs time to adjust to the regulations. However, given that Bristol City find themselves in a relegation battle for the second year running it is obvious that the current playing squad is not good enough to match the ambitions of the club. With future investment constrained by break-even the club is reliant on its new stadium to provide a boast to revenues in order to fund any new player acquisitions, but as of yet construction hasn’t even started due to legal challenges by residents close to the proposed site.

If they are relegated

Relegation means complying with a completely different set of regulations. Salary Cost Management Protocol (SCMP) is the regulation of choice for League’s 1 and 2, meaning clubs are currently restricted to a wage to turnover ratio of 65% in League 1 and 55% in League 2. In League 1 this figure will reduce to 60% from the start of next season. This would present a real problem for Bristol City who currently have a ratio of 158%! It is likely that turnover would decrease should the club be relegated, though it should also be expected, especially since the club was only promoted from League 1 in 2007, that player wages will also be contractually reduced. Even if wages are reduced in this way, the club would still face a monumental task to meet the terms of SCMP.

Other Issues

Relegated or not a lack of income means that Bristol City must reduce costs. Hopes that a new stadium is the answer seem far-fetched given attendances at their current stadium Ashton Gate. With a capacity of 21,497 and proposals to build a 30,000 seater at Ashton Vale to replace it, does the club have the support base to take advantage of this increase? The attendance figures would strongly suggest that they do not.

Bristol City Average Attendance
	2008/9	2009/10	2010/11	2011/12	2012/13
Capacity	21,497	21,497	21,497	21,497	21,497
Average Attendance	16,816	14,600	14,604	13,845	13,204
Usage	78.2%	67.9%	67.9%	64.4%	61.4%

When a 21,000 capacity stadium is on average less than two-thirds full, why build a 30,000 seater stadium to replace it? The money should be invested in developing young players to improve the club’s future on the pitch. Despite City’s lowly position near the foot of the Championship they are actually the highest placed team in the whole of South West England. £92 million would go a long way to building up a formidable academy and scouting network to aid the development of future players.

Bristol City are lucky enough to have an owner willing to invest in the club, however, the way that the club is currently operating is not conducive to its long-term success under FL regulations.

Why Arsenal’s version of the ‘self-financing model’ is not the way forward

Arsenal’s profitability over the last few years has been remarkable in an industry where financial prudence and sporting success are so often an impossible combination to achieve. The last time Arsenal reported a loss was 2002 making them one of the best financially operated football clubs in the world. However, over the last few seasons the realities of operating under such financial constraints has become apparent, not least to the Arsenal fans that are now questioning Wenger’s leadership despite his reputation as the most successful, longest serving manager in Arsenal history with the highest win ratio of any Arsenal manager ever (excluding caretaker managers). Arsenal have not won a trophy in seven years, quite a shocking fact for a club that had the 5^th highest revenue in Europe in 2011 according to Deloitte. The club has vastly increase their revenue production since their move to The Emirates in 2006, and the subsequent sale of property at Highbury, yet this money does not appear to have been used to strengthen the team. This article explores the financial data to highlight exactly what is going on at Arsenal in comparison to their main Premier League rivals, and anticipates the likely impact of FFP on the future success of Arsenal.

Financial Success

Arsenal is a financially successful club. Over the last nine years since 2003/4 Arsenal have produced an average annual pre tax profit of £26.8 million. They are also becoming more profitable as the last three years (period 3) show an average of £35.8 million pre tax profit per season.

Pre tax profit (£’000)
2004	2005	2006	2007	2008	2009	2010	2011	2012
10,577	19,265	15,885	5,573	36,668	45,512	55,968	14,776	36,588
Average pre tax profit of 26,757
Period 1 average of 15,242			Period 2 average of 29,251			Period 3 average of 35,777

This increase in profitability is being driven by a number of different factors.

Total revenue breakdown (£’000)
	Total revenue	Match day income	Media income	Commercial income	Player trading income	Other income
2004	159,169	33,765	59,780	21,017	2,282	42,325
	100%	21.21%	37.56%	13.2%	1.44%	26.59%
2005	141,289	37,397	48,594	29,092	2,894	23,312
	100%	26.47%	34.39%	20.59%	2.05%	16.5%
2006	156,562	44,099	54,870	33,014	19,150	5,429
	100%	28.17%	35.05%	21.08%	12.23%	3.47%
2007	219,310	90,613	44,312	41,582	18,467	24,336
	100%	41.32%	20.2%	18.96%	8.42%	11.1%
2008	249,428	94,580	68,360	44,311	26,458	15,719
	100%	37.92%	27.41%	17.76%	10.61%	6.3%
2009	336,516	100,086	73,239	48,138	23,177	91,876
	100%	29.74%	21.76%	14.31%	6.89%	27.3%
2010	417,993	93,929	84,584	43,973	38,137	157,370
	100%	22.47%	20.24%	10.52%	9.12%	37.65%
2011	261,948	93,108	85,244	46,323	6,256	31,017
	100%	35.54%	32.54%	17.69%	2.39%	11.84%
2012	308,469	95,212	84,701	52,515	65,456	10,585
	100%	30.87%	27.46%	17.02%	21.22%	3.43%

The move to The Emirates in 2006 significantly elevated match day income for The Gunners, more than doubling annual income from matches. Match day income in 2012 was almost three times the amount received in 2004, and more than double the amount received in Arsenal’s final year at Highbury. Media income has also grown, however, this is not exceptional to Arsenal, as broadcasting deals have continuously increased income for the vast majority of clubs, and certainly for Premier League clubs. Arsenal has also grown commercially over the period, but again this does not appear to be anything extraordinary when compared to other Premier League clubs. Player trading income at Arsenal has been consistently significant over the last few years, and is one of the most contentious elements of Arsenal’s ‘self-financing model’. This will be explored later, but for now, it is clear that income from the sale of players has played a pivotal role in driving Arsenal’s revenue over the last few years. Other income fundamentally includes financial investments, and in Arsenal’s case property investment. The extraordinary revenue peak in 2010 can largely be attributed to the sale of property at Highbury and should not be considered as a long-term growth in revenue streams. Overall, Arsenal have almost doubled their revenue since 2004 (up 94%), and are in an extremely healthy position with the advent of Financial Fair Play.

Arsenal are also doing well in terms of their costs.

Total cost breakdown (£’000) (excluding exceptional costs)
	Total costs	Costs of sales and other operating costs	Staff costs	Amortisation + player acquisition costs	Finance costs
2004	114,808	22,888	69,889	20,137	1,894
	100%	19.94%	60.87%	17.54%	1.65%
2005	110,075	27,599	66,012	14,993	1,471
	100%	25.07%	59.97%	13.62%	1.34%
2006	136,091	37,725	82,965	15,401	0
	100%	27.72%	60.96%	11.32%	0%
2007	168,466	44,677	89,703	18,782	15,304
	100%	26.52%	53.25%	11.15%	9.08%
2008	186,654	46,603	101,302	21,757	16,992
	100%	24.97%	54.27%	11.66%	9.1%
2009	199,846	55,359	103,978	23,876	16,633
	100%	27.7%	52.03%	11.95%	8.32%
2010	208,943	54,994	110,733	25,033	18,183
	100%	26.32%	53%	11.98%	8.7%
2011	210,012	49,745	124,401	21,658	14,208
	100%	23.69%	59.23%	10.31%	6.77%
2012	250,462	56,716	143,448	36,802	13,496
	100%	22.65%	57.27%	14.69%	5.39%

Like revenue, costs have also doubled over the period (up 118%), but in real terms Arsenal have improved. Costs of sales and operating costs have increased significantly over the period, most of which can be attributed to the increased costs of operating at The Emirates. Staff costs have increased, as they have at every other Premier League club, but in Arsenal’s case have actually decreased as a percentage of overall costs. Amortisation and acquisition costs are low when compared to other Premier League teams (this is explored further later). Arsenal are in a very healthy position regarding their finances, easily able to afford interest payments, and have written off the majority of their debt over the last few years. Net debt now stands at £98 million.

Football clubs are often examined in terms of their wage bills, and it is safe to say that Arsenal are extremely healthy in this respect.

Wages (£’000)
2004	2005	2006	2007	2008	2009	2010	2011	2012
69,889	66,012	82,965	89,703	101,302	103,978	110,733	124,401	143,448
Increase of 105%

Wages have risen, that is to be expected, but Arsenal, unlike so many other clubs have been able to keep the wage to revenue ratio consistent and low.

Wages to revenue (£’000)
2004	2005	2006	2007	2008	2009	2010	2011	2012
69,889/ 159,169 x 100 = 43.91%	66,012/ 141,289 x 100 = 46.72%	82,965/ 156,387 x 100 = 53.05%	89,703/ 219,310 x 100 = 40.9%	101,302/ 249,428 x 100 = 40.61%	103,978/ 336,516 x 100 = 30.9%	110,733/ 417,993 x 100 = 26.49%	124,401/ 261,948 x 100 = 47.49%	143,448/ 308,469 x 100 = 46.5%
Average wages to revenue of 41.84%
Period 1 average of 47.89%			Period 2 average of 37.47%			Period 3 average of 40.16%

The figures show that wages as a proportion of revenue have been consistently below 50% (apart from 2006) and have even been as low as 26.49% in the year Arsenal received the most from their property sale. Financially this is great news, in terms of competitiveness however, the news is not so good.

No one can argue that Arsenal have not been fantastically successful financially over the past decade, indeed many supporters have worn this fact as a badge of honour, whilst other clubs overspend and plunge deeper and deeper into debt. However, no Arsenal fan can deny that the last seven years have been tough with a lack of success and the escalating costs of supporting their club after the move to The Emirates. Many believe that FFP is the light at the end of the tunnel and that other clubs will be pegged back allowing Arsenal to manoeuvre themselves back into pole position, but does tighter financial regulation arrive too late to save them?

The problem for Arsenal fans

The issue is not that Arsenal are unable to produce the required resources to compete at the highest level, the problem is the way in which these resources are produced, and the way they are used.

Return on equity (£’000)
2004	2005	2006	2007	2008	2009	2010	2011	2012
(8,152/ 84,363) x 100 = 9.66%	(8,293/ 122,656) x 100 = 6.76%	(7,902/ 130,558) x 100 = 6.05%	(2,816/ 133,374) x 100 = 2.11%	(25,726/ 159,100) x 100 = 16.17%	(35,230/ 194,330) x 100 = 18.13%	(60,992/ 255,322) x 100 = 23.89%	(12,633/ 267,955) x 100 = 4.71%	(29,593/ 297,548) x 100 = 9.95%
Average ROE of 10.83%
Period 1 average of 7.49%			Period 2 average of 12.14%			Period 3 average of 12.85%

Over the nine years Arsenal have produced a handsome 10.83% average return on equity, and the figure has grown over the period. The club is highly profitable, indeed one ordinary share would have earned you a tidy £475.64 in the 2011/12 season, yet this money does not appear to be utilised to enhance the quality of players at the club. The obvious question is: do those that operate the club want to make money or achieve success? For the fans, the answer appears to be evident.

If we examine player trading it becomes apparent that Arsenal are significantly different to their rivals.

Player amortisation and acquisition costs (£’000)
2004	2005	2006	2007	2008	2009	2010	2011	2012
20,137	14,993	15,401	18,782	21,757	23,876	25,033	21,658	36,802
Average for the period of 22,049
Period 1 average of 16,844			Period 2 average of 21,472			Period 3 average of 27,831

Player amortisation and acquisition costs for the top PL clubs (£’000)
	2009	2010	2011
Arsenal	23,876	25,033	21,658
Chelsea	61,578	38,629	75,121
Liverpool	43,009	48,006	45,645
Manchester City	39,431	71,006	118,295
Manchester United	37,641	40,087	39,245
Tottenham	37,288	39,991	41,953

Player trading income (£’000)
2004	2005	2006	2007	2008	2009	2010	2011	2012
2,282	2,894	19,150	18,467	26,458	23,177	38,137	6,256	65,456
Average for the period of 22,475
Period 1 average of 8,109			Period 2 average of 22,701			Period 3 average of 36,616

Player amortisation is worked out by dividing the transfer fee by the number of years on the player’s contract. For example a player that is signed for £10 million on a 5-year contract would be amortised at the rate of £2 million per year. Amortisation does not therefore represent the exact inflow of talent on a yearly basis, but does give a strong indication of talent procurement over time. The amount of money that Arsenal are spending on player purchases has increased over the period and averages at around £22 million a season. Yet the outflow of talent over the period has been even greater with an average of £22.5 million worth of talent leaving the club every year. The figures show that this transformation has occurred over recent seasons. In period 1 Arsenal were spending significantly more on talent than they were receiving from player sales, however, by period 3 the average annual income of £36.6 million far outweighs the £27.8 million spent, on average, each year.

In terms of Arsenal’s main Premier League rivals they appear to be far from competitive. Of course its not all about how much money a club throws at players, but it is difficult to ignore the relationship between the amount of money a club is prepared to spend on both acquisition and wages, and the relative success that gives them on the pitch. In the Premier League Arsenal’s revenue is 2^nd only to Manchester United; therefore they should easily be able to afford top quality players and their wage demands. However, the evidence clearly indicates that money is not being spent on players. Arsenal spend around half as much as Manchester United on players per year despite having similar revenues. They also spend half as much as bitter rivals Tottenham, who despite their high spending still manage to produce a profit, or remain relatively close to breaking even, on a regular basis. It would appear that the powers that be are not simply content to run a tight ship and maintain financial prudence; they want to see significant returns on their investments, which means producing a substantial profit. The result? No trophies since 2005 whilst all of the other teams listed (Chelsea, Liverpool, Manchester City, Manchester United and Tottenham) have won at least one trophy in that period.

In all, player trading income figures demonstrate a scary outflow of talent from Arsenal, and those figures do not even include the latest notable outgoings of Robin Van Persie and Alex Song, along with a few less well-publicised transfers Carlos Vela, Henri Lansbury and Kyle Bartley, which could easily push income from player trading for the 2012/13 season to around £40 million.

Pre tax profit minus transfer income (£’000)
2004	2005	2006	2007	2008	2009	2010	2011	2012
8,295	16,371	-3,265	-12,894	10,210	22,335	17,831	8,520	-28,868
Average of 4,282
Period 1 average of 7,134			Period 2 average of 6,550			Period 3 average of -839

What is even more frustrating for the fans is that the sale of players is completely unnecessary in terms of the financial health of the club. The table above shows the profit/loss Arsenal would have made had none of their players been sold over the last nine years. As you can see the club would still be profitable producing around £38.5 million in total. The sale of star players is nothing to do with remaining financially stable, and has everything to do with the desires of the shareholders.

Light at the end of the tunnel?

Many at Arsenal will be thinking that FFP offers hope as clubs like Chelsea and Manchester City will be forced to reign in their spending. With superior revenues Arsenal should be able to become competitive once again, but only if the unjustifiable sale of talent is halted. Arsenal are on the edge of a dangerous precipice as their position in the top four has never been under more threat. It would appear, despite the fact that we are only 10 games into the season, that there are ominous signs that the top three positions have already been decided; hence Arsenal are likely to be in a tight race for the fourth Champions League qualifying position. Failure would be a significant blow. With FFP operating on three-year rotations (i.e. reporting periods for break-even requirements are taken over a three-year period (two-years for the first period 2011/2 – 2012/13)) the club will need to reinvest its profit from 2011/12 (£29.5 million) within the next couple of seasons before it becomes obsolete in terms of using it to improve the squad. As I have argued in previous posts, FFP is likely to widen the performance gap between the top teams and the rest, especially in terms of those teams in the Champions League due to the vast additional revenue they receive. It is therefore critical that Arsenal qualify for the Champions League this season and next season.

The only concern is that FFP has arrived too late to save Arsenal. In the mad rush of the last few years Manchester City have been spending big before the proverbial trapdoor slams shut on exogenous owner investment. Notably, City have purchased four players from Arsenal (Adebayor, Toure, Clichy and Nasri) for a reported combined total of £70 million (source: transferleague.co.uk). Wenger has been good in the past at buying relatively unknown young talent for reasonably small amounts of money, and selling those players on at vastly increased amounts once their best years were utilised, and a replacement had been found e.g. Overmars, Henry, Vieira and Anelka. Recently however, players have been sold at their peak and whilst Wenger has wanted to retain them. Notably Robin Van Persie, who transferred to one of Arsenal’s greatest rivals Manchester United, stated that his reason for leaving was because he did not agree with Arsenal’s strategy or ambition. Equally, Alisher Usmanov, owner of 30% of Arsenal, has voiced his concerns that the current ‘self-financing model’ is limiting competitiveness and eroding the belief of the players that Arsenal can match their ambitions. If Arsenal continue as they have done over the last few seasons, they will be busy maximising profit whilst the vast majority of other clubs, including their main rivals, will be minimising loss. The difference is subtle in theory but significant in practice.

With the trapdoor already half closed Arsenal need to ensure that they are not on the wrong side of it in the next couple of years, which means abandoning the pursuit of returns for shareholders and focusing on utilising club funds for the improvement of the club. If they don’t their future could be one of frustrating mediocrity.