Part 3 – Why FFP is the end of football as we know it.

Many of you will undoubtedly believe that Financial Fair Play is a positive step towards a more sustainable future for European football. However, as with any radical transformation to institutionalised structures, unintended consequences are often lurking around the corner. When policy makers pushed derivative markets onto exchanges to ensure firms had to post safe collateral, it was considered a huge improvement. Yet, in the long-term, the system has become more unsafe than it was before, as banks are unable to properly protect themselves, and any failure will be amplified through the financial system to a much greater level than it would have been under the old system. The point is, positive legislation does not always yield positive outcomes.

This third and final part of the series on the impact of FFP will explore the long-term effects, and will draw upon parts one and two to argue that the future of European football could appear very different to the way it looks today.

 

Soft budget constraint and the bailout mechanism

As I am sure you are all well aware the primary function of FFP is the break-even requirement, meaning clubs cannot spend more than they earn over a three-year period. There are of course caveats, the first period is two years, the rule is set to be phased in over a number of years with early periods allowing larger losses, and clubs will have a leeway of €5m to account for shocks once break-even is in full swing. In effect, UEFA are seeking to eradicate the exogenous wealth of owners from the game, making clubs reliant on self produced resources.

How does the system currently work? In his study of socialist economies, Kornai, 1986, argued that there is a softening of the budget when the strict relationship between revenue and expenditure is relaxed because excess spending will be paid by a paternalistic institution. For example, a national health service can overspend on its budget safe in the knowledge that the government will pay the excess no matter what. The same is true with public institutions in capitalist economies and, perhaps most controversially, has also been true recently with banks being bailed out using taxpayer’s money in Britain, whilst entire countries have been bailed out right across Europe. Soft budget constraints can also be applied to football. Despite the long history of a lack of profitability, the football industry has a peculiarly high survival rate. Storm and Nielson, 2012, found that “in 1923, the English Football League consisted of 88 teams organized in four divisions. In the 2007/08 season, 85 of them (97%) still existed, 75 remained in the top four divisions (85%), and 48 (54%) were in the same division as they were in 1923”. The reason behind this high survival rate is labeled by Franck and Lang, 2012, as the bailout mechanism. “Essentially English football is almost entirely dependent for its continued stability on the willingness of individual owners, increasingly non-UK citizens, to sustain losses and underwrite debt and pay the related interest payments. This situation would be regarded as intolerable and unsustainable in any other industry” (Hamil and Walters, 2010). Why would a club have any qualms about spending £20m more than they earn when they know the owner is willing to fund any excess? Why is the owner willing to do so?

There is a clear relationship between spending and performance. In my study of Premier League clubs between 2008/9 and 2010/11, observing the 14 clubs present in all three seasons, there is evidence of a relationship between both amortisation and performance, and wages and performance.

Amortisation and performance have a correlation of 0.654, whilst wages and performance have a correlation of 0.831. In short, spend more, do better. If we look at a couple of cases, we can see that improved performance comes at a cost.

Manchester City improved their league position over the period, finishing 10^th in 2008/9 and 3^rd in 2010/11. Their revenue has also increased over the period from £87m to £159m. However, this whole process has been driven by external funding from the owners taking City’s overall spend over the period to £777m, when their turnover was only £365m.

Sunderland also improved significantly over the period, moving from 16^th in 2008/9 to 10^th in 2010/11. Again their revenue increased over the period from £66m to £105m. Sunderland’s turnover over the three years was £209m yet they spent a total of £272m.

Owners are willing to fund excess spending in their clubs because it provides the necessary catalyst for improved performance. By overspending now, clubs hope to improve their performance, and thus their revenues to allow them to afford better players to maintain that higher position in the future. In effect they are gambling on future success. FFP is going to end this process and many see this as a good thing, but what does this really mean for the future of European football?

The Long-term

Markus Sass has explored the long-term development of competitive balance under break-even constraints and presents a simple process. Big clubs will get bigger, whilst small clubs will get smaller. Sass uses the same two-team model introduced in part 2, except clubs are bound by a strict break-even requirement. Other than that the same basic assumptions apply whereby the team that wins in one period is likely to have a greater market size in the next, thus improving their chance of future success. He asserts that “market size is positively dependant on a club’s historical success” (Sass, 2012, 6), and attributes differentiated market size to the ‘glory hunter phenomenon’ whereby as “a club becomes more successful, it is able to attract more and more spectators, which increases the club’s market size and future success, which in turn increases market size even further” (Sass, 2012, 10). The figure below demonstrates the long-term progression of the two-team model, as one team increases its win percentage the other team’s win percentage must decrease. This in turn drives market size, as one club becomes more successful it will grow relative to its rival and create a permanent position as the dominant team.

It could be argued that the Premier League, as well as others, is already quite predictable with the same teams likely to be challenging for the title every year. However, under FFP it could be even worse. Only five teams have won the Premier League since its inception in 1992/3, and three of those have been the result of enormous investment from wealthy owners. Could Blackburn, Chelsea and Manchester City have won their titles without the assistance of exogenous funding? I for one would argue they probably couldn’t. It has also been the case that the runner up, on every occasion one of the aforementioned teams has won the league, was either Arsenal or Manchester United, the two other teams to have won the league since 1992/3. I’ll let you make any assumptions you want to make with that information.

The Unintended Consequences

What does this all mean? The two-team contest model indicated that there was an optimal win percentage whereby clubs could maximise their revenues. However, under FFP, clubs are likely to exceed that optimal percentage causing all sorts of financial complications.

• First, part 1 of this series explored the need for an even contest to maximise consumer interest and therefore revenues. With competitive balance decreasing, interest is likely to decrease. Also, Dietl et al argue that augmented investment in playing talent increases the attractiveness of the league for fans and broadcasters. With investment levels set to fall, attractiveness will stagnate or decline.

• Second, consumer interest drives broadcaster interest. Without the demand to watch a sport, broadcasters will not be willing to pay for the rights to show it; hence decreasing interest will decrease the amount of money broadcasters will be willing to pay to show football matches. The latest Premier League deal is worth a staggering £3bn from 2013, and rest assured clubs will find a way to spend the money that they receive. Currently, income from the media comprises of around 40% of total income for Premier League teams. Should TV deals in subsequent years reduce, the impact could be catastrophic.

• Third, with the top teams getting bigger and stronger the Champions League is likely to grow in terms of overall quality and competitiveness, increasing supporter interest and thus media income for those clubs that participate. The rewards for competing in the Champions League will be staggering, whilst the risk of failing to qualify will be incomprehensible.

The conclusion? Why risk competing in a league that offers less and less revenue because of less and less supporter interest and media coverage? Domestic leagues are likely to experience a regressive trend from top priority to irritating inconvenience in the eyes of Europe’s top clubs, regrettably strengthening the case for a European Super League with similar characteristics to the NFL (closed league, equal revenue distribution, equal talent distribution). I sincerely hope that I am wrong, but it seems that FFP is the first significant step towards considerable upheaval for European football.

For those that want to explore Sass’s piece:

http://www.fww.ovgu.de/fww_media/femm/femm_2012/2012_05.pdf