Why F1's lost promise is a reality again

One of Formula 1's thorniest and most perennial topics is being visited with renewed vigour, with a budget cap now firmly on the agenda.

To Liberty Media, owner of the Formula One Group, the share price of its Formula 1 asset FWONK is king: the better F1's prospects of raking in money, the higher the price. As in any 'shopkeeper' model, Liberty's profit (read: share price) is dependent upon minimising cost of sales and maximising revenues: cut costs and/or boost income, and profits are optimised, with commensurate impact on share prices.

Liberty's two-pronged plan is to grow revenues while reducing outgoings. By far its largest cost driver is the teams' collective slice of F1's revenues, which constitute a sliver over 50% of income, or around two-thirds of retained revenues. Put differently, of F1's £1365m annual income, around £750m will this year (inequitably) flow to teams, while F1's owners will trouser about half that. The rest goes to cover expenses.

Growing revenues via expanded calendars is one option; intensified media activity provides another. Both are, though, long-term works-in-progress - particularly as hosting fee trends are downwards, as attested to by Sepang and Silverstone, while predicting media landscapes five years hence is a process as fraught as second-guessing Brexit - yet Wall Street rewards short, sharp results, and punishes uncertainty.

NASDAQ's data illustrates the volatility of the stock, with each peak or valley coinciding with some or other development surrounding F1.

Liberty's primary focus is on outgoings, more particularly team payouts. Cut these by, say, a third, and profits (and share prices) rise accordingly. However, Mercedes or Ferrari are as unlikely to countenance such reductions as you or I are willing to take pay cuts; reduce, though, the costs of competing by similar amounts (or more), and their main boards are more likely to be amenable to revenue reductions.

The largest beneficiaries of the current revenue structure are said two teams - both owned by listed companies whose share prices are affected by income, so the knock-on effect is plain to see.

The other two constructors' championship bonus teams, Red Bull Racing and McLaren, are equally unlikely to accept severe cuts: the former depends upon the personal largesse of drinks magnate Dietrich Mateschitz, to whom every dollar counts, while McLaren plans to list after consolidating its racing and automotive businesses, so, again, share price is a major consideration.

For Liberty the quickest and most equitable solution to the cost issue is to impose budget caps. F1 has been down this road before - Max Mosley's FIA tried to make it happen in 2009 - but failed in its attempts. The target date for introduction is now 1 January 2021, when new sporting/technical regulations and revised commercial agreements come into effect.

"It needs to be done in a way that it is good for the sport and respects the structures that have been created. It needs a glide path, and it needs to be fair"
Mercedes motorsport boss Toto Wolff on budget caps

That is a little over three years hence, so there is much urgency, for agreement on budget caps will not only shape the regulatory process, but F1 for many years to come. In order to achieve the objective a glide path through to end-2020 has been proposed as a precursor to annual caps of $150m (£115m at prevailing exchange rates).

The figure excludes engines (already capped at around £16m and decreasing), driver earnings (controversial given that drivers are undoubtedly performance factors), executive remuneration (private yachts are expensive) and marketing (to enable paddock folk to eat in the manner to which they have grown accustomed).

That is around $200m all-in to operate two cars for two hours on 20 (or so) Sundays per annum, or $2.5m per racing hour per car - yet it is still not enough for half the grid, with some teams spending well over double that. Those above the line are, in diminishing order: Ferrari, Mercedes, Red Bull Racing, McLaren and Renault, with the rest on or within the cap.

With engine usage and their prices controlled, standardised tyres, restrictions on testing, limits on race team personnel, controls on windtunnel hours and CFD usage, and other blanket restrictions, it costs about the same, whether for Ferrari or Force India, to run two cars for a season. That figure is estimated to be around £80m, with the difference lying in development cycles and a major team's ability to "throw" parts at a car.

Therein lies Liberty's challenge, to persuade the 'big four' that levelling the financial playing field will still enable them to win against teams that have evolved into major forces on far leaner budgets. Consider the magnificent job Force India has done on sub-£100m budgets, then imagine the challenge the team could mount given financial parity.

"It is above our budget," believes Force India's deputy team principal Bob Fernley, "but I'd much rather be able to say that Force India was capable of bridging the deficit of 30million than 200million which is where it is at the moment, and I think it's very important for the sport to have five or six teams capable of achieving a podium on merit.

"At the moment, that's not possible."

The shame of a Ferrari or Mercedes regularly getting themselves creamed by their engine customers could be too much to bear, and they may decide to exit F1 or concentrate solely on Formula E - which could in turn cause further issues: should they walk, would they, for example, take their engine supplies with them? If so, who to plug the void? Any incoming manufacturer would face the same risks.

Then there is the human cost: reduced budgets result in headcount cuts, with (conservative) estimates suggesting that the quintet currently operating at above the $200m all-in threshold would need to collectively reduce manning levels by around 1400 heads over three years, while those operating below the cap could only absorb half that - if they manage to procure the necessary budgets.

Human cost of a budget cap

How F1 staffing would be affected

* Differences in headcounts with similar budgets due to varying in-house manufacturing/outsourcing policies. For example, Williams produces approximately 90% of its car in-house, whereas, for example, Haas outsources to Dallara. Force India's model lies midway the two.

True, at Ferrari some staff could be absorbed within its road car division, or, in the case of Red Bull, be transferred to Toro Rosso, but what about the rest?

"It needs to be done in a way that it is good for the sport, that it respects the structures that have been created, so it needs a glide path, and it needs to be fair," Mercedes motorsport boss Toto Wolff told Autosport when asked about the effects of the almost-certain introduction of budget caps.

"That is very important. We have all different set-ups, we are organised in different ways."

Mercedes' F1 team is based in Brackley, with its parent located in Stuttgart, and while the British-based independents are likely to ramp up operations and could absorb some staff, the number after attrition, redeployments, transfers and absorption, up to 800 families could be affected. Factor in redundancy packages, and projected cost savings diminish rapidly - but not, of course, for Liberty...

All the while Renault has a conundrum: after years of under-investment by previous owner Genii Capital, the French firm's works team is ramping up its manning and facilities; does it place its plans on hold while awaiting clarity - during which time it will suffer a performance knock - or does Renault invest despite the uncertainty?

Talk of budget caps is cheap, but their implementation could prove extremely expensive unless handled with due care and circumspection. That they are vital for F1's future health - as well as Liberty's share price - is a given, yet, as is too often the case in this world, time is running out and a three-year glide path may yet prove insufficient to implement this complex issue.

All the while the markets will be nervous - but not half as jittery as hundreds of families who face uncertain futures.