Ferrari and Mercedes are at odds with Formula one owners Liberty Media over whether the sport should limit how much they can spend on their teams. But can the sport survive without a ‘cost cap’?

@DieterRencken explains how F1 got where it is, and asks whether the sport’s few remaining big spenders can be persuaded to embrace a change it has arguably put off for too long.

Until two or so decades ago any mention of Formula 1 budgets was met with dismissive shrugs: If you had to ask what a season cost, you were too poor to participate. The bravado had been fuelled by nicotine brands who had nowhere else to burn their billions, while talk of impending global anti-tobacco legislation ironically encouraged them to up their spends while they still could.

Those that weren’t in – such as West – entered in a hurry. Lucky Strike founded an entire team, namely BAR, in order to bring its roundel to a global audience. Budgets exploded, and teams went on massive expansion sprees, funding massive test teams (sometimes two), while paddock hospitality units were upgraded annually as a matter of course. It was too good to last, but F1 never was very good at reading social signs.

However, no sooner had tobacco funding been outlawed than F1 was sustained by an influx of motor manufacturers, all eager to prove their performance credentials. Thus they splashed out on teams: Ford/Jaguar acquired Stewart, Renault bought Benetton, Honda ditto with BAR and BMW with Sauber; others founded their own (Toyota), acquired equity in an existing team (McLaren / Mercedes), or ramped up their existing branding (Fiat / Ferrari).

Thus in the mid-noughties there were no fewer than seven car brands represented on F1 grids and, if anything, spending was even more frenzied. For example, Toyota commissioned two identical wind tunnels, both operating 24/7, while there was talk that the contract of a technical director contained a clause that the team fund his private aircraft in order to enable him to return to his family on non-grand prix weekends…

This time it truly was too good to last. Grey-suited accountants jibbed at signing off budgets measured in hundreds of millions for outfits that had no chance of placing better than seventh – or worse, found themselves beaten by independents operating on budgets half the size – and put team principals on notice to spend (substantially) less, or face closure of their operations.

The first to feel the heat was Jaguar, and thus the team proposed a form of budget cap, dressed up as an engineering efficiency exercise. The idea went nowhere for a few years – primarily as there were then still six other manufacturers willing to spend freely – and Jaguar’s owner Ford sold the team to Red Bull Racing on extremely generous terms. However, a seed had been planted in Paris…

Simultaneously the manufacturers had become dissatisfied with sharing just 23 per cent of F1’s retained revenues while the commercial rights holder – a bunch of banks who had acquired the business by default, but run dictatorially by minority shareholder Bernie Ecclestone – trousered the rest. Thue manufacturers pushed for increased slices of F1’s revenues, in the process demanding greater input into F1’s regulatory process.

None of this sat well with the FIA, which feared the tail was wagging the metaphorical dog. A budget cap could provide a solution to various thorny issues: reducing barriers to entry for prospective entrants while taking the heat out of manufacturer team demands for increased revenues. Not to mention making it harder for manufacturers to out-develop their independent rivals by merely out-spending them.

Thus the concept of a $40m budget cap was proposed from 2010 onwards, with teams adhering to the restriction being granted greater regulatory freedom than those who refused to. Former Jaguar team boss Tony Purnell devised allegedly effective control methodologies on behalf of the FIA, but matters came to a head in June 2009 when the manufacturer faction threatened a breakaway series over the regulations.

A raft of ‘wannabes’ applied for entries, four of which were eventually selected. The record shows that one (USF1) was stillborn, Campos (HRT) lasted three fraught years, Lotus (Caterham) imploded in 2014, and Manor (Virgin/Marussia) staggered through two administrations before eventually being liquidated in 2016. Of the four teams, only one (Manor) scored points, taking over four years to do so.

As for the manufacturer teams Honda, Toyota, Renault and BMW were all gone by the end of 2009. But not before they signed up to the 2009-12 Concorde Agreement, a cornerstone of which was the McLaren-devised Resource Restriction Agreement, which included controls on testing, wind tunnel/CFD usage and race crew restrictions/curfews, and aimed to control spend through a complex payroll versus purchase ledger matrix.

Yet, while the FIA preached cost saving, the CRH, from 2007-17 controlled by venture house CVC Capital Partners, annually extracted around half a billion bucks from F1…

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The RRA died in 2013 after first Red Bull, then Ferrari, questioned its effectiveness, with CVC’s offer of preferential bonuses and Strategy Group privileges to the Big Four teams (said two plus Mercedes and McLaren) slamming the final nail in the cost-saving coffin. After all, who wants cost caps when you benefit from $100m annual bonuses and first-tier regulatory input while independents struggle along without? (To understand the consequences this had on F1’s governance process, see this earlier article.)

Although the independent teams lobbied for cost savings by whatever means the majors resisted all attempts at introducing regulatory controls, arguing they were not enforceable, while Red Bull Racing has long pushed for savings via technical and sporting regulations designed to curb excessive spend. Given the vastly different business models operated by the ten current teams, there simply is no ‘one size fits all’ formula.

Thus things went relatively quiet until Liberty Media acquired F1’s commercial rights from CVC in January 2017. As a (NASDAQ) listed company, Liberty’s primary focus is its share price, which entails turning ever-increasing profits, and thus dividends.

Profits are a function of income less costs and, with team revenues being Liberty’s largest cost driver – devouring about 50 per cent of F1’s current $1.8bn annual turnover – it stands to reason that reducing team payouts and bonuses impacts rather healthily on Liberty’s bottom line. Thus a sudden surge in interest in cost caps, particularly as income is likely to fall in the short and medium terms as Liberty restructures the sport.

The problem is, though, that a series of bilateral agreement dictate F1’s regulatory and fiscal structures through to the end of 2020, so unless all teams voluntarily agree to reduce costs the chances of cost caps being introduced within the next three years are effectively zero. After all, turkeys don’t vote for Christmas.

Whenever talk has turned to post-2020 regulations, Ferrari and Mercedes have threatened to exit (‘F1xit?’), with mutterings about F1’s ‘DNA’ and threats of dumbed-down technologies underpinning their arguments. Ferrari president Sergio Marchionne has been the most vocal, although Mercedes CEO Dieter Zetsche has stated the two companies are “100% aligned on our thoughts and our strategic actions in Formula 1.”

Last week McLaren group executive director Zak Brown urged Liberty Media to get a grip on the cost of competing in F1. “Costs are totally out of control,” he said, describing F1 as “probably the only industry in the world, let alone sport, that has not addressed costs in today’s day and age.”

“That need to happen, I think that needs to happen as the highest priority.”

A further problem is that the major teams will resist any attempts at regulatory cost control, for they fear their leaner rivals used to operating to modest budgets are likely to run rings around once-bloated organisations that have suddenly been forced onto crash diets. Without putting too a fine point on matters, the majors probably employ more heads in their staff canteens than does Haas in its engineering department.

Finally, any reduction in budgets will result in commensurate headcount cuts. Force India’s Robert Fernley reckons it costs around £80m to design, build and race two cars per season, including engines, tyres and test sessions, but excluding marketing costs, and driver and executive salaries. Indeed, in 2017 the team finished fourth behind Mercedes, Ferrari and Red Bull on a total budget of approximately £100m.

Given that engines and tyre costs are fixed, that race team headcount is fixed, that wind tunnel and CFD activities are controlled, and that testing is controlled, it stands to reason that the costs for the equivalent activities run to roughly the same level, regardless of team. Yet, according to estimates, Mercedes spent £290m on its 2017 F1 programme, excluding the engine operation.

That begs the question: How does Mercedes incur the differential of around £190m? True, the team has substantially higher marketing costs, while Lewis Hamilton costs considerably more than Sergio Perez, but such factors do not explain a three-fold difference in budgets.

However an analysis of team headcounts shows that in 2017 Haas operated to a budget of £100m and headcount of 225, while Force India’s numbers were £100m / 400 respectively; by contrast, Ferrari estimated headcount (excluding engine division) was 960 (budget estimate: £350m), while Mercedes’s staffing runs to 860 heads. That is almost four times Haas’s number, and over double Force India’s complement.

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Clearly then Ferrari, Mercedes and Red Bull (£215m/700) can afford to out-develop the independents, who have little change left after designing and building their cars for a given season, and hence their increasing performance deficits as a season wears on. Where Force India can afford to spend only £20m on development per season, Mercedes can blow £210m and still operate within budget.

Thus, apart from any commercial considerations, from a pure performance perspective Liberty would do well to limit spending, for that would tighten the field. The question is, though: “What represents a reasonable level for the pinnacle of motorsport?” Set the cap too high, and it becomes meaningless; too low, and F1 is in danger of losing its cutting-edge glamour.

Either way, it is clear that Liberty needs to introduce cost caps simply to balance its books, and thus a figure of $150m (£125m) – exclusive of marketing, engines, tyres and driver / executive salaries – has been bandied about. That would enable each team to build and race two cars, leaving approximately £45m for in-season development and testing.

All inclusive, a front-running team should have change from a £180m. Although a Force India or Haas may not be able to (immediately) raise such budgets, a budget cap would at least level the field and deliver closer racing. What’s not to like? Plenty, if you’re a major team, and even more so if you’re an employee within one of the privileged outfits, for budget caps will make staff lay-offs inevitable.

Team Headcount Variance Mercedes 860* 460 Ferrari 960* 560 Red Bull 700* 300 Force India 400** 0 Williams 575* 175 Renault 620* 220 Toro Rosso 400** 0 Haas 225*** -175 McLaren 690* 290 Sauber 360*** -40 Potential total staff reduction: 1,790. * Predominantly in-house

** Mixed out-sourcing and in-house manufacture

*** Predominantly out-sources

Consider: an overall budget of £180m would restrict teams to around 400 heads maximum, meaning Mercedes would need to retrench half its staff, and Ferrari almost 60 per cent of its payroll. Red Bull would face a reduction of at least 30 per cent, as would McLaren, which runs to similar numbers.

“We are not against a cost cap as long as it can be policed in the right way and [is introduced sensibly],” said Mercedes Motorsport boss Toto Wolff in Abu Dhabi.

“[But] we are not going to cut our workforce by 30 per cent from one year to another and we are not going to give up a performance advantage that we have lightly, so there needs to be something on the other side.”

What that “something” is remains unclear, but, again, it is clear that a long hard slog awaits before F1 adopts a concept that has been kicking about for over a decade, but now has a commercial imperative.

A glide-path has been proposed to take the sport through to the end of 2020, but that suggestion is, of course, too logical for F1. So arguments will likely wage back and forth until December 2020 at which point those teams that are potentially hardest hit will simply refuse to subscribe to budget caps. Liberty is unlikely to back down, simply as it cannot afford to.

The irony of the situation is, though, that a lot more heads will be retrenched if one or more team exits F1 completely, while the question must be asked: Could F1 really term itself ‘the pinnacle of motorsport’ if Ferrari and Mercedes race elsewhere?

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Clearly Liberty needs budget caps as much as F1 needs to control its spending, but too many open questions remain, including the level of cap, how to control spending limits, and what penalties should be applied in the event of breaches. After all, fines levied on excess spending are pretty meaningless when teams have a spare £200m saved.

Equally, budget caps do not even begin to address the question of F1’s inequitable revenue structure, which arguably disadvantages the disenfranchised teams more than unlimited spend does, simply as the various non-performance-based bonuses paid by the commercial rights holder to major teams encourage excess spending.

The bottom line is that a budget cap is not the silver bullet many believe it to be, and alone will not correct F1’s many ills. In addition, over 1,000 highly qualified heads who devoted their working lives to F1 are likely to be laid off (see table), all in the name of shareholder value. Is that a fair trade-off?

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