What’s the reasons behind the crisis in Formula One?

The cause of the current financial crisis in Formula One is easy to identify — it is the unequal distribution of the $829m of TV and franchise income by Bernie Ecclestone’s Formula One World Championship (FOWC) organisation amongst the 11 competing teams. Unequal because the most money ($609m) goes to the six richest teams who don’t need it and the least money ($220m) to the five impoverished teams which desperately need it. In the process Formula One has become more akin to a game of monopoly between the haves and the have-nots rather than a test of speed.

In 2014, of the 11 teams that make up the Formula One grid, only six are financially viable — namely Ferrari, Red Bull, Mercedes, McLaren, Williams and Toro Rosso. The other five have either gone bust, are going bust or will survive on the proverbial wing and a prayer into 2015.

It’s no secret who these teams are — two have already gone under and the other three have self-declared themselves to be on the emergency list. Marussia and Caterham, barring a miracle, will not be on the grid in 2015 and as things stand now, Sauber, Force India and Lotus probably won’t be. These five teams are collectively estimated to have sustained losses of $300m between them in the past 12 months and it is money they don’t have — hence the sudden crisis.

In the past the unequal distribution didn’t really matter too much as the smaller teams got by on sponsorship with only a small contribution from Ecclestone and a lot of good luck. It was a recipe that kept long-established players like Peter Sauber and Eddie Jordan in business for years and ultimately made them multi- millionaires. Back then Bernie Ecclestone’s organisation took 70 percent of TV and race revenues and the teams made do with 30 percent.

During the 1980s and 1990s the teams were in ignorance as to the true revenues of the sport. It was only in 1997 that they became aware of just how much cash Ecclestone was pulling in that they began to get anything approaching a fair share. Now the teams probably get 60 percent of all revenues, although no-one really knows how much the central sponsorship, trackside advertising and hospitality incomes really add up to — that is still Ecclestone’s secret.

But then the share out between Ecclestone and the teams has always been controversial. In most sports the participating players get the lion’s share of revenues, but not in Formula One as Vijay Mallya, owner of the Force India team, points out: “I think it’s probably a unique sport, where the participating teams get the least amount of revenue as compared to the income. When you compare it to any other sporting activity globally, unfortunately we are at the rough end.”

Both Mallya and Gerard Lopez, owner of the Lotus team, used to be strong allies of Ecclestone but now relations have cooled as they realise the imbalance and the possible fatal threat to their futures which this time can’t be underestimated.

Ironically, the current financial crisis was foreseen by Martin Whitmarsh, McLaren’s former team principal who used to be chairman of the Formula One Teams Association (FOTA) before he was fired by McLaren a year ago. At the time, he said: “I cannot see how you can construct a sustainable business model and I fear that we will have a crisis and then we will have to get real and sort it out.”

Whitmarsh was speaking from experience. Under his watch McLaren lost, first Mercedes as its engine supplier and bankroller, and then Vodafone as its title sponsor — together they were worth an estimated $140m a year of income. This year McLaren was forced to go racing, for the first time in its proud 50-year history, without a title sponsor paying the bills. Deeply humiliating, it ultimately cost Whitmarsh his job and the only upside was that he was uniquely positioned to predict the current crisis a year in advance.

Formula One’s finances have changed a lot in the last ten years. A decade ago sponsorship was plentiful and it paid more than half of all the bills with team owners picking up 30 percent of the cost and Ecclestone contributing less than 10 percent. Now that has completely changed round with sponsorship scarce and contributing only 20 percent with team owners providing as much as 40 percent and Ecclestone’s contribution gradually rising to 40 percent.

It is a massive structural switch that has gone hand in hand with other changes. In 2004, the top three teams then — Renault, Ferrari and McLaren — shared 40 percent of the central income. Now the top three teams — Ferrari, Red Bull and Mercedes — take 50 percent of the Ecclestone revenues. A 10 percent shift in the revenues may not mean much but to the smaller teams it is the difference between surviving or not. In 2004, the bottom three teams got 25 percent of the money but in 2014 the bottom three got just 10 percent. It is these imbalances that are testing the finances of Formula One.

But how has it come to this? The heart of Formula One’s problems lies in the huge decline in sponsorship over the past ten years. In 2004 pure cash external sponsorship was $1.2bn a year; ten years later the cash has dwindled to less than $350m and many of the major sponsors that used to bankroll the sport have left. Big spenders such as Hewlett-Packard, Vodafone, Japan Tobacco, Orange, British American Tobacco, ING, West, Telefonica, Siemens, Panasonic, RBS and Credit Suisse have all left the sport with only Santander and Martini arriving as replacements.

Twelve major sponsors have been replaced by two and the sums just do not add up. The truth is that big sponsors have effectively rejected Formula One as a marketing platform. So much so that in the past eight years only one new title sponsor has entered the sport, Martini & Rossi at Williams and even then at barely a quarter of the price that Hewlett-Packard paid Williams back in the good old days. It seems that sponsoring a Formula One team as an effective global marketing tool has fallen out of fashion completely.

What has really happened is that Formula One’s lost sponsorship has migrated to a sport called soccer. Whilst Formula One has seen its sponsorship dwindle away the top soccer teams across the world in the German, Spanish, Italian, French and English leagues have been booming. Shirt deals that used to cost $6m for a season now sell for $50m and Formula One’s traditional sponsors have moved their money across.

Formula One used to dominate sports sponsorship, taking one of every two dollars. Now Formula One is lucky to get one dollar in ten.

The loss of its traditional sponsors has seen Formula One fall into a deep crisis. As well as soccer, faster-growing sports such as golf and tennis have been the chief beneficiaries of Formula One’s decline.

It has meant that the whole funding make-up of the sport has changed in the last ten years with a shift away from sponsorship to teams relying on income from television and race franchise fees, provided by Bernie Ecclestone, to make up the numbers. Formula One has sleepwalked itself into this position and most of the power players seem unaware it has happened.

Nowadays, only Ferrari pays its way from traditional income streams and the rest of the teams rely on the TV monies and financial input from their owners. Ferrari has always been different as the oldest and most glamorous team and it has cleverly leveraged its position to obtain extra monies from Ecclestone to the extent that it now takes $1 of every $5 that Formula One generates.

Max Mosley, the former president of the Federation Internationale de l’Automobile believes this is now an intolerable situation and that the $829m that Ecclestone distributes annually should be spread out equally amongst all the teams, with the teams then topping up that cash with as much sponsorship as they can find.

“It’s the only solution — to share the ‘Bernie money’ equally to every team. Otherwise it’s just not a fair competition any more,” he says. “Combined with a cost cap where you limit the amount of money each team is allowed to spend this would create a more level playing field.”

In 2009, Mosley tried and failed to implement a $60m budget limit and he regards his inability to impose a cost cap on Formula One during his time as FIA president as his biggest failure.

It all started 12 years ago when  Mosley realised that Formula One had to cut costs to see off a financial crisis he could see would eventually come. It was 2002 and Formula One was booming, awash with cash after the arrival of Japanese giants, Toyota and Honda. He was the first to realise that costs were spiralling out of control and were probably not sustainable.

Then Formula One was riding high generating revenues of some $4bn a year with car manufacturers such as Toyota, Honda, Ford, Mercedes, Fiat, BMW and Renault pumping $1bn a year into the sport and spending another $1.5bn developing and supplying engines. Mosley was right to be fearful but even he could not forecast that that $4bn would shrink by 60 percent inside ten years.

In 2003, Mosley started his assault on costs by banning qualifying cars and insisting that cars used for qualifying also had to race. Two years later he managed to restrict engine development by reducing the number of engines that could be used during a season. Before that teams used one new engine for a race and another for qualifying, throwing them both away afterwards.

In 2008, he made a real breakthrough when agreement was seemingly reached to cap costs to $80m a season. But it all fell apart when Ferrari’s then team principal, Jean Todt, would not agree and the idea collapsed.

Hurt by the failure, Mosley formed a working group consisting of the chief financial officers of each team in a committee chaired by Tony Purnell, the former team principal of Jaguar. He charged the committee with finding a solution. The committee produced a weighty document but in the end finding common ground proved impossible. Each time the CFOs took back a set of agreed proposals back to their bosses they were vetoed, with Jean Todt and Ferrari chairman Luca di Montezemolo seemingly the hidden hands behind every setback.

It was basically Mosley fighting Todt for the financial future of the sport. But then Mosley was hobbled when the News of the World newspaper published revelations about his private life and he was forced into a two-year legal battle to clear his name. During that time Todt was Mosley’s most vociferous supporter and his support effectively saved him from having to resign as president. With that the battle to cut costs got forgotten until 2009, just as Mosley was about to retire.

But before he went he decided to try one more time and thought he had come up with the answer.

“I proposed a cost cap by the back door whereby new smaller teams would be introduced into Formula One with a cost cap of say $40m a year,” he recalls. “In return they would be allowed to have more freedom with the technical regulations. But the other teams rejected this and said it would create two-tier racing. I said to them ‘but that is what you have got now’.”

In the end, much to Mosley’s chagrin, the smaller teams backed the bigger teams and decided against a cost cap.

At that point, an exasperated Mosley retired from the presidency and was succeeded by Todt. There never was any cost cap and the sport rolled on amidst diminishing sponsorship returns and the increasing contribution from Ecclestone’s central revenues to fill the gap.

Despite Ecclestone’s ever-increasing contribution, Mosley left his post fearing the worst. He says now: “It’s never ceased to amaze me that when the ten or 11 team principals, all highly intelligent people, get together they can’t agree on anything.  I remember in 2002, Dave Richards [a former team principal] telling me that they couldn’t even agree on what flavour sandwiches to have at meetings, let alone take momentous technical decisions.”

Since Mosley’s departure, Formula One has been run by a committee called the Formula One Strategy Group (FOSG) which consists of the top six teams with six votes between them, Ecclestone with six votes and Todt, also with six votes. FOSG is the equivalent of the old Formula One Commission which fell into disrepair when it stopped holding meetings.

It’s a curious paradox that Todt, the man who blocked the cost cap many years ago is now president of the FIA. In his previous role Todt guarded Ferrari’s preferential treatment closely and refused to countenance any attempt to instigate cost-cutting in Formula One or divide the central revenues out more equally. But after he became president he was forced to change his tune and effectively reverse his position completely.

At the beginning of the 2014 season there were once again vigorous talks about a new plan for a cost cap giving Todt a chance to solve the current problem before it became a crisis and force through the change that Mosley could not. In March FOSG came close to agreeing a new cost cap deal but this time found unanimous opposition from Ecclestone and the teams.

Todt was deeply distressed by his failure to push a cost cap through as he said: “I was disappointed because it was impossible to achieve the reduction which I felt was needed.”

Todt, experiencing exactly the same frustrations as Mosley, explained why he had failed: “If the commercial rights holder, Bernie Ecclestone and six teams are against it, it’s mathematics that it can’t be imposed.”

As a result of the continued failures, Todt believes that any notions of a cost cap being agreed are now completely dead as he explains: “Everyone says they are all in favour of reducing the cost, but Bernie and the six teams were against it.”

But change has to come if the three teams on life support are to survive. Lopez says: “The distribution model of revenues is completely wrong. We say things and then we tend to do the opposite. We always find excuses not to have a cost cap. Now is the time to be acting rather than talking about it.”

Todt is now seeking to achieve cost reductions by imposing new regulations but once again Ferrari is believed to be against it and the irony is that Todt finds himself in exactly the same position as Mosley was in 2006.

Mosley believes that will be impossible to impose a cost cap by regulation and he speaks from bitter experience: “When I introduced swingeing restrictions on engines in 2004 the teams spent the same money developing more efficient airboxes — it was ridiculous, impose a limit on one thing, they develop another and so it goes on.”

Ironically from talks around a cost cap of $40m, when the idea was first mooted ten years ago, the latest figure being talked about is $200m, which many people feel isn’t a cost cap at all. As former Lotus team principal Peter Collins points out: “Red Bull, Ferrari and Mercedes spend much more than that amount, while teams such as Marussia and Caterham existed on a quarter of that sum.”

Lopez thinks the answer lies in GP2, the series that supports Formula One at Grand Prix weekends. He says that a GP2 car is put on the grid for between $1.5m and $3m a year against an F1 car which costs up to 100 times as much although the spectator and the TV viewer can hardly see a difference.

“Are we really that much better?” he asks. “I mean are we really better to the point that a team needs to spend $300m to be six seconds faster? We’re not. I wouldn’t accept that argument from anybody. We’re not $300m better if you take the top teams compared to a GP2 team. So it’s a bit ridiculous to say that you need to spend that kind of money to have that kind of performance — because that makes us the worst managers in the world. If I took a financial view of this sport, comparing GP2 to F1, and the so-called ‘law of diminishing returns’, we are most probably the worst managers there are.”

Perhaps the last word is best left to the outgoing Graeme Lowdon, head of the troubled Marussia team, who is now unemployed: “The current recipe, in terms of sporting and technical regulations, has produced a sport that nobody can afford.”

Tom Rubython is the former editor of BusinessF1 magazine and author of the best selling motor racing biographies; Life of Senna and Shunt. This article was originally published in the Arabian Business.