The Economics of Football: Is football a good investment?

My client, Mr Selakovic is a Russian Billionaire who wishes to invest in the English football industry. He wishes to know whether buying an English football club is a wise investment given the current economic climate or not. He would also like recommendations on which policies he should incorporate to make his investment a success.

INTRODUCTION
Professional football in England is governed by the Football Association (FA), and the 92 professional clubs are distributed across 4 Leagues (The Premiership, Division 1, Division 2 and Division 3). The state of clubs finances varies greatly between leagues, and even within leagues, as some clubs are substantially richer or poorer than others. Consequently, it is evident that detailed statistics, such as those in the Deloitte and Touche report, must be analysed to determine the profitability of various clubs in different leagues. The football industry has never been as commercial as it is at the moment. The financial gap has been widening between clubs for some time, but for several reasons. It is important to have some sort of understanding as to the historical origins of the industry in order to comprehend the ways in which the industry may develop in the future, and I will consider this below. Football is a unique type of market; although the features of this market can be identified in similar terms to other markets for example, the factors of production still include capital, land, labour and entrepreneurship the output of this market is not only uncertain, but also takes a number of forms (not only watching matches at the various stadia, but also television broadcasting, advertising/marketing and merchandise). I have dealt with how and why the football industry is so distinctive in this report. I have weighed up the benefits and disadvantages of buying an English football club in the present economic state of the football industry. Afterwards I have compared which of the divisions has the best potential to be successful once invested in. I have then gone on to pick out a specific club that would suit the requirements and which I feel would be the best investment for Mr. Selakovic. I have used statistics from previous seasons, as well as my own background knowledge of how football clubs operate, in order to support my arguments with regards to the best investment opportunities as well as determine which policies my client should make use of if he decides to follow my advice.

HISTORY OF THE INDUSTRY

Football clubs started off in the late nineteenth century and were simply groups of voluntary people who met up and played football matches against other groups. As the sport grew and more clubs were formed, there were also spectators that attended matches. This had the following repercussions: a regularised fixture list, some sort of primitive stadia and small fees for watching. As players required more time to train for larger, more frequent matches they had to give up their normal jobs; they required payments to substitute their jobs, and in this way, football clubs took the first steps to becoming commercial businesses. The FA was also founded about the same time and, as clubs became employers, football clubs were run by local businessmen. Although clubs soon became limited companies, they were run for the enjoyment and satisfaction factor as opposed to the aim of profit; local businessman often became popular locally through running the clubs and their other businesses thus benefited. Even at present some chairmen have poured millions into clubs with little apparent financial gain Jack Hayward at Wolverhampton Wonderers being a fine example but for the satisfaction of seeing a club progress. In the 1928/29 season 24 million spectators watched football and these fans were evenly distributed across the small and large clubs. This was mainly due to the existence of a maximum wage and players being unable to move freely; many players had social links and had no desire to move, and there was no wage incentive present. Transfers were thus infrequent. In 1947, Notts County bought Tommy Lawton for 20,000; this was an English transfer record made by a third division side, illustrating that higher division clubs were not necessarily the richest. After the lifting of the maximum wage in 1961, the inequalities between professional clubs began to grow. The income ratio between first and second division clubs grew from 2:1 to 5:1 between 1950 and 1970. Within this period, clubs were allowed to keep all revenue from matches, which had

previously been redistributed to smaller clubs. Players became stars and the better players naturally wanted to be winners; bigger clubs benefited from buying good players and could now tempt them with higher wages. Sponsorship deals and more media and television coverage developed over the 70s and 80s further increasing larger clubs incomes. As leisure becomes more and more important to consumers, television companies in particular recognised this. Purchasing shares in football clubs with the aspirations of providing home entertainment, television companies have been instrumental in increasing the income of larger clubs. This vertical integration is occurring all over the world and in Italy, Fininvest actually owns a majority share in AC Milan. Although these occurrences have increased the incomes of clubs, football clubs are being increasingly run as businesses and fans cannot enjoy football as cheaply as they could in the days where football was very much a part of community. It can be seen that over the past 100 years football has become increasingly commercialised and the primary aim of shareholders is increasingly becoming that of profit maximisation. There is potential for football to be highly profitable; the main drawback is the unpredictable element of a clubs performance.

FEATURES OF THE FOOTBALL INDUSTRY AT PRESENT

The football industrys recent boom in value has been fuelled by the huge television revenue. The television revenue a division 1 team would receive by promotion to the premiership in the 1999/2000 season was worth 10 million. This value is more than some division 1 clubs are worth! Larger clubs are obviously more popular and are likely to receive even larger sum in television revenue let alone sponsorship and merchandising. A controlling share in Manchester United was worth 10 million at the beginning of the 1990s; by the end of the decade Rupert Murdoch was offering more than 600 million. There has been a huge escalation in the value of clubs, but mainly premiership teams. The recent issue with ITV withdrawing their funding for covering Nationwide League matches damaged the income of Division 1 teams significantly. Furthermore, relegation to Division 1 from the Premiership means losing an immense amount of their income, and it is risky whether to cut cost by selling the clubs best players or to gamble on achieving promotion the following season. In short, there is a huge risk in the football industry. This source of this risk is the unpredictability of football. It is a game of chance that can sway either way; even giants can fall, and spending is not necessarily the answer as is explained in detail below. The most important capital of a football club are its players, but their productivity varies according to a number of factors injuries, morale, training facilities and even the coach are all important. Thus I conclude that there is no model that can take all of these factors into account or a formula for success. Another problem associated with players is the recent Bosman ruling; players can leave on contract expiry with no transfer fee received by their former club. This is a very tricky issue especially if players are unwilling to re-negotiate contracts. This problem can even down-value a club if a star player leaves; the player as capital has been lost, there may be a fall in merchandise sales and the club is less attractive to sponsor. There is, as always, a flipside to this, however; the club that benefits could be ones own club. In which case, ones club may achieve promotion, sign star players on Bosman rulings and take advantage of boosted sponsorship and merchandising opportunities. One final issue is that of borrowing. It has been necessary for clubs to borrow, either to finance investment in facilities or transfers. This is perhaps the most risky aspect, and clubs can even go bankrupt, making the chairman very unpopular. Leeds United were in trouble last season, and recently Fiorentina of Italy were declared bankrupt, relegated to the lowest professional division and forced to adopt a different name. In summary, the football industry, as it had become increasingly commercialised, has grown immensely, but with two main drawbacks: there is a huge gap between the larger clubs and the smaller ones and managing a football club has become increasingly more complex and unpredictable.

IS IT THE

RIGHT TIME TO PURCHASE AN ENGLISH FOOTBALL CLUB?

There are many arguments for and against entering the football industry in the current economic climate. I have divided the arguments up accordingly and displayed them in bullet point format below.

It is the right time to invest in the football industry (Arguments for)

o In the Premier League income through gate receipts, TV revenue, sponsorship and merchandising have been increasing steadily. Although the increase in television revenue has steadied it is still increasing year upon year. Figure 1 also shows that sponsorship revenue has become especially important and increased quite dramatically from the 97/98 to 99/00 seasons. This is likely to be related to certain players being looked upon as icons or heroes by the public and this is therefore made use of to advertise products. A prime example is David Beckham; whilst at Manchester United he promoted goods such as Brylcream and Adidas boots, in addition to Vodafone, one of Manchester Uniteds sponsors. Vodafone are likely to have paid a large sum for such sponsorship/advertisement deals, benefiting Manchester United as well as David Beckham. At this moment in time share prices of football clubs are especially low. In the example of Manchester United, the UKs most profitable football club and one of the most successful clubs in the world, this is especially the case. As seen in Figure 2, during 2000, Manchester Uniteds shares were valued at around 350p each; at the end of 2001 and in early 2002 the shares were worth around 125p each. This is a decrease of 64.3%. Therefore shares in football clubs are extremely cheap at the moment, even in the cases of the most successful ones; this in turn makes now a worthwhile time to invest in the football industry. Player transfer fees are far lower than they were a few seasons ago. David Beckham was sold to Real Madrid for a cut-price of 25 million euros, when a few seasons ago he could have been sold from around 40mn. Players like Juan Sebastian Veron and Joe Cole are also examples of players that can be said to have been sold at a cut-price. This is a benefit of entering the industry at this moment in time because with Mr. Selakovics financial backing, any club could bring in high quality players at such low prices, enabling further investment in other areas of the club. The Increasing average ticket prices are also another benefit as this shows increasing revenue. Figure 3 shows ticket prices in all professional divisions increasing, but especially in the Premiership with an increase of 16.6%. Extra revenue and popularity can also be achieved by developing a sort of trademark or franchise player. Certain examples are Michael Owen (Liverpool), Wayne Rooney (Everton), and up until recently David Beckham (Manchester United) and Joe Cole (West Ham). These players were all bred through youth training systems and brought a sense of pride to the supporters of these clubs. These players have aided their clubs, or former clubs, in 2 ways: i) They have not cost the club any transfer fee and are fine quality players, which help their clubs strive for success; ii) They boost sales of strips and encourage supporters to attend matches because they want to see the quality of football and are proud to be a supporter of that club. Mr. Selakovic could easily invest in such youth regimes at any club and although it may take time, he could find a youth talent of his own. There is a possibility of achieving high profits through the sale of players and purchasing other cheaper players to replace them. An example is again Manchester United. Having sold David Beckham and Veron at cut-prices, they have brought in a new youngster by the name of Christiano Ronaldo. They have made a profit from the deals financially, but the club has also benefited, as Ronaldo is player with a bright future. The one skill essential in a manager to be able to make such deals is the ability to judge a players ability and potential. If Mr. Selakovic were to employ a highly sought after and experienced manager, the club that he was to buy would benefit further in similar ways. High revenues from European Competition and the satisfaction of winning such illustrious competitions are also bonuses. If Mr. Selakovic were to take over a club in European Competition, there would be added revenue; if the club were to go far in the competitions and even win, the revenue would be extremely high and, depending on the clubs costs that season there may be an extremely high profit, not to mention the satisfaction of having built up a team and to have won a spirited competition.

o o

It is NOT the right time to invest in the football industry (Against)

o In the football industry there is the worsening problem of high and increasing players wages. In Figure 4, it is shown that in the 95/96 season a total of 298m out of the 578m spent by the 92 professional league clubs was spent on wages and salaries; that is 51.6%. This leads to uncertainties with regard as to whether the season will be profitable or not, and has therefore

recently resulted in shares of football clubs, as seen above in the case of Manchester United, plummeting. In 2002, Manchester United reported a 42% surge in staff costs, to 34m, for the six months to January 31st compared with the same period a year earlier. The football industry as a whole, again seen in Figure 4, made a loss in the 95/96 season; 578m was spent and only 517m was received in revenue; the resulting loss was 61m. This shows that although the larger clubs, such as Liverpool, Arsenal, Chelsea and Manchester United, are likely to make a profit season after season, not all clubs, especially lower league clubs with drastically lower revenue, will make a profit or even break-even. Clubs can now lose out as a result of the lower transfer fees and may be forced to sell players if they cannot afford their wages or are in danger of making losses. The result of the transfer fees being lower now than a few seasons ago is that clubs may have lost out. Manchester United could have made almost 20m more from the transfer of David Beckham if they had sold him a few seasons ago. This is especially a danger for small clubs who may be in debt, and may have to sell their best players if they cannot afford the high wages. These smaller clubs then find it additionally harder to perform well and acquire promotion, which may in turn affect their financial situation; this may then turn into an awkward spiral forcing the club further into debt and possibly further down the leagues. A recent example is Leicester City, which was fortunate for the support of former players and fans solving their financial crisis. Additionally, the board of directors of some clubs would rather sell players than see losses in a season. Manchester United have had to sell some players in this way in order to balance the books after the transfers of van Nistelrooy, Veron and Carroll for 50m; they sold Stam, Cole and Greening for a total of 16.3m, resulting in a trading profit of 7.9m. This shows that even the largest clubs can also be forced into these tight situations. It is hard to find good staff and/or managers willing to work for a reasonable price. The best managers and coaching staff, which are vital to a clubs success, (for example, Sir Alex Ferguson of Manchester United) are expensive to employ as well as very hard to find, as most are already employed by other clubs and are not willing to move. Buying numerous players is not always a surety for success. Leeds United spent over 93m in recent years and has not won a single trophy. This was due to the high wages forcing Leeds to sell some of the best players and in turn affecting their performances. Leeds United is now a diminished side and fought to survive in the Premiership in the 02/03 season and may be in a similar situation this season as they are one of the favourites for relegation.

Evaluation of Arguments
All in all, I feel that the benefits of entering the football industry in its present economic state outweigh the potential costs. As Mr. Selakovic is extremely stable financially and most of the prospective mishaps or uncertainties are regarding the finances of football clubs, or more specifically, players wages, there should be little or no concern for him. The high wage costs and possible losses from dud transfer deals are valid drawbacks but will only have a large effect in the short run. Mr. Selakovic could easily pay off any clubs debt and effectively begin building a new team from scratch. The risk of the investment not paying off, however, is a legitimate argument against entering the football industry and investing large sums in it. The case of Leeds United FCs collapse was very closely related to high wages and paying far too much in transfer fees. Transfer fees are far lower now. Additionally, with such finances as Mr. Selakovic has, one could easily appoint an experienced, top-quality manager with good trade skills, thus reducing the likelihood of such mishaps occurring in the future. The increasing TV revenue, gate receipts as well as sponsorship income in addition to the low-priced shares and transfer fees in the football industry at present are all very convincing arguments. Mr. Selakovic will find it easier to purchase a football club as well as cheaper to begin strengthening, or re-building a football team if need be. There is also the added satisfaction of developing and crafting a squad of high calibre, which I am sure Mr. Selakovic would enjoy. In conclusion, I feel that it would be a good decision for Mr. Selakovic to invest in the football industry at this moment in time. Although there may be financial disadvantages, this will only affect Mr. Selakovic in the short run. In the long run with investment in new players and improving facilities, a club can win competitions both domestically and in Europe, and can operate at a profit with such revenue from these competitions as well as sponsorship, TV revenue and merchandise.

WHICH FOOTBALL CLUB IS THE MOST WORTHWHILE TO INVEST IN?

There are a number of different aspects to consider when aske3d this question. There are a number of divisions and the profit levels and quality of football varies greatly between the divisions. This means it is necessary to decide which division it is best to begin in. Once it is decided which division to purchase a club from, it is necessary to decide which club within that division is the best investment. This is extremely hard as there are a number of factors that cannot be valued in terms of money; it is therefore essential to rely upon ones background knowledge of how the clubs operate, the quality of players at the club and club reputations in terms of position achieved in the leagues, etc. Below I have evaluated which division it is best to purchase a club from and in the section following which clubs would be best to acquire.

From which division is it best to purchase a football club from?

There are 92 professional English football clubs within four divisions. The four divisions are the Premier League (or Premiership), Division 1, Division 2 and Division 3; the Premier League being the highest and Division 3 the lowest. There are great differences between each league in terms of the quality of players and football and finances or financial stability. It is shown by figure 5, that the order of divisions in terms of the better teams in the Premiership corresponds to the highest revenues or income in the premiership and the lowest in Division 3. The Premiership has an average of around 66% of the total English football income, Division 1 around 20%, Division 2 around 8.5% and Division 3 around 5%. It is therefore shown that promotion from one division into another is worth a vast sum to any football club. It is estimated that promotion from Division 1 to the Premiership is worth around 27million, regardless of whether the club is relegated the next season. As a result, clubs that achieve promotion are likely to operate at a profit. This is due to the fact that they are hardened to lower incomes from the division they were promoted from, and as a result have lower costs than the division above. When promoted the costs do not go up, and if they do, they do not increase by as much as the income does through promotion. A good example is in figure 6; within the most profitable clubs of 2000/01 was Ipswich at number 7. Ipswich were promoted from Division 1 but were also relegated that season. However, due to their lower costs, they still operated at a higher profit than clubs that had been in the premiership for a number of seasons, such as Newcastle. All of the clubs shown in the most profitable football clubs of the 2000/01 season were clubs who were in the Premiership that season, therefore again supporting the view that clubs in the Premiership have higher incomes and are consequently more likely operate at a profit. The gap between different income levels in different leagues is widening. This is shown in figure 5 by the rise by 6.5% in income between 93/94 and 94/95 seasons in the Premiership and the decrease by 6.9% for the same time period for income levels in Division 1. Figure 3 also provides evidence for this; tickets for Premiership matches rose by 10.6% more than tickets for Division 1 matches. This shows that the income for Premier League clubs is rising faster than that of Division 1. As a result, the higher income as a result of promotion is becoming an increasingly significant incentive and is extremely beneficial to those who achieve promotion. However, when clubs are relegated after many years in a division, the results can be disastrous. Examples include Barnsley and Sheffield Wednesday. Both clubs were in the Premiership at one point and hovered between this division and Division 1; problems arose however when their costs became high and both clubs were forced to sell their players and downsize themselves. Both Barnsley and Sheffield Wednesday are now in Division 2 and are a shadow of the teams they used to be a few seasons ago. This can happen especially if a club is in the process of rebuilding its first team and is not able to perform against sides that are more used to their own style of play and as a result play superior. In conclusion, I feel it would be best to purchase a club in the first division. The costs of clubs in the first division, especially wages, are lower meaning more money can be spent on strengthening and there is less uncertainty. This is due to the lower revenue in the first division. It is also far easier to build up a team in Division 1, as the teams are not of as high a quality making it easier to achieve hightable positions with players that are unfamiliar with each other (which is the case when a team is being strengthened through the acquisition of new players). Additionally, once promotion is achieved, the reward is greater than from other divisions (an estimated 27million) and the club is likely to achieve a higher profit than most teams already in the Premiership, making it a better investment. In a way, an expanding and developing squad can use the first division as a kind of training platform for the Premiership.

Which clubs are the most worthwhile to invest in within that division?
It is important to invest in a club that has a good reputation in the first division, or has even been in the premiership recently. Clubs of this quality generally hover between the first division and the premiership and will not be in any risk of relegation while they are being improved. Recently relegated clubs include WBA, West Ham and Sunderland, the highest of which finished in the Premiership was West Ham United. It is also important to have a large, loyal fan base. This is because, as shown in figure 7, a large proportion of Premiership clubs revenue is through gate receipts. This is a hard statistic to measure; however, it is known that London clubs are often well supported and generally first division clubs are reasonably well supported. It is also useful if the supporters are reasonably wealthy in order to purchase tickets, as this will also have an effect on the clubs revenue. Figure 8 shows that most London clubs have male supporters with the highest incomes. However, all except West Ham United are currently in the Premiership. A club that has a stadium of at least 20,000 seating capacity and good training facilities and youth schemes is vital to provide the framework to build a Premiership quality side. The most successful Premiership sides have large stadiums to encourage large gate revenue and provide support and encouragement for the team during home games; this helps the club both financially and results wise. Good training facilities and youth schemes are key in developing the youth and nurturing homebred players. Examples of those in the Premiership include Manchester United having raised David Beckham, Paul Scholes and Ryan Giggs; Chelsea having cultivated a future England star in John Terry; Liverpool developed the skills of Michael Owen and Stephen Gerrard. West Ham United are one first division club that seem to have a particularly outstanding reputation for breeding star players; the list includes Trevor Brooking, Paul Ince, Rio Ferdinand, Joe Cole, Glen Johnson and Jermain Defoe. There are a number of clubs that fit into each of the criteria above, but there is one club, which fits into all of the above criteria comfortably and is ideal for Mr. Selakovic to invest in; that club is West Ham United.

POSSIBLE POLICIES TO IMPLEMENT

West Ham United have recently been relegated from the Premiership, and have the vital framework required to succeed in the Premiership. Although some of their best players have been sold (Joe Cole, Paolo Di Canio Glen Johnson and Trevor Sinclair), with investment from Mr. Selakovic, better quality players could be brought in, thus making it easier to achieve promotion and maintain mid-table positions in the Premiership. If Mr. Selakovic were to invest heavily on bringing in new players of a high calibre into the side, in a similar fashion to the way a certain Mr. Abramovich has done recently, once promoted, West Ham United would be able to seriously contend for the Premiership title and compete in Europe. Although players of this high quality may be reluctant to join a first division club, I am sure that the employment of a top-class manager and promises of promotion and future European football would entice players to join the club. West Ham United also has sufficient youth schemes in place to develop its own stars, which would also play a part in bringing success to West Ham if Mr. Selakovic were to invest I it. West Ham United have recently improved their stadium, Upton Park, to a capacity of 35500, which comfortably meets the requirements of the Premiership and has been host to some England European qualification fixtures recently. As a result there is no need to invest in the ground, however, training facilities can always be improved. West Ham, as mentioned above, has a reputation for breeding England stars; if these are further improved this will in turn support West Ham in the long term. New players cannot constantly be bought in large numbers. A club need its own homegrown players to survive and improving the training facilities would enhance this and the next Joe Cole or Rio Ferdinand could be found sooner rather than later. There are, thankfully, not many, if any, financial problems at West Ham currently. After relegation, a large number of players have been sold off due to their large wages and debt has been cleared. There is still a small nucleus of skilled individuals around which the squad can be built. As a result it is easier to start rebuilding the squad and bring in new faces with no further departures, but there is still a small community and familiarity about the squad, which will help performances and help the team become more accustomed to one another.

FINAL RECOMMENDATIONS
I have divided my recommendations into short-term and long-term recommendations and have set them out in the form of a task list. The short-term recommendations are quite urgent but do not necessarily need to be carried out on acquisition of Wes Ham United FC. The long-term list should be implemented over a time and are to ensure success in the long run.

Short-term Recommendations
o o o o o Purchase controlling share in West Ham United FC Pay off all remaining debt (if any) Attempt to sign highly-rated manager and coaching staff Bring in a handful of high calibre players: half experienced, half youngsters Focus on promotion

Long-term Recommendations
o o o Invest in improving training facilities and youth schemes. Ensure that not too much is spent in too short a time. I.e. spread out spending Bring one or two new world-class rated players in every season

I have recommended purchasing West Ham United FC in particular over other clubs as they have recently been relegated and as a result their share prices have dropped dramatically, making the club easier to purchase. Additionally, the benefits of achieving promotion outweigh those of already being in a division (i.e. more profit can be made through promotion) and West Ham United are a club that have experienced the Premiership and even Europe at times, showing that the framework for a great club is already in place. It is important to clear that debt and bring in a new highly-rated manager, as this will signify a new start and boost morale in supporters (encouraging high attendance to matches and thus high gate receipts) as well as in players (as they will have high hopes for the season ahead). By bringing in a handful of experienced as well as young players, there is a balance and the younger players can learn from the experienced ones to develop better. However, if too many players are brought in costs will be high and a situation similar to that of Leeds United may arise in addition to the fact that players may feel unimportant in the squad. The higher quality players will also ease promotion and improve positions in the Premiership in the long run. It is then important to focus on promotion before trying to develop then squad further. As explained above, it will help to invest in training schemes and facilities to find youth talent, such as Joe Cole, as this will help especially in the long run; all large clubs have their own youth talent, such as Liverpool and Michael Owen. It is, however, important not to overspend and be careful not to buy letdown players, as this may in turn lead to a situation similar to Leeds United as explained earlier. Thereafter it is important to bring in a couple of world-class players every few seasons, as this will obviously improve chances of success as well as boost morale and improve the efforts of the team as a result. In the long run it is hoped that these steps will turn West Ham United into serious Premiership contenders on top of large-scale competitors in Europe.