Deloitte recently published its 24th Annual Review of Football Finance and it contained some surprising results. Historically, most teams in the English Premier League (EPL) have made accounting losses with any increases in revenues being offset by higher wage costs. However, this report found that in 2013–14 most teams in the EPL actually made accounting profits.
The Deloitte’s review reported that the combined operating profits of clubs in the EPL increased from £82 million in 2012–13 to £614 million on 2013–14 – an enormous increase of 649%. Nearly all of the teams (19 out of 20) in the league made an operating profit while 14 also reported pre-tax profits. Dan Jones, head of Deloitte’s Sports Business Group, commented that:
“The change in club profitability in 2013–14 was more profound than anything we could have forecast.”
Why has the profitability of teams in the EPL suddenly improved so dramatically? One important factor was the significant increase in revenue. The combined income of the teams was £3.26 billion in 2013–14 – an increase of £735 million, or 29% on the previous year. Although match-day and commercial revenue both increased, the majority of this growth in income (nearly 80%) came from the sale of broadcast rights. The 2013–14 season was the first year of a new three-year contract that raised over £1.7 billion per year from the sale of these rights in both the UK and overseas.
However, clubs in the EPL have received big increases in revenue from TV deals before and still made substantial accounting losses. For example, the broadcasting contract that ran from 2010–13 generated over £1.1 billion per season – a £243 million per annum increase on the previous deal. Significantly, in the first year of this deal (2010–11), 81% of this increase in revenue went straight into higher player salaries, whereas in 2013–14 this figure was only 16%. The ratio of wages to turnover also fell from 71% in 2012–13 to 58% in 2013–14
So why did a smaller proportion of the increase in revenue go to the players compared with previous years? The explanation appears to be the impact of two new controls and regulations that were implemented by the EPL at the beginning of the 2013–14 season.
One of these has received considerable media attention and is similar to UEFA’s Financial Fair Play regulations. The Profitability and Sustainability Rules allow the clubs to make a maximum cumulative loss of £105 million over three seasons before having to face sanctions from the league. The size of the permissible loss is significantly higher than in the UEFA regulations.
The other control that has received far less attention is called Short-Term Cost Control (STCC). This regulation places limits on the extent to which clubs can increase their total wage bill. It operates from 2013–14 to 2015&ndash16: i.e. it covers the same three years as the current TV deal. For the 2013–14 season it worked in the following way.
If teams had a wage bill of less than £52 million they faced no restrictions on their spending on players’ salaries. Only Crystal Palace (£46 million) and Hull City (£43 million) fell into this category. Unsurprisingly, the five biggest spending clubs, Man Utd, Man City, Chelsea, Arsenal and Liverpool, had much greater wage bills of £215m, £205m, £192m, £166m and £144m respectively.
Any of the 18 teams that exceeded the £52m limit would still not face sanctions if their wage bill increased by £4 million or less. For example, Stoke City’s wage bill only increased from £60m to £61m, while Tottenham Hotspur’s increased from £96m to £100m. Some clubs actually managed to reduce their total wage bill, including the champions, Manchester City, which managed to lower its from £233m to £215m.
However, there were still 12 teams with a total wage bill that was greater than £52 million in 2013–14 and which had increased by more than £4 million on the previous year. For these teams not to face any sanctions, they had to prove to the EPL that any of the increase above £4 million was either due to player contracts entered into before January 2013 or could by financed from the following two sources.
• Club Own Revenue Uplift
• Profit from player transfers
Whereas the profit from player transfers is straightforward, the ‘Club Own Revenue Uplift’ requires some explanation, as it excludes a very important part of teams’ incomes – Central Fund payments.
Some revenues earned by clubs in the EPL are referred to as ‘Central Fund payments’. These are, in effect, income payments from money that is raised centrally by the EPL on behalf of the clubs and then distributed to the teams using an agreed formula. The majority of the revenue generated under this category is from the broadcast deals, although some commercial income, such as the sponsorship of the league, also falls under this category. For some teams the money raised from Central Fund payments makes up the majority of their revenue.
‘Club Own Revenue’ in STCC calculations refers to all revenues other than those from Central Fund payments. This includes a number of income streams that the club has more direct control over. They include:
• Gate money/other match-day revenue
• Commercial deals negotiated by the individual club
• Income from playing in European competitions, including TV revenue.
The uplift refers to increases in revenue from these sources compared to 2012–13.
For example, assume a club has made no profit from its transfer dealing and did not enter into any significant player contracts prior to January 2013. If this club’s wage bill increased from £100m in 2012–13 to £110m in 2013–14 then it would have to provide evidence to show that £6m of this increase could be financed from growth in its Club Own Revenue. In other words, it would have to demonstrate how its income from gate money, commercial deals and playing in Europe was at least £6m higher in 2013–14 than it had been in 2012–13.
It will be interesting to see if (1) the profitability of the clubs continues to improve in future years and (2) the STCC regulations are extended when the new broadcast deal comes into effect in 2016–17.
The EPL Proves Cost Control Works The Judge 13 (4/6/15)
English Premier League clubs made more revenue than Spain and Italy’s clubs combined UK Business Insider, Lianna Brinded (4/6/15)
Premier League football club revenues and profits soar BBC News, Bill Wilson (4/6/15)
Deloitte Premier League list: Clubs’ revenue boom to £3.3billion as Tottenham record highest ever pre-tax profits after Gareth Bale transfer The Independent, Joanna Bourke (4/6/15)
Annual Review of Football Finance 2015 Premier League clubs generate over £3bn revenue in season of records Deloitte (4/6/15)
Premier League top of the rich list with record income of £3.26bn The Guardian, David Conn (4/6/15)
Questions
- What is the difference between an operating profit and a pre-tax profit?
- If a club reports that it is making an accounting profit, does this mean that it must be making an economic profit? Explain your answer.
- Give some examples of the economic costs of running a football club that might not be included in accounting calculations of profit.
- How is the profit/loss from player transfers calculated?
- Explain why the current rules may give teams that play in European competitions a competitive advantage.
John Nash was one of the pioneers of game theory and in 1994 was awarded the Nobel prize in economics for his work in this field. He was also the subject of the 2001 film, A beautiful mind, where the young John Nash was played by Russell Crowe, for which he won an Oscar.
Tragically, John Nash and his wife were killed in a car crash on May 23: he was 86 years old. Since his death there have been many tributes paid to him and his work.
As a student of economics you will almost certainly have studied the concept of a Nash equilibrium: a situation where everyone makes their best choice, given the choices of the other ‘players’ in a ‘game’. But a Nash equilibrium is not in the collective best interests of the participants in a non-cooperative game.
This is a very different concept of equilibrium from the simple equilibrium in a perfectly competitive market. In fact, in the complex world of strategic decision making, where firms are constantly looking at their rivals’ behaviour and possible reactions to their own behaviour, there are all sorts of Nash equilibria which are clearly sub-optimal. Competition may be highly destructive.
The following obituaries look at Nash’s contribution to the development of economics. As the Bloomberg article states:
The game theory concepts that Nash’s math[s] brought to the field were a true paradigm shift in economics. Macroeconomists, who continue to use the old Walrasian notion of equilibrium typically engage in hand-waving about how the macroeconomy is too big for strategic interactions to matter. But most of the economics profession has gradually shifted toward Nash equilibrium. The 2014 Nobel winner, Jean Tirole, is emblematic of the new economics. And many of the biggest successes in applied economics, like the auctions that power Google’s advertising, rely on Nash’s technique.
Do we owe him as much as Adam Smith?
Articles
Death of John Nash and His Beautiful Ideas Bloomberg, Noah Smith (26/5/15)
John Nash, economist and mathematician, 1928–2015 Financial Times, Ferdinando Giugliano (25/5/15)
Obituary: John Nash: Lost and found The Economist (28/5/15)
Remembering John Nash: Finding equations to explain the world The Economist (28/5/15)
John F. Nash Jr., Math Genius Defined by a ‘Beautiful Mind,’ Dies at 86 New York Times, Erica Goode (24/5/15)
Explaining a Cornerstone of Game Theory: John Nash’s Equilibrium New York Times, Kenneth Chang (24/5/15)
John Nash’s Indelible Contribution To Economic Analysis Forbes, Jon Hartley (25/5/15)
John Nash’s ground-breaking contributions to maths BBC News, John Moriarty (24/5/15)
From the archives: Nash’s Nobel prize The Economist (24/5/15)
A beautiful strategy: John Nash’s ‘game theory’ explained Hindustan Times, Gaurav Choudhury (25/5/15)
Interview with John Nash
Interview with John Nash Nobelprize.org (Sept 2004)
Questions
- What is meant by the ‘prisoners’ dilemma’? How is this a demonstration of a sub-optimal Nash equilibrium in a non-cooperative game?
- Why is it difficult to predict the outcome of a non-cooperative game?
- Give some examples of non-cooperative games played by companies competing with each other.
- Give some examples of non-cooperative games played by nations competing with each other.
- Why do competition authorities try to prevent cooperation between businesses?
- Why may a cooperative equilibrium between firms be an unstable one?
Many of the major industries in Australia are oligopolies/oligopsonies. Examples include banking, telecoms, supermarkets, insurance and iron ore. The dominant firms in these markets have been accused of exploiting their market power, both in charging high prices to consumers and driving down the prices paid to suppliers. The result, it is claimed, is that they have been making excessive profits.
But things may be changing. With the rise of online trading, barriers to entry in these markets have been falling. Many of the new entrants are established firms in other countries and hence already have economies of scale.
The first article below examines the challenge to established oligopolists in Australia.
Articles and blogs
The death of the oligopoly: Australia’s incumbents face new rivals Financial Review (Australia), Michael Smith (21/4/15)
Australian Oligopolies The Grapevine, Adam Dimech (27/12/14)
Paper
Breaking up Australia’s oligopolies Ashurst Australia (14/8/13)
Questions
- Find out which are the major firms in Australia in the five industries identified above. What is their market share and how has this been changing?
- What barriers to entry exist in each of these industries in Australia? To what extent have they been declining?
- What can new entrants do to overcome the barriers to entry?
- What technological developments allow other companies to challenge Foxtel’s pay television monopoly?
- To what extent are developments in the supermarket industry in Australia similar to those in the UK?
- To what extent does Australia benefit from increased globalisation?
Over 90% of UK households buy their gas and electricity from one of the ‘big six’ energy suppliers – British Gas (Centrica), EDF, E.ON, npower (RWE), Scottish Power (Iberdrola) and SSE. The big six are currently being investigated by the Competition and Markets Authority (CMA) for possible breach of a dominant market position.
An updated ‘issues statement‘ summarises the investigation group’s initial thinking based on the evidence it has received. In paragraph 16 it states:
Comparing all available domestic tariffs – including those offered by the independent suppliers – we calculate that, over the period Quarter 1 2012 to Quarter 2 2014, over 95% of the dual fuel customers of the Six Large Energy Firms could have saved by switching tariff and/or supplier and that the average saving available to these customers was between £158 and £234 a year (depending on the supplier).
Between 40% and 50% of customers have been with a supplier for more than 10 years. The companies are thus accused of exploiting these ‘loyalty’ customers, many of whom are too busy or ill-informed to switch to an alternative supplier. According to the uSwitch article below:
This is a particular issue for the most vulnerable of customers, including the elderly, who view switching as ‘impossible’.
But the elderly were not the only consumers losing out; the CMA found that those customers most likely to be on expensive standard tariffs were less educated, or on lower incomes, or single parents, and did not necessarily have access to the Internet.
And the problem of penalising ‘loyalty’ customers who do not shop around applies in other industries, most notably banking. People who regularly switch savings accounts can get higher interest rates, often for a temporary ‘introductory’ period. Similarly, people who regularly transfer credit card debt from one card to another can take advantage of low interest rate, or even zero interest rate, deals for an introductory period.
Returning to the energy industry. Is the problem one of oligopoly? Do the big six have too much market power and, if so, what can be done about it? Should they be split up? Should regulation be tightened? Should new entrants be encouraged and, if so, what specific measures can be taken? The following articles explore the issues and possible policies.
Articles
British energy customers missed out on savings Reuters, Nina Chestney (18/2/15)
U.K. Energy Customers Could Save by Shopping Around: CMA BloombergBusiness, Aoife White (18/2/15)
Big six energy firms overcharging customers by up to £234 a year The Guardian, Sean Farrell (18/1/15)
Big six energy firms may lose quarter of customers by 2020, analysts warn The Guardian, Terry Macalister (1/10/14)
UK watchdog says big energy groups do not enjoy unfair advantage Financial Times, Michael Kavanagh (18/2/15)
CMA energy market investigation update: millions are punished for being loyal uSwitch, Lauren Vasquez (19/2/15)
Gas and electricity bills – the key questions Channel 4 News (18/2/15)
Energy customers miss big savings, says CMA inquiry BBC News, John Moylan (18/2/15)
Big Six energy companies overcharging loyal customers by up to £234 a year says watchdog Independent, Simon Read (18/2/15)
Consumer groups demand change after ‘Big Six’ accused of penalising customers out of hundreds of pounds Independent, Simon Read (19/2/15)
Energy companies’ loyalty problem lights the way forward The Conversation, Bridget Woodman (19/2/15)
CMA press releases and reports
Energy market investigation – updated issues statement Competition and Markets Authority (18/2/15)
Energy market investigation Competition and Markets Authority (23/2/15)
Energy Market Investigation: Updated Issues Statement Competition and Markets Authority (18/2/15)
Questions
- What barriers to entry exist in the electricity and gas supply markets?
- Explain how the big six are practising price discrimination. What form does it take and how are the markets separated?
- Find out what tariffs are offered by each of the big six. When you have done so, reflect on how easy it was to find out the information and why so few customers switch.
- How could more people be encouraged to ‘shop around’ and switch energy suppliers?
- Explain the five theories of harm identified by the CMA. Would a rise in market share of the smaller energy suppliers adequately combat each of the five types of harm?
- In what ways may UK energy regulation be ‘a barrier to pro-competitive innovation and change’?
- What are the arguments for and against breaking up the big six?
- What are the arguments for and against electricity and gas price control?
The recent low price of oil has been partly the result of faltering global demand but mainly the result of increased supply from shale oil deposits. The increased supply of shale oil has not been offset by a reduction in OPEC production. Quite the opposite: OPEC has declared that it will not cut back production even if the price of oil were to fall to $30 per barrel.
We looked at the implications for the global economy in the post, A crude indicator of the economy (Part 2). We also looked at the likely effect on oil prices over the longer term and considered what the long-run supply curve might look like. Here we examine the long-run effect on prices in more detail. In particular, we look at the arguments of two well-known commentators, Jim O’Neill and Anatole Kaletsky, both of whom have articles on the Project Syndicate site. They disagree about what will happen to oil prices and to energy markets more generally in 2015 and beyond.
Jim O’Neill argues that with shale oil production becoming unprofitable at the low prices of late 2014/early 2015, the oil price will rise. He argues that a good indicator of the long-term equilibrium price of oil is the five-year forward price, which is much less subject to speculation and is more reflective of the fundamentals of demand and supply. The five-year forward price is around $80 per barrel – a level to which O’Neill thinks oil prices are heading.
Anatole Kaletsky disagrees. He sees $50 per barrel as a more likely long-term equilibrium price. He argues that new sources of oil have made the oil market much more competitive. The OPEC cartel no longer has the market power it had from the mid 1970s to the mid 1980s and from the mid 2000s, when surging Chinese demand temporarily created a global oil shortage and strengthened OPEC’s control of prices. Instead, the current situation is more like the period from 1986 to 2004 when North Sea and Alaskan oil development undermined OPEC’s power and made the oil market much more competitive.
Kaletsky argues that in a competitive market, price will equal the marginal cost of the highest cost producer necessary to balance demand and supply. The highest cost producers in this case are the shale oil producers in the USA. As he says:
Under this competitive logic, the marginal cost of US shale oil would become a ceiling for global oil prices, whereas the costs of relatively remote and marginal conventional oilfields in OPEC and Russia would set a floor. As it happens, estimates of shale-oil production costs are mostly around $50, while marginal conventional oilfields generally break even at around $20. Thus, the trading range in the brave new world of competitive oil should be roughly $20 to $50.
So who is right? Well, we will know in twelve months or more! But, in the meantime, try to use economic analysis to judge the arguments by answering the questions below.
The Price of Oil in 2015 Project Syndicate, Jim O’Neill (7/1/15)
A New Ceiling for Oil Prices Project Syndicate, Anatole Kaletsky (14/1/15)
Questions
- For what reasons might the five-year forward price of oil be (a) a good indicator and (b) a poor indicator of the long-term price of oil?
- Under O’Neill’s analysis, what would the long-term supply curve of oil look like?
- Are shale oil producers price takers? Explain.
- Draw a diagram showing the marginal and average cost curves of a swing shale oil producer. Put values on the vertical axis to demonstrate Kaletsky’s arguments. Also put average and marginal revenue on the diagram and show the amount of profit at the maximum-profit point.
- Why are shale oil producers likely to have much higher long-run average costs than short-run variable costs? How does this affect Kaletsky’s arguments?
- Under Kaletsky’s analysis, what would the long-term supply curve of oil look like?
- Criticise Kaletsky’s arguments from O’Neill’s point of view.
- Criticise O’Neill’s arguments from Kaletsky’s point of view.
- Will OPEC’s policy of not cutting back production help to restore its position of market power?
- Why might the fall in the oil price below $50 in early 2015 represent ‘overshooting’? Why does overshooting often occur in volatile markets?
