Saturday, 7 May 2011

The economics of Sugar (Lord Sugar, that is)

Alan Sugar has belatedly discovered an important economic concept: the idea of incidence.

The star of The Apprentice and former owner of Tottenham Hotspur has just realised that when new income pours into a competitive industry which relies on scarce resources, incumbent companies don't get to keep the money.

The standard example of this in economics is farm subsidies. Although one might think farm subsidies are good for farmers, that is not really true. Because there's a fixed supply of farmland, whose price is determined by how much money a farmer can generate from it, all of the extra money is - eventually - captured by landlords in higher rents. Farmers might benefit in the short term, as this paper suggests, but when their leases are up for renewal the rent will go up.

Football is no different - there's a limited number of talented players, and all the clubs want to buy them. So now that the Premier League makes £2 billion a year (twelve times the amount of 20 years ago) the extra money passes straight through to players' wages, and clubs don't make any more profit.

The picture isn't quite as simple as for farmland, because clubs have a share of "property rights" in a player through their long-term contracts. This is why they are able to sell players to other clubs for such high transfer fees. But they also have to pay transfer fees to other teams - so the net effect is zero (except for small clubs which luck into signing a talented player and sell them to a bigger team). In fact, players and their agents tend to take a percentage of transfer fees, meaning that they are a net drain on clubs.

Of course, football players aren't as limited a resource as farmland. At the lower end, there are lots of substitutes (literally). But the top players are irreplaceable, and the top teams have little choice but to hire a whole team of top players. The limited number of players per team prevents innovation in squad formation - for instance putting 13 cheap players up against 11 expensive ones. And the idea of outsourcing your team to an Indian call centre is more or less off the table (though the Scottish Premier League is reportedly considering it).

In the US, some sports have imposed a salary cap in order to try to retain more profits for the team owners. However, they've had to get a special exemption from cartel law in order to do so; and this would certainly be illegal in Europe. Part of this situation arose because Belgian player Jean-Marc Bosman took a team to court to be allowed to sell his services to the highest bidder after his contract ended. European law is generally pro-free-market (something that may surprise my American readers) and it's unlikely the teams will be able to easily change this state of affairs. UEFA are trying to limit the ability of rich owners to subsidise their clubs, and this will make some difference, but won't change the basic competitive process that's going on.

So while football has fixed size teams and a highly competitive structure, and takes place mainly in the EU, it's likely that players will continue to capture most of the revenues. At West Ham, for example, player salaries were 90% of revenue - an impressively high figure.

There's one way that teams can hang onto more of the money. That's by adding their own value, which is embedded in the intellectual property of the clubs and not built just on the backs of naturally talented players. Three teams are good at this: two of them are Manchester United and Liverpool, which have historically strong brands that can generate tons of money, regardless of short-term performance on field. Those clubs both make good money.

And the other is Arsenal. Arsenal's success (albeit recently comprising more second and third places than wins) is not primarily a function of buying and paying expensive players, but comes from building a genuine asset that the club itself possesses: a superb team strategy. The club and its manager succeed as a unit, and they rarely buy famous players for pure natural talent. This is a regular source of frustration for many of their fans, but it shows up in the business results of the club. They are highly profitable and the money does not all flow down to the players - because so much the value is added by the whole team.

Lord Sugar is broadcasting his theory on a TV show tomorrow night. It is probably pre-recorded. But if there's a sequel, he might think of travelling across north London for some advice on profitable football from his greatest rivals.

1 comment:

JESÚS ALFARO AGUILA-REAL said...

What if the players were prepared to surrender a part of their salaries in order to play in a great club? (Cristiano Ronaldo - Real Madrid) Great clubs would retain a bigger part of the players' salaries than second-rate clubs since they are able to do the most with these players popularity (merchandising, wider audiences...) This sounds to efficient allocation of resources as it would happen if farm subsidies go to the most efficient farmers