Breakdown of Formula One, a fascinating business

Patrick O’Shaughnessy released a wonderful podcast episode on Formula One as a business. If you are not familiar with the sport, Formula One is the pinnacle of motorsports. It features more than 20 races in a calendar year around the world with 10 teams, some of which are iconic brands such as Ferrari, Mercedes, Aston Martin, McClaren or Renault, and, arguably, 20 best drivers that we have to offer. Teams compete for driver and constructor championships. The higher a constructor finishes in the standing at the end of the season, the more money it receives. The more successful a driver is, the higher salary he can demand. The likes of Alonso, Vettel, Verstappen and Hamilton earn between 10 – 40 million dollars a year. These cars can easily hit 180mph on the straights and take corners at a speed that normal cars have on a highway. This is a sport that uniquely combines entertainment, legacy, world-class engineering, science, data analysis, drama and strategy.

I have been a fan of Formula One half of my life. While I am pretty familiar with the sport, I still get to learn about the business from this podcast episode. If you want to know about the sport itself or if you are looking to learn about the business, have a listen. It’s definitely worth the time. Here are some of my notes:

Even though Formula One has a big global fanbase, it is still somewhat under-monetized, compared to other sports

There are 400 million or so unique fans globally. And just to give you a comparison point there, the NFL might have more like a hundred million. And even the Premier League is probably closer to 300 million. And the Premier League is truly a global sport in some ways, even though the avid fans are more regional and local. And so there’s just a huge fan base here. And the fans are really, almost all of them, tend to be avid because it’s such a technical sport. Now the Drive to Survive series on Netflix has changed that a little bit with a little bit more of the casual fan coming in, which is why there’s probably an opportunity to grow that 400 million number even further. But it is one of the largest, if not the largest league in the world by the fan base, depending on what metric you use.

Just to step back and stay at the macro level, for a second, we talked about $2 billion of revenue, more or less, and 400 million fans. So if you want to think about it, that’s about $5 of monetization per unique fan. In the NFL, we talked about 16 billion with about a hundred million fans. So that’s over $150 per unique fan. The premier league does 6 billion in revenues with 300 million, that’s $20 per unique fan. So without getting into the specifics for a second, if you just step back and say, what’s the opportunity to monetize, it’s there. It’s just, it’s there. Right? So now the question is, how do you go execute that?

Breakdown of revenue: 33% from promoter fees, 33% from broadcast, 15% from sponsorship & advertising and the rest from paddock club

Absolutely. There are three main primary drivers of revenue. The first is race or promoter fees. Those are essentially the fees that a local partner pays Formula One to host a race. Formula One isn’t actually putting on the race itself. It charges a fee to a local partner, who then hosts the race, sets up the race track, sets up all the entertainment around the race. And that’s just under a third of revenues today.

The second bucket is broadcast revenues, obviously just transmission of the broadcast, rights at the sport, across the world to different broadcast partners. That’s just a touch over a third of revenues. And then finally there’s sponsorship and advertising today. That’s about 15% of revenues. Though, I would say that’s probably where there’s the most opportunity for growth versus the other two.

There’s a final bucket, let’s call it, which is, other. That’s about 15% of revenues as well. The primary driver there is paddock club revenues. So paddock club is essentially the VIP section at a race and the league, Formula One has the right to sell tickets to that and to host the VIP section in a handful of races. And so that’s kind of the biggest driver. There are other drivers. Formula One’s involved with Formula Two and Formula Three racing, kind of the minor leagues, if you will, and generate some revenue from there. There is some revenue tied to transporting the team’s cars around. There’s a fleet of 747s that basically help this circus go from one spot to the other around the world. But those are all lower margins if you will than the primary three. So even though it might be 15% in that final bucket of revenue, it’s a smaller portion of profits. And so I would really think of the big three that we just talked about as the primary drivers of the business.

Promoters can pay more than $30 million for a race, but those who pay the highest fees tend to generate the most revenue and profits. Vietnam GP was cancelled twice because of Covid. I wonder how much we paid the sport to host the race

If you want to think about the way that revenue works, is, as you said, the promoter will usually agree to pay a fee to Formula One. That fee can be anywhere from near zero, which is what a Monaco is given the historic importance and historic relationship that city, it’s not even a race track, has had with the sport. Typically, you’ll have a group of what they call core races in Western Europe that might pay more like a 10 to 20 million fee depending on the race. And again, these are individually negotiated. They are not publicized, so they’re not readily available. Nobody likes to talk about them. And then finally, you have flyaway races. These are races and kind of the emerging world where usually the promoter or the government has an interest in trying to use the F1 name to bring tourism or to bring some of that VIP pizazz, if you will, to the local market where you’ll see 30 million-plus race fees.

And there’s been a big debate about whether or not fees that are paid are sustainable. In other words, do the promoters get to generate a return on that. It’s very expensive to put on a race like this. The FIA requirements for a Formula One race track are very high. You can imagine if you have a car going at the speeds these things are going at, potholes are not okay. And so things just have to be exacting standards. That said, I think there is good evidence that it’s funny, the relationship to the profitability of a race versus the fee to a race is not direct. So some of the more profitable races also happened to be the highest fee races. It’s really increasingly become evident that it’s how well someone does at monetizing the race itself. How good a job do you do, creating demand for the sport? How much of a show do you put on? Do you have concerts? Tier one musical acts? Do you bring in different famous people to kind of try to draw more attention to it? Do you start tiering your offering so that there’s something even beyond the paddock club, VIP club that you can charge even more for? And the best promoters are very good at doing that and can pay high fees and yet also generate a profit. And some of the promoters have a harder time doing it.

Formula One has a few costs it bears, mainly around creating the broadcast, which then it resells to its broadcast sponsors. But in terms of actually putting on the race, all of the costs associated with that are with the promoter. And then the primary revenue is ticketing. As you said, sometimes it doesn’t include VIP because the squeak has kept it, in some agreements, it does. And then like you said, Austin does a very good job. For example, they’ll have a, usually a headline musical act associated with it. If you buy a higher-tier ticket, you can get access to that act. And so they can create some monetization that way.

Formula One from the perspective of an OEM

…There are two OEMs and an FMCG consumer business, they really view this in a holistic way with their core businesses, in terms of brand building and advertising. Mercedes has come out and said, they think there’s $1 billion of advertising equivalent value to being a part of Formula One. Ferrari talks about it in their public filings, about how Formula One is a key competitive advantage for the brand and strategic folks for the brand. For Ferrari, I mean their primary marketing budget is F1. That’s how they market the business. If you go to a race, they have their own club. All the Ferrari owners in the local market come to those races and are hosted there. It’s a huge part of that brand, its history, and its success.

And Mercedes similarly, and Red Bull, a little bit different, not so much an OEM, but essentially that whole idea of an extreme sport and 200 miles per hour plus cars are pulling multiple Gs, it certainly fits that bucket. McLaren is a little bit different. McLaren is essentially a racing team. They’ve now created an OEM out of that. McLaren started as a racing team and that was kind of their singular focus, and they and Renault, which obviously is another OEM, certainly see value in terms of the brand. Now they’re both OEMs where the racing team, in McLaren’s case, was the primary driver. And in Renault’s case, they, like Ferrari and like Mercedes, see value for the brand in being part of the sport. And they’ve been able to spend more as a result and kind of, not quite as much as the largest teams historically, but enough to be competitive year in and year out.

My thoughts

Formula One is in a unique position because there is nothing else like it in the world and Liberty Media has a complete monopoly over the commercial side. Yes, there are many sports that, like Formula One, love to attract eyeballs and money from viewers, but it is not a zero sum game in this case. People can pay and spend time to watch Premier League and Formula One at the same time. In some situations, you pay for a TV subscription and can watch multiple sports, including Formula One. Even with that unique advantage, the monetization of the sport, in comparison with that of others, shows that there is a lot of value to unlock. There are countries where Formula One presence and popularity leave much to be desired. Take America, for example. It’s arguably the biggest media market in the world. Haas team is owned by an American and the country is going to host two races soon. Yet, not a lot of people in this country understand Formula One, let alone coughing up some money to watch it.

The question now is how Liberty Media can make the sport more understandable and accessible. On the surface, Formula One looks to be simple and even boring. 20 cars complete the same track layout multiple times in 2 hours to determine the standing. Mercedes has won the last 7 driver and constructor championships in a row. What else is there to watch for, right? But the beauty of the sport lies in the intricacy and complexity that are not often understood. How does a shift of a couple of degrees on the track surface change the competitiveness of the cars drastically? Why does a team opt for a two-stop strategy while its rival goes for one stop only? Why are some cars fast on soft tires and others on harder tires? How can drivers find more lap time?

Unfortunately, these details are often glossed over and not explained well on TV to average viewers, myself included. If viewers don’t fully grasp the beautiful complexity of the sport, they won’t fully get the appeal of Formula One. When they don’t get the appeal of Formula One, that effect will cascade down into the commercial side, particularly the promoters, broadcasters & teams. But if Liberty Media can bring the sport closer to viewers, fans will engage and pay more. Then, promoters are more willing to pay to host races as there is always a limit on how many races can take place every year. Broadcasters will also put up more money to earn the rights to broadcast races. This influx of money will directly benefit teams which, in turn, will be more committed to making the spectacle more spectacular.

On this note, I have been very pleased with what Chase and Liberty Media have done so far. The series Drive To Survive on Netflix has been a hit and a great user acquisition tool. There has been a lot of interest on Twitter in Formula One out of the series. According to Sportpromedia, “a recent study published by Nielsen even cited the docuseries as a key reason for the sport’s increasing popularity among those aged between 16 and 35, who accounted for 77 per cent of Formula One’s audience growth in 2020.” It really is a nice place to start if you want to learn about Formula One.

In addition, Liberty Media has created some great content on YouTube that helps average viewers understand more the technicality embedded in the sport. Take this one as an example. This is how drivers and their engineers can use data to identify where on a track they lose time and what correction actions they can take. It’s hard enough to correct how you approach a corner with a normal vehicle. These guys have to do it at an insane speed. Or this video which helps explain in layman’s terms some of the common phrases used in Formula One such as oversteer, understeer, apex…Understanding these terms will enable viewers to get why some teams and drivers struggle with their pace than others.

In short, I am really glad that the sport I love is getting more recognition and interest that I think it deserves. Liberty Media has done a great job so far with the marketing and some important behind-the-scenes issues such as Concorde Agreement that can ensure the sustainability of Formula One. I really look forward to two things: a Grand Prix in my homeland and discussing Formula One with more people here in the U.S.