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Theme 3, Week 10 The economics of sporting contests: 

EC340 Topics in Applied Economics (a) Department of Economics University of Warwick Dr. Chris Doyle 7 December 2011 Theme 3, Week 10 The economics of sporting contests

Structure of lecture: 

Structure of lecture Organising sporting events Formula 1 Mean Variance Utility – quality and variance Organising sports contests – individual contests Conclusion

Organising Sporting Contests: 

Organising Sporting Contests A major sporting contest is primarily aimed at delivering enjoyment (i.e. direct utility ) to observers ( fans at events and armchair fans ) The more exciting a sporting contest, the greater the likelihood more fans will enjoy the sport (demand increases with excitement – willingness to pay is higher) But what constitutes excitement? Skill? Close competition? Occasional/Frequent unpredictability? Where demand is higher on the part of fans (one side of the market), demand on the other side of the market will be higher Sporting events are two-sided markets One side comprises fans (direct consumers of sporting contest outputs) The other side comprises sponsors, broadcasters, advertisers, etc. In addressing how best to design a sporting contest any indirect externalities across the two sides of the market should be accounted for Governing bodies in sport, e.g. FIFA, IOC, EPL, IPL, FIA, etc., then design the rules of the sporting contest presumably to maximise their members objectives (profits in many cases)

FIA, Formula 1: 

FIA, Formula 1 The FEDERATION INTERNATIONALE DE L'AUTOMOBILE (FIA), a non-profit making world organization and an international association of national Automobile Clubs, Automobile Associations, Touring Clubs, and national Federations for motoring and for motor sport . The FIA is also the governing body for motor sport worldwide. It administers the rules and regulations for all international four-wheel motor sport including the FIA Formula One World Championship, FIA World Rally Championship and FIA World Touring Car Championship. “Promoting the development of motor sport, enacting, interpreting and enforcing common rules applicable to the organization and running of motor sport events .” Article 2 FIA Statutes Formula One Management Limited ('FOM') a wholly owned subsidiary of Formula One World Championship Limited ('FOWC') acts as an agent and business manager and together with Formula One Licensing BV and Formula One Administration Limited, these companies form the Formula One group of companies ('Formula One Group'). The Formula One Group is a group of companies responsible for the promotion of the FIA Formula One World Championship and exploitation of the sport’s commercial rights. The Group is owned ultimately by Delta Topco, a Jersey–based company owned by CVC Capital Partners' funds (approximately 70%) and JPMorgan (approximately 20%). Bernie Ecclestone's family trust owns the remainder apart from small shares held by financial advisers and Ecclestone himself .

FIA, Formula 1: 

FIA, Formula 1 FOM provides partial investment for new tracks and teams , to allow them to establish themselves in the sport and grow Formula One's presence in new markets . The season calendar for the championship is structured by FOM with some oversight . Payments to the teams are determined by a Concorde Agreement , which gives the teams 50% of the television money in constructors championship order, and awards a prize fund to teams based upon their results, which is drawn from the fees Grand Prix promoters pay for staging the race .

FIA, Formula 1: 

According to media reports in 2007 turnover estimated at $4.3bn of which: $1.5bn team owners $835m on car sponsorship (regarded as commercial income) $380m TV rights (regarded as commercial income) Race hosting (regarded as commercial income) “The average fee has increased by 70 per cent over the past five years, from $11.3m to $19.3m. The highest fee this year came from Malaysia, which is paying $38m. Countries are increasingly keen to get on F1's calendar because the sport attracts nearly 600 million viewers worldwide. Their governments bankroll the huge hosting fees, and over the next three years India, Singapore, Abu Dhabi and South Korea are set to become part of the World Championship for the first time .” A recent report (June 2011) issued by Formula Money claims commercial income will rise Predicts that revenues will increase at a rate of 12.7% a year. Revenues are expected to reach $ 1.8bn this year before passing the $2bn in 2012 and reaching $ 3.2bn in 2016 Race fees are highlighted as a key area for expansion, as they generated an estimated $568m in 2010. Most race contracts include an annual escalator and upcoming races in new markets such as Russia and India are expected to pay above the average rate, predicting that the highest race hosting fee, which currently stands at $50m (£30m), will be more than $100m (£60m) by the end of the decade. FIA, Formula 1

Formula 1 Design Issues: 

Formula 1 Design Issues What variables appear relevant for the commercial success of Formula 1? Number of teams (current maximum 12 – why?) Number of cars per team (limited to two – why?) Points awarded as follows (how is this designed?) Detailed technical rules

What seems to matter: 

What seems to matter Consumers of sports events would appear to enjoy quality, but like also ‘close’ competition High quality events people are more likely to value more Close competition between high quality teams/individuals enjoyed the most One-sided events not enjoyed as too predictable and perhaps result in less effort by higher quality side who can win more easily The above are testable hypotheses and empirically confirmed in hierarchical league structures Organisers of sports events serve at least two sides of a market Consumers of the sporting spectacle Fans at events (often a small fraction of the total viewing base) Armchair fans (TV) Sponsors and commercial interests Seek to advertise via the popularity of sport Sponsorship may raise quality and make competition more interesting leading to higher demand, more viewers, and hence greater exposure – something that may be difficult to extract solely via pay per view or gate receipts

Mean Variance Utility: 

Mean Variance Utility A sports fan may have a utility function where consumption represents the average quality in the sport and within the sport there is a distribution with a given variance Mean variance utility functions typically specify: Arrow-Pratt index of absolute risk aversion is:

Mean Variance Utility: 

Mean Variance Utility Suppose quality is distributed normally with mean  and variance  It can be shown (see Spiegel ) that expected utility is: Objective of the consumer is to maximize: Consumer cannot affect these variables BUT sponsors and sporting federations can

Sports Event Organiser: 

Sports Event Organiser What profits/revenue is maximised? Is it all the teams/competitors? How is the profit/revenue distributed? Incentive compatibility constraints – ensure coalitions do not break-away Participation constraints – must earn at least what can be earned via another option Szymanski (2003, JEL ) looks at some of the issues

Economic Design of Sporting Contests: 

Economic Design of Sporting Contests Individualistic contests Winner-takes-all contest Programme:

Economic Design of Sporting Contests: 

Economic Design of Sporting Contests Assuming all contestants are equally able, Szymanski specifies a Contest Success Function (CSF) The CSF is a function describing the probability of wining as a function of efforts In the symmetric case the Logit function is a good candidate The higher the value of  the steeper the curve – the more effective an individual’s effort relative to all other participants

Economic Design of Sporting Contests: 

Economic Design of Sporting Contests Solving for the individual’s effort choice Individual and aggregate effort increases in the prize value V , the  discriminatory parameter Individual effort decreases in the number of contestants Aggregate effort increases in the number of contestants Organiser’s design problem straightforward given the above

Conclusions: 

Conclusions Sporting contests are illustrations of market design problems The simple model of individual sport contests can be developed further For example: What if the marginal cost of effort varies across participants? Suppose the probability of success is influenced by technology involving a fixed cost (e.g. equipment) – this provides a rational for sponsors The literature has only recently taken on board two-sided market issues Team sports and leagues give rise to challenges related to coalition constraints Intermediaries acting on behalf of higher quality participants act to transfer rents – is this good for sports and welfare more generally?