What is Financial Fair Play?
"I don't think it was a good day for football yesterday, to be honest," Liverpool manager Jurgen Klopp told a virtual news conference.
This reaction came after Manchester City successfully overturned their two-year ban from European club competitions. After UEFA had initially announced that the club had committed "serious breaches" of Financial Fair Play (FFP) regulations between 2012 and 2016.
Klopp added, "FFP is a good idea. It is there for protecting teams and the competition so that nobody overspends and have to make sure the money they want to spend is based on the right sources."
"It's not up to me to judge this and I don't, but I think this FFP framework we should stick to."
So, what is Financial Fair Play and how does it work?
The initial economic concept for that is the basis for FFP comes from economist Peter Sloane, who in 1971published the article titled 'The Economics of Professional Football: The Football Club As A Utility Maximiser.'
In his article, Sloane highlighted the key difference between North American and European sporting cultures.
In the U.S. sports organizations are run as 'profit-maximizers' and therefore are constructed to be 'closed' leagues. This is done to ensure that franchises are protected against any economic penalty of falling out of the system.
However, European systems are designed to be 'open,' allowing for the opportunity for teams to be promoted or relegated to other leagues within the same country. This is classified as 'utility-maximization', where sporting success is the sports organization's true objective.
Therefore, profit or underwriting losses only become important when it is necessary for a club's long-term stability and survival.
It is not unheard of for European soccer clubs attempting to turn themselves into 'profit-maximizers'.
One example comes from Tottenham Hotspur, under the ownership of Sir Alan Sugar, who tried to run the club like a business.
Although Sugar remained in control for 10 years he later described his experience of running Spurs as “a complete waste of my time”.
Tottenham fans also suffered during this period as the club stagnated. Spurs would fail to crack into the top six in the league while winning just one trophy, the 1999 League Cup.
While at the same time Sugar only managed to make around $2.5million in profits, over the first 6 years. This return was far less than the profits made by North London rivals Arsenal, who also managed to compete at the top of the Premier League.
In the book Soccernomics, by Stefan Szymanski (@sszy) and Simon Kuper (@KuperSimon) explained, "When business people try to run a football club as a business, then not only does the football club suffer, but so does the business."
An issue that the 'open' system of promotion and relegation brings is that soccer clubs are at risk of overextending to the point of threatening their existence.
The classic example can be seen with English club Leeds United. In the early 2000s, the club was competing at the upper echelons of English and European soccer. Even making it to the Champions League semi-final, in 2001.
While the club was under the stewardship of Peter Ridsdale, Leeds would take out a number of loans against the future prospect of achieving Champions League soccer.
However, Leeds would fail to qualify for Europe's premier club competition the two consecutive years after reaching the semi-final.
The lack of extra revenue coming from participating in the Champions League ensured that the club became unable to repay the loans taken out by Ridsdale. This would force the club to sell off valuable on-field assets such as Rio Ferdinand (@rioferdy5), who would be sold to Manchester United for $38 million.
As the fire sale of players continued, Leeds' on-field performances suffered dramatically. The West Yorkshire club would find themselves tumbling out of the Premier League after finishing 19th, during the 2003/04 campaign.
In second-tier of English soccer, Leeds would continue to see the squad dismantled. Furthermore, the club would start to sell physical assets such as the club's training ground and their Elland Road home.
In 2007, Leeds United would finally enter administration. The club would receive a 10-point penalty by the English Football League, for failing to control their finances, and were relegated to the third division for the first time in their history.
Unfortunately, Leeds United's story has not been an uncommon sight in European soccer. Between 2000 and 2008, 49 English and Scottish clubs entered into administration, due to financial mismanagement.
However, fortunately for Leeds United, they have finally secured their return to England's top-flight after 18 years of hurt in the lower leagues.
A key factor in the increase in financial issues stems from the dramatic growth in revenues that soccer clubs across Europe received. This increase in revenue came thanks to the rise in pay-per-view television during the 1990s.
However, the 1990s also brought with it the Bosman Case, which gave the athletes more bargaining power, when discussing contracts. Therefore, the increased revenue received by clubs now was used to cover player salaries.
Alan Sugar later described the 'prune juice effect.'
"Anyone who knows the effect of prune juice, it is pretty simple, it goes in one end and comes out the other and that is exactly what is going to happen with this money.
"A deal is a deal. I suppose the Premier League hierarchy have done a good deal in squeezing the most amount of money out of broadcasters and someone has done a very, very good job so I suppose they are happy.
"Will they be happy in a year when all the money they have got they have given to players and players agents is another story."
As larger amounts of money were now in the sport, the risks of financial mismanagement became much higher.
After the 2008 global economic recession UEFA came to two conclusions.
First, the chronic loss-making was not sustainable for clubs.
Second, the threat of a breakaway European Super League, with no promotion or relegation was increasing, with the big clubs growing tired of chronic loss making.
In 2010, UEFA would establish FFP regulations. The initial aim being to ensure that soccer clubs were not spending more money than they earned.
Therefore this would hopefully prevent teams from falling into financial troubles. In the words of UEFA "to improve the overall financial health of European football".
In basic terms, FFP states that soccer clubs must balance their books over a period of three years.
The regulations stipulate that clubs can lose a maximum of $34.7 million, over this three year period.
If clubs are unable to keep within the regulations penalties include bans from competing in UEFA competitions: monetary fines and transfer embargos.
After FFP was implemented several economists criticized the regulation and questioned its potential. Overall, there seems to exist three main strands of critique against the Financial Fair Play-program:
FFP hinders necessary capital injections to financially distressed clubs
FFP prevents competition in the player market and serves as a U.S. salary cap without improving competitive balance
FFP ‘freezes’ the existing club hierarchy and makes it impossible for small clubs to break the existing hierarchy.
However, Swiss economist Egon Franck, who has advised UEFA in forming the principles behind FFP, disagrees with all three strands and argues that, contrary to what the critics say, FFP would benefit European soccer.
The first point of critique of the FFP concerns the need for clubs to have money injected if they get into financial trouble. According to the critics, the clubs’ overspending is not a problem, and the central rule that clubs must break-even is therefore superfluous. Critics say that intervention is unnecessary because clubs losing money is not a problem to outside society as long as creditors, rich owners or other stakeholders wish to spend their money supporting them.
According to Franck, the problem is, however, that clubs who continue to survive even serious economic problems start calculating with the fact that they can get away with spending more than their budgets allow. The European soccer clubs are in general too big to fail, which means that they expect to be bailed-out, should they fall short on capital.
This means that instead of taking hard managerial decisions regarding the football product, the clubs are busy pleasing sugar daddies and other club creditors.
The second criticism is that the FFP constraints player salaries and is comparable to U.S. major league salary-caps. Assumed, as it is, salary-caps limit clubs' salary expenses and improves competitive balance. Combined with redistributive mechanisms in terms of spectator and television revenues, 'rookie drafts' etc. it creates a more even level of sporting competition between the U.S. teams. In the open European leagues, however, such a tool would not affect the competitive balance, critics say, including Szymanski. In general, they believe that it is inappropriate to restrict the clubs' ability to invest (overspending and building debt) because this is the way business works. In reply to this, Franck argues that it makes no sense to say that free and unlimited (over-)spending on players and player salaries creates a better situation than ensuring that clubs do not actually spend more than they have. How can letting go of the problems of over-spending improve the current situation, asks Franck. Compared to the U.S. salary-caps, Franck sees the FFP rules as relatively soft, and even though the rules may not contribute to improved competitive balance, this was never the primary purpose of the program.
In a European context, Franck points to many other ways to ensure exciting matches, and the promotion and relegation system – which also ensures an opportunity to play other top teams via the European tournaments – is a way to maintain tension in the competitions. The clubs are continuously promoted and relegated based on their current level of competition. If a club is relegated, its matches the following seasons will be more equal – and vice versa. The last of the main strands of criticism is an argument that FFP will 'freeze' the existing hierarchy between the clubs because smaller clubs are unable to gamble to the same extent or invest at the same level as today’s big clubs have been capable to. This puts the established clubs in a favorable position because they have already made the investments that the smaller clubs are now prevented from making. Some researchers have pointed out that this may even conflict with EU competition law. This point is also rejected by Egon Franck. He says that the argument of a frozen hierarchy seems to rest on the assumption that the only way that smaller clubs can compete is by significantly overspending while hoping for an economic rescue.
In his opinion, this is not only an untenable situation at the outset, but the argument does not stand because according to Franck, FFP only limits ‘inflated’ contracts, meaning what can be defined as ‘over-price’-deals with willing owners or patrons. In theory, there is no maximum to the amount of money poured into the clubs as long as it reflects a fair market value transaction between a club and an extern party. The only difference is that the deal must be completed in a regular manner and not work as a financial rescue. According to Franck, this restriction will have favorable effects on incentive structures as well as club management.
Generally, Egon Franck rejects that smaller clubs should have better chances of competing if FFP was abandoned.
According to the Swiss professor, sugar daddies will (continue to) seek towards clubs that are already big, because these clubs – ceteris paribus – have a better chance of maintaining or expanding their success. If FFP does not regulate capital injections, this becomes a self-reinforcing effect, where the big get bigger. In other words, the exact opposite effect than what critics argue that FFP will entail.
FFP will essentially force clubs to focus more on better management rather than merely following the logic of the big wallets. It will change the 'zombie race', that the sporting arms race between the clubs has turned into: Technically insolvent clubs that infect each other with poor financial management because everyone is trying to keep up with the upward wage spiral, while hoping for bailout by public or private actors when unsuccessful. Contrary to what critics suggest, a positive side effect of FFP is financially healthy clubs that are run within their means, and on the basis of their real self-created market potential, says Franck. This will not only create a better industry, but may even strengthen the competition on the market, instead of the current situation where the deepest pockets decide the game.
As player transfers continue to rise, clubs are utilizing innovative tactics to ensure that they comply with FFP.
One such way is through the universal accounting practice known as player amortization.
For clubs, this tactic has become fundamental in how they calculate player costs. Rather than recording the entire purchase when it was made, the club will spread the transfer fee over the length of the player’s contract.
Therefore, if a player is bought for $50 million over a five-year contract, the transfer value is amortized for $10 million every year. In the balance sheet, there is a $50 million investment but in the income statement, there is only $10 million amortization for the next five years. This will make net profit look more stable yearly.