Magoosh GRE

The efficiency of Premier League clubs

| March 24, 2015

INTRODUCTION
Football is one of the most popular sports in the world with over 3 billion fans worldwide, spanning several regions (Premier League, 2010). The game is played by thousands of football teams who compete in their respective leagues and competitions for top honours.
“ANNUAL income twenty pounds, annual expenditure nineteen pounds nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds and six, result misery” (Economist, 2002). This statement by Mr Micawber might sound ingenuous to most of the chief financial officers of an organisation. But if we give a closer look to the clubs of English Premier League, we can see that Mr Micawber might be having a point.
Off the pitch, Real Madrid is Europe’s most successful football club when measured by revenues. But it is Chelsea who generates the maximum money from its fans. Currently Chelsea is also at the top of the English Premier League. In terms of match day revenues to average gates, English sides earn a good amount from their fans. Not only the ticket prices are high, the corporate boxes also come at a premium (Economist, 2010).

As a global brand, English football has never been more powerful. It crosses all kind of geographical boundaries and has followers in each and every corner of the world (The Spectator, 2010). Clubs make money through sponsorship agreements, stadium ticket sales, merchandise sales, domestic and international TV rights amongst others.
The 1980s saw the English football reach its lowest level till date. Hooliganism was at its peak and few of the top world players even contemplated before paying in England. The stadiums were also of sub- standard.

The most important event of the English football happened in 1985 when the Premier League sold its overseas television rights for a staggering amount of £200,000. The significance of this amount can be understood from the fact that currently the deal for TV rights which are being sold to American and Chinese channels are considered to be worth more than £1 billion.
The huge inflow of money has led to a highly competitive English clubs. The main activity; that is; football has been of a very high quality. As a consequence of this, the English club teams have ruled the European Champions League in the last five years.

Although the revenues of the English clubs are mushrooming, most of this triumph has come as a consequence of a financial illusion. Over the years, club owners have been bidding against each other to get the world’s leading players- sometimes going beyond what they can afford, creating an illusion of their financial clout. Even the leading English clubs are making financial losses. Manchester United is £716 million in the negative; Arsenal has a debt of £297 million; Liverpool has £237 million; and the list goes on (The Spectator, 2010).

The way clubs reached at this juncture is quite similar to what led to financial crisis. To buy the costly stars the club owners borrowed money from the banks. By continuing to do this they created a kind of a bubble. Even though the extremely loyal fans of the clubs were apprehensive about the buy-outs the club owners remained undeterred. An interesting point to be noted here is that investors are yet to lose money in the Premier League. Some have even managed to make millions by investing in this industry. The key reason behind investors making a killing in the Premier League is the influx of foreign money. Foreign money is mainly used to write off debts and gain controlling stakes in the clubs. The liberal policies of Britain’s investment market and similarly easy policies by sport’s administrators have led to global businessmen easily entering into the market of Premier League.

All the Premier League clubs play the game with the goal of succeeding on the football ground. But it is not necessary for the playing field’s success to convert into financial success also. While some clubs show progressive financial results other clubs show negative results. Moreover the financial pressure is having a negative effect on the on-field performance of the clubs. It can be said that for football clubs to remain competitive their financial stability is of primary importance (Szymanski and Kuypers, 2000). The Premier League earns most of its revenues from the sale of TV rights. Thanks mainly to BskyB, the broadcasting revenues has grown at a rate of 29%, compounded annually, from the season of 1991-92 to the season of 2007-08. The league’s worth has now reached a staggering amount of £2 billion (Economist, 2010).

Everyone is saying that the Premier League clubs are making losses and this industry is not profitable anymore. But if we give a closer look to the annual report of Deloitte (2010) we will see a completely different picture. It is not a big secret that clubs make money through sponsorship agreements, stadium ticket sales, merchandise sales, domestic and international TV rights amongst others. During the period of 2008-2009, although the commercial revenues fell by £449m, the revenues of Premier League augmented by £49m during the same period, an increase of 3%. For the first time in the history of the Premier League, the total revenues of the top 92 English clubs crossed £2.5 billion in 2008-2009. Broadcasting continues to generate the maximum revenues for the Premier League accounting for 49% of the revenues in the last year.

As per the Deloitte’s report, the next contracts of Premier League broadcast rights are expected to fetch close to £2.2 billion. In the last few years overseas packages have been the main revenue generator, amounting to a value of £1.4billion in last three years. As a consequence of the hike in wage rates the operating profits of the Premier League dropped to £79m, a drop of more than half. Furthermore the operating profits fell to its lowest level since the year 1999-2000. The last year has seen a continued growth in the support of fans for the Premier League matches with the public attendance crossing the level of 30m. Despite the economic downturn, seat occupancy of the Premier League matches were above 90% for the 13th straight year.

Looking at the debts of the Premier League clubs, their net debts increased to £3.3 billion during the period of 2008-2009. One of the major events in the Premier League during the past year has been the financial demise of Portsmouth, which gained the dubious distinction of entering into Administration while in Premier League.

Since the time, Chelsea, the Premier League leaders have been bought by the Russian energy oligarch, their fortunes has transformed. Now the Chelsea team is filled with superstars and is at the top of the league tables. The main reason behind this change is the huge cash pooled in by the Russian oligarch in the club.

In contrast to this, Manchester United, one of the oldest clubs in the Premier League, has been bought by an American family. As the owners are not willing to pool in more money for the club, the club is already lagging behind in the league tables. The tale of these two major clubs shows the way Premier League clubs are operating and performing (Financial Times, 2010).

In this paper, the views of various academicians to analyze the economics of English Premier League will be discussed. The methods to analyze football’s profitability and the variables and factors affecting its profitability will be discussed in detail. Furthermore most of the research for this paper has been done on a qualitative basis and not on a quantitative basis. Even though quantitative research provides useful insight into the number associated with measuring the economics of Premier League, a qualitative research provides a more holistic view of the research area.

LITERATURE REVIEW
Most of the Premiership clubs have been successful in developing highly profitable relationships with downstream actors. However, they suffer from adverse relationships with main actors in the upstream network. These include the players who are the “major beneficiaries of the Murdoch Revolution” (Lonsdale, 2004).

Deloitte and Touche (2010) is of the view that clubs such as Manchester United and Liverpool FC that were subject to leveraged buyouts by their American owners have been suffering skyrocketing interest rates as a result, thus affecting profitability. Lonsdale (2004) has provided an analytical study on the “dyadic buyer-supplier relationships in the English football supply network”. He opines that the current situation of the Premiership clubs is as predicted. Also, the regulatory events that occurred post 1992 have worsened it further. The dominant position of the buyer over the supplier has significant impact on the commercial outcome of the relationship. Similarly, when the supplier is dominant, this becomes a constraint for the ambitions of the buyer.

STADIUM-VISITING SPECTATORS
The ticket prices and number of people attending the match play major roles in the dominant position of the clubs with respect to the spectators. However, with the increased involvement of supporter’s forums, supporter representation on club boards and “supporter consultation” has resulted in changes to the above scenario. That said, in most cases, the clubs deal with the supporters in a highly transactional manner.

TELEVISION BROADCASTING COMPANIES:
As a result of increased collaboration between the television broadcasting companies, the clubs have been adjusting the match itinerary to the suit BkyB requirements. Thus the matches now begin on multiple different timings and different days.
Also other joint sales and marketing ventures have come up in this aspect. But the players have majority of the surplus here. This leads to a lack of control by clubs and thus leads to financial problems in many clubs which can cause total ruin in many clubs.
Analysis shows that though Premiership clubs have had dramatic increase in revenue over the past 10 years, some of the clubs have not had significant profits. The increased wages of players are a major reason for this. The individuals with talent critical factors are responsible for revenue generation. “If such individuals become aware of their power then they are able to appropriate the highest returns in the network”. (Londonsdale, 2004)

DEA (Data Envelopment analysis approach) is a “linear programming technique that enables management to benchmark the best-practice decision unit (DMU), i.e. the football clubs.”

DEA is useful in providing estimates for further improvement for those DMUs which are inefficient in their operations. Charnes et al. (1995), Coelli et al. (1998), Coelli (1996), Cooper et al. (2000) and Thanassoulis (2001) written in detail of the various aspects of DEA. These papers provide a rich insight into the advanced procedures followed in profit improvement.
Barros and Barrio (2008) has provided an analytical study of the “technical efficiency of English football”. The random frontier model is used which “allows for heterogeneity in the data and is considered the most promising state-of-the-art modeling available to analyze cost functions”. This has been supported by (Greene, 2003, 2004, 2005). This model has a twofold gain over other models
1. It allows for the error term to combine different statistical distributions.
2. The use of random parameters i.e., parameters that describe factors not linked to observed features on the cost function.
This type of estimation disentangles the explanatory variables to determine which of them must be treated in a homogeneous way and which managed by clusters. (Barros and Barrio, 2008) concludes that “homogenous frontier models should be abandoned as far as they do not capture relevant aspects of the examined context”. In contrast, random frontier models allow separating the homogenous and heterogeneous variables.
Also, new frontier provides the alternative ranking which reports the cost average cost efficiency for each team across seasons. “The cost efficiency is defined as the ratio between the minimum cost and the actual cost, implying that it takes values between 0 and 1. Hence, the closer to 1 is the ratio, the more efficient the team is.”
The results of the heterogeneous frontier model are more intuitive than those of the homogeneous model. Also the comparison suggests that the homogeneous scores present larger variances than those computed from the heterogeneous frontier. This implies that heterogeneity in variables deteriorates the scores.
As expected, the outputs also have a positive impact on the costs, as enhancing sales or attendance is costly. The opposite occurs with the points which are scored in the pitch based in the investment made in players. The authors conclude that their results corroborate previous studies in this area (Barros and Leach, 2006). They propose that “heterogeneity must be considered a major issue in the English Premier League and thus “public policies towards clubs ought to take into account such heterogeneity.”

Two contemporary methods are used to measure efficiency: – “the econometric or parametric approach and the non-parametric approach.”
Below are the some papers which used the non-parametric approach. “Fizel and D’ Itri (1996, 1997), applied DEA analysis to measure the managerial efficiency of college basketball teams to assess the conflicting thesis concerning the impact of managerial succession on organizing performance; and Porter and Scully (1982), who analysed the managerial efficiency of baseball managers with a nonparametric approach. Recently Barros and Santos (2004) analysed the Portuguese football first division clubs with a DEA-CCR and BCC model. Haas (2003a) analysed the efficiency of the English first league with a DEA-CCR model, and Haas (2003b) analysed the efficiency of the USA soccer league.”
In contrast, Zak et al. (1979) analysed production efficiency in the basketball market with a Cobb–Douglas deterministic frontier which was the econometric frontier, Also Scully (1994), analysed managerial efficiency for professional baseball, basketball and football coaches, with a deterministic and a stochastic econometric frontier. A survival analysis was used to measure the coaching tenure probability in these sports. Extending the analysis of efficiency in sports, “Ruggiero et al. (1996) analysed the efficiency of baseball teams with panel data. Hoeffler and Payne (1997) analysed the stochastic frontier with cross-section data. Audas et al. (2000) analysed involuntary and voluntary managerial job termination with hazard functions for English professional soccer. “
A Poisson regression model was used by Hadley et al. (2000) to analyse the performance of the NFL league. Dawson et al. (2000) analysed the managerial efficiency of English soccer managers with an econometric stochastic frontier and Carmichael et al. (2001) analysed the efficiency of the English Premiership clubs with residuals. Gerrard (2005) analyses the production function of coaches working in the English Premier League with win-ratios for the period 1992 to1998. Kahane (2005) analyses the efficiency of the USA Hockey League discriminatory hiring practices with a stochastic frontier model.
Following are the major implications and results from study
1. The best-practice calculations signify that most clubs were operating on a high level of pure technical efficiency in the period.
2. “All technically efficient CRS clubs are also technically efficient in VRS”. This signals that “dominant source of efficiency is scale.”
3. The BCC results, which measures pure technical efficiency, due to management skills, all clubs are efficient in the period.
4. According to the scale efficiency, some clubs are efficient while others are not. Those clubs with DRS (decreasing returns to scale) are too large in size. Scale size should be decreased if decreasing returns to scale prevail.
5. English Premier League football clubs are “well managed by pure technical efficiency, but dimension makes a difference, and therefore some of them have decreasing returns to scale (DRS).”
The attractiveness of DEA is that the derivation of the performance efficiency index is dependent on a mixture of physical data and other types of information. Smith’s (1990) enhanced DEA to include “information from the financial statements”. It “seeks to determine whether financial statements information can yield any useful insights into efficiency…”‘.

CANONICAL CORRELATION ANALYSIS (CCA)
The CCA objectives can be summarized as follows:
“1. To demonstrate if two groups of variables are independent, or, conversely to determine the magnitude of the relationship that exists between the two groups.
2. To explain the nature of the relationships among the groups of dependent and independent variables, measuring the relative importance of each variable to the canonical functions.”
Hotelling (1936) developed a method that used two sets of variables—inputs and outputs. Both the variables are taken from the group of analysed units. CCA identifies and quantifies the associations between two sets of variables. The main aim is to “find the maximal correlation between a chosen linear combination of the first set of variables and a chosen linear combination of the second set of variables.”

MALMQUIST TOTAL FACTOR PRODUCTIVITY INDEX (TFP)
Total factor productivity is defined “using distance functions to describe a multi-input, multi-output production technology.” The non-parametric TFP has been developed by Caves et al. (1982). This is one of the popularly used measures of productivity change as per (Fare et al. 1997). “TPF measures the change between two data points by calculating the ratio of the distances of each data point relative to a common technology.”
The following two output variables are selected:
– points won in a season and,
– total revenue for the corresponding financial year.
The first step in applying CCA methodology is to select the variables required to measure the efficiency score in accordance with the expected results, and thus obtain the preliminary DEA model (two outputs: point won and revenues; three inputs: staff cost, other expenses and directors* remuneration). Then “the degree of correlation between the outputs-inputs sets” is obtained using CCA. In parallel, “the redundancy index is studied to determine the variance of the criterion variables (outputs) that can be explained by the predictor variables (inputs).” It is observed that the “TFP has a continuous growth for the first four seasons, with a slight decrease for the 20() 2-2(X) 3 season.” The study demonstrates an overall deterioration of the position of clubs relative to the efficiency frontier.

ONCLUSION

In the last decade, club level football has changed to a great extent. Running a Premier League club has become a multifaceted business with financial matters becoming intertwined with the club’s operations and performance. Television, satellite television in particular, has played a major role in driving the revenues for the Premier League clubs in the last decade. Furthermore the fan base of the Premier league clubs has increased many folds over the years. This has further helped the Premier League clubs in selling the overseas television rights at a premium rate. While football players are enjoying their iconic statuses and are charging a hefty amount of appearance fees from their clubs, clubs are still willing to buy those players. The club owners know that by having star players in their team, they can charge a good amount from their suppliers and fans.
Although the revenues of the clubs have increased the player wages have also increased simultaneously. This has been the main factor leading the clubs to go into huge debts. In this paper, an attempt has been made to analyze the efficiency of Premier League clubs by using methods like DEA and canonical correlation theory. The different variables to be considered while evaluating the efficiency of football clubs are also discussed.
However there is still further scope to do more research in this area. The economics of Premier League clubs in countries other than United Kingdom needs to be researched. This will give a clearer picture about the various factors contributing to the economics of these clubs. Also how the clubs manage to perform in the current extremely difficult and changing situation needs to be looked into and researched further.

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