How do you make (or lose) money in Formula One?

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Lotus F1 CEO: I'm trying to offer sponsors more than a sticker on a car

The Lotus Formula One Team is a big operation. Based in Oxfordshire, UK, it employs over 400 people.

The annual budget for competing in the 19 races on the F1 calendar is around $200 million (£130 million) to put 2 cars on the track.

But, their chief executive Matthew Carter tells me that this is much less than what the top teams are spending.

Lotus F1 is currently owned by Genii capital, a Luxembourg-based venture capital group. They brought in Carter to look at the team's operation from more of a business than an F1 perspective.

In 2012 and 2013, the team had posted losses of £55.3 million and £64.9 million, respectively. After introducing cost-cutting measures including redundancies, Carter believes this year the team will come close to breaking even.

However, sporting success and the budget tend to move in opposite directions.

In the previous two seasons, Lotus finished 4th in the constructors' or teams' championships.

This season, they are currently in 8th place and with only 5 races remaining they are unlikely to improve. Carter says they are likely to stay where they are.

Williams, another Oxfordshire-based team, recently announced losses of £20 million to date in 2014.

But, on the track, they are having their best season for a long time and are currently third in the constructors' championship.

They are even ahead of big spending Ferrari.

The team explained the losses as necessary in order to ramp up investment and turn around its recent poor F1 form.

Image source, Getty Images

Race for revenue

The F1 rakes in a huge amount of cash from TV rights, fees for hosting races, sponsorship and merchandising.

Each country on the F1 calendar, with the exception of Monaco, pays for the privilege of hosting a race.

Last weekend was the Singapore Grand Prix. Although a relatively new race, it has quickly become an iconic venue as a night race around the Marina Bay street circuit.

Singapore pays $65 million a year to bring F1 to the city state each year. Only Malaysia and Abu Dhabi pay more.

Yet, there is no shortage of countries willing to host races. With a global TV audience of around 500 million, bringing F1 to town can offer both international prestige and commercial opportunities for the host.

This has been reflected in the F1 calendar which, over the last decade, has increasingly moved into emerging markets in Asia and the Middle East.

Last year, F1 generated around $1.6 billion in commercial revenues, of which $700 million was distributed to the teams. Roughly half of this cash fund is shared equally with the other half allocated according to where the team finished in the championship.

Last year's champions Red Bull Racing received around $100 million.

On top of these commercial revenues, individual teams can bring in their own sponsorship, merchandising, and corporate revenues.

Advertising your company name on the rear wing on an F1 car could set you back $25 million per season depending on the team. Somewhere less prominent like the wing mirrors may still cost $5 million per season.

Cheap marketing?

Although commercial revenues have increased, most teams only look to break even. Teams operated by the large engine manufacturers, such as Mercedes, Ferrari and Renault regard expenditure on F1 as part of their global marketing strategy.

In 2015, when Honda re-enters the F1, competition among the engine manufacturers may result in even more spending.

Some teams are also backed by large multinational companies. Red Bull, the global energy drink company, has reportedly spent $1.2 billion on its F1 team over the past decade, according to Formula Money.

However, the advertising value equivalent of its F1 expenditure, which is how much it would have to spend in on-screen advertising to achieve a similar level of exposure, is calculated at $1.6 billion for the last five years.

With teams spending much of what they earn, there has been a budget explosion in F1. The richer teams spend up to $400 million per year, the poorer ones less than a quarter of this.

As team spending becomes more polarised, the gulf in performance between the front and back of the grid has also widened.

The richer teams tend to be the more successful, which over the years further strengthens their commercial support. The sport's governing body has long talked about a budget cap to narrow the divide between the teams and improve the competition in F1 racing, but the richer teams have yet to agree.

There are, though, other measures in place such as limiting test runs which try to level the playing field.

Image source, AP
Image caption,
Lewis Hamilton currently leads the F1 drivers' World Championship

Man versus machine

Is it better to have the best car or the best driver? Fernando Alonso currently drives for Ferrari and is considered to be one of the best drivers in F1.

He is a two-times world champion and the highest paid driver. His last race victory was back in May 2013 at the Spanish Grand Prix.

Since then, only two teams - Red Bull and Mercedes - have won races. Between them, they have a 28 race winning sequence.

This year, Mercedes is dominating, having won 11 of the 14 races so far. New engine regulations introduced at the start of the season have helped them wrestle the advantage from Red Bull, for whom Sebastian Vettel had won the previous 4 world championships in a row.

Mercedes' two drivers, Nico Rosberg and Lewis Hamilton, are currently so far ahead of the others that their rivalry for the world championship has reportedly strained team relations.

So, is it the case that if you have the best car you win? The growing numbers of so-called pay drivers in the sport suggests driving talent is less important than it used to be.

While the top drivers earn €1 million per race, pay drivers actually pay for their own seat by bringing sponsorship deals with them to the team.

At Lotus, the Venezuelan driver Pastor Maldonado is financially-backed to the tune of tens of millions of dollars by the state-owned oil company PDVSA. He is yet to score a point in this year's championship.

When I asked my panel of F1 experts, they - with the exception of the Marussia F1 team president - opted for the best car over the best driver.

Graeme Lowdon, though, added that the best driver in a slower car wouldn't win the race, whereas the odds are much better if the car was the fastest on the circuit even if the driver wasn't the top one.

Leading technology

F1 is a sport where tenths of seconds matter and there is huge expenditure on R&D to find the small margins necessary to win races. As a result, F1 teams are essentially becoming similar to technology companies. But can their know-how be profitably used outside of the sport?

Mercedes justifies its investment in F1 by trying to incorporate its technology into the next generation of road cars. The current engines used in F1 are hybrid, and recent regulations have pushed hard on fuel efficiency.

In the past, F1 has led the development in tyre performance, aerodynamics, carbon fibre chassis, and traction control, which have found their way in varying degrees into road cars. KERS (kinetic energy recovery system), which captures the energy released when cars brake to provide extra engine horsepower, may be the next invention to progress from the track to the road.

McLaren, which is the second oldest active team in F1 after Ferrari, has announced a long-term strategy to diversify its business by applying their expertise and technology to a wide range of industries outside of F1.

If they are successful, it will be bring meaning to the importance of acting fast in business.