What about the budget?

Where the commercial and footballing planes of value intersect

In post #2 we went a little deeper into why aligning a universal unit of account with your organization’s objectives makes sense, and why cascading it down through the organization using SMART goals is not controversial, and further why for a general manager charged with increasing his team’s place in the standings year over year, it makes sense to cascade this objective down by converting it into “marginal goal difference.” He should peg the overall objective at an equivalent “goal difference” value such that all of his important decisions (e.g. which players to sign) can be measured in expected goal difference improvement as a way to ensure decisions move the club toward its objective rather than away from it.

In the coming weeks we will build out the theoretical framework and process for evaluating and denominating player signings in “marginal goal difference.” Now, before we get to eavesdrop on a conversation between our fictional GM, the chief scout, and the data analyst in the next installment, I wanted to just tie off and put a bow on one important administrative point: the interaction between dollars and goals in the upper levels of management at a club — what the budget constraint is, and why the presence of a budget constraint should not require that we leap forward to thinking in terms of dollars before goals.

Two Planes of Value

In a nutshell, this whole newsletter focuses on “value:” how to identify, measure, and project value, and it will rely on principles borrowed from corporate finance to form a solid structure for doing so. But in truth, there are at least two distinct planes of “value” that exist for a soccer club. One of them is the plane of commercial success, in which value is measured in dollars, revenues, incomes, and assets. The other is the focus of this site: the competitive on-field plane where value is measured in trophies, points, wins, and our beloved goal difference. Today’s post is about where those two planes intersect. There is some theoretical house-keeping needed in order to continue to build towards our focus.

Smoke-filled Rooms

Somewhere in the club there is an executive(s) who is charged with planning and executing the overall vision for the company, which involves the preparation, review and approval of a capital and operating budget, complete with revenues and expenses, investments, financing, etc. It is at this level (which I’m going to presume is above the GM/Technical Director/Sporting Director and their soccer operations departments, but there are all shapes and sizes of soccer clubs), where the ultimate decisions and trade-offs between financial investment, commercial success, and on-field success is contemplated.

Like it or not, in a capitalist society, operationally the objective of a for-profit enterprise is to provide adequate return to shareholders sufficient to compensate them for the risk and opportunity cost they’ve born by investing their capital in the enterprise and not in others. In the case of a football club, capital is invested into the operations of the club to generate long term revenues in excess of their associated operating costs, and the primary source of those revenues is the club’s customer base: its supporters. Whether directly through ticket sales and merchandise sales, or indirectly through sponsorship deals (whereby sponsors essentially pay more to put their name on clubs with a larger and more loyal fanbase) and through league television deals (which again are driven by the number of viewers - i.e. the number of fans), the primary goal is to acquire and retain fans/supporters. Generally speaking, these customers value success on the field, and so the chief value creating activity for the football club is its soccer operations, whereby the general manager aims to maximize the success on the field for a given fixed amount of budget resources approved by the President and/or Board of Directors. The GM takes inputs in the form of economic resources (costs and expenses) and uses processes to convert them into outputs — some level of on-field success by the team — which then if supported adequately by the club’s back office activities (e.g. sales and marketing), becomes brand equity and then is converted back into the ultimate output of revenues (and cash flows) for the club. In this sense, for a profit-seeking football club, one might describe the footballing realm of value to be subordinate to the commercial realm of value, though this would be an ontological reality, not an aesthetic one, and hardly an operational one.

Internal Budget Constraints

Even for an infinitely wealthy group of shareholders, there is a finite limit to the amount of on-field success the club can have in the sense that they can place no better than first in their league — they can do no better than lift a trophy or a cup. Because of this, even in the absence of league rules and regulations around wage spending, conceptually there is a weak-form limit to the economic resources that shareholders can and will authorize the GM to use in the pursuit of on-field success to be converted into revenues and income. There is a declining marginal utility even of smart and effective authorized budget spending. And with every dollar spent on the team’s wage bill, there is always risk that success does not come, that supporters in turn do not show up to the games, that they do not tune in on the television, that they pass on buying custom-branded collars for their dogs and cats, license plates and bumper stickers for their vehicles.

Practically speaking, most clubs do not approach the horizon at which their next investment dollar into the club’s wage bill is incapable of improving the team’s place in the standings. Those that do are the true global titans of the game: the Real Madrids, the Bayern Munichs of the world. More often, a club is limited not by the marginal utility of capital but by the available capital and risk preferences of its shareholders (another weak form constraint). While they might recognize the potential to improve the club’s on-field performance with more investment (and thus its long-term revenues), they operate at the lower level of investment (and risk) that they are more comfortable with given their profile. In doing so they set a fixed amount of economic resources for the general manager to work with, and also they set a realistic expectation of success on the field that they require given that level of economic investment. To the extent the investment is well below an amount that would reasonably be expected to win the league, we would assume they would then not turn around and charge the GM with winning the league “or else.”

External Budget Constraints

Some clubs are dynamically capped by pseudo-regulatory bodies such as UEFA and its dynamic “financial fair play” rules, such that the level of a club’s commercial successes “legally” dictates the allowable level of investment, not only indirectly through the budget cycle as described in this post, but directly via confusingly enforceable or unenforceable laws and punishments, which are examples of semi-strong-form budget constraints. Further, some leagues are operated not as a confederation of individual clubs but as a single entity (e.g. Major League Soccer in the states) where owners are shareholders in the league, and the individual teams are run by these shareholders as owner-operators with the level of investment of individual teams largely (but not entirely) set and “capped” centrally by the league office. “Designated Players” excepting, this is an example of a strong-form budget constraint and the most explicit example of a GM working with an "allocated” amount of authorized budget spending in the sense that the funds are tradeable between teams and literally called “allocation money.”

All that is to say, that for the purpose of our continuing discussions around a general manager leading a Soccer Operations department, whether by weak-form or strong-form constraints, or some combination of the two, he is not tasked with the rather existential questions of the club itself, with the unenviable position of determining the appropriate risk/return trade-off between economic investment and on-field success. He is instead charged with maximizing the on-field success for a given operating budget, and more realistically, charged with meeting a minimum level of on-field success with a fixed wage/transfer budget. Regardless of which bucket a club falls into, it almost certainly operates under some form of this fundamental assumption whereby economic resources are limited.

For our purposes

And because of this, we can confidently narrow our focus for a time to the competitive plane of success: the decisions the general manager faces that have direct impacts on the wins, losses, and draws of his club — these which we know from above will be converted ultimately and indirectly (but not insignificantly) into shareholder value. Admittedly, because he has a fixed amount of resources, there is definitely an aspect of budget rationing that he must be mindful of — a direct link to corporate finance — and we will cover this, but the primary input and the very first input he needs for every player recruitment decision is “how will signing or releasing this player impact the team’s goal difference [over some discreet time horizon] and what are the estimated ranges of these outcomes?”

Notes of Caution

Because in soccer we often use language like “buy” and “sell” and because transfer fees make for such enticing journalism, there is a tendency to “over-financialize” this type of analysis — first, to dehumanize the players themselves as nothing more than resources. A club is not “buying” or “selling” a player, it is negotiating a wage with a talented individual, entering into a contract for services, and simultaneously negotiating the termination of any existing contract he might have signed with a different club. This objection on my part may seem ironic or hypocritical given the topic of this newsletter, but I want to reiterate the distinction: the pitch of “Absolute Unit” is not that a GM should think of people as resources — that in doing so, he might unlock additional value. Rather, it is that by borrowing some valuation concepts from the business word, he can better organize his staff’s activities to identify players who will contribute to meeting his organization’s objectives, better harness the insights of his experts, and better manage the economic resources he is entrusted with in order to achieve these things, indirectly creating value for the club. It’s more about which contracts should he enter into and which should he avoid.

The second problem with the seductive language of the transfer market — this phenomenon that sometimes even the supporters begin to think of players in terms of dollars and cents — is that someone who is trying to organize his club’s activities in a structured, organized way might be tempted to use the financial currency itself as the unit of account for making football decisions, and this is a mistake. Remember, the board has already made the decision about how much success on the field is worth in terms of their investment dollars. The sporting director is now charged with creating value for the firm by achieving the competitive objectives and the successful attainment of these competitive objectives (not some other financial objectives) is what will draw and retain supporters/customers. So while he will need to ration his economic resources in order to do this, it is much more important that the critical squad building decisions he makes are tracking not towards some budgetary outcome but towards the correct “marginal goal difference” target. Again, this is why the first question out of his mouth should be “by how many goals will this player improve our team’s performance in the upcoming season and over the course of his contract?”

This is a question our GM will now concretely consider for the first time, in the next post. It will be a development opportunity for him and his staff.

Post Scriptum: The caveat of the budget cycle

Above, I have absolved the GM of the responsibility of determining “how much investment is the correct amount for this club and its shareholders?” and similarly the question: “Given the amount of investment, what level of on-field success should we require of the general manager?” In truth, the process of answering these two questions, undertaken at the very top of the organization by the president or by the board of directors or by an activist shareholder/owner does involve input from the GM… if done correctly. Like any budgeting cycle at any organization, the leaders charged with making these decisions must solicit input from those in the organizations who are impacted by it and who will be impacted by it, and who have insights necessary for supporting these conclusions. Because of this, the GM who is charged with a required level of success and allocated a budget with which to accomplish it, must move forward focusing in on those two things and not on the “why and how” of the figures themselves, but if he is doing it right, he has already influenced them through the budget building cycle, and one would hope the way he accomplished this was by harnessing the insights generated by the subject matter experts on his team. In this way, what we have here is a cycle - a circle of life. This circuitous nature can distract us from finding our footing before we launch forward into the fun stuff, so this post is all just to say that for the purpose of this series going forward, we are entering this wheel at the point where the Board has charged the GM with an objective and allocated a fixed amount of budget resources to get the job done, not before, and not after.

Thanks for subscribing. Please share this. Oh, and by the way. Plenty of you readers work in football. Feel free to comment on these posts or reach out to me directly with feedback (tiotalfootball at gmail). I’m sure there are some critical points I am missing, and I would love the opportunity to supplement these discussions in followup posts, addressing questions/concerns.

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