Wednesday, January 25, 2012

A Quick Note on Tiered Engine Pricing

By now I am sure you are aware of the engine lease hoo haa that has bottlenecked the final shoring up of the IndyCar grid for 2012.  In short, the story goes…
To prevent the squeezing out of any one of the three manufacturers by the other two, IndyCar instituted a 40% max rule for any single engine manufacturer.  This essentially meant that at worse, 20% of the field would run the least preferred engine from the three suppliers. 
IndyCar told the manufacturers that the engines would be loss leaders.  Teams would pay the manufacturers $690k a year for engines that in reality cost much more than that.  The hit the engine manufacturers took was to be written off as a marketing expense..ie advertising spend. 
In order to budget this expense, the manufacturers asked IndyCar for an estimate of field size, IndyCar guestimated 25.  So mfrs assumed the largest number of these loss leader engines they would supply would be 10 per mfr.
Then things got tricky…Turns out if you wipe the slate clean and level the playing field with everyone starting over with new chassis, there were teams dying to get into IndyCar that have now taken the plunge.  The field looks to have ballooned to potentially 30 entrants.
So theoretically an engine mfr could now supply up to 12 cars in the field…BUT… remember Mfrs are losing money on these engines and they have only planned to lose $X off 10 engine deals. 
What’s more, one of the mfrs, Lotus does not have the physical resources to supply more than 5 or 6 cars on the grid so while they could supply up to ten if they wished…they just don’t wish to.
So now there’s gridlock…Chevy and Honda don’t want to do extra engine deals to pick up the slack because of the money they are losing and now there are teams with sponsorship deals in place that cannot get and engine deal done…
A compromise was struck that allows chevy and Honda to each provide an 11th and 12th engine deal, but at “Tier 2” pricing of $1m a deal so as to minimize the financial loss.  Got all that?  If you are still confused GO HERE.
The problem with this deal is that the teams that will be granted the 11th and 12th engine deals at the tier 2 pricing will be the smallest teams on the grid, the big teams signed early and got the tier 1 pricing.  Doesn’t seem equitable does it.  Ganassi, Penske, Andretti and KV might point out that these are the spoils of success, accomplishments of hard work.  Others might view it as a barrier to competition favoring the rich over the poor.
With that as a back drop I pose one policy change for 2013.  Keep the tier 1 and tier 2 pricing.  Each mfr is obligated to provide up to 10 deals at tier 1 pricing, $690k per.  Then any extra engines, still conforming to the 40% rule, will be offered at the Tier 2 price of $1m.  Now here’s the twist.  Any single team, at most, can purchase no more than 2 engine deals at tier 1 pricing.  Cars 3 and 4 must be signed at tier 2 pricing. 
This will mean that each mfr can supply up to 5 two car teams at tier 1 pricing, 15 teams in all.  This regulation allows the little guys like SFR, Coyne and ECR in the game and but still allows the big teams to scale, just not at the sweetheart deal rate. 
But will it chase off the 3rd and 4th entries from the bigger teams?  I doubt it.  Remember the most expensive car to run is the first, each additional car added to the grid essentially only adds variable costs allowing the fixed costs of running a team to be amortized over more entries.  For the big teams this basically will equalize the cost of running cars three and four relative to the cost of running cars 1 and 2.
To me, this seems like a reasonable solution.
Another suggestion: As has been discussed, the mfrs are losing money on the Tier 1 deals with the loss being chalked up as advertising spend.  Another variable yet to be discussed is the effectiveness of this advertising spend.  How many people are exposed to the mfrs brand and product?  IE what is the TV rating…how many people are in the seats?  If both of these numbers rise, then the mfrs actually got more exposure than they budgeted for, in advertising lingo…Better GRP’s.  Perhaps the tier 2 pricing could include an end of the year rebate back towards the $690k relative to final ratings numbers generated by the race broadcasts.  If the product is good and morre people watch, the 3 and 4 cars don’t end up costing as much to the teams, because the mfrs got a better return on their involvement in the series than originally thought…
Again just a thought…

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