Time-Value

Acquiring a player in football is very common in clubs around the world.  So how does it all work?  If we go by the media reports clubs reach an agreement on the specific fee ($ value) that a player is worth, and if both sides accept the deal, the player moves to the new club. This simplistic picture is communicated by the idea that clubs “buy” and “sell” players, which makes transfers apparently easy to understand. We all know what buying and selling means, and have some basic understanding of a system of valuation.

Unfortunately, the current perception of the transfer market has very little to do with what’s exactly happening.  The economics of football transfers are remarkably more complicated, and a simple “buy-sell” model, although useful in allowing fans to celebrate the acquisition of their new icon, is nowhere nearly sufficient to explain what truly going behind transfers.

So why are transfers in football complicated?

Because unlike business there aren’t just two parties involved. The players aren’t just a product with a set value, they’re trying to make as much money as possible out of any deal and thanks to the way transfers actually work, their market value will almost always see an exponential increment if they play their cards right.

What actually happens in Transfers?

There are two steps to any transfer. The first one all football fans are familiar with: An interest to purchase is made by one team and then the two teams negotiate a transfer fee and it’s easy enough to follow and understand so far.   The second step involves what’s known as “personal terms,” which actually involves cancelling the current contract and signing a new one with another club.  This is the complicated thing in the whole transfer process, why? Because a player’s current contract refers to his value at the current club and not what his actual market value is.

Every footballer is worth some amount of money to his club. Players generate value to them and to the club through their performance (which leads to prize money, huge television rights and attendance) and these performances lead them to be extremely marketable. For their wonderful game and on field performance, they are compensated handsomely, with many of the European club players looking at six figures a week.

We’re not discussing in natural value here the weight of a player’s performances and marketability can lead to what is known as an excess value, we can think of excess value as that player’s worth to a club minus what they’re paying him in wages.  This is always a very huge number, despite a huge criticism about footballers’ wages. It’s the excess value that clubs are looking at while selling any player.  Having a player like Lionel Messi is very well and good, but if you’re paying €500 million a year for the benefit it’s unlikely to lend your club much of a competitive advantage financially.

This excess value is an immensely difficult number to keep aside. Over the course of a five-year deal worth €40,000 per week, the only known factor is the €10 million total commitment.  It’s incredibly difficult to predict performance in the current season, and trying to put that performance to a monetary value more of an art than a science (Torres in Liverpool and Chelsea).

So what happens when a player is sold?

A new contract completely changes the equation.  If the player gets a significant raise, his excess value per year is naturally declined, but this won’t have any impact to his current club, which gets to keep him on his current contract if he’s not sold.

This implies that there are two conflicting valuations in a transfer. The first is the selling value, which will ideally be greater than or equal to the excess value of a player under his current contract.  The second is the buying value, which should be less than or equal to the excess value of a player under his expected future contract. If the two situations were not matching, completing a transfer becomes very difficult and in all probability unlikely.

The above explains why we most often see transfer offers for players whose contracts are set to expire. A buying club can pay off one year of excess value to the selling club and look to spread that out over five years of ownership while giving the player a raise and Win-Win situation arises.

It’s easy to put together various scenarios in which the exact opposite applies. Since Edison Cavani (PSG) is the biggest name being talked about this summer (PSG to Manchester United/Arsenal), let’s talk about him. In summer 2012, Cavani signed a contract extension with his current club Napoli, and one very successful season later it looks as though a number of clubs might activate his astronomically high €63 million release clause and take him away from Napoli

Annoyingly, this could actually be a middling deal for two out of the three parties. Cavani is one of the best centre forwards in the world, and although he’s being paid well, he’s on third-tier star wages and his excess value to a Champions League level team could very well exceed €63 million over the next four seasons.

But as soon as he negotiates a new contract, much of that value evaporates. Depending on how much he makes, Cavani could end up costing his new club well over €100 million over five years. That amount of money requires a player to be one of the world’s best for the entire length of the contract and many believe this is not wise gamble to take.

Without realising a player’s actual value to his club and amount of contract he had it becomes impossible to comment fairly on transfer fees. A football transfer isn’t equivalent to buy an expensive toy in a Play store where the price of the toy is determined by the market rules of demand and supply.  In the case of football transfers it’s a far more complicated issue.

When it’s believable that a player like Cavani can simultaneously be worth less than and more than €63 million, depending on which side is doing the asking, it’s clear that Economics of transfers is complex and fascinating.

What’s the reason behind this complex economics?

If you observe the whole player transfers, it was all related to time value of money. People often think value of player’s contract as sum of all cash flows of the contract. When Time value of money was considered, the values actually exceeds the player’s current estimation. Time value of Money is based on the concept that a dollar that you have today is worth more than the promise or expectation that you will receive a dollar in the future. The reason is straightforward: A dollar that you receive today can be invested such that you will have more than a dollar at some future time. This leads to the saying that we often use to summarize the concept of time value: “A dollar today is worth more than a dollar tomorrow.” This Financial concept was the basis for the whole football transfers.

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