Sports margins – price wars?

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Sports margins – price wars?

Sports margins – price wars?

When bookmakers increase gross margins by offering poorer odds (consumer prices), then their revenue goes down, not up (over time). This might seem to be a statement of the obvious to many of our readers – if it is, then there may not be much point reading on. However, an increasing number of stakeholders – regulators and tax authorities; product owners, and; new market entrants, look to price distorting polices to achieve commercial or policy outcomes. In commercial environments (where it is the operator’s choice or reaction to circumstances), this can put old fashioned, short-term greedy, or simply incompetent bookmakers at a significant competitive disadvantage – demonstrating that markets work. However, in a regulatory-driven environment (when policy distorts price, either through turnover taxes or other measures), the entertainment utility of betting is diminished for many, while a significant few (especially in spend terms) will simply turn to the black market. Offering less attractive prices than the underlying market is bad for business and bad for policy outcomes – yet it seems to be on the rise.
Most of the focus on sportsbetting in the last few years has been on product (especially in-play and false/self-fulfilling assumptions on the decline of horseracing), user experience (especially mobile and retail self-service) and the ability to attract customers (advertising and sponsorship in abundance, affiliates getting a bad press). It seemed that cracking these operational drivers was the key decider of growth (and their aggressive exploitation a key driver of criticism), and to a large extent they still are. However, a new front has been opened to challenge the success or otherwise of bookmakers – how regulation might impact gross margin. Turnover taxes have been popular in some parts of Europe for some time (eg, Germany, France, Ireland, Poland, Portugal, Austria), factor into the US at the federal level (0.5% handle) and are effectively present as product fees in some parts of Australia (especially Victoria); Italy is something of a lone positive in (recently) moving from turnover to gross win -based taxes. All of these fiscal-regulatory choices, to some extent, impact the price the customer receives from domestically licensed operators.

Similarly, concerns have also been raised by some stakeholders (eg, horseracing in GB) that operators could ‘tactically’ lower gross margins on certain products to make less revenue (hoping to generate it elsewhere – effectively running ‘loss leaders’), potentially impacting specific product revenue – and that margin control mechanisms could be the answer. Such measures would also impact price. Indeed, price distorting fiscal-regulatory frameworks are surprisingly prevalent – by our count in 30% of jurisdictions where some form of domestic regulation exists (counting the US and Australia as one each), and as more jurisdictions and product owners adapt to online wagering, this could easily grow.

There is sometimes logic for this: if the duty is collected for or by a sport then a direct stake in benefiting from outside chances could raise fiduciary issues. Equally, if the duty is sufficiently low as a proportion of turnover that it can be absorbed by the bookmaker (however painfully) then this need not be particularly distorting for the customer (typically 2% of turnover or less from a purely pricing perspective for most products, but highly liquid soccer singles are often now priced at 2% or less, meaning some products will be distorted some of the time at almost any level).

However, the majority of jurisdictions which go down this path have rates either much higher than this, or additional burdens imposed on top (eg, taxes as well as product fees). Equally, very few regimes recognise that since turnover is a product- and customer-related outcome (more of this later) one-size-fits-all rarely works (eg, soccer singles / exchange fees at 1-4% margin vs. multiples at c. 15-30%, all on the same underlying pricing, cannot logically all be treated with the same turnover tax/fee rate without creating significant distortions and – for what it’s worth – unfair trading terms).

When turnover taxes are so high that the customer is directly impacted (ie, taxes are too high to be absorbed), the competitive economic model starts to creak and a leaky oligopoly almost certainly follows (whether this is a bad thing is up to governments – our concern is that it may not be an intended consequence). However, our focus here is not on what happens to supply – the bookmakers keep arguing that point and very few stakeholders seem to listen (bookmakers have few friends at the best of times, especially on the issue of their own profitability  – and this is not the best of times, anywhere). Instead, we want to explain what the demand (ie, customer) impact is on price distortion – and why it is a bad thing for policy, regardless of bookmakers’ profits.

Fixed odds betting used to be simple. An adversarial contest between punter and bookie, where the bookmaker held the advantage of margin and a few punters held the advantages of more diligent study and/or better information. The breadth of sports now offered, market access point expansion (especially mobile), availability of data (especially real-time in-play), and the capacity of bookmakers to cope with this (swapping opinion for maths, counters for computer screens) has made this old world obsolete at best and redundant in many instances. However, some vestiges remain in the operating assumptions of some older bookmakers (surprisingly) and wider stakeholders (more forgivably).

There remains a central assumption that customer staking (bets placed, turnover, handle) is a meaningful measure of ‘activity’ and the margin is a measure of bookmakers’ success in monetising that activity. In the very short term (eg, for an event, or at best a financial quarter or two), this can be true: high margins mean high revenue, and vice versa; and it is certainly true on a race-by-race / match-by-match basis (as old fashioned bookmakers tend to think of the world – and with their cash flow on the line every time they opened for business, one can understand why). However, this assumption completely misunderstands consumer behaviour over time (especially in an account-based online environment, where the bookmaker keeps the customers’ money), as we will attempt to demonstrate.

Customer segmentation in gambling is typically not sophisticated enough and we are not about to help matters. However, to address this issue with some meaningful behaviours and figures we have created two axes: whether or not a customer is ‘price sensitive’ and whether or not they are big spenders. Both of these is a spectrum and customers can vary over time and/or by product, but we seen these as the two key drivers for understanding the impact of price distortion.

What our hypothetical sample seeks to demonstrate is that a relatively large number of customers (c. 80%) and a significant proportion of revenue (c. 50%) is barely price sensitive at all: they bet for fun and have no expectation of winning over time. Consequently they do not shop around for price and probably won’t directly notice even material price distortions. The size of this cohort explains why France or Portugal (for example) has a domestically regulated market at all. So these guys can soak up high turnover taxes and there is no problem, right? Wrong…

The problem with recreational customers (our term) is that while they might not be price sensitive they do (over time) know how much they are prepared to spend and stop when they get there – this used to be known among British bookmakers as ‘betting to extinction’.  This theory was proved (the other way around) in 2001, when the UK government removed taxes and product fees on stakes (c. 9%) and put them on gross win (c. 20%: 15% GBD and 10% GB Horserace Levy on about half the revenue). The theoretical impact of this based upon customers recycling all of their extra staking money was a .c 40% increase in staking for the same revenue (gross margins less duties were c. 22% so 9/22). The result? An immediate 41% increase in staking with an almost unnoticeable impact on revenue (customer net spend). While we accept that not all reactions are equal when the drivers are opposite, we would suggest that this is very strong empirical evidence that it is net spend (revenue) and not turnover (handle) which is the constant for recreational customers when price is the variable. That this remains the case (and applies the other way around) is also strongly backed up by the fact that after the phenomenally strong soccer margins experienced in Q117, Q118 was exceptionally weak in both turnover and revenue terms for most operators (the ‘Q1 hangover’, as we dubbed it).

Back in the ‘good old days’ (and they never were), recreational customers used retail channels and price sensitive customers used (usually offshore) telephone (which typically traded to a c. 6% margin, or c. 1/4 that of retail on basically the same underlying product: also demonstrating that margin is a function of customers and product mix much more than bookmaker pricing). What was the biggest killer of telephone betting (at least in the UK and Ireland)? The betting exchange. Why? Because they (or it) undercut prices by about 50%. Price sensitive customers remain a key component of the ecosystem: these are people with many accounts (the top 10% of actives tend to have more than a dozen and a recent Eurogroup study into Portugal commissioned by the RGA found 68% of these were with offshore providers) – combined with a willingness to try operators completely unfamiliar to the casual customer. These customers will not bet less in a price restricted market – they will simply find offers which give them what they want – even in the black market. Our worked example of a 2ppt price distortion which is not absorbed by the bookmaker but passed on to the customer suggests that 13% of the total betting market then leaves the captured ecosystem – therefore unlikely to be taxed at all (and with consumers unprotected by any domestically mandated safer gambling measures).

This issue is not just one for policy considerations – it works from a competitive standpoint also. Bookmakers such as Paddy Power, Sportsbet, Skybet, FdJ and Tabcorp all aim for recreational customers and they all have high margins. Conversely, bet365 is by far the global market leader for more heavy user customers and it offers consistently lower margins. A large part of this is product (eg, relative multiples mix and geographic variations), but customer type matters a great deal too. Should Skybet choose to increase its prices by a significant amount, we suspect most its customers would simply stake less over time (and eventually they might drift elsewhere); should bet365 do so, then they would create a reason for its core customers to find a new bet365.

It is also telling that bet365, one of the best value sportsbooks from a customer perspective is also the leading online-only sportsbook globally in revenue terms (ie, excluding agent revenue). If mainstream logic were followed, then bet365’s keen prices would drive low sportsbetting revenue and higher gaming mix (ie, offering a ‘loss leader’ sports product). In fact the opposite is true (bet365’s gaming mix is among the lowest of all large operators, we believe), demonstrating (unsurprisingly) that betting customers respond to sportsbetting value with more sportsbetting activity – so long as the overall offer is strong. The ‘strategy’ of using sportsbook to cross-sell into gaming products, while valid up to a point, is more often than not just a palatable cover story for a weak sportsbetting proposition (or pedalled by those providers with one), in our view.

In other words, offering poorer prices to customers is not a way for bookmakers to make more money. Instead, it reduces staking volumes for non-price sensitive customers over time and it creates a competitive opportunity for price sensitive customers to move their business elsewhere (legal or not). Bookmakers who threaten poorer prices as an outcome they have control over merely threaten their own business (and so deserve the outcome). Bookmakers who are forced to offer poorer prices due to fiscal-regulatory pressures will lose a proportion of their revenue to the black market – while ‘ordinary’ customers have less fun: a loss for all responsible stakeholders.

There is an additional point to make here. Some operators have tried, or considered, increasing their gross margin by reducing customer prices to offset high operating costs (eg, high taxes). If those costs are not directly linked to handle/turnover (eg, Pennsylania’s high GGR tax or Australia’s rapidly increasing duty and product fee costs), then this approach simply will not work for exactly the reasons explained above: poorer consumer prices will mean lower rates of turnover for non-price sensitive customers and loss of market share from price sensitive customers –  less tax may be paid, but this is because less revenue will be generated and so relative losses will increase.

Artificially high gross margins are bad for business and bad for turnover volumes – and so, somewhat ironically, any taxes or product fees based upon them. There are many logical reasons for a regulatory framework to restrict certain behaviours, especially from a harm perspective, but fiscal-regulatory measures which interfere with price create bad outcomes for customers, regulators, tax authorities and responsible bookmakers. Equally, (and just as importantly) bookmakers who attempt to grow their margins by offering less attractive prices will simply create bad outcomes for themselves.