Letting The Pennsylvania Lottery Run Online Gambling Would Be A Costly Misstep

Having The Pennsylvania Lottery Run Online Gambling Would Be A Mistake Taxpayers Would Pay For

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The latest twist in Pennsylvania’s years-long attempt to regulate online gambling surfaced Tuesday when Sen. Joe Scarnati floated the notion of the Pennsylvania State Lottery – rather than Pennsylvania’s land-based casinos – operating online casino and poker games.

Scarnati’s suggestion may appeal to some. But the likely outcome of such a proposal would be damage to Pennsylvania’s casino industry and diminished revenue for the state, a combination that will ultimately leave Pennsylvania taxpayers holding the bag.

Here’s why.

Pennsylvania would lose over $100 million in upfront license fees

Current legislation in Pennsylvania calls for operators to pay an upfront license fee of anywhere from $8 to $10 million. Certain classes of suppliers would be obliged to pay a license fee of $2 million.

The total estimated take for the state from those license fees if online gambling remains a privately-run enterprise? Even conservative estimates call for a number north of $100 million. Robert DellaFave’s forecast at PlayPennsylvania.com puts the number at $126 million.

The upfront take for the state if the lottery runs the show? Likely less than $10 million from supplier fees.

That’s a pretty big gap for the lottery to make up from the word go. And doesn’t take into account the ongoing license fees operators and suppliers would have to pay down the line.

The lottery’s inexperience with online gambling would threaten state revenue

The Pennsylvania Lottery has absolutely no experience operating online games, let alone online casino and poker games.

That’s not a knock on the agency – it’s just a fact.

But the lack of expertise has serious consequences when comparing the efficacy of an online casino product operated by the state’s casinos and one operated by the lottery.

Delayed implementation

There is little question that a lottery-run online casino product would take longer to launch than an industry-run product.

The industry collectively enjoys the benefits of years of experience in New Jersey, Nevada, and Delaware; a substantial background in online wagering on horse racing; and a general technological edge in terms of online operations.

The longer it takes for online gambling to launch, the longer the state waits for revenue. The longer the state waits, the more likely tax increases become a solution to Pennsylvania’s pressing budget woes.

Inferior product

The lottery’s inexperience would logically manifest in an inferior product.

Again, this isn’t a knock on the lottery. It’s simply the logical conclusion one reaches when comparing a product deployed by an industry with decades of experience and hundreds of millions of dollars in practical investment in the online product with a product deployed by an agency that has neither.

An inferior product results in consumers continuing to chose black market sites. This not only undermines one of the tenets of regulation – increased consumer protection – but ultimately decreases the revenue the state will realize from regulation.

Inferior marketing

New Jersey has shown that smart marketing is critical to consumer education and engagement. When the state’s operators dialed in effective and efficient marketing revenue – and profits – began to follow.

The lessons how to market regulated online gambling are not obvious or readily available to the Pennsylvania Lottery.

What is the right mix of television, radio, land-based, and digital? What digital channels of the dozens available are worth the spend? How do you calibrate the mix of channels to achieve resonance? How do you balance that mix across separate seasons? How will the agency track the efficacy of each channel?

The lottery’s inability to meet its own sales targets does not inspire confidence in the agency’s ability to effectively generate solutions to a wholly new marketing challenge.

The agency would pay, either through lessons learned the hard way or expensive consulting contracts. And in doing so, it would further reduce the revenue left on the table for the state.

The lottery is unlikely to generate superior returns from online gambling

The senator argues that the Pennsylvania Lottery would reap substantial profits from online gambling, implying that a lottery-run online casino program would generate more revenue for Pennsylvania than one operated by casinos.

There is no clear reason to believe this is so.

Operating an online gambling site is a low-margin endeavor for companies that excel at the product. It tests credulity that the Pennsylvania Lottery, lacking any experience, would manage to outperform publicly-traded industry giants.

Greater need to outsource than industry

Because of the lack of existing capabilities, expertise, and partnerships, the Pennsylvania Lottery would need to outsource nearly every – if not in fact every – aspect of regulated online gambling. That would create an immediate, and unique, pressure on margins.

Ironically, in this way, the state would still end up with a privately-run regulated online gambling system. And lottery privatization – already rejected by once Pennsylvania – has been a nightmare for Illinois.

Less bargaining power than industry

On top of the need to outsource all aspects of the online operation, the Pennsylvania Lottery would do so from a position of extreme weakness.

Casino operators have deep relationships with suppliers that span multiple properties, multiple states, and in some cases multiple continents. This provides casinos with substantial leverage when it comes to negotiating supply contracts for online gambling.

The lottery enjoys none of those advantages, creating an additional pressure on margins.

If the industry loses money, the state still gets paid. If the lottery loses money, the state loses money

The senator’s plan skirts a critical distinction.

If casinos run online gambling at a loss, the state is unaffected. The tax rate is applied to revenue, not profits. So if the casinos run in the red, Pennsylvania still gets paid.

But if the lottery runs online at a loss, the state not only doesn’t receive revenue – it loses revenue.

That’s a serious risk that should be thoughtfully considered before advancing any proposal to put online gambling in the Pennsylvania Lottery’s hands.

The loss of the online channel would erode casino revenue

The beauty of regulated online gambling in New Jersey is that the product is complementary to the land-based casino product.

Revenues for online and land-based in Atlantic City are rising in tandem. Regulated online gambling has produced over half a billion dollars in new revenue for New Jersey casinos.

The Borgata, Caesars, and the Golden Nugget have all publicly confirmed that over 80 percent of online customers are new customers.

Splitting online casino operations from land-based casinos would rob Pennsylvania’s casinos of the opportunity to capture that new customer base and the new revenue it brings. Splitting operations would further deprive Pennsylvania’s casinos of the opportunity to use online gambling as a way to reactivate dormant customers and deepen engagement with existing customers.

The internet has already proven to be the future of banking, retail, and entertainment. For many consumers, it is already the their preferred channel for gambling, a trend that will only accelerate in the years to come.

If Pennsylvania politicians block the access of casinos to the internet, they do so at their own peril. With fewer consumers spending less, the revenue the state receives from casinos will diminish.

And all Pennsylvania will have to offset that loss is an online casino product operated by an agency that is ill-suited for the task at nearly every turn.

Image c/o christine592 / CC BY-ND 2.0

- Chris is the publisher of OnlinePokerReport.com. Grove also serves as a consultant to various stakeholders in the regulated market for online gambling in the United States.
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