Optimal Product Fee Models for Australian Sporting Bodies. July 2012

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1 Optimal Product Fee Models for Australian Sporting Bodies July 2012

2 Optimal Product Fee Models for Australian Sporting Bodies 2

3 Contents Definitions and Acronyms 4 Executive Summary 5 1 High Court Decision a catalyst for change? 9 2 Sports betting: an emerging two-sided, global market Sports betting: an emerging market A competitive global market A two-sided market Issues of integrity in a two-sided market 19 3 The economics of sports betting Sports betting revenue and cost structure Implications of a marginally profitable, substitutable product 25 4 Optimising outcomes for the sporting codes: a game-theoretic analysis Framework for analysis: a game theory approach Expectations for NRL wagering growth and payoffs under the status quo fee model Expectations for NRL wagering growth and payoffs under a turnover-based fee model Game equilibrium and implications for product fee model negotiations 33 5 Conclusions 35 Appendix A: Overview of Industry Growth Modelling Methodology 37 Optimal Product Fee Models for Australian Sporting Bodies 3

4 Definitions and Acronyms AFL Betting in the run DBCDE Australian Football League Wagering on a sporting event after the event has commenced Commonwealth Department of Broadband, Communications and the Digital Economy Direct costs Includes both direct variable costs - including the GST and product fees - and and direct fixed costs, including staff costs and other non-variable items Gross Win, GW, or Revenue High Court Represents total amounts wagered by consumers less amounts won by consumers High Court of Australia IGA Interactive Gambling Act 2001 NRL Sporting bodies or sporting codes TAB Terminal Value Turnover (T/O) Wagering operators National Rugby League For the purpose of this analysis, the NRL and AFL as the context requires Totalisator Agency Board The present value, at a future point in time, of all future cash flows based on a stable future growth rate Represents total amounts wagered by consumers Licensed Australian corporate bookmaker, totaliser or betting exchange Optimal Product Fee Models for Australian Sporting Bodies 4

5 Executive Summary This report, commissioned by Sportsbet Pty Limited (Sportsbet), considers alternative product fee arrangements for sporting bodies in Australia and the elements of an optimal agreement which provides mutual upside to both the sporting bodies and the wagering operators. On 30 March 2012, the High Court of Australia handed down its judgements in the cases between Sportsbet and Racing New South Wales (Racing NSW), and Betfair Pty Limited and Racing NSW. In both cases, the High Court found in favour of Racing NSW, and effectively ruled that they were able to charge authorised wagering operators a fee of 1.5 per cent of wagering turnover to reproduce NSW race fields information. These rulings were widely anticipated by wagering industry participants in Australia and, as a result, a number of racing and sporting bodies have reviewed or are reviewing the product fee models for their sporting code. Scope of this report This report considers the business models and economics of alternative fee models for the Australian Football League (AFL) and the National Rugby League (NRL) sporting codes, as they are the two most prominent sporting codes in Australia. It focuses specifically on the NRL in an analysis of the potential impact of product fees on wagering turnover and product fee revenues (to the NRL) because on 24 April 2012 the NRL announced that it was considering its position with regards to product fees following the High Court case, and they may seek to enact legislation which replicated that of Racing NSW in order to maximise its product fee revenues. Specifically, the report considers: alternative models for charging product fees, that is, whether to levy a fee based on a percentage of wagering turnover or a percentage of wagering gross win (revenue); the quantum of the product fee charged and how this affects the marginal profitability of a wagering product; and the impact that product fees can have on the ability of a sporting body to protect the integrity of its sport. The analysis utilised confidential information obtained from Sportsbet, information obtained from interviews with industry participants, publicly available information and other sources as referenced. Using the NRL as a case study, the analysis demonstrates: the significant impact that the product fee model can have on wagering turnover; the impact the product fee model can have on wagering operators contributions to the league and its clubs directly, through product fees and sponsorships, and indirectly by influencing the demand for media spend on the sport and the corresponding impact on the value of media rights; and that sporting codes also benefit from wagering operators promoting wagering products on the sport. Optimal Product Fee Models for Australian Sporting Bodies 5

6 Key findings The report finds that sports wagering is a clear two-sided market, where it is in the interests of both the Australian licensed wagering operators and the sporting codes to maintain a competitive, innovative wagering product that will maximise returns to both sides. Doing so will prevent consumers from migrating to unregulated and unlicensed offshore wagering operators, and protect the integrity and long term financial viability of product fees and other contributions from Australian licensed wagering operators. Specifically, findings outlined in the report include: Total turnover on sports wagering continues to grow in excess of 13 per cent per annum driven by strong growth in online sports wagering of 28 per cent, however the total market remains significantly smaller than racing ($3.3 billion compared to $20 billion); NRL and AFL wagering represent the two largest wagering sports, representing approximately 50 per cent of all sports wagering in Australia and 7 per cent of total wagering in Australia (NRL: $750 million, AFL: $900 million); Sports wagering turnover is expected by industry participants to continue to grow in excess of 13 per cent per annum, with NRL/AFL wagering turnover estimated to double in five years under the current gross win based product fee model (NRL: $1.5 billion, AFL: $1.8 billion); Australian wagering operators generated an estimated $81.5 million gross win revenue from NRL and AFL wagering (NRL: $36.5 million, AFL: $45 million) in 2011, which represents approximately 4.5 per cent of the total gross win revenues generated by Australian wagering operators on racing; Wagering operators also contribute approximately $45 million per year to NRL and AFL related products through sponsorship and advertising expenditure; After marketing expenditure and other direct costs (including product fees), wagering operators are estimated to earn a margin of $13.4 million on NRL wagering under the current 5 per cent gross win based product fee model (AFL: $15.5 million); If adopted, a 1.5 per cent turnover product fee model would significantly reduce the profitability of NRL wagering products, such that, after overheads, the product category would effectively be loss making for wagering operators; Wagering operators are therefore likely to take action to preserve profitability, including significantly reducing or reallocating marketing expenditure, and reducing odds offered to consumers; These actions, in the long run, would significantly reduce NRL wagering turnover and therefore product fees paid to the NRL, such that on a net present value basis, the NRL would be an estimated $11 million worse off under a 1.5 per cent turnover based product fee model; and In addition to the financial implications, this also represents a significant risk to the integrity of the sporting codes as consumers will migrate to offshore wagering operators who do not have integrity agreements in place with the sporting bodies and do not pay product fees; The winners under all potential scenarios if the NRL were to adopt a 1.5 per cent turnover based product fee model would likely by the AFL, NSW racing and offshore wagering operators, which would be expected to gain some of the market share that would have otherwise been wagered on NRL products. Optimal Product Fee Models for Australian Sporting Bodies 6

7 The report concludes that there is an optimal form of agreement between sporting codes and Australian licensed wagering operators which provides mutual upside to both parties. This theoretical optimal agreement would be a product fee arrangement which: would be charged on a gross win basis; would potentially represent an increase on the current arrangements of 5 per cent of gross win, but not to a level that would require wagering operators to take steps to preserve profitability, as this would have a significant detrimental impact on the wagering turnover growth rates currently achieved; and would provide financial upside to both sides of the two-sided market by ensuring ongoing competition and innovation amongst Australian licensed wagering operators whilst protecting the integrity of the sporting codes in Australia. Optimal Product Fee Models for Australian Sporting Bodies 7

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9 1 High Court Decision a catalyst for change? This section provides a high level summary of the High Court judgements and the potential implications for sports betting in Australia. Any changes to the product fee model by other sporting codes may significantly change the sports betting landscape in Australia, which is analysed in subsequent sections of this report. The High Court judgements and implications for sports betting On 30 March 2012, the High Court of Australia dismissed appeals by Sportsbet and Betfair in the cases of Sportsbet Pty Limited v State of New South Wales and Betfair Pty Limited v Racing New South Wales, which effectively upheld Racing NSW s right to charge wagering operators a fee of 1.5 per cent of turnover to reproduce NSW race fields information. Although the judgements of the High Court are only in respect of the NSW race fields legislation, in light of the decision it is likely that Australian racing bodies will re-evaluate their race field s regimes and give consideration to amending the basis for the calculation of product fees such that they are calculated by reference to turnover. Racing Victoria has already indicated that it will move to a turnover-based product fee regime and explore a similar model to that of Racing NSW over a 12 month trial period, upon expiration in 2012 of existing agreements with authorised wagering operators, and subject to amendments that may be required to Victorian legislation. It is likely that there will now be considerable pressure for the product fees payable to all sporting bodies to be reviewed. However, any decision regarding a proposed fee model needs to be balanced by the potential impact that it may have on the business models for wagering products offered by licensed Australian wagering operators, and in turn, wagering turnover market growth and the integrity of the sporting code. The most significant wagering operators in Australia are either entities listed on the Australian Securities Exchange (ASX) or are significant subsidiaries of entities listed on overseas exchanges. If product fees were to increase materially, inevitably these businesses, in order to continue to maintain profitability and meet shareholder expectations, would be expected to review the prices at which they offer betting products. Accordingly, their capacity to continue to invest in market growth (through sponsorship, promotion, advertising and other contributions to sporting codes and their clubs) would be expected to diminish. Objectives and Structure of this report Media reports have speculated that the NRL has an interest in advocating to government for product fee legislation similar to existing legislation in NSW for payment of product fees by wagering operators which reproduce NSW race fields information. If this was to become a reality, it would effectively replace the current commercial agreements in place between the sporting bodies and wagering operators. This speculation, following on from the High Court decisions, has prompted a review of the wagering industry s growth prospects under the current product fee regime, the implications of alternative fee models on these growth expectations, and the optimal long-term product fee model. Deloitte was engaged by Sportsbet to consider alternative product fee arrangements for sporting bodies in Australia and the elements of an optimal agreement which provides mutual upside to both the sporting bodies and the wagering operators. Our analysis utilised confidential information obtained from Sportsbet, information obtained from interviews with industry participants, publicly available information and other sources as referenced. Optimal Product Fee Models for Australian Sporting Bodies 9

10 This report considers each of these elements: Section 2 provides a summary of the growth potential and competitive dynamics of the sports betting industry, independent of the potential product fee changes, and considers the issues of integrity in a two-sided market; Section 3 analyses the profitability of sports betting products under the current product fee regime and the implications of a 1.5 per cent turnover-based product fee for market participants given the current level of maturity and consumer price elasticity profile; and Section 4 presents a game theoretic analysis of the potential fee models that could be applied in the sports betting industry, and our analysis of potential payoffs to the sporting bodies and wagering operators utilising industry turnover growth projections prepared by Sportsbet and discussed in interviews with other industry participants. The report concludes that, given the likely significant negative impact of a 1.5 per cent turnover based product fee on the viability of the sports betting business model and the twosided nature of the market, it is in the interests of the sporting codes, from both a financial and integrity perspective, to work with wagering operators to identify and implement an optimal model and quantum of product fees ( the optimal agreement ). A key characteristic of such an optimal agreement is that the product fee charged by the sporting codes would: provide long term protection of the integrity of the sporting code by ensuring there is a strong incentive for consumers to wager with Australian licensed wagering operators with whom the sporting bodies currently have integrity agreements in place; and maximise financial returns to the sporting codes from product fees, sponsorships and media licensing deals. The objectives can be achieved by setting a fee which ensures: Australian licenced wagering operators can set odds which are competitive with those being offered by offshore wagering operators which offer markets on local sporting events - these offshore operators do not contribute product fees to, and do not have integrity agreements in place with, the sporting codes; wagering operators earn a reasonable profit margin such that they are incentivised to undertake ongoing marketing and promotional activity - the high levels of marketing and promotional expenditure by wagering operators not only drive increased wagering spend but also increase the profile of the sporting code and therefore inherently enhances the value of sponsorship and media rights agreements; and competition among the wagering operators in Australia is maximised, resulting in ongoing innovation and industry development - competition will be maximised by a product fee which taxes all wagering operators on an equal economic basis. Optimal Product Fee Models for Australian Sporting Bodies 10

11 2 Sports betting: an emerging two-sided, global market This section outlines the market for wagering operators in Australia, including a summary of domestic providers, international competitors, industry growth expectations and the relationship between sports betting and the sporting codes. 2.1 Sports betting: an emerging market The wagering industry is comprised of both traditional wagering on racing (thoroughbred, harness or greyhounds) and the less mature, but rapidly growing, area of sports betting. 1 While wagering on racing is a well-established and mature betting market, sports betting is an emerging market which has experienced considerable growth in recent times and offers strong ongoing growth potential in the medium term. The growth in sports betting has been closely linked to increased access to advances in technology, such as broadband internet and smart phones, and has been associated with the growth of corporate bookmakers. Although sports betting shares some common features with wagering on races, betting is generally a secondary reason for a consumer to follow sporting events. By contrast, wagering is typically the primary reason for a consumer to follow racing. Racing is a gambling-based activity and the industry is heavily reliant on betting proceeds for its existence. As an emerging market, sports betting turnover has increased significantly in recent years, contrasting with the limited growth in the mature market for wagering on racing. From 2004 to 2011, sports betting experienced a Compound Annual Growth Rate (CAGR) in wagering turnover of over 13 per cent. This figure greatly exceeds the equivalent figure of 4 per cent growth in racing wagering, which is broadly in line with recent growth in household disposable income. Figure 1: Wagering turnover, 2004 to 2011, Australia Source: Australian Racing Board (2011), Australian Racing Factbook, A Guide to the Racing Industry in Australia Some bookmakers also offer betting products in relation to events such as elections or reality television, though this remains a very small part of the entire wagering market. Optimal Product Fee Models for Australian Sporting Bodies 11

12 These contrasting growth rates are depicted in Figure 1 above, although it is important to note that in absolute terms, with a total turnover of some $20 billion in 2011, the total estimated market size for racing wagering remains significantly larger than for sports betting at $3.3 billion. Industry players generally expect growth in demand for sports betting to remain high for the medium term. Provided product offerings, market pricing and the regulatory environment are not significantly altered, the nominal growth rate in turnover is expected by industry participants to remain at least consistent with the current CAGR of 13 per cent, if not higher given the online growth. This growth would be consistent with the growth profile for sports betting previously experienced in a number of overseas markets that have now matured. Much of the growth in sports betting is aligned with growth in online gambling. As shown in Figure 2, internet gambling has grown strongly around the world over recent years, with a CAGR of 18 per cent between 2003 and 2010, and is projected to continue that growth trend. This growth has been driven, at least in part, by consumers switching from traditional forms of wagering such as phone, on-course and in retail outlets to internet-based forms of wagering. Figure 2: Gross Win, Internet gambling, , globally (actual and projected) Source: H2 Gambling Capital, egaming Data Set, February 2012 Growth in online gambling has also been strong in the Australian market, growing at 17 per cent per annum over the period As shown in Figure 3, both sports betting and wagering on racing have experienced strong growth in online betting. In absolute terms, this growth has been largest for racing; however, the rate of growth for online sports betting has been particularly strong, with a CAGR of 28 per cent compared to 16 per cent for racing. Anticipated continued growth in online wagering is likely to remain an important factor supporting the ongoing growth of sports betting in Australia. Optimal Product Fee Models for Australian Sporting Bodies 12

13 Figure 3: Turnover for racing wagering and sports betting and corresponding percentage of total racing and sports betting turnover, , Australia Represents 27% of total racing turnover Represents 47% of total sports betting turnover Source: Australian Racing Factbook, 2011 Along with the shift away from telephone, on-course and in retail outlet wagering, the significant growth in online wagering in Australia has coincided with an overall decline, since 2008, in the amount of wagering estimated to be offshore, as outlined in Figure 4. The opening of the advertising market, following the Betfair 2 case in 2008, significantly increased competition amongst Australian licensed wagering operators, which has resulted in new products, markets and prices for the consumer and has created a notable shift back onshore as consumers have sought to take advantage of the significant competition in the local marketplace. Figure 4: Percentage of Wagering Turnover estimated to be offshore , Australia Source: H2 Gambling Capital, egaming Data Set, February Betfair Pty Limited v Western Australia (2008) HCA 11 (27 March 2008) Optimal Product Fee Models for Australian Sporting Bodies 13

14 The significant growth in sports betting and online wagering has been achieved in the absence of wagering operators being able to offer online betting in the run on live sporting events. The Interactive Gambling Act 2001 (IGA) currently does not allow betting in the run online, although such bets can be placed over the phone or at TAB retail outlets. On 29 May 2012, the DBCDE released their interim report following a review of the IGA, and among other things, recommended that the IGA be amended to dovetail its provisions regarding sports wagering with the provisions currently being developed by the Minister for Sport to deal with integrity in sports and match fixing. Such an amendment would effectively mean that betting in the run (whether online or over the phone) would be allowed provided that the bet types are authorised by the relevant State/Territory regulatory authority and the relevant sports controlling body, if applicable. The recommendation, if adopted, would correct the current inconsistency between online and telephone betting in the run and create platform neutrality. While the responsible Minister, the Minister for Broadband, Communications and the Digital Economy, Senator the Hon. Stephen Conroy has noted that the Commonwealth Government has not yet made any decisions in relation to the review of the IGA, he has also publicly acknowledged the inconsistency of betting in the run. 3 Industry participants expect such an amendment to significantly increase sports betting turnover with Australian licensed wagering operators, above current rates of 13 per cent CAGR growth, which would be consistent with other international markets AFL and NRL wagering This report uses the AFL and NRL sporting codes as case studies because they are the two most prominent sporting codes in Australia. Although specific information is not publicly available, given the prominence of the sporting codes, it is expected that wagering on AFL and NRL matches represents a significant portion of sports betting in Australia. Based on an analysis of confidential data obtained from Sportsbet, interviews with other industry participants, and analysis of publicly disclosed information, Deloitte has estimated that in 2011 sports betting on the AFL and NRL generated turnover of approximately $900 million and $750 million, respectively. These figures imply that wagering on these sporting codes jointly accounts for over 50 per cent of all sports betting in Australia and, based on wagering figures in the Australian Racing Factbook 2011, represents approximately 7 per cent of all wagering in Australia. 4 As with wagering markets more broadly, most sports betting on the AFL and NRL is conducted through TAB organisations, which consist of several different registered operators across Australia. 5 In 2011, across all TAB organisations, we have estimated sports betting on the AFL and the NRL to be $500 million and $425 million respectively accounting for approximately 56 per cent of all sports betting for each these codes. The remainder of AFL and NRL sports betting is shared between the various corporate bookmakers and the betting exchange, Betfair. These wagering operators have enjoyed increasing market share since their establishment in the mid-1990s. Over the period bookmakers have experienced a CAGR of 9 per cent compared to an approximate 4 per cent growth experienced across TAB organisations. 6 The bookmaking market is characterised by a diverse array of providers as reflected in Figure 5 below. 3 The Australian, 24 May 2012, interview on Nine Network, 23 May Australian Racing Factbook, Includes Tabcorp in Victoria and NSW, Tatts in Queensland, South Australia, the Northern Territory and Tasmania, and the TAB in WA and the ACT. 6 Australian Racing Factbook, 2011 Optimal Product Fee Models for Australian Sporting Bodies 14

15 $ Millions Figure 5: Estimated sports betting turnover by corporate bookmaker and Sporting Code, AFL AFL NRL NRL Source: Deloitte analysis of Sportsbet data and interviews with industry participants. Betfair is not included above due to the different basis on which turnover is measured compared to traditional corporate bookmakers. As explored further in the following section, the diversity of wagering operators and the importance of online betting contributes significantly to creating a highly competitive sports betting market in Australia. 2.2 A competitive global market The sports betting market in Australia is highly competitive, characterised by a large number of wagering operators and a highly price sensitive customer base. This is particularly the case for sports betting on the AFL and NRL, which as noted above, is estimated to represent over 50 per cent of total sports betting turnover. The competitiveness of sports betting for these codes is driven by two key factors: Fierce competitive rivalry The large number of sports betting service providers, both in Australia and overseas, creates a wide range of betting options for consumers. Strong buyer power Sports betting consumers tend to have lower brand loyalty and be more price-sensitive across wagering channels, compared with traditional racing consumers. 7 The large and growing online market segment, in particular, is characterised by high consumer price elasticity, given low switching costs between both domestic and international wagering providers. These factors contribute to a market in which consumers are highly sensitive to price (i.e. the value of the odds on offer), creating an environment in which the margins for wagering operators face significant and ongoing constraint. 7 Based on consumer surveys conducted by Sportsbet and interviews with industry participants Optimal Product Fee Models for Australian Sporting Bodies 15

16 2.2.1 Competitive rivalry: Overview of domestic and international sports betting providers operating in Australia In 2011 TAB operators had approximately 50 per cent of total market turnover in the sports betting market, with the remainder shared by domestic corporate bookmakers and offshore operators. 8 The large number of domestic corporate bookmakers ensures a level of competitiveness which constrains margins and limits the profitability of any individual operator. The significant presence of online offshore wagering operators in the Australian sports betting market imposes further competitive pressure on domestic wagering operators. Notably, the offshore wagering operators can offer online in play betting or betting in the run and therefore have a distinct competitive advantage over domestic wagering operators. Where there is a greater variety of products (i.e. online betting in the run ), and odds provided by offshore wagering operators offer better value than those provided by domestic wagering operators, offshore wagering operators would be well placed to take an even greater percentage of the domestic market. Although there are currently no regulations that prevent Australian consumers from establishing a betting account with offshore wagering operators, there are restrictions on international providers advertising to Australian consumers. Additionally, the IGA makes it an offence to offer online betting in the run to Australian residents, although there does not appear to be any restrictions in place to prevent Australian residents from betting with these offshore wagering operators, nor does there appear to be any instances of prosecution of such operators for breaches of the IGA. Most industry participants believe that online betting in the run comprises the majority of the offshore wagering operators turnover generated from Australian residents. The websites of a number of offshore wagering operators were monitored during the writing of this report. UK corporate bookmakers, Ladbrokes and William Hill offered multiple markets on weekly NRL and AFL matches. The websites of Victor Chandler and Stan James offered multiple markets on weekly NRL and AFL matches and also included online betting in the run markets on multiple NRL and AFL games each week along with other sports. The markets on Australian sporting codes offered by offshore wagering operators are potentially undermining the scope of the sporting codes to receive payment for their products and putting the integrity of Australian sporting codes at risk Sources of buyer power: online sports betting The online component of sports betting is particularly competitive and represents a significant portion of the overall market for sports betting. As presented in Figure 3 above, measured by turnover, approximately half of all sports betting is conducted online, almost twice the share of online wagering for the racing industry. The competitiveness of online sports betting is affected by a number of factors that ultimately provide the consumer with a significant amount of choice, the proliferation of smartphone technologies and various web applications that result in low switching costs and allow consumers to seamlessly move between different wagering operators. The proliferation of technologies, such as smartphones, allows easy access to a wide range of wagering operators at any time and in any location, which creates pressure for wagering operators to continually update odds, markets and the betting interface to meet consumer demands. In 2011, smartphone penetration in Australia was estimated at 39 per cent and is expected to increase to 77 per cent by 2015 (representing approximately 88 per cent of total mobile phone users). Further, competition is also evolving in the tablet market, with penetration of tablets expected to reach 55 per cent by The availability of online 8 Deloitte analysis of Sportsbet data and interviews with industry participants. Estimates for the share of overseas wagering operators are based on data from H2 Gambling Capital, egambling Data Set, February Telesyte Australian Smartphone Study 2012 Optimal Product Fee Models for Australian Sporting Bodies 16

17 betting applications on these devices will continue to increase the competitiveness of this market and place significant power in the hands of the consumer. In addition to improved technologies, the development and growth of online bookmakers and odds comparison websites and software gives the consumer the ability to obtain the best odds and markets at all times. These websites, such as way2bet.com.au, oddschecker.com, and top100bookmakers.com, allow online customers to easily compare the odds offered by domestic and international wagering operators, creating a market in which consumers are able to seek out and obtain the best odds available and easily identify offshore wagering operators that allow online betting in the run. Together, these factors lower the transaction costs faced by consumers as they seek the best odds and regularly switch between different wagering operators, including overseas operators. Compared to consumers of land-based wagering operators, online customers are also likely to have less loyalty to particular wagering operators given the ease of switching between operators. Lower loyalty means consumers are more likely to switch between wagering operators on the basis of convenience and the value they offer. Marketing studies undertaken by Kantar, on behalf of Sportsbet, indicate that the sports betting consumer base is highly price elastic, with 47 per cent of respondents indicating the main reason for switching between wagering providers was the odds on offer. The second most important reason for switching, noted by 27 per cent of respondents, was lack of promotions and/or other offers Implications for consumer price elasticity There are a number of factors which allow customers to be highly price sensitive when selecting the wagering operator with which to place a bet: low brand loyalty; large number of competitive wagering operators; low barriers to switching between domestic and overseas wagering providers; and access to improved and convenient technologies such as smart phones and tablet PCs. The impact of the price sensitivity of sports betting consumers has been observed in overseas markets where regulatory changes (high taxes) have ultimately influenced the odds offered to consumers (Box 1) as wagering operators could not absorb the tax. Within Australia, the sensitivity of consumers is currently reflected in comparatively low margins for sports betting compared with racing products, as explored further in the following section. Optimal Product Fee Models for Australian Sporting Bodies 17

18 Box 1: International example of sports betting consumer price elasticity France In May 2010, the French government chose to regulate the gambling sector by enacting Law , which among other things, imposed a turnover based tax of 8.5 per cent on sports betting and 7.4 per cent on racing. Additionally, the legislation limited payout ratios to 85 per cent. As a result of the increased tax and limited payout ratios, wagering operators offered lower odds to customers in order to preserve their margins. This highlighted the price differential with other providers not based in France and customers followed the odds, which resulted in a 24 per cent quarter on quarter reduction in gross win generated from sports betting in A simple example below highlights the relative profitability of a regulated local operator and an offshore operator in France under this regime, which highlights that offshore operators can offer a higher payout ratio and therefore better odds to consumers, yet all else being equal, maintain the same profitability as local operators. Local Operator Offshore Operator Turnover Payout Ratio 85.0% 93.5% Gross Win Tax (8.50) - Profit after Tax To maintain profitability, wagering operators reduced their media advertising budgets by 58 per cent in 2011, which was further exacerbated by the fact that the majority of this marketing expenditure was based on bonuses and sponsorship allocations. As a result of the regulatory regime and the resulting declining margins, a number of wagering operators incurred losses which forced a number of participants to exit the market, including William Hill and Ladbrokes. It is widely speculated by industry participants that wagering operators in France have still not found a sustainable operating model in order to break-even, and it would therefore appear likely that further decline in the regulated wagering industry will continue in France for the foreseeable future. 2.3 A two-sided market Two-sided markets emerge where the operations of one entity provide financial opportunities for another entity. In this context, both entities have an interest in increasing the overall size of the market. Whilst historically, interest in sporting events has been independent of wagering, growth in sports betting is inevitably likely to increase interest in viewing sporting events. To this end, a clear two-sided market is emerging, which can already be observed in the racing industry: Sporting codes will increasingly benefit from wagering as it increases viewing of sports and potentially the rates they can charge sponsors of their events (by virtue of both increased viewership of the sporting event and the demand created from the wagering operators for advertising during relevant content programming), as well as generating direct revenues to the sporting bodies through the levying of product fees, which form part of the integrity agreements the sporting bodies have signed with Australian licensed wagering operators (Refer Section 2.4). Wagering operators in turn benefit from increased sports viewing because of its impact on demand for wagering related to the event. Optimal Product Fee Models for Australian Sporting Bodies 18

19 Demand for sports betting is highest for those sporting codes that attract significant public interest and have a large spectator following, which in Australia is dominated by AFL and NRL. The co-dependency of the wagering industry and the sporting event is, however, unlikely to ever be as strong as that observed in the racing sector. As noted previously, although sports betting shares some common features with racing wagering, betting is generally a secondary reason for a person to follow sporting events, whereas wagering is typically the primary reason for a person to follow racing. Racing is a gambling-based activity and the industry is heavily reliant on betting proceeds for its existence. Nevertheless, Australian licensed wagering operators have a strong interest in promoting the sporting codes on which they offer betting markets. Reflecting this interest, wagering operators provide significant financial support to the sporting codes. By supporting the sporting codes with direct sponsorships, stadium contracts and fees to controlling bodies, Australian licensed wagering operators contribute to the finances of the sporting codes and their clubs. Additionally, significant volumes of advertising dollars are spent annually on relevant content programming for the sporting codes in television, radio, print and online media (Refer Section 3). In contrast, overseas wagering operators do not pay product fees to the sporting codes and also do not advertise on relevant content programming or otherwise support the sporting codes. Equally, the sporting bodies have a strong interest in ensuring that regulated Australian wagering continues to grow, so that it can continue to collect revenues from Australian licensed wagering operators and charge higher fees to other event sponsors due to increased interest and competition for advertising space and increased viewership of the sporting event. The sporting bodies also have a vested interest in ensuring that the continued growth in sports betting stays with Australian licensed wagering operators to continue to protect the integrity of the sporting code. This is explored in greater detail in Section 2.4, and continues to be a high priority for all Australian sporting codes. 2.4 Issues of integrity in a two-sided market As a two-sided market, weaknesses in either sports betting or the sporting codes can have significant negative implications for both sides of the market. For instance, the presence of unregulated or unlicensed wagering operators, which operate with limited transparency or oversight, can contribute to a context in which match-fixing is prevalent. This means that a lack of integrity in sports betting can also contribute to a lack of integrity in associated sporting codes. A lack of integrity poses dangers for sporting codes, particularly if spectators come to believe that outcomes are fixed, leading to a decline in spectator interest and numbers. In this context, sporting codes are faced with both the additional costs of policing their games and the potential for a decline in sponsorships. 10 The dangers for sporting codes caused by unregulated sports betting providers is reflected in the challenges experienced most prominently in cricket, as experienced recently in the Indian Premier League. In response to concerns regarding match-fixing and sports integrity, on 10 June 2011, all Australian sports ministers endorsed on behalf of their governments a National Policy on Match-Fixing in Sport, with the aim of protecting the integrity of Australian sport. Whilst both the AFL and NRL appear to already have strong integrity measures in place, which include integrity agreements with Australia licensed wagering operators, there remains a substantial cost of keeping such measures in place. 10 Altoona B (2011) The effects of corruption on the Olympic Ideals and Sponsorship programmes Optimal Product Fee Models for Australian Sporting Bodies 19

20 Even ignoring the financial implications outlined in this report, there also remains a substantial risk of losing the effectiveness of such integrity measures if betting is transferred to unregulated offshore providers. The sporting codes would lose the transparency that is currently available to them under the integrity agreements with Australian licensed wagering operators, which allow investigation into irregular betting activity, betting accounts, and to restrict certain bet types offered by wagering operators. Whilst a number of the offshore wagering operators are large multinational businesses and are regulated and licensed in other jurisdictions (eg. UK), if regulatory change spawns growth in offshore wagering, it could be expected that unregulated offshore operators would increase in number, which would have further negative implications for both consumers and the sporting codes. Notwithstanding the integrity measures in place, both the AFL and NRL have experienced their own challenges in relation to betting plunges and wagers placed by players, which has resulted in suspensions in both sporting codes. The CEO s of both sporting codes have made numerous public statements on the importance of protecting integrity in the sport, and have taken a strong stance against breaches by players, coaches and officials. Most recently, on 12 June 2012, the Coalition of Major Professional and Participation Sports hosted a luncheon, with the CEOs of Australia s major sporting codes also acknowledging the risks posed by unregulated offshore wagering and the need to maintain an appropriate integrity framework. It would therefore appear to be in the sporting bodies interests to adopt a fee model that would encourage consumers to place their bets through Australian licensed wagering operators so as to protect and strengthen the integrity measures that are currently in place. Optimal Product Fee Models for Australian Sporting Bodies 20

21 3 The economics of sports betting This section analyses the revenues, related costs and marginal profits of wagering operators in the sports betting sector. The analysis shows that sports betting is currently a very low margin product even under the gross win based product fee model. If a turnover-based product fee was introduced, the marginal profitability would be substantially reduced, which is likely to trigger a review of the odds provided to consumers or a reduction in the costs of providing the service. Given the elastic nature of demand for sports betting (with low transaction costs for substitute products), the viability of a domestic product is likely to come under short, medium and long-term threat. 3.1 Sports betting revenue and cost structure The revenue and cost structures of providing a market for wagering on sports vary across wagering operators and there is limited publicly available information specific to sports betting. It is, however, widely accepted in the industry that the revenue (gross win) achieved in sports betting is less, as a percentage of turnover, than that achieved on racing wagers Components of revenue and cost The average revenue margin achieved varies across wagering operators depending on the nature of the customer base and the markets offered. The cost structure will also vary, depending on the markets offered, the focus on market growth (marketing and promotion expenditures), the betting platform used, as well as fixed overhead costs. For the purpose of our analysis, we have assumed that the average gross win margin achieved on sports betting is approximately 5 per cent of total turnover, which is at the higher end of what many wagering providers may be currently achieving (based on observable public pricing of binary outcome markets). Consultations with industry participants have indicated that smaller wagering operators are likely to be operating on a revenue or gross win margin of less than 5 per cent. The basic cost structure of a wagering provider is broken down as follows: direct variable costs vary in direct proportion to the turnover or revenue (gross win) of the business, and include GST of 10 per cent of revenue, product fees (currently 5 per cent of gross win for sporting codes such as the NRL and AFL) and other direct variable costs; direct fixed costs staff (traders) required to continually monitor and update the available markets and fixed betting platform/it costs; other direct costs predominantly discretionary expenditure but which has a direct impact on revenues, such as advertising and promotional expenditure, and product development and innovation; and fixed overhead costs includes the basic overhead costs required to operate a wagering business including occupancy costs, staffing costs across the typical corporate functions of finance, legal, risk, IT, call centre and general marketing/sales and other costs such as utilities, licensing and webhosting. For the purposes of our analysis, we have ignored the fixed overhead costs in order to focus on the marginal profitability of sports wagering. Optimal Product Fee Models for Australian Sporting Bodies 21

22 3.1.2 Alternative Product fee models Looking to the racing industry for precedent fee models reveals that a variety of approaches are in operation, depending on the jurisdiction and product. 11 Whilst there is diversity in the rates applied, there are two base fee models in operation: Fees based on Gross Win The gross win model is based on taking a percentage of the value to the wagering operator of the total amount of bets taken (turnover) less winnings of the consumer. This is the current model applied by the majority of the sporting codes (5 per cent of gross win) and is still being applied by some of the racing bodies. Consistent with the findings of the Victorian Thoroughbred Wagering Review, May 2011 and the Productivity Commission Inquiry Report, 26 February 2010, the advantage of this approach is not imposing high costs on low margin operators, which has the benefit of: o o o continuing to drive competition and therefore growth in the two sided market ; allowing domestic licensed wagering operators to remain competitive with offshore operators; fostering product innovation, improved product delivery and customer service; and o favourable pricing outcomes for the consumer. The wagering operators expect to make a profit under this fee model into the foreseeable future without having to make significant changes to the existing business model or cost structure. Fees based on Turnover A turnover-based model is based on taking a percentage of the value of all bets received by wagering operators. The advantage of the turnover-based model is that there can be relatively greater certainty of outcome (and generally higher revenues) to the sporting codes where the event and associated wagering market is mature. This is the case, for example, in the racing sector. The turnover-based approach, however, has a large negative impact on wagering operators that take large volumes of bets at a low margin. This is one of the models which may be considered by the NRL (1.5 per cent of turnover). As is outlined further in Figure 6 below, a turnover-based product fee of 1.5 per cent of turnover would exert a disproportionate impact on the relative margins of NRL wagering compared to other sporting codes and racing (11 per cent vs. 52 per cent). These two broad base models can be refined in terms of the rates applied such that there are potentially an infinite number of agreements that could eventually be reached between the NRL and wagering operators Profitability of sports wagering vs. wagering on racing This section sets out a high level analysis of the profitability of wagering on sports for wagering operators, compared to that of racing. The NRL is used as a case study sporting body and corporate bookmakers as the case study wagering operator (as opposed to the TAB or a betting exchange). Figure 6 provides an estimate of the marginal revenue and cost structure from NRL wagering services offered domestically in 2011, with two different estimates of product fees and net margin depending on whether product fees are based on 5 per cent of gross win or 1.5 per cent of turnover. As shown in Figure 6, total gross win from NRL wagering services offered domestically has been estimated at approximately $37 million in 2011 (total turnover is estimated at $750 million). Over the same period, NRL wagering operators incurred approximately $21 million 11 Refer to Victorian Thoroughbred Wagering Review, May 2011 for a detailed breakdown Optimal Product Fee Models for Australian Sporting Bodies 22

23 in total direct costs and $2 million in product fees, thus leaving them with a net margin before overheads of around $13 million, or 37 per cent of gross win. Under a scenario where product fees are levied based on 1.5 per cent of total turnover, NRL wagering operators would have faced much higher product fees of approximately $11 million, leaving them with a net margin before overheads of only $4 million. Figure 6: Total gross win and cost structure NRL wagering (2011, $m) Notes: CM = Contribution Margin Source: Deloitte analysis of confidential Sportsbet data and interviews with industry participants Under a turnover-based product fee regime, the wagering operators would achieve an approximate 11 per cent contribution margin on gross win (revenue) before overheads (compared to 52 per cent on racing, as estimated in Figure 7). Any reasonable allocation of overheads, which has not been included in either scenario, would show that the NRL product category would effectively be loss-making under a turnover-based product fee of 1.5 per cent, and the marginal profitability relative to racing and other sports would be significantly reduced. Optimal Product Fee Models for Australian Sporting Bodies 23

24 Figure 7: Total revenue and cost structure Race wagering ( , $m) Notes: CM = Contribution Margin before overheads Source: Deloitte analysis of confidential information provided by Sportsbet and information contained within Australian Racing Factbook, 2011 As outlined in Figure 7, revenue from domestic race wagering services has been estimated at approximately $1.8 billion in Although not shown in the figure, turnover during the same period was $20.2 billion as reported by the Australian Racing Factbook, Wagering operators incurred an estimated $568 million in total direct costs and $303 million in product fees, leaving them with a net margin before overheads of $944 million, or 52 per cent of revenue. When compared with NRL, wagering operators earn a much higher net margin on racing, even under a turnover-based product fee regime, which is reflective of the nature of bet types offered, the multiple outcomes on racing wagering (which inherently increases margins) and the size of the industry overall. A turnover-based product fee of 1.5 per cent on NRL wagering would reduce the marginal profitability of the wagering operators to such a level that they could be expected to take action in order to maintain their overall profitability, whether via a reduction in costs or modifying the odds to achieve a greater initial margin. This is driven by the relatively small size of NRL wagering, the lower win margins achieved on sports betting generally, and the investment made by wagering operators in continuing to develop the emerging two sided market. This suggests that it may not be appropriate to apply a product fee model applied in the racing industry to the less mature sports betting industry. In Section 3.2 we explore in greater detail how the wagering operators could be expected to respond to an increased product fee based on turnover in light of the substitutability of the NRL wagering product Profitability of AFL versus NRL sports betting This section sets out a brief analysis of the profitability of wagering on AFL and NRL, as highly substitutable wagering products, for wagering operators. Figure 8 provides a comparison between the sporting codes of net margin before overheads under a gross win and a turnover-based product fee regime. Given the broadly similar size of the AFL wagering market, the relative profitability of AFL wagering is likely to be favoured by the wagering operators and would be expected to be more heavily promoted, if a turnover-based product fee regime were adopted by the NRL. Optimal Product Fee Models for Australian Sporting Bodies 24

25 Contribution Margin ($ million) Figure 8: Estimated contribution margin before overheads by sporting code ( , $m) Status Quo % Turnover AFL Source: Deloitte analysis of confidential information provided by Sportsbet and interviews with industry participants Notably, in the above analysis, a product fee of 1.5 per cent of turnover would result in a product fee 5 times greater than that based on the current model of 5 per cent of gross win (for both AFL and NRL), and would result in a contribution margin of approximately 25 per cent of that under the current product fee regime. 3.2 Implications of a marginally profitable, substitutable product The impact of a marginally profitable and substitutable product will inevitably trigger a range of possible actions by the wagering operators, all of which, in different ways, will stagnate the current rapid growth in the industry, and is likely to have a longer term detrimental effect on the revenues generated by the sporting codes. As noted earlier, an overtaxed regime in France, implemented in May 2010, triggered a range of responses by wagering operators including a reduction in advertising expenditure by 58 per cent year-on-year, a number of participants leaving the market altogether, and customers shifting to operators outside of France. Taken together, these actions in response to the change in product fee models, reduced quarter-on-quarter revenue by 24 per cent, with the full effect yet to be seen, as wagering operators are still struggling to find an optimal operating model under the current regime. Given the relative profitability metrics, a shift to a 1.5 per cent turnover-based product fee in the Australian sports betting market is likely to generate similar responses from the wagering operators, which could include: NRL reducing controllable costs, such as advertising and promotion expenditure, which comprises approximately 75 per cent of controllable expenditure or investments in product development / innovation, diverting such expenditure to promoting wagering on other sports and racing whether there are no product fees paid to the Australian sporting bodies; passing on the incremental cost to the customer via reduced odds, which as outlined in Section 2.2 would be expected to have a detrimental impact on industry growth given the high degree of consumer price elasticity; absorbing the cost increases (i.e. doing nothing ); exiting the product category altogether; or some combination of the above. Optimal Product Fee Models for Australian Sporting Bodies 25

26 3.2.1 Overview of Marketing Expenditure Our estimates, as outlined in Figure 9, indicate that investment from wagering operators on AFL and NRL-related product was approximately $40 million, which includes direct sponsorship of the relevant sporting body, its clubs and its stadiums; and television, radio, print and other media promotional and advertising spend during relevant content programming. Inclusive of product fees paid under the current regime of 5 per cent of gross win, which is estimated at $4 million to $5 million across both sporting codes, we have estimated that wagering operators in aggregate contribute close to $45 million annually to specific AFL and NRL-related products. These estimates do not include the indirect impact which the demand by wagering operators for advertising time inevitably has on the value of media rights deals negotiated by the sporting codes. Based on media reports and interviews with industry participants, we have estimated the above amounts include direct sponsorship of the AFL and its clubs of approximately $3.5 million to $4 million and NRL-related bodies of approximately $2.5 million to $3 million. Sportingbet and Centrebet have already publicly announced that they would have to reconsider their respective sponsorship contracts in the event that a turnover-based product fee was adopted. Figure 9: Estimate of marketing expenditure, by type (2011, $m) Source: Deloitte analysis of confidential information provided by Sportsbet, interviews with industry participants, and publicly available information Figure 9 provides a breakdown of marketing (advertising, promotional and sponsorship) expenditure among all domestic sports betting providers, by promotion/sponsorship type. As indicated, the majority of AFL and NRL-related promotions/sponsorships by domestic sports betting operators relate to television, followed by mixed media campaigns and radio. Whilst sponsorship contracts could potentially be replaced by third parties, the withdrawal of sponsorship support by wagering operators is likely to significantly reduce the rates obtained given the reduced overall competition for the sponsorship expenditure. No other industry has such a strongly correlated two sided market with the sporting codes and therefore it is likely that the current rates achieved would not be obtained in the future, which would reduce sponsorship dollars available to the clubs and the sporting codes themselves. Further, a significant proportion of the relevant expenditure is also dedicated to television, radio, print and online promotion and advertising on relevant content programming, which is likely also to be replaced. However, as with the direct sponsorship, the withdrawal of significant advertising expenditure by the wagering operators will significantly reduce demand and may therefore potentially have longer term implications on the value of broadcast and other associated rights not directly considered in our analysis. Optimal Product Fee Models for Australian Sporting Bodies 26

27 4 Optimising outcomes for the sporting codes: a gametheoretic analysis This section presents a game-theoretic framework for analysing potential negotiations between the NRL and the wagering operators in relation to the appropriate product fee regime. We have analysed the options available using a game-theoretic framework because of the nature of the two-sided market that is present in sports betting. The analysis indicates that both the NRL and wagering operators can achieve the maximum gain by working together to reach a solution that does not require the wagering operators to either significantly reduce costs or modify betting odds. This will in turn preserve the longer term integrity of the industry by supporting the growth of Australian licensed wagering operators. 4.1 Framework for analysis: a game theory approach The recent High Court decisions have brought forward discussions between wagering operators and the relevant sporting codes regarding the optimal long-term fee model associated with wagering on the sporting event. This analysis considers the specific issues in relation to NRL wagering. With the NRL signalling that it is reviewing the fee model applied to wagering on its code, the wagering operators and the NRL have inevitably found themselves in a bargaining situation, which can be analysed using a simple game theoretic framework to determine the optimal moves for each player in the game. All bargaining situations have two things in common: Surplus Value to be gained The total payoff the parties to the negotiation are capable of creating and enjoying is greater than the sum of the individual payoffs they could achieve separately. Without this excess value, or surplus, the negotiation would be pointless. The division of the excess surplus between the parties is the bargaining space. In this report, the surplus value to be shared among the NRL and wagering operators is the growth in sports betting profit. Not a Zero Sum Game When a surplus exists, the negotiation is over how to divide it between the parties. Each participant tries to get more for themselves and leave less for others. This may appear to be zero-sum, but behind the negotiations lies the risk that if an agreement is not reached, no one will get any surplus at all. In this report, if the wagering operators or NRL do not reach an agreement that supports the industry s growth, both the NRL and wagering operators can expect to be worse off. This is the very essence of a two-sided market: by acting together there are gains to be shared; but conversely, without coordination, the gains may be wholly lost to both players. Optimal Product Fee Models for Australian Sporting Bodies 27

28 In the bargaining situation, each player pursues a set of actions, given their expectations of the other player s likely response actions and payoffs. This, in turn, results in an outcome to the game, or what is referred to in game theory as equilibrium. In this report, we have defined two fee models that could be potential moves by the NRL; these are: The Status Quo Maintain the current fee model based on 5 per cent of gross win 1.5% Turnover Implement the proposed fee model of 1.5 per cent of turnover. In response to these actions by the NRL, the wagering operators 12 can choose to: Do nothing that is, maintain current odds and levels of promotional expenditure and absorb the implemented fee model Reduce the odds offered to consumers to reflect the higher fees charged by sporting codes Reallocate marketing expenditure that is, from NRL wagering products to other more profitable sports betting products, such as AFL wagering and racing (which is likely in the case of NRL wagering consumers to be racing in NSW) Do both reduce the odds offered to consumers and reduce controllable costs Exit the industry that is, not offer NRL wagering product The payoffs to each player are based on the present value of future cash flow outcomes over a 5 year-horizon plus a Terminal Value estimate based on projected long term growth rates (which for the purpose of this analysis is represented as projected growth in household disposable income). For the NRL, this is the present value of product fee revenues. In the Status Quo fee model, this would be based on 5 per cent of gross in revenue. In the turnover based product fee model this is based on 1.5 per cent of turnover. For wagering operators, the payoff is the present value of contribution margins across all sports betting products, with a specific focus on AFL as the primary substitutable product. Accordingly, the analysis below highlights the total payoff to wagering operators across both the NRL and AFL. The estimates of payoffs presented in this section are based on Deloitte analysis of modelling undertaken by Sportsbet and industry participants under alternative fee model scenarios (refer Attachment A). Game theory indicates that a rational player, in this case the NRL, in considering the optimal product fee model, will evaluate the payoffs they can receive given the likely responses of the wagering industry to a particular proposed fee model. Importantly, the NRL does not have the ability to simply select the option which maximises their payoff because their payoff is dependent upon the response from the wagering operators. The wagering operators are likely to respond in such a manner that maximises their total payoff across both the NRL and AFL products, which may not necessarily be the option that maximises their payoff on NRL products. The NRL will therefore select a fee model that maximises their payoff but having regard to the likely responses of the wagering industry. 12 The wagering industry is comprised of a range of companies, each with their own levels of profitability and corporate strategy. It is therefore likely that there will be a range of responses by different wagering providers; they won t all necessarily do the same thing, because they can potentially gain from acting in the market against each other as well. The industry would likely go through a phase of consolidation, and intra-industry developments over time would be complex. This analysis has simplified these individual players into a single player for the purpose of evaluating the macro outcomes for the sporting codes and the wagering operators, as in the short term we would generally expect that the parties act on a similar basis to maintain profitability. Optimal Product Fee Models for Australian Sporting Bodies 28

29 $ Millions 4.2 Expectations for NRL wagering growth and payoffs under the status quo fee model Recent data shows that NRL wagering has grown above the CAGR for the wider sports betting industry, at a CAGR of 20 per cent compared with the sports betting industry average of 13 per cent over the last seven years as noted in Figure 1 earlier in this report. Consistent with global industry trends, it would be expected a growth rate of at least 13 per cent, if not higher given the strong online growth rates, would continue into the medium term, delivering a positive stream of profits to the wagering operators under the current status quo (gross win) fee model if there were no change to the odds offered or marketing expenditure. High level analysis of future turnover and revenue growth developed by Sportsbet and industry participants (refer Appendix A for further details on methodology) indicates that if the industry continues with the existing product fee model, and maintains current levels of marketing spend and odds, and all other factors are equal, total turnover would be expected to grow from roughly $750 million today to almost $1.5 billion in 5 years time. Figure 10: NRL wagering turnover projections - status quo fee model (5% gross win) 1,600 1,400 1,200 1, Source: Deloitte analysis of Sportsbet industry modelling and interviews with industry participants Table 1: Payoff Outcome summary status quo fee model (5% gross win) Wagering Operator Response Do Reallocate Reduce Nothing marketing odds Do Both Total Payoff to Wagering Operators (NPV 10% )* $960m N/A N/A N/A Payoff to NRL/AFL (NPV 10% ) $89m N/A N/A N/A Payoff to Wagering Operators NRL only (NPV 10% ) $455m N/A N/A N/A Payoff to NRL (NPV 10% ) $40m N/A N/A N/A *Represents total potential payoff across both the AFL (as the primary substitutable product) and NRL Source: Deloitte analysis of Sportsbet industry modelling Industry modelling shows that if the wagering providers were to Change Odds, Reallocate Marketing or Do Both in the status quo fee model, that they would reduce their total payoffs compared with Do Nothing. Therefore if the NRL maintains the status quo fee model, it would be expected that the wagering providers would respond by Doing Nothing in order to maximise their own payoff, therefore all other options, for simplicity, are shown in Table 1 as N/A. The maximum payoff to the NRL under would therefore be expected to be $40 million in present value terms. Optimal Product Fee Models for Australian Sporting Bodies 29

30 $ Millions 4.3 Expectations for NRL wagering growth and payoffs under a turnover-based fee model If a turnover-based product fee of 1.5 per cent is applied, it is expected that the NRL wagering product would become a significantly less profitable or even unprofitable product (Refer Section 3). Wagering providers would seek to redress the situation using the actions outlined above in order to preserve profitability, which would contribute to a significant decline in turnover compared with the status quo fee model (Refer Appendix A for assumptions in industry modelling under different product fee scenarios). Expectations for future turnover growth under the Change Odds, Reallocate Marketing and Do Both scenarios are shown in Figure 11, which also provides a comparison against projected industry growth under a status quo fee model (on the basis that Do Nothing under a 1.5 per cent turnover-based product fee model is not considered a viable alternative as outlined further below). The reductions in turnover would also translate into lower gross win revenues and margins to the wagering operators. Figure 11: NRL wagering turnover projections 1.5% turnover based fee model 1,600 1,400 1,200 1, Do Nothing Reallocate Marketing Reduce Odds Do Both Source: Deloitte analysis of Sportsbet industry modelling and interviews with industry participants. Note: Do Nothing represents turnover projected under a gross win based model for comparison only In light of the reductions in turnover and gross win revenue under a 1.5 per cent turnover based product fee regime, the wagering operators will be incentivised to pursue the option that will maximise their total payoff across all relevant substitutable products. As outlined in Table 2 on the following page, the total payoff to wagering operators is maximised under a Do Both scenario, where marketing expenditure is reallocated and where odds are reduced. We would expect that the wagering operators would always take some form of action, because given the marginal profitability of the NRL product, taking no corrective action is clearly not going to maximise their own payoff. Accordingly, the option of Do Nothing is shown in Table 2 as N/A. The other theoretical payoffs to the NRL ( Reallocate marketing and Reduce odds ), which are included in the shaded boxes have been shown for comparison purposes, but importantly, the NRL does not have the ability to simply select the option which maximises their payoff because their payoff is dependent upon the response from the wagering operators. The wagering operators are likely to respond in a manner that maximises their total payoff, which is shown in Table 2 and explored in further detail below. Optimal Product Fee Models for Australian Sporting Bodies 30

31 Table 2: Payoff Outcome summary 1.5% turnover based fee model Wagering Operator Response Do Reallocate Reduce Nothing marketing odds Do Both Total Payoff to Wagering Operators (NPV 10% )* N/A $654m $686m $887m Payoff to NRL/AFL (NPV 10% ) N/A $139m $117m $107m Payoff to Wagering Operators NRL only (NPV 10% ) N/A $68m $23m $72m Payoff to NRL (NPV 10% ) N/A $74m $59m $29m *Represents total potential payoff across both the AFL (as the primary substitutable product) and NRL Source: Deloitte analysis of Sportsbet industry modelling The following sections detail the drivers of industry growth trends under alternative responses to a proposed 1.5 per cent turnover-based product fee. The modelling suggests that the winners under all three of the scenarios would likely by the AFL, NSW racing and offshore providers, which would be expected to gain some of the market share that would have otherwise been wagered on NRL products (but which is not necessarily due to the relative reduction in the appeal of wagering on the NRL). Due to the relatively high substitutability of AFL and NSW racing wagers for NRL wagers (Sportsbet data indicates that of those who wager on NRL, 60 per cent also wager on AFL and 78 per cent wager on NSW racing), and competition from offshore wagering providers, demand that would have been captured by NRL products would likely migrate to AFL products and/or offshore providers. Growth in AFL wagering, in particular, is expected by industry participants to be in excess of $2.5 billion in 5 years time, if the NRL were to adopt a 1.5 per cent turnover based product fee. This would represent a growth rate of 24 per cent, which is significantly in excess of the 13 per cent growth rate for sports betting overall, reflecting the shift in wagering activity away from the NRL to the AFL Wagering Operator Response: Reallocate marketing Industry modelling estimates that reducing marketing expenditure on NRL (and transferring the expenditure to promote AFL or racing) product categories would drive an increase in customer churn and a loss of 'less sophisticated' customers. More sophisticated consumers that gamble regularly and place bets based on price are unlikely to be as affected by reductions in advertising and promotion. Overall, this would be expected to lead to reduced turnover and significantly declining gross win margins as the churn continues over time. From the wagering providers perspective, whilst turnover from NRL products would be expected to decline, turnover for AFL wagering would be expected to increase (although the modelling assumes there would be limits to the growth potential for AFL wagering in response to increased advertising spend). The potential payoff to wagering providers, therefore, across both sporting codes would be $654 million in present value terms. This would not represent the profit maximising alternative, so wagering operators are not likely to pursue this course of action on a stand-alone basis. The theoretical payoff to the NRL under this scenario would be $74 million in present value terms Wagering Operator Response: Reduce odds Reducing the odds offered to customers would be a strategy to pass on the cost of higher fees associated with the turnover-based model. The model predicts that this strategy would drive a similar increase in customer churn and significantly less new customer acquisitions as the reallocate marketing scenario. Because the cost of the product to customers has increased, however, the customers that are churning away would also include the regular Optimal Product Fee Models for Australian Sporting Bodies 31

32 $ Millions gamblers that are more price-sensitive. Accordingly, turnover is expected to fall faster than in the reallocate marketing scenario. A significant portion of these price-sensitive consumers would be expected to migrate to offshore wagering operators who do not pay any product fees. From the wagering providers perspective, turnover from NRL wagering would be expected to slow significantly as a significant proportion of customers would migrate to AFL wagering, other products (such as NSW racing) and/or move to offshore providers. The wagering providers would receive a potential payoff of $686 million in present value terms if they pursued this strategy. However, this would still not represent the profit maximising alternative, so wagering operators are also not likely to pursue this course of action on a stand-alone basis. The theoretical payoff to the NRL is therefore estimated at $59 million in present value terms, reflecting a reduction from the reallocate marketing scenario due to the strong price sensitivity of consumers in the sports betting market Wagering Operator Response: Do Both The combination of the above two strategies would result in the highest rates of customer churn, and greatest reductions in turnover (driven by reducing bet size and frequency), leading to overall fastest decline in industry turnover. If the wagering providers pursued this strategy, this would yield a total potential payoff of $887 million in present value terms to the wagering providers. Turnover from NRL wagering would be expected to decline the greatest in this scenario, but the net effect of growth in AFL wagering and reduced marketing expenditure maximises the net total return available to the wagering operators. The payoff to the NRL is projected to be $29 million in present value terms, reflecting the compound effect, on turnover, of reduced marketing expenditure and reduced odds. Comparing the payoffs across the three potential actions in response to the application of a turnover-based product fee model indicates that the Do Both strategy represents the profit maximising option for the wagering operators and is therefore considered the most likely course of action to be adopted. From the NRL s perspective, this would be a significantly worse payoff than would be projected under the status quo scenario, where industry turnover (and gross win) is expected to grow significantly, also increasing product fees Implications on NRL product fees Figure 12 shows the projected product fee revenues to the NRL under both a status quo (gross win) fee model and a turnover-based product fee model given the most likely selected potential industry actions that could occur. The wagering operators maximise their payoffs in the Do Both scenario, which as shown in Figure 12, results in significantly reduced product fee revenues over time, as turnover continues to decline. Figure 12: 5 year product fee projections under selected fee model and most likely industry response $10 $9 $8 $7 $6 $5 $4 $3 $2 $1 $ Optimal Product Fee Models for Australian Sporting Bodies 32 Status Quo - Do Nothing 1.5% Turnover - Do Both Source: Deloitte analysis of Sportsbet industry modelling and interviews with industry participants

33 As a result of the declining product fees over time, as highlighted in Figure 12, and as highlighted in Table 2 earlier in this report, the payoff in present value terms in the Do Both scenario would be significantly less than the payoff in a Status Quo/Do Nothing scenario. The payoff to the NRL therefore, if a 1.5 per cent turnover-based product fee model were adopted would be $29 million in present value terms, compared with a payoff of $40 million in present value terms if the status quo fee model were maintained. The $11 million differential is driven predominantly by significantly reduced product fees in future years. 4.4 Game equilibrium and implications for product fee model negotiations The analysis suggests that if a turnover-based product fee model is introduced the industry will respond by both changing odds and reallocating marketing expenditure to substitutable and more profitable products ( Do Both ). Therefore the NRL s best option given the expected industry response to the alternative fee models, would be to either maintain the current fee model (the status quo) or seek to negotiate a compromise agreement with the wagering operators that would not result in a change to the odds on offer or marketing expenditure, thereby maintaining and maximising current levels of industry growth. As shown in Table 3, under a status quo fee model, the NRL is projected to receive payoffs of $40 million in present value terms, compared with payoffs of $29 million in present value terms under a 1.5 per cent turnover-based fee model (given expected industry response). The other theoretical payoffs to the NRL ( Reallocate marketing and Reduce odds ), which are included in the shaded boxes have been shown for comparison purposes, but importantly, the NRL does not have the ability to simply select the option which maximises their payoff because their payoff is dependent upon the response from the wagering operators. The wagering operators are likely to respond in a manner that maximises their total payoff, which is the Do Both scenario. Table 3: Payoff Outcome summary Wagering Operator Response Do Reallocate Reduce Fee Model adopted by NRL Nothing marketing odds Do Both Status Quo (5% Gross Win) Total Payoff to Wagering Operators (NPV 10% )* $960m N/A N/A N/A Payoff to NRL/AFL (NPV 10% ) $89m N/A N/A N/A Payoff to Wagering Operators NRL only (NPV 10% ) $455m N/A N/A N/A Payoff to NRL (NPV 10% ) $40m N/A N/A N/A 1.5% Turnover Total Payoff to Wagering Operators (NPV 10% )* N/A $654m $686m $887m Payoff to NRL/AFL (NPV 10% ) N/A $139m $117m $107m Payoff to Wagering Operators NRL only (NPV 10% ) N/A $68m $23m $72m Payoff to NRL (NPV 10% ) N/A $74m $59m $29m *Represents total potential payoff across both the AFL (as the primary substitutable product) and NRL Source: Deloitte analysis of Sportsbet industry modelling Optimal Product Fee Models for Australian Sporting Bodies 33

34 The above analysis demonstrates that it is in the financial interest of the NRL to consider alternative fee models to the suggested 1.5 per cent turnover-based product fee that would not trigger the wagering operators to modify the odds on offer or reduce mutually beneficial marketing expenditure. If an alternative agreement were negotiated, the wagering providers clearly have a preference for a gross win based model, as it enables the industry to mature and continue the current growth patterns being exhibited. Wagering providers are continually incentivised to develop and support new products and markets which would be expected to drive continued rapid growth in the industry and would continue to benefit both the sporting codes and the wagering operators. Moreover, given the immaturity of the sports betting industry (relative to racing), the preferred base model over the longer term is a gross win based model as opposed to a turnover-based model. A gross win based fee model would continue to encourage innovation and industry development, which would be expected to drive revenue growth in the medium term and would maintain the integrity of the sporting codes. Additionally, if legislative amendments were made to the IGA that allowed online betting in the run, it would be expected that turnover of the wagering operators would increase even more significantly, although margins may decline accordingly. The modelling prepared for this analysis do not consider the incremental revenue impact from online betting in the run, which would be expected to further increase revenue opportunities available to both the sporting codes and the wagering operators. Under such a change in legislation, a turnoverbased product fee regime would result in an even higher disproportionate product fee being paid. Optimal Product Fee Models for Australian Sporting Bodies 34

35 5 Conclusions Whilst a turnover-based model has now been adopted in NSW and at least temporarily in Victoria in the racing industry, the margins and costs on racing products are significantly different from those of the NRL, as is the total size of the market. Adopting a turnover-based model on NRL products is likely to trigger reactions from the wagering operators that would stagnate growth in NRL wagering as more profitable, substitutable products are promoted. This may also have broader implications for the value of broadcast licences and advertising rates as the competitive forces (and viewership) may be reduced as wagering growth stagnates (which is not considered in this report). Such a response would also naturally push a significant amount of NRL wagering to offshore operators. To the extent consumers migrate to overseas wagering operators, this represents not only a significant risk to the integrity of the relevant sporting codes, but also a significant financial risk, as the overseas wagering operators do not contribute to product fees or taxes. Moreover, having regard to the analysis and commentary contained in this paper, we therefore believe that it is in the NRL s interest to preserve a gross win based product fee model with the wagering operators. Given the competitive forces at play, we believe the percentage applied would be expected to be higher than the current status quo; however, it should be set at such a rate that would not necessitate corrective action from the wagering operators to maintain profitability. The analysis suggests that it is in the interests of both the Australian licensed wagering operators and the sporting codes to maintain a competitive, innovative wagering product that will maximise returns to both sides, prevent consumers from migrating to unregulated offshore wagering operators, whilst protecting the integrity and long term financial viability of product fees and other revenue streams contributed by Australian licensed wagering operators. A gross win based product fee regime would also be consistent with regimes adopted in a number of jurisdictions globally where sports betting and the related two sided markets have continued to thrive, is consistent with the recommendations of the Productivity Commission, and notwithstanding the differences between racing wagering, is consistent with comments made by the CEO of Racing Victoria, Rob Hines, who recently indicated that, We still believe that the best result for thoroughbred racing nationally is a gross revenue model. He also commented that, the corporates and Betfair would probably have abandoned focussing on racing in NSW and focussed on racing in Victoria, which is consistent with the courses of action suggested in our analysis in relation to sports betting. Optimal Product Fee Models for Australian Sporting Bodies 35

36 [This page intentionally left blank] Optimal Product Fee Models for Australian Sporting Bodies 36

37 Appendix A: Overview of Industry Growth Modelling Methodology High level modelling was undertaken by the Sportsbet to evaluate the likely trends in turnover growth under alternative levels of promotional spend and odds offerings for both NRL and AFL product categories for the purpose of payoff analysis undertaken by Deloitte. Figure 13 shows a schematic of the modelling methodology, which is comprised of three modules: an NRL module, an AFL module and an off-shore wagering operator module. Based on industry data since 2008, when advertising restrictions on Australian licensed wagering operators were lifted, the model projects turnover by product category, gross win, cost and profit expectations over a 5-year period and incorporates a terminal value estimate based on long term market expectations from Year 5, which are broadly projected to flatten out to be consistent with annual increases in household disposable income. Critically, the model assumes, based on available industry data, the relationship between demand (turnover and gross win) for NRL wagering, AFL wagering, and offshore wagering providers is directly related marketing expenditure and odds offered to consumers. Figure 13: High level modelling overview Optimal Product Fee Models for Australian Sporting Bodies 37

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