Daily Fantasy Sports Has Quickly Gone From Underrated To Overrated

Thoughts On A Poorly Understood Space

With Draft Kings and FanDuel raising large rounds at high valuations (relative to their age), all of a sudden there is all kinds of attention being focused on daily fantasy sports. It wasn’t too long ago that the space was being completely ignored, to recent coverage in the WSJ, NYT and an in-depth profile on this week’s HBO Real Sports. Consistent throughout all the coverage is the narrative that daily fantasy sports is a “booming” new market or “the future of “ or “the evolution of” fantasy sports.

Not too surprisingly, the media narrative seems far from reality. Right now, there are probably in the neighborhood of 3 million daily fantasy sports players. It’s entirely bizarre that a consumer Internet market that has been around for five years and only counts a few million users is described as “booming” or “exploding”, a designation usually reserved for products or markets that reach that many users in a number of weeks.

The real story is that the broader fantasy sports market has grown so large and influential that it is large enough to be spawning billion dollar subsectors. The traditional season long fantasy format isn’t losing users to daily fantasy sports at all. Rather, the increase in daily fantasy sports is actually causing the growth rate of traditional fantasy sports to further accelerate.

A recent article in the Atlantic noted:

In standard fantasy sports, players draft a team at the start of the season and follow that roster all year. Winning demands a huge investment of time, and the competition takes an entire season. So, for most who play, fantasy functions just as a hobby and form of community — an excuse to follow the game and talk smack with friends. The trophy matters more than the money.
Not so with daily play. Users can draft a new lineup whenever there’s a new slate of games. The time commitment is small, the results are immediate, and the payoffs can be huge. That’s why daily play is booming — and why the game could change the way Americans bet.

That’s consistent with the recurrent missive from the FanDuel and DraftKings commercials, citing instant gratification as a key value proposition for daily fantasy. However, industry data suggests something different, with only 17% of current participants citing instant gratification as a motivation.

And while it’s true that seasonal fantasy sports are more of an involved strategic and social game, it’s similarly incorrect to suggest that the trophy matters more than the money. The same industry data shows that the percentage of users who pay league or contest “entry fees” (i.e., the conversion rate) is almost identical between daily and seasonal formats. Players who play both the seasonal and daily formats spend twice as much on entry fees when playing the seasonal format, spend twice as much on auxiliary products and overwhelmingly favor the seasonal format. (There are outlier professional “whales” in the daily space skewing the ARPU, but all fantasy formats feature very high conversion rates and very high ARPUs.)

So What Percentage of Fantasy Sports Does The Daily Format Become?

Regarding daily fantasy’s market penetration in fantasy sports, DraftKings CEO Jason Robins noted in July:

“[Current numbers] are a pretty low market penetration — about 1 or 1.5 percent for an industry with enough liquidity to have these large prize pools and daily content that is evergreen”

The impressive and oft-cited growth rate remains a function of small absolute numbers. The season long game with a draft format remains the largest format by a dominant majority of total users and it remains the clearly preferred format by the dominant majority of total users. A majority of current daily fantasy participants are veterans of the seasonal fantasy format, and are playing daily fantasy in addition to, not instead of, seasonal fantasy sports. Assuming one believes in the existing industry data, there isn’t yet a credible data point that suggests the daily format will become the dominant fantasy format.

When considering the potential future growth of the daily format, it’s worth noting the history. Daily fantasy sports is largely based on “salary cap” games, a format that has been around for a lot longer than FanDuel or DraftKings. In a 2006 industry survey, over 20% of fantasy players claimed to play salary cap fantasy games. That would suggest that the percentage of the fantasy sports market playing salary cap games has actually shrunk dramatically since then.

Neither is the real money aspect of fantasy sports new, even if the average and median entry fees are increasing across the board in all formats. Fantasy sports was the original “real money game”. FanDuel and DraftKings have only succeeded in making it easier. That’s the real innovation here.

It’s also fair to consider whether FanDuel andDraftKings don’t have a lot in common with ProTrade, which was a fantasy sports as moving stock market format that launched in 2005 and shut down in 2009. Liberally adjusting for broadband adoption rates and the lack of social or mobile distribution platforms, ProTrade had user numbers that were roughly comparable to where FanDuel and DraftKings are today. ProTrade had found a very passionate if not smaller user base, but was unable to monetize. Now that the legal issues are more clearly resolved and the path to monetization is obvious, it sure looks like ProTrade was just too early. Around 2007, the narrative was that a stock market format was “the future of” fantasy sports too.

Executed correctly, I’m sure a similarly large company could be built on the back of the Pick’em format, which is another form of sports gaming that has been around for decades. I remember as a kid, my father would bring home a Xeroxed sheet of weekly NFL games with spreads and I circled the winners in pen with total points for the Monday night game as the tiebreaker. And at $20 per weekly entry, the ARPU of that paper-based game is in the same ballpark with daily fantasy and seasonal fantasy. These aren’t new markets. Just as Twitch capitalized on the decades old practice of watching friends play video games, these are large and well-entrenched gaming practices that have never been effectively productized.

Daily fantasy sports does have the advantage of shorter game cycles, creating great advantages in the ability to monetize, but ecosystem liquidity is currently being driven by sports handicapping “whales” who are using algorithms to arbitrage the market. Remove these pseudo-hedge funds and the median “entry fee” drops significantly. As the daily fantasy market grows beyond a niche, how much of an edge remains for these professionals remains to be seen.

How much bigger daily fantasy gets is anyone’s guess but it’s still too early for anyone to draw conclusions. DraftKings and/or FanDuel can build billion dollar companies with highly liquid ecosystems, but that’s more of a statement about the continually underestimated broader fantasy sports market than an indicator of the future of the daily fantasy space.

I have more on these market dynamics and where the opportunities for investors and entrepreneurs lie in subsequent posts.

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