The Sports Betting Industry in 2020: A Tale of Substitute Products & Negative Switching Costs
An abridged version of this article was published, with permission, by SportsHandle.
The US Sports Betting industry is continuing its rapid inflection toward sustained compound annual growth. Twenty-six months after the overturning of PASPA, there are vast insights to be gleaned by assessing the state of the ecosystem, trends within the product landscape, and the evolution of incentive structures therein. That examination will pave the way for a more robust discussion of the opportunity set available to new entrants in the space.
It is especially important to recall that the term “season-long fantasy” was not used until daily fantasy sports (DFS) companies innovated on the legacy model and showed that entirely new revenue streams were available to those who could think outside the box. In the early 2000’s, “fantasy sports” was thought to be an exhaustive term that covered all possible product offerings, despite entirely excluding the role of daily contests, which generated $350mm in revenue last year.
This article considers the possibility that a similar phenomenon is taking place today where, just as the impact of DFS was utterly absent from early fantasy sports industry projections, there exists a yet-to-be-developed set of products and services that will shape the future of sports betting in dramatic fashion and with significant commercial implications.
Current State of US Sports Betting
The present state of the industry would aptly be characterized as having a high availability of substitute products with negative switching costs.
The New Jersey market is often used as an industry benchmark, especially given their speed to legalization post-PASPA (went live June 2018), number of licensed mobile operators (18), and robust handle ($4.58bn in 2019). Prior to COVID’s impact on the retail business, the state was also a market leader in the percentage contribution to handle from online channels, with levels consistently exceeding 85%, similar to those seen in mature markets.
As seen below, total sports betting handle is increasingly being driven by online (mobile and desktop) users nationwide, causing the role that product plays in differentiation to grow accordingly.
Online sportsbooks in the market frequently offer sign-up bonuses of $500, in addition to other deposit matches and free bets. However, once a user signs up and takes advantage of such an offer, they must forfeit the opportunity cost of a competitor’s sign-up bonus to continue wagering on the same platform.
And yet, aside from the eponymous spread betting alternative offered by PointsBet, there has not been a single differentiated product offering in the entire market. Further, those product offerings are substantively similar to the plethora that exist in established markets, the bulk of which have remained relatively stagnant and largely devoid of innovation.
Perhaps this is slightly unsurprising given that nine of the 18 mobile operators in New Jersey are built on technological infrastructure purveyed by just three vendors (SBTech, Kambi, GVC).
Even within that supplier landscape, forensic audits of line movement reveal that odds origination is really only being conducted by a single entity, from whom even the largest stakeholders appear to automatically copy posted lines and line movements.
DraftKings and FanDuel, currently combining to claim 63% of US online sports betting (OSB) market share, have recently and quietly released a litany of new in-game betting markets, pool betting functionalities, and micro betting opportunities, not to mention new rewards programs and VIP platforms.
A few examples are showcased below:
There is a massive engineering challenge in facilitating liquidity for micro betting markets. The difficulties include obtaining low-latency, high-fidelity data feeds and integrating them into cutting edge predictive models. Mathematical missteps can lead to massive economic losses in short periods of time. This risk is typically borne by the bookmaker, though it is often passed on, at least partially, to users in the form of less favorable odds and higher overrounds.
These product releases represent a critical data point that provides a few key insights:
- The largest, best-capitalized operators in the US are dedicating at least some non-trivial portion of resources to attack mathematically challenging data science problems that, when solved, unlock entirely new product categories
- The surreptitious launch suggests that operators are hoping to test these products in shallow, less risky waters and then optimize the back-end infrastructure before promoting widespread adoption and, therefore, handling more substantial order flow
- Smaller operators may struggle to compete with market leading product offerings if they are solely reliant on in-house development and innovation, providing a lucrative opportunity for startups and tech suppliers
The situation also begs the broader question of how the industry came to be in such great need of innovation while also struggling to provide it organically. Through this lens, the enormity of the opportunity in the sports betting space becomes much clearer, both for new entrants and incumbents.
The Genesis Story
A quick review of the history of sports betting overseas helps preface a discussion on how the current state of affairs came to be.
Social & Legislative History
With an English-speaking populus and over 8,000 brick and mortar betting shops, the UK is often used as a comp or template for what a mature US market could look like. Additionally, stakeholders whose domain expertise derives from established markets have had significant influence on the formative years of US sports betting, especially owing to the lack of comprehensive domain expertise that existed within the US talent pool immediately pre- and post-PASPA.
Gambling in the UK can be traced back to England’s first national public lottery, launched by Queen Elizabeth in 1566 to fund repairs for the nation’s harbors. The 16th century also saw the rise of horse racing and passage of the Unlawful Games Act of 1541, which made almost every form ofgambling illegal. And, while the act was never enforced, it did establish that gambling debts could not be collected through the courts.
By the end of the 17th century, playwrights commonly portrayed gambling as a vice rather than a leisure activity. The 18th century saw a proliferation of state-run lotteries as well a series of gaming acts passed, though they were all ultimately superseded. In the 19th century, another set of policies simplified regulations and led to the popularization of betting establishments, bookmakers, and runners, even though gambling contracts were still not considered to be legally enforceable. Gambling became a fixture in the leisure landscape of the mid-Victorian working class, launching from local betting houses and then migrating to pubs and city streets.
The 20th century brought legislation that provided the foundation for the current state of the UK market, especially as relates to horse racing, greyhound racing, football (soccer) pool betting, lotteries, and private casinos. It also brought technological advances, such as the telegraph, that allowed betting operations to scale and for customer ease of access to increase while cost of access decreased . After World War II, the previously-escalating social and moral aversions to gambling were essentially reversed, as the need for leisure activities and tax revenue was prioritized. England’s greyhound racing industry had its best year in history in 1946, the year after World War II ended, seeing a total handle of £196mm, equivalent to £8.7bn today, after adjusting for inflation.
The early 21st century witnessed the passage of the Gambling Act of 2005 and the establishment of the UK Gaming Commission, catalyzing the industry’s rapid growth. It also hosted the explosion of concerns over problem gambling and precipitated the onset of clashes between operators, regulators, press, and legislators.
When the UK market moved into the digital mainstream in the early 2000’s, the cultural milieu surrounding gambling was significantly different when compared that same market today, and essentially unrecognizable when compared to the United States in present form.
Betting Parlors vs. Sportsbooks
Not long before the turn of the millennium, many sports bettors in the UK (referred to there as punters) reported graver concern pertaining to being seen walking out of a betting parlor than a brothel, despite the former being a legal establishment and the latter being an illegal one.
Betting parlors, themselves, are useful data points on this topic.
The image above was taken outside of a William Hill betting parlor located in Mayfair, one of London’s most upscale districts, just off of Hyde Park. The image below depicts a typical layout for such a location.
These images may seem somewhat familiar to those who have visited off-track betting (OTB) establishments to wager on horse races in the United States. While there are often televisions for viewing the events being wagered on, both UK betting parlors and US OTB parlors serve a primarily transactional purpose.
On the opposite end of the spectrum, Las Vegas sportsbooks (like those at the Bellagio and Westgate, pictured below) have long been serving as vibrant social destinations, providing value far beyond simply processing bets.
Smacktalk Culture & Gamification
An estimated 60mm+ people play fantasy sports in the United States. Frequent participants in season-long contests have consistently listed the social benefits and joy of competition as being senior priorities to winning cash prizes. Eiler & Krejick, a boutique research firm with expertise in US gaming, has assessed that 70% of DFS players fail to generate a positive ROI over their lifetime of play.
The favoring of social benefits over economic ones supports the notion that “smacktalk culture” composes a robust portion of the cultural dynamics surrounding sports and drives a significant level of purchasing decisions within the ecosystem.
This can also be seen intertwined with the broader gamification trend that permeates modern US culture in a way not present during the formative days of other established markets. When the Gambling Act of 2005 was passed, Facebook was still called “The Facebook”, loot boxes were just starting to appear in video games, and Candy Crush wouldn’t come out for another seven years.
The relative popularity of the term “gamification” in the UK, over time, appears to confirm this notion, with one major caveat. The usage of the buzzword exploded when it was included in Gartner’s Hype Cycle in 2011. It is, of course, possible that the ideas were being readily researched in times prior, just under alternative search terms.
Currently, the world is enraptured with gamification, few places more so than the United States. Yet, in the nascent days of its sports betting industry, none of the product offerings reflect the seismic shift in relevant consumer behavioral patterns while most function relatively similarly to the first generation of mainstream online sports betting UIs.
Fortunately for operators, early adopters in the US market had grown accustomed to clunky user flows during the pre-PASPA days where only black- and gray-market options were available.
As fan engagement and sports media has grown increasingly gamified, it also has taken on an unprecedented social component. An estimated 40 million Americans participate in March Madness bracket pools annually, often in the workplace. Super Bowl box pools have become mainstays at many annual gatherings, for fans and non-fans alike. Additionally, with the rise of social media, talking about betting on sports in a public forum has become all but completely normalized.
This takes place at a time when investment companies like Robinhood have succeeded in gamifying the retail investing experience and allowed for it to enter the mainstream discussion, often directly adjacent to the topic of sports betting. This fusion of pursuing risk-adjusted returns and enjoying the competition, camaraderie, and social relevance along the way is crystallized in the colossal success seen by Barstool Sports’ Dave Portnoy aka Davey Day Trader, whose lucrative deal with Penn National Gaming serves as validation of the value placed on this form of engagement.
Robinhood recently reported enormous clusters of $1200 and $2400 deposits (the exact amounts in which stimulus checks were received by many US taxpayers during the COVID-19 crisis) at a time when sports were at a standstill, leading many CNBC anchors and industry analysts to suggest that retail order flow was being driven by a lack of sports betting opportunities.
Innovator’s Dilemma
The Innovator’s Dilemma is especially pronounced in the US sports betting industry due to the burdensome regulatory framework, surging customer acquisition costs, and complex technical requirements.
The theory, posed by Clayton Christensen in his 1997 book of the same name, specifies that incumbent companies and market leaders are not incentivized to develop truly disruptive innovations or serve new user segments. This, according to Christensen, is because the amount of value an organization derives per increment of innovation follows an S-curve, in addition to the fact that such organizations suffer the constraints of lofty sales goals and revenue targets.
We can see this phenomenon in play in plain view. In DraftKings’ 2Q20 earnings call, CEO Jason Robins noted that their proprietary in-play NFL product would not be fully showcased until the 2021 season. In order to generate $71mm in revenue during that quarter, the company had to incur $230mm in expenses. It is very costly to enter new states, acquire new customers, and operate sophisticated technology.
The Innovator’s Dilemma is frequently prominent in sectors with a high concentration of market power among few participants. The Concentration Ratio, denoted CRN, of an industry is a commonly-cited metric conveying the extent of competitive control wielded by the top N market leaders.
CR4 is a standardized instantiation of this measure, summing the market share obtained by the 4 largest holders. A CR4 in excess of 70% is typically considered to indicate a very high concentration of competition, sometimes nearing oligopolism. The US online sports betting market has a CR4 of 78%, based on 1H20 figures.
There is a convincing business case to be made for focusing primarily on maximizing Monthly Unique Players (MUPs) in the short-term while offering minimally viable in-house innovation and then rolling out more significant product expansions down the road.
To this point, those with bullish views on the US market often point to the underpentration of gaming as a share of consumption, often referred to as gaming share of wallet, when compared to other countries.
The chart above shows the comparatively small share of wallet composed by sports betting for US consumers when viewed in relation to other established markets.
Goldman Sachs estimates that COVID-related restrictions and behavioral changes have resulted in 6% of discretionary retail sales now being up for grabs on an annual basis. They further estimate that, with sports betting at an inflection point, gaming companies will be some of the primary beneficiaries of this $230bn shift in share of wallet.
Porter’s Five Forces
We can also examine the competitive forces shaping the landscape using a framework frequently taught in business schools today, Porter’s Five Forces. For any industry, an audit of the relationship and impact of these forces is often thought to be the best tactic for gaining a comprehensive understanding of its competitive makeup.
We can examine each force separately to build a more robust picture of the US sports betting landscape.
Analyzing the competitive landscape makes apparent the operational achievements and execution success that market leaders have had in the market’s embryonic stages, but also some of the critical market gaps, especially as relates to product development and user experience.
Current Market Gaps
The market appears to be aware of the stepwise engagement boost that sports betting provides to the broader ecosystem. According to the American Gaming Association (AGA), the four major leagues stand to gain $4.2bn in annual revenues owing specifically to this increase in engagement. Mark Cuban has stated that every major sports franchise in the US doubled in value the moment PASPA was overturned. Prior to the 2018 decision, the AGA also published research showing that the legalization of sports betting would result in bettors composing 36% of the total NFL audience while consuming 56% of the minutes viewed of NFL regular season games.
In terms of consumption habits, sports bettors are known to be avid sports fans who watch more television, more games, and more minutes of each game, than non-bettors.
However, there is much less formalized and commercialized insight into behavioral patterns that speak to the genesis of betting activity itself. It is also utterly unclear what the future constitution of the sports betting user base will look like in terms of sophistication, price sensitivity, and purchasing power.
It seems evident that noticeably missing from the product landscape in 2020 is any widely distributed formalization or digitization of the ways in which US sports bettors have been engaging with the activity in recent decades, even if within legally ambiguous confines. In addition, especially when compared to other industries, there is a noticeable lack of personalization involved in the execution and delivery of value propositions.
Social Functionality
Ask any longtime sports bettor or fantasy sports player in the US, particularly a Millennial or Gen-Z’er, about their preferences and they will not be likely to mention things like pricing, ROI, and risk-adjusted return. Rather, they’ll tell you that bragging rights and social relevance are chief among the benefits they derive from the activity. They will talk about placing bets with, alongside, or against friends, often facilitated by group text messages and Twitter threads. They will talk about PPH websites (though not by that name), often run by a friend of a friend of a guy they know. They will talk about placing bets on sporting events that are applicable to their social lives. They will even talk about betting on an event just to have a rooting interest, a sensation many gamblers enjoy and refer to as “the sweat”.
Customers who wager primarily in social settings are also often lured by the siren of the multi-leg bet or parlay. Sportsbooks love parlays as they tend to be ~2x as profitable as single-game wagers. Customers love parlays because they, much like lotteries, offer the advantages of rational calculation and inexpensive fantasy combined with those of instant gratification.
Generally, longshot parlay bettors will exhibit less price sensitivity, as there is only a minor perceived difference in, for example, receiving 150:1 odds as opposed to 165:1 odds.
Given the theme of the importance of social relevance, however, it may be possible for branding efforts and marketing initiatives to convince customers that there is actually social capital to be derived from obtaining best pricing. Absent such efforts, it is unclear what level of price sensitivity various user bases will exhibit.
Todd Fuhrman, a prominent Fox sports betting analyst, recently posted the following poll on Twitter:
Conspicuously missing from the list of options is any mention of which regulated legal book the user’s friends prefer. The omission of this option is not an oversight on Todd’s part, but rather a reflection of a fundamental characteristic of the current state of the market. The social element of sports betting has simply not been captured by digital offerings…yet.
Currently, users gain only a minimal amount of incremental benefit from selecting a sportsbook that their friends or co-workers use. Concurrent presence on the platform is virtually never acknowledged and there are very few social functionalities embedded into the mainstream online sports betting experience.
Also not listed above, again because of a lack of current relevance, is which sportsbook has partnered with celebrities and influencers that resonate with the prospective user. Barstool Sports has made no secret of its intention to leverage in-house personalities to acquire and retain users more efficiently. Stoolies can look forward to tailing “Dave Portnoy’s parlay of the day” or fading “KFC’s player prop of the month” with a single click.
Bettors on other platforms may soon see their favorite celebrities’ picks integrated with the user flow in a similar fashion. PointsBet was one of the first to seize on this concept in conjunction with their partnership with polarizing sports media figure, Darren Rovell. Perhaps DraftKings will soon offer “Kevin Hart’s lock of the day” or a chance to “fade Drake’s playoff picks.”
It should be noted that there are, of course, consumers who have the resources, expertise, and tools to turn sports betting into a career, but they make up such an infinitesimally small portion of the population (not to mention that they are seen as loss centers for bookmakers), that their needs are likely to be deprioritized by operators and tech vendors.
It is clear that innovative sports betting products have the opportunity to capture a share of the post-COVID reallocation of discretionary spending. However, there is also the opportunity to capitalize a portion of the “other” sports betting activity that is currently relegated to informal mechanisms and offline networks.
An estimated $4.6bn was wagered on March Madness brackets last year, making up over half of the $8.5bn in total wagers on the event. Of the 26 million people estimated to have bet on the most recent Super Bowl, 16 million bet with a bookie, in a pool or squares/boxes contest, or casually with family or friends.
When the quasi-infamous “Ron and Mike” NFL survivor pool was busted by the FBI, it boasted 20,000 users competing for $2mm in prizes. As ESPN’s David Purdum discusses further, office pools are an immensely popular form of both fan engagement and more generalized social engagement in the US.
Personalization & Recommendations
Netflix famously saves $1bn annually because of the proficiency of its AI-powered recommendation engine that serves users the content they are most likely to enjoy based on past behaviors. As Machine Learning, a subset of Artificial Intelligence, continues to revolutionize every industry on earth, recommendation engines are playing increasingly critical roles in enterprise technology offerings.
Any two users of Netflix, Hulu, Facebook, Instagram, TikTok, YouTube, Reddit, Twitter, eBay, Spotify, or Snapchat will be served entirely different experiences compared to one another, each based on their respective behavioral patterns. It is only a matter of time before online sports betting takes on a similar disposition, alongside the incorporation of the new features and functionalities discussed in this article.
Presenting users with a “bet of the day” or “parlay of the day”, where that recommendation is based on a rigorous analysis of first-party and third-party data, has the potential to fundamentally alter current user flows as well as the adjacent tools and platforms that support them
To these ends, sports betting operators can increase revenue on both an absolute and per-user basis by shifting consumption from informal, offline channels to streamlined, digital channels. If users are offered (or are convinced they are being offered) a more optimized, engaging, and intuitive product, operators can increase revenue without requiring their customers to increase spending.
Business Implications
Sports is a unique realm in which fans can enjoy simultaneous camaraderie and competition with friends, family, and strangers alike. Sports fans and markets are currently on the precipice of a titanic shift in the nature of fan engagement and the role that teams and athletes play in people’s lives.
This confluence of trends will manifest as a fusion of sports betting, content, analytics, social channels, investment opportunities, and experiences into a single, cohesive fan ecosystem that also seamlessly integrates Esports, video gaming, online casino play, and hobby gamification.
We can see that the transition has already begun:
- Capital One’s “The Match” featuring Tom Brady, Peyton Manning, Tiger Woods, and Phil Mickelson was a blockbuster hit for all parties involved and is indicative of the shift toward more intimate and accessible forms of content
- Spencer Dinwiddie, self-proclaimed “tech guy with a jumper”, has teamed up with venture capitalists and blockchain specialists to tokenize his own contract and allow fans to partake in his future growth
- Dapper Labs, the company behind cult sensation CryptoKitties, has partnered with the NBA on a program called NBA TopShot, a blockchain-powered digital platform where fans can collect and trade tokenized moments in league history
- Athletes in the US are taking on an unprecedented role in speaking out for social issues that matter to them
- Fortnite’s creator, Epic Games, has made no secret of their multifaceted strategy to build toward the “Metaverse”, a massively decentralized, digital shared space populated by avatars with which users interact in virtual or augmented reality
- Private funds like Arctos Sports Partners and Dyal Capital Partners are offering wealthy investors access to baskets of passive minority ownerships stakes in professional sports teams
- Athlete-led venture capital groups and owner-led SPACs are gaining an increasing amount of momentum and popularity
- Virtual reality goggles, haptic technology, augmented reality tools, AI coaches, and wearable biometric trackers have all made their way into the mainstream sports ecosystem
Personalization, interactivity, and gamification are beginning to pervade every corner of the sports world. COVID-19 has dramatically accelerated enhancements to the at-home fan experience and paved the way for real-time engagement opportunities that were not possible in the past.
Conclusion
Sports betting will play one of the most critical roles in shaping the trajectory of fan engagement.
The unceremonious release of potentially groundbreaking functionality by the market’s two largest players should be an indication to all relevant stakeholders that the opportunity for product innovation is massive, but that the window of opportunity may soon start closing.
It may only be in retrospect that the most transformative sports betting innovations seem like obvious ideas. And, as the industry sits in in the proverbial first inning of its growth, there seems to be less a question of the enormity of the opportunity set, and more of who will seize it.
