A reality check on the true potential of the US online poker market

It’s been a rough road for regulated US online poker so far

Online poker returned to the United States in 2013 when Delaware, Nevada and New Jersey legalized state-wide online poker to its residents. To say the profit projections for the return of online poker were high would be an understatement.

New Jersey Governor Chris Christie’s administration had projected a $180 million boost in tax revenue in the current fiscal year which comes to a close in June. As of February, the actual amount generated was $4.2 million and in April New Jersey experienced its first decline in overall internet gambling revenue. New Jersey’s state’s treasurer had originally lowered the projected revenue to $160 million but has since pulled all public estimates altogether.

Delaware has struggled as well, falling short of their online gaming projections that they would generate $5 million in revenues within the first year of operation. Online poker in the state took a nosedive in February, dropping 16% to $73,971 in monthly earnings in comparison to the $88,390 in January. The state is on pace to fall well short of its original annual goals.

What happened this week is what often happens when companies or government underperform to their shareholders, taxpayers, and constituents.

People start to point fingers.

50 shades of grey

In a recent article released by The Associated Press titled ‘Experts Say Illegal Sites Slow Growth of Online Gambling’ a number of state officials and industry experts blamed the lack of growth on non-regulated grey operators that also offer online poker to US residents.

Back on April 15 2011 (also known as Black Friday to poker players) the Federal Bureau of Investigation temporarily seized the URLs of the three biggest non-regulated poker sites still operating in the US. Full Tilt Poker, Poker Stars, and Absolute Poker were all forced to pull out of the United States market for illegally operating within their borders. Several smaller unregulated sites stayed behind and continued to offer online poker in the United States and are referred to today as grey operators.

The premise behind the aforementioned article is that these remaining sites are poaching players that would otherwise be playing in the state wide poker rooms, thus accounting for the millions of dollars difference between projected profits and actual revenue.

Numbers don’t lie and this just simply doesn’t add up.

According to PokerScout.com, widely regarded as the online poker traffic rankings authority, Full Tilt, Poker Stars, and the Absolute Poker Network accounted for 15,831 average players before leaving the US Market.

The numbers as of May 29 2014, show the combined 7-day average of players across grey market poker sites was just 2,835 players. Therefore across the entire United States, grey online poker sites account for 18% of the online poker market. Hardly a threat to regulated operators.

In May 2014, Americas Cardroom (one of the remaining grey poker sites in the United States) announced it was pulling out of New Jersey, Nevada, and Delaware in response to these allegations.

Michael Harris, a spokesperson for the company had this to say about their decision. ‘These three states combined accounted for only 1% of our overall traffic. Grey sites are being blamed for regulated online poker sites underperforming at a state wide level when the reality is these companies and states overestimated their earning potential and operate on a poor business plan.’

Online poker needs liquidity

With this statement Harris may just have addressed the elephant in the room that nobody seems to want to talk about… people made mistakes.

When formulating profit projections in any business it’s important to have a strong understanding of the market and what drives the business. In online poker, the profit potential is based almost entirely upon the size of the player pool.

Experts Dr. Ann-Christin Wilcke and Dr. Fiedler illustrate the key drivers of the online poker business in the following quotes from their paper ‘The Market for Online Poker’, published at the Gaming Research & Review Journal of the University of Nevada, Las Vegas.

‘The market concentration in Online Poker is mainly driven by positive network effects, which means that larger player pools attract more players and grow over time while small player pools decline or must continue to offer a product at a lower price. A high volume of poker players is thus essential to survive in the market.’

‘Stakeholders should keep this in mind when considering the future regulation and characteristics of the market. If the market is “ring-fenced” by not allowing people from abroad to join the player pool, the resulting player pools of the legal operators with only native players will be comparatively smaller than an open market.’

Now let’s examine how this pertains to the problems New Jersey is having today. A state wide player pool such as New Jersey couldn’t be more ‘ring fenced’ as it is illegal for anyone out of the state to play or deposit out of its borders.

Compound this limited geographic player base with the fierce competition between operators and you run into yet another factor. In New Jersey alone there are at least six operational rooms competing for the limited player base along with five more opening soon contingent upon licencing approval, dividing the player pool into even smaller segments.

The failure to understand the fundamentals of how the online poker business actually works and the impact a limited player pool is a more plausible explanation as to why initial projections were way off the mark.

State government doesn’t seem to be the only ones who overestimated their potential. The operators themselves seemed to have miscalculated their cost position based on recent expenditures versus profit.

New Jersey operators Borgata (Bwin Party), Caesars Entertainment Corp. (CZR), Golden Nugget, part of Landry’s Inc., and Ultimate Gaming, a unit of Las Vegas-based Station Casinos Inc. may have different cost structures, but all are at risk of spending over the limits of their potential market.

Leading the pack in overall profit of the group is Borgata (Bwin Party) with revenues of $4.11 million in April. However, it has come to light that their recent NBA’s Philadelphia 76ers/NHL’s New Jersey Devils marketing deal has a price tag of at least $10 million. Spending roughly one fifth of overall annual profit on one marketing deal may lead one to believe that they too overestimated the earning potential of the New Jersey market.

Other excuses by both government and operating CEOs are beginning to surface for the revenue shortfall which include the need for software development, privacy issues, and public awareness of legality. While these factors may hold some minor weight, they do not equate to the millions upon millions of dollars of over-projected revenue.

Other states considering online poker legalization should take note of what’s happened so far and learn from their peer’s mistakes. Government should be looking for ways to maximize every dollar brought in through online poker to the state such as forcing operators to employ only local businesses for operation costs such as advertising and software development.

The cited examples are mainly from New Jersey, but Nevada and Delaware are not much different. All three states are subject to the foundational micro-economic limits imposed by market size. The reality is that the stakeholders in online poker should be focusing more on addressing the fundamental misunderstanding of the economics of the online poker business rather than looking for scapegoats or excuses.

It’s just another common scenario of upper management needing to justify why they’re not successful. In all fairness however, if I was CEO or a government analyst that was responsible for making projections that far off the mark I’d be looking to play the blame game as well.

Jamie H., Winning Poker Network

Fiedler, I., & Wilcke, A. (2012). The Market for Online Poker. UNLV Gaming Research & Review Journal, 16(1).

Post-Black Friday performance

NJ Online Gambling Revenues Fall To $11.4m In April

So Far, Online Gambling Revenues Have been Pathetic

New Jersey Vastly Overestimated Online Gambling Revenue

Gambling Sponsorship for 76ers, Devils Is First by U.S. Teams

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