Brexit: implications for the gambling industry

All Bets Off – Gambling’s Brexit Gamble

Dan Waugh, Partner at Regulus Partners blogs on last week's discussion co-hosted with Olswang.

There are few industries as familiar with the vagaries of life than gambling – which may be just as well given the uncertainty that faces the industry in the wake of Britain’s EU referendum.

The binary uncertainty of ‘Leave/Remain’ has now been replaced with myriad unresolved questions concerning the effect of Brexit on the judicial, legislative and economic landscape for all of us.

So for gambling – as for the rest of the UK – life must go on. What that life (on the other side of the Brexit looking-glass) will be like was the topic for discussion when Jenny Williams, former CEO of the Gambling Commission, chaired the Olswang/Regulus Brexit debate in London last week.

Those joining Williams on the expert panel – Dan Tench and Tamsin Blow from Olswang and Paul Leyland from Regulus – were quick to discount any lingering hope of the ‘Remainers’, that Article 50 would somehow not be triggered. The bookies may have called this one wrong but there will be no Stewards Inquiry.

Positively, this is one political secession that would be undertaken in a considered and well-ordered manner. The future may be uncertain but major disruptive upheaval is not on the cards. Indeed, once we are out it may be that much of life (and law) will feel much the same as before.

In particular, if the UK joined the European Economic Area (EEA) “EU directives or not, key legislative requirements of UK gambling firms on matters such as money-laundering and data protection are highly unlikely to be changed”, said Tench. And even if the UK left the EU and did not join the EEA “Substantive EU law will remain on the statute books and there will be no hurry to redraft them.” Indeed, the practical need to have consistent reciprocal laws with our continental neighbours may mean that the influence of legislators in Brussels will continue to be felt within our shores for the foreseeable future.

Yet if our laws are likely to remain largely unchanged, the question of who interprets them is a little harder to judge. If the United Kingdom remains within the EEA, then the highest court would shift from the CJEU to the European Free Trade Agreement Court. Given the slimmed down nature of this court (just three judges, currently drawn from Iceland and Norway), the UK may expect to exert greater influence on it than it had been able to on the CJEU.

And if the UK did not join the EEA on Brexit, the UK's own Supreme Court in London would be likely to have the final say – but even here the need for coherence of interpretation (with respect to our EU trading partners) will remain a consideration.

In terms of the broad economic outlook, Paul Leyland advised firms to buckle up for a roller-coaster ride with the financial markets highly sensitive to the volatility that the Brexit negotiations and their aftermath seem likely to bring (something that share trading had exemplified in only the first few weeks post-referendum). 

Inward investment would falter, with multi-national companies exercising caution on major capital projects. Early high profile property asset sales in the wake of ‘Leave’ would no doubt be followed by others.

Critically for gambling companies, securing lending (already a tough beat) is only likely to get tougher. How the consumer reacts to all of this is harder to discern – but with a weaker Pound and jobs under threat in certain quarters, risk appeared to be largely on the downside.

Against this background, Theresa May’s new Government will be highly sensitive to the needs of business; but not all businesses are created equal. Gambling’s political significance typically outweighs its economic importance – and that may make it vulnerable to tax increases (to fund spending) and regulatory intervention (in response to the politics of party fragmentation). The following day’s announcement that John Whittingdale (widely seen as a sympathetic observer of the gambling industry) would be replaced in the new PM’s Cabinet by the crime-busting Karen Bradley reinforces this analysis, as does the re-appointment of FOBT disliking Tracey Crouch.

Gambling’s take on Brexit has undoubtedly been skewed by concerns over the fate of offshore territories such as Gibraltar, Isle of Man and Alderney - where so much of the value of Gambling Inc is now located. Gibraltar knows from experience how Spain can turn the screws (in terms of border crossings) when it chooses to – and Madrid has not been slow to draw the link between a UK free of the EU and a Gibraltar free of the UK.

It was true that UK would undoubtedly fight to defend the interests of Crown dependencies and other offshore jurisdictions – but that the matter was unlikely to be anywhere near the top of Brexit Minister David Davis’s priorities (nor for that matter Boris Johnson’s – although he has since met with Picardo to give reassuring words).

All of which leaves remote operators in these territories with a dilemma – sit tight and hope that political pragmatism will protect their ability to operate within the EU from small islands; or relocate. Stay put and trust to fate or precipitate the scramble for Malta (with all the attendant issues of bandwidth, talent and resource)? Companies will have to make such calls on the shifting sands of HM Treasury policy, although for some the threat to the offshore exemption on input VAT may just help to make the options clearer.

Rather closer to home, is the possibility that our impending break with the EU will result in the dissolution of the Act of Union and the rebirth of an independent Scotland. Given the current position on FOBTs of the Scottish Nationalists, this would clearly pose challenges for the betting shop sector – but any move towards regulatory localisation will present opportunities too.

Every question answered on the future of gambling in the Brexit and post-Brexit eras appears destined to spawn many more. The journey to schism has started and requires careful and close scrutiny from here on in. 

Mayday – the National Living Wage will drive channel shift

By Paul Leyland, Founding Partner

“The production of too many useful things results in too many useless people” Karl Marx

Today is the International Labour Day holiday and in the UK, the new National Living Wage has been in force for a month. This has been presented by government as strengthening the value of workers; the gambling sector has largely presented it as a minor inconvenience. It is neither. The vast majority of workers will not be any better off, meaning that increased pay does not (in the short term) deliver increased spending power. Moreover, while the initial rate may be easy to swallow, NLW is a ratchet.

NLW: locking in wage inflation

The early years of the National Minimum Wage drove material cost increases for employers of the low paid (1999 – 2006 CAGR of 5.8%); however, this was from a low base (starting at £3.60), occurred during a (mostly) strong economic period, and grew disposable income (HDI) in the same period increased by 4.7% pa). However, despite Brown’s redistributionist rhetoric, the NMW largely stalled during the recessionary period 2008 – 2012 (CAGR 1.9%) and grew by only 2.5% pa during the coalition government. By contrast, the Welfare Budget has grown by 5.4% CAGR between 1999 and 2015 (ie, adding c. £8bn pa).  

However, between 2015 and 2020 the Welfare Budget is effectively capped other than for pensions, meaning that a significant and long-term low-pay fiscal stimulus has effectively been removed. Changes to in-work benefits also mean that the NLW is essentially HDI neutral in year one. Thereafter, it is likely to add c. £1.1bn pa to the spending power of the low paid – but this is dwarfed by the previous benefits increments. On the flip side, employers of the low paid have a fairly visible c. 6.7% annual wage inflation to contend with. 

‘Convenience’ retail gambling is the most impacted…

Ladbrokes and William Hill have both quantified their NLW impact at c. £2m: a relatively small sum, the impact of which is easy to dismiss. However, these businesses employ c. 13,000 people in their UK retail estates each and have total retail salary bills of c. £200m. Average salaries for the two businesses combined (across channels, functions and countries) is £20,700 (NB, an FTE on NLW would earn £13,000 pa ex any employer or state benefits).  

From a retail context (and this applies reasonably well to AGCs and bingo halls also), if we suppose 80% of staff are ‘low paid’ (c. £15,000), c. 10% ‘low-medium paid’ (c. £30,000) and c. 10% ‘well paid’ (£60,000 or more), this would get us to the average salary; it would also reinforce the view that comparatively few workers are directly caught in the NLW net. However, 80% of workers are very close and a further 10% are in a directly comparable pay tables – only 10% of the workforce are not affected by the NLW at all. By 2020, the FTE salary on NLW will be over £17,000 – directly capturing over 80% of the retail workforce, on our assumptions. 

In other words, a large proportion of the retail workforce is already subject to indirect wage inflation, and this will become increasingly direct over the next four years. In these circumstances, annual wage increases in retail of less than 4% would probably be very optimistic; especially since front-line staff numbers have been cut to the bone in most sectors.

The average cost of salaries as a proportion of revenue for William Hill, Ladbrokes and Mecca (retail only) is 23%; the average EBIT margin is 16.4%. All things being equal, therefore, the introduction of NLW is likely to reduce profits by c. 6% pa (1ppt of margin) over the next four years: this is not trivial.  

 …and these are the sectors most at risk from channel-shift

The problem for retail sectors is that all things are not equal. Outside a few stand-out products, broad-based top-line growth is proving elusive, while we have demonstrated that the NLW cost impact far outweighs any spending benefits, even in the medium-term. Equally, the two other big cost items for retail – rents and content – are also likely to prove inflationary. NLW is therefore reducing business cost flexibility and increasing margin erosion at a time when revenue growth is tough, without any direct upside. 

Retail top-line growth is likely to become tougher still as anecdotal evidence continues to point to accelerating retail-to-mobile channel shift. To put this issue into stark relief, it would take a retail operator just six years to swing into loss on 0% topline and 4% cost growth if it started on a 15% EBIT margin: disruption and dislocation would likely occur much sooner. Eroding profits will also reduce supply and discourage investment: reducing retail’s competitiveness vs. remote and further accelerating channel shift.

Equally, UK retail gambling is dominated by just seven major operators; these same operators control only c. 25% of the UK remote market: channel shift redistributes revenue away from the major retail incumbents, even when they are competent online. This makes talk of omni-channel urgent and defensive, not (on its own) a growth strategy. 

Can we afford the future?

There is an irony to all this – in embracing the much less labour intensive world of remote gambling, both consumers and operators have been moving inexorably from a business of people to a business of things, and so (in line with the wider economy) being part of the process which is undermining its own future.

Retail gambling has been very effective at ‘transactional services’, but over the last ten years or so many operators have undermined the ‘personal service’ through (largely) cost-driven investment in EPOS and electronic forms of gambling (including machines). Product knowledge and community contact has been significantly eroded. Increasingly, if the consumer wants simply to ‘transact’, the mobile is a far more efficient medium.  

The government is forcing employers to pay their staff more, the only way this can be turned into a positive is if more can be got out of staff. Retail gambling still holds enormous latent advantages over remote gambling (not just tapping into the cash economy): it is a dedicated venue; it can be a destination; it can be/reflect a community, and; it can deliver a personal touch. Leveraging these 'social' advantages is no longer about hope or chance, it is about survival.   

Please see our previous blogs on this subject:

http://regulusp.blogspot.co.uk/2015/02/time-to-think-outside-box.html?m=1

http://regulusp.blogspot.co.uk/2015/04/omni-channel-castles-in-sky.html?m=1

The Budd (breakfast) Report

This week, Olswang and Regulus Partners co-hosted Sir Alan Budd, one of Britain’s foremost economists and the man who chaired the 2001 Gambling Review Body (whose report gave rise to the Gambling Act 2005). Sir Alan recounted his experiences from that time, explaining the processes, pitfalls and issues arising from the eventual legislation – and in so doing offering valuable lessons for any future review.

Here is our summary of his hugely informative and insightful perspective.

Sir Alan Budd started by making the often overlooked point that government policy was at that time often generated by committees of people “of a certain class” without much experience, knowledge or even interest in the subject of their considerations. Luckily for gambling, Budd took a keen interest in the subject and could bring an economist's training to bear. The appointment of the Gambling Review Body was precipitated by three forces; a sense that gambling legislation was “in a muddle” (with different acts for different parts of the industry); there was an untested perception of greater permissiveness since the key legislation of the 1960s; and the nascent but clearly emerging issue of online gambling needed to be dealt with.

It was Budd's view, which guided thinking, that good gambling legislation should be about both enabling and protecting the consumer – and he referred to the need to find a balance between the two as his ‘central dilemma’.

The Gambling Review Body was not interested in the profitability of gambling companies, high employment or in moral judgements on the simple desirability of gambling. Yet while the committee received around 200 operator submissions, undertook numerous meetings with industry and conducted site visits, they received little in the way of direct testimony from ‘the consumer’. Thus they considered the behaviour of ‘Punters’ through the prisms of observed experience and research (mainly the British Gambling Prevalence Survey, the Family Expenditure Survey and their own ONS participation survey). Critically, however, the principle that (proportionate) harm reduction trumped the freedom of the majority was enshrined from the start. While the committee included taxation within its terms of reference, it was not mandated (nor indeed equipped) to opine on fiscal policy.

Budd recommended that the legislation should be flexible and enforcement simplified.  The regulator (we owe to Budd the creation of the Gambling Commission) would ensure that principles were followed, the sector behaved responsibly and technological changes were adapted to. This was largely followed, though with the significant caveat of machines stakes and prizes, which was reserved by DCMS. Other advice not taken or fudged was to ensure that remote operators were licensed in the UK (now fixed), that the NHS should be mandated to address problem gambling and that ambient gambling should be removed (first clubs were protected, now the Greene King case is challenging the licensing principle of ‘primary purpose’). 

The immediate success of the ‘Budd Report’ was that the vast majority of its recommendations were enshrined within the Gambling Act. The longer-term effects are more difficult to ascertain but gambling legislation in 2016 is undoubtedly simpler and more flexible as a result of the ‘Budd Report’; choice has been extended significantly for adult gamblers; strong controls are in place to restrict crime; problem gambling rates have remained relatively stable; and remote gambling has flourished without giving rise to the scale of public health issues feared at the time. 

No discussion of this episode would have been complete without reference to the political controversy that swirled around Budd’s proposals for resort casinos. The dilution and final extinction of plans for destination gambling was, it seemed, an example of how moral judgement (often disguised as paternalism) can trump considered analysis. Sir Alan noted Professor Peter Collins’s assertion in ‘The Great British Casino Shambles’ that this represented “typically British political decision-making”. 

In the round-table discussion which followed Sir Alan’s opening remarks, it was recognised that the Gambling Commission today has considerable flexibility under the framework provided by the Gambling Act, but that this framework is much tighter on the supply and shape of land-based gambling than it is on the remote sector. It was acknowledged that there has been a recent shift in industry perceptions on and engagement with ‘Responsible Gambling’; and that in time this may pave the way for less defensive modes of engagement on legislation and regulation. Happily, the vexed subject of FOBTs only made a brief appearance, with the standard arguments being rehearsed; though there was some recognition that perhaps the Gambling Act had 'unintended consequences' of proliferating high stakes gaming and putting casinos at a relative disadvantage. Given the increasing evidence (supporting both sides) and increasing harm mitigation initiatives, it was suggested that a Triennial Review would be helpful to tackle these issues. 

More broadly, a view emerged that under the Gambling Act, remote gambling was less heavily regulated and faced fewer constraints than its land-based counter-parts (a bias largely reinforced in the tax code) - despite Budd having recommended casino-style regulation for ‘online gambling’. Moreover, it was suggested that some of the current regulatory friction was being generated by land-based operators rubbing up against the confines of restrictive (possibly anachronistic) licensing regimes.

While the idea of a new gambling review was met with caution, the discussion posed an important regulatory question - whether the Government is happy to preside over a legislative regime that encourages and accelerates channel shift from land-based to remote gambling. There are clear benefits to this shift, notably the greater levels of data and technology-driven harm prevention measures that can be deployed; but there are likely to be problems too.

Perhaps most significantly, our breakfast briefing with Sir Alan Budd served as a reminder of a period when benefits to the consumer (both in terms of their enjoyment and risk of harm) were placed explicitly at the heart of government thinking and policy on gambling.  

Need financial support? Don’t Bank on it…

"I sincerely believe... that banking establishments are more dangerous than standing armies" - Thomas Jefferson

The Banking Crisis supposedly ended six years ago. It probably doesn’t feel like that if you work in the remote gambling sector, however.

Back in the first heyday of remote gambling IPOs (2004 – 2005), banks were happy to lend, albeit on expensive terms and rapid rates of payback, and were more than happy to provide commercial services and process payments. The banks’ appetite for ‘risky’ remote gambling companies changed markedly in the summer of 2006, when UIGEA ended the party and put the banks in the spotlight, both for enforcement and past ‘misdeeds’ for supporting businesses facing the USA. The global Banking Crisis (2007-09) swiftly followed, highlighting some rather riskier banking activities and putting any form of even slightly controversial banking activity beyond the pale. These two events meant that the banks were firmly shut to many (most) remote gambling operators and largely have been since, an economic recovery and substantial remote growth notwithstanding.

But before we bash bankers too much, it is probably worth flagging that their Risk Committees had a point when it came to remote gambling. There are (or were) seven things typically found in remote gambling which give bankers pause – and it is the presence of all seven that made remote gambling particularly toxic (rather like the Titanic, bankers would probably have been more or less relaxed about the breech of any three of these risk-assessment bulkheads, but any more would be fatal).

First, and probably most importantly, the US government made its anti-remote gambling ire known to the financial services industry: every global bank has perforce extensive US interests - which are probably bigger than most countries’ gambling markets; it is not an unreasonable commercial decision that most banks fled from potentially upsetting the US government, whatever their own views were.

Second, back in 2006 the vast majority of remote gambling was regulated on a point of supply basis. Given that even many gambling executives use the shorthand of ‘unregulated’ for this activity (or even pointedly don’t put some revenue in a ‘Sustainable’ category when reporting), it is unsurprising that many banks regard ‘point of supply’ revenue as risky.

Third, and as a result of the second point, most remote gambling companies have their Headquarters in ‘exotic’ jurisdictions, typically associated with ‘tax optimisation’. With tongue firmly away from cheek, many bankers frown on these sort of structures, especially if…

… Fourth, most gambling companies are rather small by international corporate standards (eg, not one gambling company is in the FTSE 100, pending the Betfair – Paddy Power ‘mega merger’), meaning that the ‘return on risk’ on most remote gambling business simply doesn’t stack up for banks.

Fifth, the ‘entrepreneurial’ nature of many remote gambling companies meant that things like social responsibility and corporate governance were not early priorities. This not only plays badly in a corporate box-ticking environment, but also (far more importantly) increases the risks of negative regulatory change: especially where some mainstream press has an ‘anti-gambling’ stance. All of this naturally reduces a bank’s already low appetite for the sector still further.

Sixth, back in the .com world where most operators took money from most jurisdictions, providing a lot of trading access (or at least details) to a regulated entity with a fiduciary duty to block or report ‘dubious’ transactions was probably considered poor risk management from the gambling companies themselves: relying on ‘sector specialist’ financial services was much safer and more reliable.

Finally, many remote gambling companies are relatively young and, given the cash generative nature of such (more successful) businesses, have not hitherto needed much ‘vanilla’ financial services support. This has meant that there is no long-standing relationship or network of relationships within the financial services community to leverage: it is much easier to turn down a new business than turn off an established one.

Many of these ‘legacy’ issues are now being solved however. The US has been firmly shut for nearly a decade - levels of compliance have been comfortingly high and the US has even positively modified its regulatory stance (albeit in certain highly specific areas). Many remote gambling companies now generate most or all of their revenue from regulated markets, while UK Point of Consumption licensing has made many companies more visible and more accountable. Remote gambling is now big business, driven by a combination of organic growth and M&A: in the UK (the most liberal domestically regulated market), remote gambling is now the single largest commercial sector by official Gross Gambling Revenue stats, as well as one of the fastest growing.

Further, many companies have made the transition to well governed, socially responsible entities, through a combination of increasing scale, increasing regulatory scrutiny, and changes in management and/or ownership. Lastly, many remote gambling companies are now (at least) ‘medium sized’, well established businesses with a strong track record of sustainable (and audited) revenues and growth. 

Unfortunately, none of these positives have yet been accepted by mainstream financial services businesses, with appetite to deal with remote gambling companies (especially small and/or new ones) very low. This is important. In fact it is a lot more important than the remote gambling sector realises – I would point to five key reasons (Finance Director readers could probably add many more!).

The most obvious impact of having high volume ‘vanilla’ providers of financial services closed off as an option is that the cost of doing business increases - for commercial banking, processing or financing. This puts new and/or remote only businesses at a competitive disadvantage in terms of day-to-day activities (eg, payment processing as a cost represents c. 25% of typical remote profits).

Another impact of limited supplies of debt is that it materially impacts flexibility to grow. If substantially all of a company’s increased costs need to be organically funded by revenue or through equity investors, then growth is made both slow and expensive; reducing competition and innovation while favouring the larger incumbents.

The supply chain is probably the area where significantly reduced financial services options have the biggest and most problematic long-term impact. Platforms and content need R&D and infrastructure spend to grow. If this can only come from organic resources then the focus will be on short-term wins and tried-and-tested ideas. It will also keep small developers small unless they hit lucky with one very high return product or service or find a very generous equity backer. This not only polarises the supply chain into very few haves and very many have nots (materially reducing operator choice), it also stifles innovation. 

A potential regulatory risk issue for the sector is that forcing operators to use more exotic forms of financial services also puts them (perhaps unwittingly) into the ‘grey market’ supply chain. In a very narrow sense, this perpetuates the problem by providing life to the support structures of the industry that often cause greatest concern. In a wider sense, operators already plugged in to ‘regulatory flexible’ payment solutions or financing may become tempted to broaden their revenue base to riskier markets. This could be especially compelling when combined with the need to generate high margin revenue to support costs, given the paucity of attractive financing options.

Finally, by helping to keep large parts of the remote gambling sector small and ‘colourful’, the lack of mainstream financial services engagement helps to perpetuate the stigma that causes the sector so many problems, from inviting negative press and adverse political risk to making talent difficult to attract.

A further tangential risk worth flagging is that traditional land-based businesses are becoming increasingly remote (indeed need to); many of these companies also have material amounts of ‘vanilla’ debt. If the large banks maintain their anti-remote gambling position then increasingly ‘omni-channel’ businesses could see themselves growing their financing risk to dangerous levels; especially if land-based profits decline.

The lack of effective access to large-scale financial services therefore touches nearly every key aspect of the remote gambling industry. Moreover, as the industry matures, this lack of access is likely to be felt ever more acutely, causing deeper problems to perpetuate.

I would suggest that high-level stakeholder engagement, including regulators and equity holders, is key to resolving this impasse before the issue distorts the sector further and potentially also causes value destructive levels of risk. The sector should also be prepared to engage on more creative means of securing attractive financial services for the ‘regulated age’, without simply turning to expensive and high risk ‘.com’ solutions.

At the beginning of a year it is usually tempting to focus on which channel will see most growth, or M&A gossip, or some other form of crystal-ball gazing. But as the remote industry matures, it should spend less time pondering the ‘next big thing’ might be and more time focussing on resolving the very real issues that are retarding its ability to be taken as not only the most dynamic gambling sub-sector but also the most sustainable. As the remote sector challenges land-based sectors in terms of scale in many jurisdictions, the fate of the entire gambling industry might rest on making this transition successfully.

This article appears in the January/February edition of iGaming Business

DFS, ducks and the gun lobby.

By Michael Ellen, Partner

“Not so much the issue of whether DFS is legal under existing relevant law, but rather whether DFS should be legal.”

It doesn’t waddle or quack but DFS looks very like a substitute for a sports betting duck to the untutored eye. The title quote comes from a White Paper on DFS (and onwards into eGambling regulation) published this week by the Massachusetts Gaming Commission, and reads like the blast of applied common sense the world has been awaiting on this particular duck-shoot.

Given its enormous and popular following, the current hiatus of, variously, recognition, passive acceptance and prohibition plus sanction across the federation does no credit to the U.S. legislature. 

There is rumour of a Federal investigation into the activity, which if true almost certainly means an indictment is threatening one or both the major DFS players (to be resolved, probably late this year). Current proceedings in California seem very likely to find that the activity falls within existing regulations on pool betting. The rumoured UIGEA carve-out for DFS (allegedly excluding DFS from the “unlawful activity” that UIGEA was aiming to choke off federally) bears no examination at all – its not there; the reference to Fantasy Sports, the annual version, serves only to exclude it (and not the Daily version) from UIGEA; and neither of them from other previous blocking legislation.

If prohibition is threatening, outside Massachusetts, we should recognise that it has never been effective in stopping the average American citizen from sports betting. Prohibition and a regulatory vacuum apparently serve the long-term interests only of vested commercial operations. Conversely licensing and regulating, as already provided to DFS activity in Nevada, provides assurance on probity and fairness; and it raises taxes, a consideration that may to sway California and New Jersey into legitimising sports betting this year, subject to resolution of another pre-existing regulation (the continuing relevance of the 1992 federal legislation known as PASPA, which outlawed the further development of sports betting, is likely to be formally resolved by New Jersey this year).

One interesting side-effect of legitimising and regulating both verticals would (or will) be the sea change it generates in social responsibility and at-risk player protection, not just in sports betting but radiating across the whole sector in USA. It is an existing identified cancer within an otherwise generally healthy body of activity. It will seem, in ten years’ time, to have been the madness of the previous generation not to have faced this issue more directly – very like smoking – but as President Obama is finding out now on gun control, US federal priorities are not always logical; and election year will certainly divert political energy.

In testing times we’d be daft to duck the question

"Guilty Mallard?"

By Dan Waugh, Partner

“If it looks like a duck, sounds like a duck and walks like a duck it’s unlikely to be a horse.”

One of the problems with regulating gambling in a relatively permissive society like Great Britain is that the target simply refuses to stand still. Changes in technology and consumer behaviour propel gambling companies forward in search of ways to grow the market and to capture greater share – sometimes rubbing up against the confines of regulation.

If the regulatory cords are tied too precisely, they may become outmoded and so create loopholes; too loose and they give rise to inconsistency of interpretation and possible exploitation.

This is the sort of problem that the Gambling Commission has been grappling with in trying to ensure that licensing regimes are used for the purposes intended (and more specifically to guard against the proliferation of machine gaming in ‘ambient’ premises). Attempts to set some measurable parameters around the principle of ‘primary purpose’ (the idea that a betting shop licence should be used primarily to offer betting, a bingo licence for bingo and a casino licence for table games) have been met with predictable entrepreneurship (often manifested in tokenism) from the industry. This in turn has led the Commission to seek to implement the well-worn ‘duck test’.

The ’duck test’ which focuses on outcomes rather than compliance tends to trump the industry’s best-laid arguments. The recent travails of DraftKings and FanDuel in the USA illustrate the point. The daily fantasy sports sector may be correct in asserting that their activities are exempted from the proscriptions of UIGEA and the Bradley Act; but if the regulator decrees that the carve-out is being exploited to offer sports betting by proxy, there will be only one winner.

Back here in Britain, local authorities may soon be asked to consider whether a bingo club is really a bingo club, not on the basis of technical specifications (bingo positions vs slots, floor space allocation, revenue splits) but on whether it meets their expectations of what a bingo club should be.

It is a common sense approach to licensing that the Commission hopes will put paid to pubs masquerading as bingo clubs, arcades aping casinos and betting shops bereft of sports. In some respects it may be seen in the same vein as the current regulatory emphasis on impact and effectiveness rather than simply compliance – a renewed recognition that the spirit is every bit as important as the letter of the law.

There is of course the risk is that the proposed new approach leads to inconsistency of interpretation between local authorities; but the Commission will be only too aware of its task in meeting this challenge.

Perhaps the more important concern is that in applying the ‘duck test’ to licensing, we are once again addressing symptoms rather than getting to the heart of the matter.

Britain’s terrestrial gambling operators are – generally speaking – a fairly well-behaved and conservative bunch. The widespread inventiveness in licensing that we have seen since the Gambling Act has often resulted from challenges to the traditional business model (such as the smoking bans of 2006 and 2007 or the casino duty increase of 2007) rather than base avarice. Sometimes covetousness creeps in where there are obvious regulatory imbalances (e.g. FOBTs being permitted in betting shops and not arcades; bingo clubs having better slots entitlements than pubs) but deep down this has been about the need to adapt to a changing world.

As I have argued in previous articles (notably http://regulusp.blogspot.co.uk/2015/02/time-to-think-outside-box.html), the prognosis for licensed gambling venues in Great Britain is worrying and this is largely because they are still defined by parameters set in the 1960s and the needs of a dwindling band of customers. Our arcades, betting shops and bingo clubs are looking increasingly anachronistic while the much vaunted rise of the casino has somehow failed to materialize. Gambling activity seems to be shifting inexorably to remote channels – a trend that may not be unambiguously positive.

Against this backdrop, it is unsurprising that operators have become more enterprising in how they interpret regulations. Done in the right way, it can even serve to force positive change. Several years ago, I was involved in the process to supplement machine numbers in bingo clubs through multi-licensing – a response to a restriction in the Act that limited clubs to just four jackpot machines per premises (at a time when some clubs were receiving up to 1,000 visits a day). With no evidence of harm arising from the machines expansion in bingo clubs, successive governments have relaxed restrictions and so largely obviated the need for multi-licensing.

Nevertheless, the rise to prominence of machine gaming in venues where it is intended to be a secondary activity is a justifiable source of concern for the Gambling Commission as is the land-based industry’s growing dependence on those machines. Application of the ‘duck test’ is a sensible response to current challenges (notably Greene King’s attempts to deploy bingo licensing in community pubs) but it is unlikely to end the game of cat and mouse over licence definitions, precisely because it does not address the root cause of incipient obsolescence. It asks the question of whether the licensing regimes are being adhered to rather than whether the licensing regimes are themselves appropriate.

This is existential stuff for the industry but will never be a priority for government; so the onus is on companies to address it. Put simply, if our ambitions fail the Commission’s ‘duck test’, perhaps it is time for us to consider whether we wish to be ducks at all – particularly those of the sitting kind.

Gambling in the UK: the perversity of eschewing diversity

Time to get another basket?
A decade on from the Act, gambling is still the only show in town for most of Britain's major operators.

By Dan Waugh, Partner
As Genting prepares to open Britain’s first truly integrated destination casino at the NEC in Solihull this week, Dan Waugh asks why our gambling industry has been so slow to embrace mainstream leisure.

A few years back, the American Gaming Association published ‘Beyond the Casino Floor’, a report which claimed that the economic value of commercial casinos in the United States was between three and four times greater than its $35bn of annual gross gaming revenue.

It is unlikely that the British gambling industry will be following the AGA’s example any time soon for the principal reason that gambling in Great Britain – unlike in an increasing number of US states and other markets - underpins nothing so very much more than....well.... gambling (and its traditional adjuncts, horse-racing and dog-racing). Whereas in the US, around a third of casino expenditures relate to non-gaming activity (more than 70% on the Las Vegas Strip), in Britain it is closer to 5% (in licensed gambling venues).

The unwillingness or inability of gambling companies to diversify revenue beyond gambling is perplexing to many overseas observers. For all the hyperbole of the Gambling Bill era, betting and gaming remain niche leisure pursuits - many of us do it but not very often; very few of us engage in it frequently.  As a result, consumer expenditure on gambling is relatively small beer at the macro level.

Restricting commercial activities to gambling thus confines the opportunities for growth. Given that most gambling businesses have fairly high fixed-costs, the opportunity to generate marginal revenues from existing areas of consumer spending should be highly attractive – but for a variety of reasons this has not proved to be the case.

The image of Britain as a nation of gamblers owes much to the National Lottery, which skews participation rates towards the three-quarters commonly quoted. The key sectors of land-based gambling – betting shops, bingo clubs, arcades and casinos – enjoy relatively low levels of patronage compared with leisure at large. This is despite the relatively high dispersal of licensed venues (there are around 10,000 overseen by the Gambling Commission) which makes gambling significantly more convenient than in many jurisdictions.

In the major global markets, the expansion of non-gambling amenities within venues has driven increased visitation and encouraged trial (if you want to be mass market then it pays to lead with mainstream activities rather than those which are niche or taboo – just ask Ann Summers).

The reason for the industry’s obsession with gambling may lie in the high gross margins and large VIP expenditures that are characteristic of certain sectors. If one can make millions through the relatively simple process of spinning a wheel or plugging in a slot machine, why bother with the grind of activities which require more labour, more effort, different skills and may yield lower margins? 

A decade ago, a gaming executive I knew defended the unspeakably bad food in his bingo halls by explaining to me that he would rather see his customers spend their time and money on high margin bingo games than on dining. He seemed to have completely missed the point that his customers were spending their money in the local chip shops instead (and then bringing the food into the clubs to eat). Things have moved on since then – but not by as much as we might have hoped.

So does gambling’s reliance on gambling actually matter? The industry appears not to care too greatly, the regulator has a range of other issues to deal with and the Government is not particularly interested; and why should they? Yet what if the question of diversification involved more than simply the opportunity cost of foregone revenues?

First, there is the fact that gambling is a politically volatile business, subject to unhelpful regulatory interventions and opportunistic tax raids. On three occasions in the last eight years, three different sectors of the gambling industry have seen their business models unexpectedly challenged by Budget Day changes to gambling duties - casinos in 2007 and 2009; bingo clubs in 2009; and betting shops in 2014 (this excludes the extension of remote gaming duty in 2014 to offshore operators which was well flagged in advance).

Such changes are not unique to Great Britain (think UIGEA, the current government crackdown in Macau, the backlash in Italy, the banishment to Siberia of the Russian casino industry, the imposition of retrospective remote gambling taxes in Spain, the outlawing of slots parlours in Poland – the list goes on) and the lesson seems obvious - a business that is built entirely on gambling revenues is one that is vulnerable to that which issues from the politician’s soapbox or the bureaucrat’s pen.

Gambling – a sector that often suffers from an unhelpful status in mythology and morality – is weak in part because it has so few champions. A small percentage of customers care passionately about their right to have a flutter, but taken as a whole the Great British public’s attitude to gambling is one of mild disapproval. Output is not significant within the context of national economics; employment is reasonably large (c.0.3% of Britain’s workforce) but highly dispersed, modestly paid and in decline; and while some communities truly value gambling (bingo clubs in some towns; arcades in seaside resorts, betting’s support for race courses), opposition tends to be more active and more vocal (e.g. the 93 local authorities who supported the London Borough of Newham’s Sustainable Communities Act gambit or the councils who have adopted no casino policies in spite of the fact that the law does not permit them to license casinos anyway).

Linked to this issue of political volatility is the question of gambling-related harm. There is a comforting story that we tell ourselves within the gambling industry that we are working towards a world where all gamblers spend within their means, allowing operators to benefit from affordable (and so sustainable) consumer expenditure and long-term customer relationships. Gambling businesses, we tell ourselves no more want problem gamblers than pubs wants alcoholics. It’s a neat line but what if it isn’t true?

Several studies (notably the Australian Productivity Commission and in this country the work of Professor Jim Orford) have suggested that gambling companies are highly sensitive to the expenditures of problem gamblers. We don’t know this to be the case but we do know that certain sectors (casinos, betting shops and remote) derive large portions of their incomes from a small proportion of highly frequent customers (n.b. frequency is a key flag for possible harm).

This is what the writer and former Wall Street trader, Nassim Nicholas Taleb calls ‘Extremistan’ – a place where the mean is meaningless and the behaviour of the few markedly skews the overall picture. Pubs on the other hand largely inhabit ‘Mediocristan’, where consumption values from one customer to the next are less divergent.

If Orford is correct then this suggests an unhelpful paradox where ‘responsible gambling’ may be put squarely at odds with commercial objectives. If (and this remains to be proven) certain types of gambling are sensitive to the expenditure of problem gamblers, it makes it that much harder for companies to take meaningful action because to do so is to work against near-term financial self-interest. Sacrifices that hurt tend to be harder to make.

In this situation, revenue diversification would seem to have two things going for it. First, companies are going to find it easier to do ‘the right thing’ if they are less dependent on ‘the wrong thing’; and second, by offering customers a wider range of amenities, there may be positive incentives for them to take breaks from gambling (as opposed to the negative incentives of limit-setting). It shifts our interpretation of responsible gambling from a series of mitigations to inherent characteristics. This logic was embedded in the Budd view of gambling reform that somehow got lost along the way.

All this is fine in theory but how on earth does gambling make that journey from Extremistan towards Mediocristan (noting that dependence on high-value customers is not the same as reliance on problem gambling and the distribution of revenues will always be more skewed than in other parts of the leisure market)? By dint of the current licensing regimes, casinos and bingo clubs have the greatest opportunity for revenue diversification. Indeed, Simon Thomas at the Hippodrome has been demonstrably successful in taking the casino mainstream despite the obvious limitations of the 1968 Act regime; and now Genting is raising the bar again (under the more generous 2005 Act) at the NEC.

Yet there is nothing to stop arcades and betting shop operators from seeking to exploit new revenue opportunities. Their business models may need to change in order to do so; but this is perhaps overdue anyway given the erosion of the traditional customer base and the need to appeal to younger customers in both formats. For all sectors, there are models of diversification from overseas that might be adopted or adapted (see http://regulusp.blogspot.com/2015/02/time-to-think-outside-box.html); and though this may require changes to regulation, reform is more likely to be achieved if its consequences are in keeping with social policy objectives.

The dynamic of land-based gambling in Great Britain appears today to be a long-term shift towards obsolescence with the threat of near-term regulatory shocks. Both require strategic action, including a willingness to do things differently. Kicking gambling’s dependence on gambling may just be an important part of that process.