11 May 2006

Betfair into the USA and betting exchange economics

Betfair’s Christian Hellmers sparked up the Betfair Plans Rumor Mill by mentioning how betfair could provide USD 50m in revenues for racetracks and horsemen (oh, and betfair as well!) by 2008 if it is allowed to operate in the USA. Let’s think about the statement a bit.
There is no doubt that betting exchanges tend to re-vitalize what might otherwise be a flagging market. But where does that re-vitalization come from? Here is some background on the economics of exchanges in more mature markets (i.e., UK) to understand what is happening.
Betting exchanges allow savvy punters to take advantage of “free market” or “perfect market” pricing. The operator’s “excessive” margin is torn out. What does this mean for operators (or operators that trade on the exchange)? It means that operator over-rounds (profit margin) is eroded to almost zero (zero margin = perfect margin folks). If you’re betfair, this is great – you collect 2-5% commissions. If you’re the operator, you’ve been put on an extremely leveled playing field that only allows you to differentiate on price (approaching zero margin!).
But is a betting exchange really creating a “perfect” market for their punters? No, not really. Once you factor in the 2-5% commission for betfair, PLUS the eroded but present margin present in the exchange’s prices, the punter is in a similar position to where they were before. The punter pays a premium to betfair to wring out every drop of margin from the betfair layers.
So what has really happened here?
Betfair has been one of three market forces driving down bookie prices. The second force is the bookies themselves competing against each other. The third force is internet tools that allow the comparison of odds between multiple operators (e.g., Betbrain, OddsChecker). One might argue that the second and third forces would force down prices to the bone as well, albeit a bone that was defined by traditional gambling operator's cost model. Of course, betfair could drive out the additional bookie cost of odds compilation and trading, meaning that they could compete from a little better cost position then the bookies.
The US market, even more so than the UK market of 5 years ago when betting exchanges first appeared, is populated by fragmented monopoly operators. There is plenty of margin to be “removed” (that is, in part transferred to betfair) up by the betting exchanges. Given that this is the case, then it becomes a win-win for betfair and US punters (and a BIG LOSE for existing legal gambling operators in the US).
You’ll notice that Christian’s list of beneficiaries didn’t include existing US racing operators. In fact, by excluding other operators as beneficiaries, he is essentially suggesting that betfair be the (new) monopoly operator in the US market. Of course, the lead betting exchange, by virtue of the value of liquidity and p2p network effects, would naturally evolve to a monopoly position anyway.
It would be a huge coup for betfair to be able to legally (as might be made legal by US government law in the future) offering US horse racing to US citizens. The US focused, so-called “peer to peer” betting exchange betbug claims they can operate legally already in the US so there is some, albeit trivial, precedence.
Betfair, at least in times past, has offered US horse racing. Is there much interest in US racing outside the US? Not much. Who is participating in those market? I wonder. Its not that US-based punters aren’t familiar with offshore accounts to transfer funds to and from, a common practice encouraged by the early, wild, and wooly days of US offshore betting down in the Caribbean.
It’s too bad that betfair is bound (no doubt by its US venture capital investors) to play nice in the US market. Just imagine what they could do if they took the sportingbet or betonsports positions of gladly accepting US customers.
So where does that leave betfair? It is well understood from betfair that a majority of their exchange business is on racing. They’ve pushed into the Australian racing market, and signs suggest (see previous posts) that Japan is next via the Softbank deal. I would guess that betfair will continue to push on the US, quietly growing their US horse racing business by taking bets from US punter’s offshore accounts, and wait for a chance to move into the market in a bigger way.

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