APPENDIX 1
National Lottery licensing and competition
An independent report prepared for Camelot
by Frontier Economics Ltd, London (Executive Summary)
1. In July 2003 the Government announced that it
had decided that a radical new approach to licensing the National
Lottery is needed, both to increase competition for licences,
and also to allow more companies to participate in the Lottery.[175]
The Government therefore proposes to replace the current "single
licence" model, whereby the National Lottery is run by a
single operator, with a "multiple licence" model in
which the National Lottery Commission (NLC) may offer one or more
operating licences to run different parts of the Lottery.
2. Camelot asked Frontier Economics to carry out
an independent economic assessment of the government's proposal
to adopt a multiple licence model, focusing in particular on the
likely impact of this on the money raised for good causes.
Key assumptions
3. The impact of the multiple licence model on good
causes will depend on the specification of the licences that are
offered by the NLC, and also on the details of the licence award
process. The NLC has not announced a final decision on these issues,
but has given some indication of its likely approach. For the
purpose of this report we have assumed that:
- there will be no significant change in the legal
definition of a Lottery, and so the scope of activities that may
be licensed by the NLC in future will be similar to now;
- operating licences will be "full capacity"
licences as defined above. That is licences will cover specified
games or classes of games, and also the means to deliver them;
- the NLC will continue to regulate the design
of individual games (or classes of game) promoted by operating
licensees in a similar manner to the current Section 6 licences;
and
- the NLC will award operating licences by competitive
tender to the bidder(s) who (subject to meeting probity and player
protection conditions) offers the best deal for good causes.
4. Subject to these assumptions, our analysis is
not predicated on a particular view of the operating licences
that the NLC might offer. Instead, we have focused on examining
the key issues and trade-offs that are inherent to the multiple
licence model as compared to the single licence model. As a consequence,
our main conclusions do not depend on the exact nature of the
operating licences offered.
5. In the two previous licence competitions commercial
gambling firms have been prevented from bidding by the requirement
that the National Lottery be operated by a single purpose company.
It is possible that the government could relax this restriction
in order to encourage bidding competition in future licence competitions.
This would, however, blur the distinction between the National
Lottery and harder forms of commercial gambling in the public
eye. In addition, Camelot would be placed at a disadvantage relative
to commercial gambling firms unless it was allowed to diversify
beyond the National Lottery.
Government policy and the effects of competition
6. The Government has made it plain that the promotion
of effective competition is one of its key policy goals. Competition
is recognised to be a powerful mechanism for delivering consumer
benefits, in terms of lower prices, higher quality and innovation.[176]
7. So far as the National Lottery is concerned, the
multiple licence model may appear to offer a way of pursuing this
policy goal by adding competition "within the market"
(between Lottery operators, for customers) to competition "for
the market" (between bidders for one or more licences to
run the Lottery itself). The NLC could encourage competition "in
the market" by using tendering processes that make it difficult
for a single firm to win all the licences, or by reserving one
or more licences for a new entrant. By making it easier for entrants
and/or small bidders, the multiple licence model is seen by some
of its advocates as a way of also increasing competition "for
the market".
8. There a number of problems with this argument.
First, the conventional consumer-based rationale for promoting
competition is not directly applicable to the National Lottery.
This is because the primary purpose of policy with respect to
the Lottery is to raise funds for good causes, rather than to
maximise the consumer benefits enjoyed by those who play the Lottery,
in terms of lower prices or higher payouts. Competition should
therefore be seen as an objective only in so far as it protects
or enhances these funds.
9. Second, as explained below, competition "in
the market" may actually reduce the money available for good
causes, absent any increase in bidding competition.
10. Finally, it is questionable whether the multiple
licence model would in fact increase competition "for the
market" (e.g. by increasing the number of bidders) by enough
to compensate for the negative impact of competition "in
the market", or indeed whether it would lead to any significant
increase in competition for licences at all.
Key conclusions
11. We have reached five key conclusions as follows.
Multiple licence holders competing "within
the market" could reduce funds for good causes.
12. The funds available to good causes depend upon
the economic value of the Lottery (defined as the net value of
Lottery sales less costs) and its distribution between licensees
and good causes. Allowing a number of operators to run different
parts of the Lottery could result in lower net Lottery sales revenue,
and higher costs, compared with those achieved by a single operator,
resulting in a reduction in the economic value of the Lottery.
This is because a single operator has both the incentive and the
ability to develop the Lottery more efficiently than multiple
operators.
13. There are a number of specific ways in which
the economic value of the Lottery could be undermined with multiple
competing operators:
- licensees may develop products that cannibalise
rivals' sales rather than expand the market;
- product launches may be undermined by a lack
of co-ordination between licensees;
- free-riding by some operators may result in under-investment,
notably in the Lottery brand and infrastructure; and
- there may be a loss of economies of scale and
scope that cannot be effectively remedied by access agreements
and the sharing of infrastructure, which would increase total
operating costs.
14. The NLC's role would change radically in the
multiple licence model in terms of both scale and complexity.
In particular, the NLC would be required to intervene in key areas
such as product development, marketing and brand management in
order to reconcile operators' competing interests and ensure the
efficient development of the Lottery. This would be a very challenging
regulatory role, and it is doubtful that the NLC currently has
the commercial and technical expertise that would be needed to
fulfil this role. Moreover, the increased level of regulatory
intervention in the multiple licence model would be costly in
itself, and could stifle product innovation, particularly if operators
seek to use the regulatory process to inhibit product development
by rivals.
The multiple licence model would only increase
funds for good causes if competition "for the market"
were increased significantly.
15. Since the economic value of the Lottery is likely
to be lower in the multiple licence model than in the single licence
model, the multiple licence model would generate more money for
good causes only if the share of the economic value of the Lottery
that goes to good increases by enough to offset the fall in the
economic value of the Lottery. This would be the case only if
the multiple licence model leads to a significant increase in
competition "for the market" in the form of stronger
bidding for licences.
Moving from a single to a multiple licence
model might not increase competition "for the market"
16. To assess the impact of changing to the multiple
licence model on bidding competition for licences, it is necessary
to assess the degree of competition that is likely under the single
licence model. It is far from clear that there will be an absence
of competition for the third licence. The changes made to the
conditions of the second Lottery licence (such as asset and intellectual
property ownership) should significantly reduce or remove any
incumbency advantage enjoyed by Camelot. Moreover, it does not
appear that Camelot has any significant brand advantage, exclusive
contracts or relationships, or any proprietary technological knowledge
that would inhibit competition. A further important factor is
that the Lottery will be more mature and hence easier to value
in 2009 than at previous bidding rounds
17. It is also unclear that the multiple licence
model would in fact lead to stronger bidding competition. This
is because bidders would face a significantly more complex and
uncertain strategic environment when developing their business
plans and preparing bids. For example, bidders would have to take
into account the potential impact of market competition in the
event that there are multiple operators. This will depend on the
eventual outcome of the licence award process, and also on whether
the NLC decides to issue additional licences sequentially. The
increased market and regulatory risk, combined with the likely
increase in the cost and complexity of bidding may deter some
bidders, thus decreasing rather than increasing bidding competition.
18. It might be argued that the multiple licence
model, by allowing for "bite-sized" licences could attract
small bidders who would be unwilling to bid for the entire Lottery.
This is not necessarily the case. For example, it is possible
that a firm bidding for all (or most) of the licences would be
able to take advantage of synergies between the licences and outbid
small competitors bidding for single licences. In this case, small
bidders could be deterred by this "large operator" advantage
and may rationally decide not to enter the competition in the
first place. The NLC could guard against this by reserving licences
for entrants or small bidders, but this would run the risk of
imposing an inefficient outcome to the detriment of the development
of the Lottery and the good causes.
Competition "for the market" can
be increased within the single licence model
19. There are a number of ways in which the bidding
process for a single licence could be modified, in order to encourage
competition against the incumbent. For example:
- gambling and gaming firms could be allowed to
operate the Lottery through a subsidiary (although as noted earlier
this could affect the National Lottery brand, and also place Camelot
at a disadvantage unless it is permitted to diversify beyond the
National Lottery);
- the Lottery operator could be permitted to select
different suppliers during the course of the licence;
- bidding costs could be underwritten; and/or
- the incumbent could be required to submit a final
binding bid before others are asked to bid.
A reserve price based on the incumbent's historic
performance could also be incorporated to protect against the
risk of weak competition.
20. The evaluation of these and many other techniques,
familiar in the fields of economic regulation and auction theory,
is outside the scope of this study. At this stage it suffices
to note that there are a number of possible ways in which the
single licence model could be modified to provide a more efficient
and less risky way of increasing the money available to good causes
than moving to the multiple licence model.
Offering multiple licences would be a complex
option with significant risks and no clear benefits to good causes.
21. We therefore conclude that the multiple licence
model is complex and risky, and that it could lead to a significantly
worse outcome for good causes. As explained above, the multiple
licence model could result in competition between operators and
a significant increase in regulation, both of which could undermine
the development of the Lottery to the detriment of good causes.
For this reason, we think that the multiple licence model is only
likely to increase the money for good causes if it leads to stronger
bidding competition than the single licence model. On the evidence
we have seen, we think that there are good reasons to doubt that
this would be the case.
Recommendations
22. We recommend that the Government should consider
the following issues before the next licence is awarded.
- First, the government should undertake a rigorous
assessment of the risk of weak bidding for a third single licence
in 2009. This will require a careful analysis of the size and
competitive impact of any incumbency advantage enjoyed by Camelot
(along the lines well-established by UK competition authorities),
taking into account the conditions in the Second Licence, the
range of potential bidders, and the maturity of the Lottery market.
- Second, if this assessment indicates that there
is a risk that competition for a single third licence would be
weak, the government should assess the alternative options that
could be used to negate any residual incumbency advantage and
encourage competition within the single licence model.
- Third, the government should consider whether
the contribution to good causes in the single licence model could
be increased by modifying the shape of the retention schedule.
This influences the marginal incentives to grow Lottery sales,
and it may be better (for good causes) to move from the current
declining schedule to a flatter or upward sloping schedule in
future.
- Fourth, if the Government decides to proceed
with the multiple licence model it should take steps to mitigate
the risk to good causes. For example, the government should:
- ensure that the bidding process permits a single
operator to win all licences. In this way a multiple licensing
approach would not rule out the possibility that the Lottery could
continue to be operated by a single operator, if this is the most
efficient approach; and
- ensure that licences are designed so that competition
between different operators would be limited, and economies of
scale and scope are preserved.
- Fifth, the Government should recognise that moving
to the multiple licence model would require the NLC to intervene
in complex commercial and strategic aspects of the Lottery, as
well as to adjudicate on access pricing and allocating risk and
investment between licence holders. This would be a very significant
increase in the scale and complexity of the NLC's remit, and it
will be important to ensure that NLC is properly resourced to
meet this challenge effectively.
175 Foreword to DCMS Decision Document (July 2003). Back
176
See, for example, the OFT guidelines ( February 2002). Back
| 
