Joint Committee on the Draft Gambling Bill Minutes of Evidence


Supplementary memorandum from the British Horseracing Board (DGB 163)

COMMENTS ON THE BETFAIR REPORT "THE FUNDING QUESTION" (NOVEMBER 2003)

Introduction

  1.  In November 2003, Betfair produced a paper which purports to deflect the charge that the shortfall in Levy income for the 41st Scheme can in any substantive way be attributed to betting exchanges and their impact on bookmaker margins. Instead, Betfair claims that the shortfall is created by changes in punter behaviour towards short priced favourites and migration to other products most notably fixed odds betting terminals. The paper was widely but briefly reported on in the major racing papers.

  2.  The paper is long on theory but short on evidence. Critically, Betfair have no evidence to support their claims of shifts in punter behaviour. Without this, the foundation stone of their arguments, Betfair's attribution of the shortfall to other causes has no basis in fact.

  3.  Ladbroke subsequently commissioned a leading expert witness consultancy, LECG, to review the Betfair report. It is a rebuttal of Betfair's arguments.

  4.  The LECG review largely reconfirms the conclusions of an earlier analysis presented to the Board, "The Impact of Betting Exchanges", which was based on bookmaker data and which demonstrated that while gross margin had migrated to other products, the primary cause of the shortfall was not a shift in the weight of money towards short priced favourites (although this was acknowledged as a secondary, minor factor) but the inflation of starting prices brought about by the ability of the on course market to trade into betting exchanges which operate to far lower overrounds.

  5.  LECG have had access to the same data and have come to the same conclusions as the BHB. It is understood that the LECG report has been submitted to the Joint Scrutiny Committee.

The Context and Relevance of the Betfair Report

  6.  Betfair claim to have produced the report in response to the BHB Chairman's widely reported IBC speech which referred to the negative impact of betting exchanges on the funding of horseracing. For many, the paper appeared to have been well thought through and therefore has had success from a PR point of view.

  7.  The shortfall is not however directly relevant to the execution of the charging policy which BHB now believes is appropriate for betting exchanges and their users. The relevant questions which have to be answered in relation to betting exchanges, in so far as funding is concerned, are:

    (a)

    are betting exchanges in the same market as bookmakers?

    (b)

    are the users of betting exchanges themselves in a distinct market?

    (c)

    should betting exchanges and their users pay for data on the same basis as bookmakers?

    (d)

    if the answer to (c) is no then on what basis should betting exchanges and their users pay?

  8.  The question of the shortfall is secondary to and dependent on the answers to these questions which form the necessary guide to a distinct charging policy for betting exchanges and their users and to which BHB maintains a clear focus.

  9.  This paper does not address the issue of the charging mechanism which BHB proposes to adopt in relation to betting exchanges.

Overview of the Betfair Report

  10.  In its executive summary, the Betfair report makes five assertions. A more detailed review of these is made in the Appendix.

    (a)

    "A flawed basis of calculation. Horseracing has based its funding model on a study whose assumptions and calculations are fundamentally flawed. It has been neither understood nor accepted that the calculations by OCP report failed to factor in the effects of changed punter behaviour that might be brought about by the new basis of tax".

  11.  It is self evident that the full recycling assumption, upon which estimates if levy yield were made, were wrong. Betfair produce no evidence, however, on changed punter behaviour but instead focus on questionable theories of presumed rational punter behaviour to support their arguments, which are then dressed as conclusions.

  12.  The evidence from Ladbroke, seen by BHB and LECG, on weight of money and singles betting is that there was no material change and that the principal cause of the greater than expected margin percentage decline can only therefore be attributable to margin as driven by changes in starting prices or the expected win rate of horses. This answers the key question not of where did the money go, but why did the greater than expected decline in margin percentage happen in the first place.

  13.  Betfair admit that margins on non favourites have shortened as a result of on course bookmakers' activities on exchanges. As they do not have access to the data they do not appreciate the material impact this has on overall margins. Bookmakers make over 42 per cent of their gross win from non favourites. Betfair dismiss this as if it were not material. It is very material.

  14.  BHB and LECG dispute Betfair's analysis of starting prices on favourites. Actual margins on favourites for Ladbroke between the 38th Levy Scheme (the base year for the forecast of the 41st Levy Scheme yield) and the 41st Levy Scheme declined by 5 per cent. BHB does however agree with Betfair when they assert that small changes in SPs can make large changes to margins.

  15.  The calculations made by OCP are not fundamentally flawed. Betfair's are. This is referred to below.

    (b)

    "Punter behaviour has changed. As a group, punters now bet a higher proportion of their stakes on low-margin favourites and singles. Less sophisticated bettors now bet some of their money on FOBTs while those who have stayed with racing are the more sophisticated players who by definition are lower margin as a group".

  16.  The only possible source of data to support the first claim is bookmakers. Betfair has no evidence. The evidence from Ladbroke seen by LECG and BHB is that there was some early limited change in behaviour, there has been no material shift in either favourites betting or singles.

  17.  Betfair also has no evidence for the latter claim. While there is no doubt that some of the additional money won by punters went on FOBTs, the evidence from the published results of Ladbrokes and William Hill is that the overwhelming bulk of money on FOBTs during the period of most significant growth (late 2002/early 2003) is incremental.

  18.  LECG point out that margin decline did not take place until some five months after the change in GPT which was well signalled. This casts further doubt on Betfair's claims. LECG see it as much more likely that the fall in margins from February 2002 was caused by the increasing growth in the use of exchanges by the on course market. LECG also find it noteworthy that the upward blip in over-rounds in March and April 2002 happened when it was decided for a short period of time that the on-course market could not hedge into exchanges. When this decision was reversed, overrounds went back down again. Betfair make no reference to this.

    (c)

    "Turnover target was too low. When underlying structural changes are considered, the turnover increase of 45 per cent that racing has experienced represents a dramatic and significant underperformance. A 95 per cent increase is what was needed to hit targets".

  19.  The key flaw in Betfair's re-calculation of the turnover needed to produce a static level of gross margin pre and post GPT is the assumption that the cash margin derived, not only in total , but from each category of horse ( favourite, non favourite, outsider etc) should stay the same. If this were the case, the mix of betting on favourites would increase by 26 per cent which, we have seen, has not happened.

  20.  It is quite simple to re-format Betfair's calculations to demonstrate that a 45 per cent increase is indeed a much more likely expected outcome of the change in tax. This re-working is contained in the Appendix.

  21.  Given the higher than expected margin drop, we do agree, however, that turnover would have had to increase by over 60 per cent for gross win to have then remained static.

    (d)

    "Over-round per runner is an irrelevant metric. Although often cited OPR is an irrelevant metric for the funding of horseracing, because margins on horses are not consistent. Gross punter loss is the only driver of horserace funding. The theoretical over-round is by definition not the actual gross loss".

  22.  OPR is on its own is merely a signpost to potential moves in margin but it is not irrelevant. While a downward change can, as Betfair claim, be benign it is far more likely to be evidence of negative margin pressure. Indeed, LECG in their review find OPR a good "surrogate" for margin. BHB's analysis linked inflation in SPs to changes in OPR and final margin in a way which is consistent with what is seen in the market. This analysis has been validated by Ladbroke.

  23.  Unless the pattern of winning horses changes markedly, the primary driver of the level of gross win is price ie the SP. If this inflates, then margins decline. If SP inflation accounts for the bulk of a margin shortfall, shift in weight of money or betting patterns can only account for the balance. This is what has been seen in the market and what the evidence points to.

  24.  Going forward there is no market event which would lead BHB to believe that there is likely to be any material change to weight of money or betting patterns.

  25.  Any further decline in OPR is therefore very likely to reduce margin and yield.

  26.  As on course OPR continue to exceed OPRs on exchanges there is further capacity for the on course OPR to decline.

    (e)

    "Incremental benefits of exchanges have been ignored. An understanding of a betting exchange's business model clearly demonstrates that the product it offers is generating incremental money both in horseracing and tax revenue".

  27.  BHB agrees that part of the betting exchange turnover and therefore the yield that it produces is likely to be incremental. Betfair make no attempt to analyse the negative impact of migration from other channels most notably telephone and internet betting.

  28.  BHB agrees that if integrity issues can be adequately addressed, betting exchanges and horseracing are almost uniquely suited to each other. Horseracing forms the bulk of an exchange's business as other sports are less suited to an exchange and an exchange cannot diversify into for instance FOBTs. The question is not whether the income betting exchanges produce from racing is incremental but if it is the right amount, charged on the right basis.



 
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