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Entrepreneurship and Innovation in the UK Betting Industry:
European Management Journal Vol. 23, No. 3, pp. 351–359, 2005 Ó 2005 Elsevier Ltd. All rights reserved. Printed in Great Britain 0263-2373 $30.00 doi:10.1016/j.emj.2005.04.013
Entrepreneurship and Innovation in the UK Betting Industry: The Rise of Person-toPerson Betting DES LAFFEY, University of Kent The emergence of Web-based ventures in 2000 offering person-to-Person (P2P) betting represented a genuine revolution in the oligopolistic United Kingdom betting industry. The radical innovation of P2P betting was that it enabled punters (the term for betting customers) to lay (accept) bets, a role that had previously been the preserve of bookmakers. This created a free market in betting, offering dynamic markets to punters and also enabling trading style activities as seen in financial markets. P2P betting flourished and by 2004 it was estimated that it accounted for up to 25–30% of UK horseracing betting turnover. The oligopolistic bookmakers, however, were less than enthusiastic about this innovation, challenging the P2P concept. In response, the P2P firms claimed P2P betting brought innovation and transparency to betting markets. This article considers P2P betting in context, and looks at its impact on the United Kingdom betting industry. Ó 2005 Elsevier Ltd. All rights reserved. Keywords: Person-to-Person betting, Betting, Betting exchanges, E-commerce, New venture creation
greater efficiency, would lead to the dramatic industry shakeouts described as ‘seismic shifts’ by Day (1997), whereby incumbents in stable industries are unable to cope with the onset of new competition. In reality, however, the Internet did not redraw industry structures; in the main it was an enabling technology, which made existing firms more efficient, a situation confirmed by the dot com meltdown of 2000 (Porter, 2001). One industry targeted as inefficient was the UK betting industry, historically dominated by a few big firms with healthy margins traditionally in the range of 15–20% (Bowen, 2002). In 2000 new ventures were launched which enabled people to bet directly against each other through websites, thus cutting out the bookmakers, in a concept known as personto-person (P2P) betting. Whilst many new ideas did not survive the bursting of the dot com bubble in 2000, P2P betting was to be a highly successful innovation. By 2004 the UK horseracing establishment estimated that it accounted for up to 25–30% of horseracing betting activity in the UK (UK Parliament, 2004).
Introduction
Objectives
In the 1990s dot com entrepreneurs backed by enormous amounts of venture capital funding tried to enter a wide range of markets. Many believed that the Internet, by lowering entry barriers and enabling
This paper considers the development of the P2P betting market in the UK: Section 2 will outline the key features of the UK betting industry. Section 3 will go on to consider what P2P betting is and the emergence
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of the early players in the market, Flutter and Betfair. Section 4 will explain the different models of P2P betting and the emergence of an industry standard model – the exchange – as pioneered by the dominant firm Betfair. Section 5 will then consider the challenges faced by P2P betting including those running a real time Internet operation, and the legal and ethical challenges which question the whole basis of this innovation. Finally, section 6 will discuss some possible future trends in the sector.
The UK Betting Industry Prior to P2P Betting What is Betting? The betting industry forms part of the wider gambling industry, which includes casinos, bingo and lotteries. The general distinction that may be drawn between gambling and betting is the possible element of judgement in betting – for example, that a certain horse will win – which contrasts with the pure chance of gambling activities.
Market Size and Structure All governments which allow betting make choices which balance the economic benefits of this activity with the ethical and legal concerns it raises. Whilst some jurisdictions ban betting or severely restrict provision, the UK market is a relatively liberal environment (Paton et al., 2002). In 1999–2000 turnover (the amount staked) of the UK betting industry was approximately £7.3 Billion, out of total gambling turnover of £27.2 Billion (National Audit Office, 2005). The dominance of horseracing within betting caused the historic categorisation of the industry into on-course betting, meaning at the racecourse where the event is taking place, and offcourse betting. Off-course betting has been legal in the UK since the early 1960s at licensed betting offices (LBOs), and has seen the growth of telephone betting and more recently electronic channels such as the Internet. Of these off-course channels the LBOs accounted for over 80% of total UK betting stakes and were oligopolistic in nature, being dominated by the ‘Big Three’ bookmakers – Ladbrokes, William Hill and Coral – who had a combined market share of 60% (Paton et al., 2002). There was regional competition from independent bookmakers but the large capital investment required to develop a network of betting outlets and a restrictive licensing system meant that challenging the established order was difficult (Paton et al., 2002). The remainder of turnover was split between the more fragmented and competitive on-course sector and the telephone betting sector where the Big Three had 78% of the market. Bets placed at offcourse channels were historically subject to general 352
betting duty (GBD), which stood at 9% in the 1990s. The GBD generated revenue for the government and was used to pay The Levy, funding for UK horse and dog racing in return for data rights for their events. Betting Products on Offer The traditional range of betting products available in the UK were described in the Budd Report (DCMS, 2001) as follows: Fixed Odds: This still makes up the vast majority of betting in the UK and involves betting at predetermined odds, for example £100 at 3-1. Pool Betting: This is a traditional form of betting which is used all over the world, also known as pari-mutuel, whereby the winners share the amount staked – the investment pool – minus the deductions of the operator. This type of betting is only significant on-course in the UK where it is controlled by the monopoly operator, the Tote. Spread Betting: An innovation in betting was the emergence of spread betting companies, who offered markets in ‘uncertain outcomes’1. The relative complexity of spread betting and greater risk, as potential loss is not predetermined, meant that it remained a niche product in the sector. A relatively small proportion of its activity centred on horseracing, thus limiting its threat to the fixed odds bookmakers (Ashforth, 2002). The Imperfect Market Levitt (2004, p223) considers why traditional fixed odds betting markets are organised differently to financial markets when they have much in common; investors using information who seek to gain through uncertainty, exclusive outcomes with a winner and a loser, and large amounts of money at stake2. However, while the neutral financial market maker seeks to equate supply and demand between players who can buy or sell (for example shares), the market maker in fixed odds betting markets, i.e., the bookmaker, is an active player who takes positions against the punters. Thus the fixed odds betting market is a seller-controlled market where punters can only ‘buy’ – bet that something will happen – whilst ‘selling’ (taking bets) is the preserve of the bookmaker. Odds for a horserace are set considering the estimated probability of an outcome occurring, which add up to 1. However, bookmakers make money by setting less generous odds, illustrated by a concept known as the over-round; how much greater than 1 the probabilities add up to, which represents their theoretical margin. The actual margins – the difference between the amount staked and the amount paid out, called the gross win – were traditionally in the range of 15–20% in the UK (Bowen, 2002). European Management Journal Vol. 23, No. 3, pp. 351–359, June 2005
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Betting Turnover in the United Kingdom 35,000 30,000
£ Millions
A further key characteristic of UK betting markets was the use of the final odds available on-course – known as the SP (starting price) – to set odds in the LBOs for horseracing. This was an effective mechanism as over 80% of bets placed in betting shops were made at the SP (DCMS, 2001). Moreover, the ‘‘Big Three’’ would intervene if they felt the odds were too generous, and feared a large liability on a particular race, by placing a heavy bet with an oncourse bookmaker to force the odds downwards (Monopolies and Mergers Commission, 1998).
25,000 20,000 15,000 10,000 5,000 0 1999-00 2000-01 2001-02 2002-03 2003-04
The Initial Impact of the Internet on Betting The emergence of the Internet as a business medium in the 1990s appeared to be well suited to the industry given that betting is based on the exchange of information. The share of Internet betting would rise from 1% of the market in 1999 to 5.5% in 2003 (National Audit Office, 2005). The low set up costs of the Internet saw the emergence of new entrants, for example BlueSquare.com and UKBetting, expansion by independent bookmakers as well as the development of Internet channels by the Big Three. Along with the lower search costs for punters in finding the best odds, for example by use of comparison services such as http://www.oddschecker.co.uk, this made the Internet betting sector a more competitive environment than the LBO sector. However, the established firms were able to hold their own and grew significant Internet revenues, whilst their grip on the LBO sector was not challenged.
The Move Offshore A more dramatic change was the setting up of offshore operations by the large UK bookmakers – which operated mainly through the telephone, but also through the Internet – in order to avoid the general betting duty (GBD). This threatened the taxation the UK government accrued from betting, some £500 million in 2000 (Paton et al, 2002). After advice from UK based academics Paton, Siegel and Vaughan Williams and negotiation with the major bookmakers the UK government replaced the GBD in 2001 with a tax and levy on the gross win of bookmakers which effectively halved the incidence of tax (Paton et al., 2002). This, together with further liberalisation of the gambling laws, led to a boom in UK betting as illustrated in figure 1.
The Emergence of Person-to-Person (P2P) Betting What is P2P Betting? After the industry had adjusted to the impact of ecommerce and the end of the GBD a more radical application of Internet technology was starting to European Management Journal Vol. 23, No. 3, pp. 351–359, June 2005
Figure 1 UK Betting Turnover 2000–2004 Source: National Audit Office (2005)
develop, namely P2P betting. Its main innovation was that it allowed users to set their own fixed odds against an outcome – known as ‘laying’ – and invite others to place bets, something which had previously been the preserve of bookmakers. The user would state on the website the odds and what amount of bets they were prepared to take – for example, £100 at 3-1 – and deposit funds to cover this liability with the website, i.e., the stake the user was willing to accept multiplied by odds offered, in this case £300. Those wishing to bet in the normal way, or back, are able to see the bets that have been laid. In the above example someone could accept the bet and deposit their £100 stake with the website, which is termed a matched bet3. Backers can also request better odds and the amount they wish to bet, which will then be left available on the system, an unmatched bet, which a layer can accept. In facilitating betting as a neutral intermediary the website does not take on the risk function of the bookmaker and generates revenue by taking a commission from the winner. This means that a wide array of events can be bet on as the website does not manage the setting of odds. This neutral position enables the P2P websites to offer stakes only limited by market liquidity, and to promise not to ban successful punters, something bookmakers would reserve the right to do. The trust role of the P2P website as an intermediary is also vital, holding deposited funds of both backers and layers which after the outcome are transferred to the winner’s account. Allowing users to lay their own odds enables a competitive market with different odds on the same outcome offered, which has become a major attraction of P2P betting. The P2P betting websites Betfair (www.betfair.com) and Betdaq (www.betdaq.com) state that odds on their respective sites are consistently 20% better than betting through bookmakers. Furthermore, the P2P sites would usually offer far more generous odds on outsiders than bookmakers. Better odds are possible because layers do not have 353
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the same overheads to cover as a traditional bookmaker and do not pay tax or levy. They also have far lower risk than bookmakers as they can lay selective outcomes in contrast to the bookmaker who is expected to lay all participants and as a consequence suffer large short term losses on certain events4.
The Importance of Liquidity to P2P Betting
The Main Early Players in the P2P Market: Flutter and Betfair
However, success in this new market crucially depended on achieving liquidity, in this context the ability to back and lay outcomes to the desired value quickly5. In simple terms if a punter visits a P2P site and is unable to place the bet they want they are less likely to return. Betfair achieved liquidity by delivering a far superior product to Flutter and was achieving market dominance over its rival, who were left with just 4% of the market in December 2000 (Ashforth, 2003b). So how did Betfair achieve this liquidity?
The new millennium was to see a number of entrants to the P2P market in the UK, the most significant of whom were Flutter and Betfair. Flutter – the term is British slang for a bet – was founded in February 1999 by Bain management consultants Joshua Hannah and Vince Monical. After deciding to launch a P2P venture they left the United States because of its prohibition of Internet betting, instead setting up their headquarters in London to take advantage of the UK’s liberal gambling environment (Red Herring, 2000). Betfair was the idea of Andrew Black, a colourful character whose work experience included financial trading, software development, and professional gambling. He used this experience to team up with Edward Wray, a former Vice President at the Investment Bank J.P. Morgan, to form what would later be known as Betfair in May 1999 (Thomas, 2003). Financing For such innovative ventures as P2P betting funding is most likely from ‘risk capital’ sources, in the form of cash for equity, rather than traditional sources of finance (Audretsch and Thurik, 2001). The major sources of risk capital are venture capitalists, professional investors who manage funds on behalf of others, and wealthy individuals who invest directly. In the 1990s venture capital investment had boomed in Europe, although not coming anywhere near American levels, increasing from €10.6 billion (Euros) in 1999 to €19.6 billion in 2000 (European Venture Capital Journal, 2001). Flutter secured a first round of venture capital funding from Europ@web, an investment fund set up by the French billionaire Bernard Arnault, worth $5.2 million (US Dollars) in October 1999 (Red Herring, 2000) which enabled them to launch their website in April 2000, to coincide with the biggest annual betting event in the UK, the Grand National horserace. Betfair were unable to attract venture capital funding, but after presenting their idea to wealthy individuals via contacts in the London financial community raised £1 million (UK pounds) (Thomas, 2003). The Betfair website then opened for business on 7th June 2000, the date of one of the major events of the racing calendar, the Epsom Derby. 354
With the vastly superior finances of Flutter – a second round of venture capital funding worth $33 million was arranged in June 2000 involving elite firms such as Benchmark Capital, UBS Capital and J.P. Morgan Chase (Fast Company, 2000) – it appeared that the odds were stacked in their favour.
System of Matching There was a significant difference between the P2P betting models of Betfair and Flutter which enhanced the liquidity of the Betfair site. Flutter in its original design required a complete match between a single backer and a single layer, which made betting a cumbersome affair. In contrast Betfair’ created a far more efficient system which aggregated backers, and layers, stakes into pools which could be matched. This was achieved by Andrew Black using his experience of the traditional ‘‘open outcry’’ financial market (also called pit or floor trading), where traders would buy and sell through physical interaction shouting their bid and ask prices to reach an agreed price, to create what would become known as a betting exchange (Thomas, 2003). As an example if 3 separate punters offered odds of 4-1 against a horse with stakes of £100, £200 and £300 this would be shown as £600 available at 4-1, of which a punter could back any amount6.
Industry Knowledge Flutter made another crucial error, a belief that they could thrive by attracting punters who participate with friends for social reasons, rather than professional punters who were banned (Red Herring, 2000). This betrayed their lack of industry knowledge as these players would bring liquidity, a matter exacerbated by further policy mistakes such as setting the maximum betting stake of £100 and placing a limit of 50 bets per month (Racing Post, 2000). In contrast, the betting experience of Andrew Black enabled Betfair to develop a more innovative European Management Journal Vol. 23, No. 3, pp. 351–359, June 2005
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product range, which included allowing the highly popular betting in-play, i.e. after an event has started. This is a much higher risk product for a bookmaker to offer as uncertainty about the final outcome can swing wildly, although some now offer such facilities, albeit not on racing events. Betfair have stated that for some events they have matched up to ten times more in-play than beforehand, showing the appeal of this product (Arnold, 2003).
This success inspired a vast number of copycat websites, all based on the exchange model, with the two most well known the Ireland based Betdaq and the UK rival Sporting Options. However, the liquidity of the enlarged Betfair was a formidable barrier to entry, illustrated by the inability of the new players to grab market share with lower commission rates – Betdaq even ran with no commission for the first year of operation.
After failing to match the Betfair product Flutter moved to an exchange model. This had a dramatic impact as market share increased to 16% in July 2001 and 30% in December 2001 posing a serious threat to Betfair (Wood, 2002).
Profiling Exchange Customers Number of Users In January 2004 Mark Davies of Betfair when being questioned by a UK Parliament Committee on Gambling legislation revealed that his company had ‘‘around 200,000 registered clients of whom about 30,000 are active on the site in any given week’’ (United Kingdom Parliament, 2004). Although growing in popularity the exchange concept was a niche product, as shown by a 2004 survey which found that less than 1% of the UK population had spent money on a betting exchange in the last 12 months compared to 11% who had done so via betting with a bookmaker on horseracing (Creigh-Tyte and Lepper, 2004).
Winner Takes All In December 2001 the two companies announced that they were merging. There were different views on what motivated the merger, with Wood (2002, p2) suggesting that whilst ‘‘the received wisdom is that Betfair saved Flutter from oblivion’’, an alternative view is that Betfair were feeling increasingly threatened and bought Flutter ‘‘to close them down’’. However, Flutter had spent heavily and their funders took the opportunity to acquire a 25% share in the enlarged merged company. Given that the new entity was called Betfair, and that Edward Wray of Betfair was its CEO, it seems that in practice this was a takeover.
Attracting Customers Through Value and Innovation
The enlarged company’s growth now accelerated rapidly as it gained further liquidity from the influx of ex-users of Flutter. The new users had the opportunity to bet larger amounts on a wider array of events, which led to rapid growth of the business in 2002. This is illustrated by figure 2 as the figure of £50 million of bets matched in a week was reached in August 2002.
The betting exchange concept was attracting ‘‘value punters’’ through the better odds on offer for traditional backing, and those drawn by its ‘‘product innovation’’ – laying, place betting and in-play. Whilst the exchange customers were a minority of UK betting customers they were generally seen as more sophisticated higher value customers, with the average stake being 3 times that of the LBO customer (Stanley, 2003). In addition to this the unlimited stakes were drawing in the ‘‘high rollers’’, those prepared to stake enormous sums, who bookmakers
Growth in the value of Betfair's matched bets 2001-2002 60,000,000 50,000,000 40,000,000 30,000,000 20,000,000 10,000,000
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Value of weekly matched bets £
The emergent Betfair now had an effective monopoly with an estimated market share of 98% (Wood, 2002).
Figure 2 Bets Matched by Betfair. Note figures from January 2002 are for the merged entity Source: Developed using Betfair press releases
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would often refuse to take bets from, wary of their more sophisticated betting strategies or suspecting the use of inside information. The amounts such punters are prepared to stake was shown by the largest bet offered on an exchange to date; a Betfair user ‘‘backed’’ a greyhound for £900,000 in May 2004 (Kay, 2004). This type of bet confirms the reliance of the exchanges on a small number of punters.
Changing the Nature of Betting However, the exchanges were also seeing the emergence of behaviour normally seen in financial markets, and identified in the spread betting sector of betting markets (Vaughan Williams, 2004). This behaviour can be categorized according to Arnold (2002) – writing at the time about users of the derivatives markets – as speculation, hedging and arbitrage.
Speculation This speculation is not about whether a horse will win, but upon movements in the prices on offer. For example, someone might back a horse at 4-1 with a stake of £1,500 before the race. During the race the horse is leading and its odds shorten to 3-1, so that the punter can lay at £1,875 at 3-1 ‘in-play’, thus producing a guaranteed win situation, as shown in Table 1. As with the derivatives market these speculators bring considerable liquidity to the Betfair market. They are encouraged to back and lay on the same event, as commission is charged only on net winnings from an event, meaning that losses can be offset, and are encouraged to bet greater sums of money by a sliding commission scale. The requirement for constant access to a betting exchange, television coverage of sports events and the time to engage in such speculation limited the number who could take part in such activity. However, evidence given in 2004 to the UK Parliament Gambling Bill confirmed that some users (i.e., speculators) would make large numbers of bets during an event to make relatively small profits on a single event as described above (United Kingdom Parliament, 2004). This sophisticated trading approach was in stark contrast to the primitive nature of many Table 1 Speculation Scenario using P2P Betting, Backing an Outcome at 4-1 with a Stake of £1,500 and Laying at 3-1 with a Stake of £1,700
Return (before commission) Loss Net profit (before commission) Source: Author
356
Horse wins
Horse Loses
£6,000 £5,625 £375
£1,875 £1,500 £375
of the LBO customers, who would make their decisions on irrational grounds, such as ‘‘the colours worn by a jockey, or the name of a horse’’ as Mark Davies of Betfair states (Stanley, 2003, p2).
Hedging The betting exchange concept has offered a useful hedging mechanism to the on-course bookmakers, as risk can be offset. Historically, on-course bookmakers would have had to do this through specialist bookmakers at unattractive odds. The 20% better odds of the exchanges make hedging more viable.
Arbitrage The exchanges have also enabled arbitrage by oncourse bookmakers laying to punters and then backing on Betfair simultaneously to make an instant profit by exploiting price differences. This arbitrage opportunity exists through the lower costs of layers on Betfair and the existence of on-course punters who are either unaware of exchanges or not comfortable with the process, the former is inherent to the economics of the different models, whilst the latter may be curtailed over time. For an on-course bookmaker who had instant access to Betfair arbitrage became possible, and the scenario of Table 1 could be achieved. However, as in financial markets such activity is not without risks, in particular synchronisation risk, that the odds available in the Betfair market alter, or trading volumes fall when the bookmaker tries to exploit the disparity between the two markets. For the ‘‘Big Three’’ hedging and arbitrage activities had serious implications, interfering with the starting price mechanism, covered in Section 2.2.2. Risks for on-course bookmakers were reduced (UK Parliament, 2002), so they could make their odds more attractive which in turn reduced the margins of the LBOs. The ability to manipulate the starting price was also removed, as on-course bookmakers could recycle the ‘‘Big Three’s’’ money on betting exchanges to lock in a profit as above.
Market Size The commission income generated by Betfair, accepted as the overwhelmingly dominant player, is in the public domain and detailed in Table 2. When compared to the gross win (stakes minus money paid out in winnings) of £722 million in 2004 by William Hill, it would appear that the betting exchange concept has had little impact. HowEuropean Management Journal Vol. 23, No. 3, pp. 351–359, June 2005
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Table 2 Betfair Commission Income 2001–2004 (Year ending April 30th)
Commission Income £ thousands
2001
2002
2003
2004
480
6,090
32,319
66,725
Source: Betfair Annual Report 2004
ever, the commission of exchange betting vastly understates its impact as it is a low margin model. As betting losses in an event can be offset against winnings the actual margin made on the volume of turnover (matched bets) is far lower than the advertised commissions of 2–5%. Estimates for Betfair’s turnover (matched bets) range from £2.5 Billion to close to £6 Billion for 2004 whilst in comparison, William Hill had a turnover of £8.3 Billion in 2004. However, it is very difficult to compare exchange turnover to that of a traditional bookmaker, as most of the activity on betting exchanges is generated through products not available at a traditional bookmaker.
Challenges Faced by the Betting Exchange Model Technical Challenges Running a betting exchange poses a demanding set of problems. At peak times Betfair matched 1 million trades per day, 4 times that of the London Stock Exchange (Phillips, 2003). Betfair’s website was not always able to cope with such demands leading to the site crashing on occasion causing major problems given that in-play and new forms of betting activity were such a major part of their business.
Security In 2004 it was reported that many betting sites were facing extortion threats from criminal gangs based in Eastern Europe (Nuttall, 2004). Unless payments were made denial-of-service attacks would be launched, whereby a website is overloaded with requests for data, causing it to crash. With the dependence of revenue on major events and the need for real-time service to facilitate in-play this was a particular threat to the exchanges. Such attacks were to bring down the Sporting Options and Betfair sites in 2004.
against betting exchanges, claiming that the model was illegal. To quote David Hood of William Hill ‘‘If I stand in the high street outside a betting shop and offer to lay a bet which you take, I am breaking the law, because I am not a licensed bookmaker. If we both boot up laptops in the street and strike the bet using a betting exchange, I am not breaking the law. What is the difference?’’ (Phillips, 2003, p2) They went on to argue that individuals, some of whom were already bookmakers, were trading such large sums on betting exchanges that they were using it to run a business. This was taking money away from UK horseracing, as conventional bookmakers had to contribute towards The Levy and the horseracing establishment thus argued that layers should be licensed and also liable for the same charges as bookmakers, measures which would severely affect betting exchanges. Betfair and the other betting exchanges responded by claiming that they rather than their clients were the bookmaker, that the exchanges paid tax and levy, and their clients were punters who either backed or laid a selection. Race Fixing A fundamental danger of the exchange model is abuse of the system by those with insider knowledge. A layer may offer attractive odds against an outcome that has been fixed or when they know the horse is carrying an injury. Although there had been earlier allegations of race fixing this became national news in the UK in March 2004 when high profile jockeys Kieren Fallon and Sean Fox lost races in controversial circumstances. On both these races the odds for the horses had moved significantly with Sean Fox’s horse Ice Saint ‘drifting’ from even money (1-1) to over 5-1, with large amounts available for backers. Whilst horse racing has a long history of corruption, meaning that it would be unfair to blame betting exchanges for the existence of underhand deals, the innovation of laying certainly makes race fixing far easier as in conventional betting throwing a race only leads to a definite gain if all other horses in the event are backed.
Challenges from the Established Order
On the other hand, exchange betting can provide evidence of corruption as all users are registered, in contrast to the mostly anonymous cash bets of the LBOs. Such audit trails were used by the Jockey Club, who regulate horseracing, to bring disciplinary enquiries against leading owners in 2004. As a result of this Miles Rodgers, who had traded £4 million on a Betfair account in one year, was banned from racing for two years for laying his own horses to lose (Lees, 2004).
Are Layers Bookmakers? After initially ignoring the emergence of exchanges the bookmakers started a concerted campaign
The Legislative Battle The issue of betting exchanges was considered in the Gambling Bill, designed to modernise Britain’s laws
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in this area. In 2004 a UK government report stated that whilst it welcomed the transparency brought by the exchange model it presented new risks and those layers using betting exchanges to run a business should be licensed (UK Parliament, 2004). However, this presented problems of definition and also failed to deal with the issue of overseas users of betting exchanges, who would be outside regulation. Because of these problems the UK government decided not to implement the recommendations.
The Future of Betting Exchanges Developments in the UK The difficulty of challenging Betfair in the UK market was shown by inability of Sporting Options or Betdaq to make inroads into their dominance. This was confirmed by the exit of Sporting Options in November 2004. The P2P concept did start however, to initiate change in UK bookmaking, at least at the fringes as some of the new Internet and telephone bookmakers, such as Bet365.com, started to give their customers limited opportunities to lay outcomes. There were also rumours that the ‘‘Big Three’’ were going to launch exchanges, offering zero commission in an attempt to challenge Betfair. From the experience of Betdaq and Sporting Options such a challenge would be difficult given Betfair’s enormous market liquidity. In the short term as part of their wider strategy the bookmakers’ main focus has been on offering risk free (for the bookmaker, if not the punter!) gambling products in the LBOs, at the expense of betting on horseracing.
Growth of Exchanges Overseas The sizeable betting exchange turnover generated by overseas accounts – press releases regularly quote 25% for Betfair and 60% for Betdaq – illustrated the potential for the export of the betting exchange model. However, many jurisdictions were either hostile to the idea of Internet betting in general, or disliked the concept of betting exchanges. But even in jurisdictions where Internet betting is illegal there was still enormous demand. The United States generates huge Internet betting turnover (McCoy, 2002) and The Hong Kong Jockey Club, which has a local monopoly on betting, was blaming Internet betting operations including betting exchanges for its 30% fall in turnover since 1997 (Hong Kong Jockey Club, 2003).
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Conclusion In conclusion this paper has looked at the growth of P2P betting in the UK and the meteoric rise of Betfair and their exchange model. What is particularly striking is the manner in which the experiences of the founding entrepreneur enabled the development of a superior betting exchange model which defeated a rival with an overwhelming financial advantage. The paper has also drawn out some specific lessons for P2P betting. There is a need for scale to achieve liquidity – the ‘‘network externalities’’. Today, given Betfair’s overwhelming control of this market, it is difficult to see how other P2P exchanges can compete effectively with them. However, these lessons can be learnt by firms in the booming P2P poker market, where liquidity is again crucial. There are also a number of key challenges faced by betting exchanges due to their unique nature. The regulatory issues will not go away, but neither will betting exchanges, if only because of the innovation and choice they offer customers.
Notes 1. As an example the spread betting firm could offer a spread of points for the UK Football Premiership of 60–65 points for Liverpool. The punter could buy points if they think Liverpool will get more than 65 points and sell if they think Liverpool will get less than 60 points. The punter specifies a unit stake, for example £100, and then wins or loses this amount multiplied by the number of points Liverpool finish above or below the top or bottom of the spread. 2. One major difference, however, between financial markets and the fixed odds betting market are the definite losses incurred through activity in betting markets. 3. The matched bet is used as the basis for P2P turnover. The main measure given has been the backer’s stake multiplied by two, as in contrast to the traditional bookmaker there are layers as well as backers. 4. Examples of these short term losses are provided by a quote from Tom Kelly, Chief Executive of the Association of British Bookmakers, speaking in January 2004, ‘‘The industry lost some £20 million at last year’s Cheltenham Festival and some £30 million when Frankie Dettori rode all seven winners at Ascot [in 1996]’’ (UK Parliament, 2004). 5. This is a form of network externality whereby the more users there are of the product the more valuable it becomes (Shapiro and Varian, 1999). 6. The success of the exchange model was rather ironic as it was made possible by the advent of websites, when open outcry markets across the world were in decline due to the introduction of electronic trading.
References Arnold, G. (2002) Corporate Financial Management. (Second ed.). Financial Times/Prentice Hall, Harlow England. Arnold, H (2003), Good at winning and losing, The Financial Times, 22nd April 2003. Ashforth, D. (2002) Interview: Compton Hellyer - ‘I am confident we aren’t losing business to exchanges, Racing Post, 30th October 2002.
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Ashforth, D. (2003b) Comment, Racing Post, 10th December 2003. Audretsch, D.B. and Thurik, A.R. (2001) What’s new about the new economy – sources of growth in the managed and entrepreneurial economies. Industrial and Corporate Change 10(1), 267–315. Betfair (2004) ‘‘Betfair Annual Report’’, London, available via www.betfair.com. Bowen D. (2002) Inside track: Betting on Internet exchanges, The Financial Times, 26th September 2002. Creigh-Tyte S., and Lepper, J. (2004) Survey of Participation in, and Attitudes Towards, Gambling: Key Findings from the 2004 NOP Survey, Department of Culture, Media and Sport, Technical Paper No. 4, April 2004. Day, G.S. (1997) Strategies for surviving a shakeout. Harvard Business Review 75(2), 92–102. DCMS (2001) Gambling Review Report, Department of Culture, Media and Sport, Gambling Review Body, July 2001. European Venture Capital Journal (2001) EVCA reports record levels invested and raised in 2000, European Venture Capital Journal, 13th June 2001. Fast Company (2000), Josh Hannah, available via www.fastcompany.com/ftalk/london/hannah.html. Hong Kong Jockey Club (2003) Annual Report 2003, Hong Kong Jockey Club. Kay, J. (2004) Greyhounds: Derby bet ‘the biggest ever’, Racing Post, 9th May 2004. Lees, J. (2004) ‘‘Rodgers’ betting history revealed’’, Racing Post, 7th September 2004. Levitt, S.D. (2004) Why are gambling markets organised so differently from financial markets?. The Economic Journal 114(April), 223–246. McCoy, K. (2002) Online gamble pays off for Internet sports books, USA TODAY, 29th March 2002. Monopolies and Mergers Commission (1998), Ladbroke Group Plc and the Coral Betting business: A Report on the Merger Situation, The Stationary Office, London.
National Audit Office (2005) HM Customs and Excise, Gambling Duties, 14th January 2005. Nuttall, C, (2004) Hackers blackmail Internet bookies, The Financial Times, 23rd February 2004. Paton, D., Siegel, D.S. and Vaughan Williams, L. (2002) A policy response to the e-commerce revolution: the case of betting taxation in the UK. The Economic Journal 112(June), 296–314. Phillips, T. (2003) A gambler’s broker, The International Herald Tribune Online, 29th September 2003, available via www.iht.com. Porter, M.E. (2001) Strategy and the Internet. Harvard Business Review 79(3), 63–78. Racing Post (2000) Net prophet: punters take on each other at flutter.com, Racing Post, 5th May 2000. Red Herring (2000), VCs roll dice on UK gambling site, available via www.redherring.com. Shapiro, C. and Varian, H.R. (1999) Information Rules: A Strategic Guide to the Network Economy. Harvard Business School Press, Boston, Massachusetts. Stanley, B. (2003) Online exchange rocks sports betting. The Associated Press, available viahttp://cjonline.com/ stories/110103/bus_betting.shtml. Thomas, M. (2003) Success Story: Andrew Black talks to Startups.co.uk about the gamble that paid off, available via www.startups.co.uk. United Kingdom Parliament (2002), Select Committee on Culture, Media and Sport Memoranda Submission 28, Memorandum submitted by Betfair. United Kingdom Parliament (2004), Draft Gambling Bill, Joint Committee Reports, available via http:// www.publications.parliament.uk/pa/jt/jtgamb.htm. Vaughan Williams, L. (2004) Decision-making in betting markets. Significance 1(3), 109–112. Wood, G. (2002) Flutter’s departure leaves bitter taste. Guardian Unlimited, available viahttp://sport/ guardian.co.uk/horseracing/story/0,10149,634157,00. html.
DES LAFFEY, Kent Business School, University of Kent, Canterbury, UK, CT2 7PE, E-mail: D.J.Laffey@kent. ac.uk Des Laffey is Lecturer in E-Commerce at Kent Business School. His research interests include new ventures enabled through ecommerce, online advertising, website quality and the betting industry.
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Entrepreneurship and Innovation in the UK Betting Industry: The Rise of Person-toPerson Betting DES LAFFEY, University of Kent The emergence of Web-based ventures in 2000 offering person-to-Person (P2P) betting represented a genuine revolution in the oligopolistic United Kingdom betting industry. The radical innovation of P2P betting was that it enabled punters (the term for betting customers) to lay (accept) bets, a role that had previously been the preserve of bookmakers. This created a free market in betting, offering dynamic markets to punters and also enabling trading style activities as seen in financial markets. P2P betting flourished and by 2004 it was estimated that it accounted for up to 25–30% of UK horseracing betting turnover. The oligopolistic bookmakers, however, were less than enthusiastic about this innovation, challenging the P2P concept. In response, the P2P firms claimed P2P betting brought innovation and transparency to betting markets. This article considers P2P betting in context, and looks at its impact on the United Kingdom betting industry. Ó 2005 Elsevier Ltd. All rights reserved. Keywords: Person-to-Person betting, Betting, Betting exchanges, E-commerce, New venture creation
greater efficiency, would lead to the dramatic industry shakeouts described as ‘seismic shifts’ by Day (1997), whereby incumbents in stable industries are unable to cope with the onset of new competition. In reality, however, the Internet did not redraw industry structures; in the main it was an enabling technology, which made existing firms more efficient, a situation confirmed by the dot com meltdown of 2000 (Porter, 2001). One industry targeted as inefficient was the UK betting industry, historically dominated by a few big firms with healthy margins traditionally in the range of 15–20% (Bowen, 2002). In 2000 new ventures were launched which enabled people to bet directly against each other through websites, thus cutting out the bookmakers, in a concept known as personto-person (P2P) betting. Whilst many new ideas did not survive the bursting of the dot com bubble in 2000, P2P betting was to be a highly successful innovation. By 2004 the UK horseracing establishment estimated that it accounted for up to 25–30% of horseracing betting activity in the UK (UK Parliament, 2004).
Introduction
Objectives
In the 1990s dot com entrepreneurs backed by enormous amounts of venture capital funding tried to enter a wide range of markets. Many believed that the Internet, by lowering entry barriers and enabling
This paper considers the development of the P2P betting market in the UK: Section 2 will outline the key features of the UK betting industry. Section 3 will go on to consider what P2P betting is and the emergence
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of the early players in the market, Flutter and Betfair. Section 4 will explain the different models of P2P betting and the emergence of an industry standard model – the exchange – as pioneered by the dominant firm Betfair. Section 5 will then consider the challenges faced by P2P betting including those running a real time Internet operation, and the legal and ethical challenges which question the whole basis of this innovation. Finally, section 6 will discuss some possible future trends in the sector.
The UK Betting Industry Prior to P2P Betting What is Betting? The betting industry forms part of the wider gambling industry, which includes casinos, bingo and lotteries. The general distinction that may be drawn between gambling and betting is the possible element of judgement in betting – for example, that a certain horse will win – which contrasts with the pure chance of gambling activities.
Market Size and Structure All governments which allow betting make choices which balance the economic benefits of this activity with the ethical and legal concerns it raises. Whilst some jurisdictions ban betting or severely restrict provision, the UK market is a relatively liberal environment (Paton et al., 2002). In 1999–2000 turnover (the amount staked) of the UK betting industry was approximately £7.3 Billion, out of total gambling turnover of £27.2 Billion (National Audit Office, 2005). The dominance of horseracing within betting caused the historic categorisation of the industry into on-course betting, meaning at the racecourse where the event is taking place, and offcourse betting. Off-course betting has been legal in the UK since the early 1960s at licensed betting offices (LBOs), and has seen the growth of telephone betting and more recently electronic channels such as the Internet. Of these off-course channels the LBOs accounted for over 80% of total UK betting stakes and were oligopolistic in nature, being dominated by the ‘Big Three’ bookmakers – Ladbrokes, William Hill and Coral – who had a combined market share of 60% (Paton et al., 2002). There was regional competition from independent bookmakers but the large capital investment required to develop a network of betting outlets and a restrictive licensing system meant that challenging the established order was difficult (Paton et al., 2002). The remainder of turnover was split between the more fragmented and competitive on-course sector and the telephone betting sector where the Big Three had 78% of the market. Bets placed at offcourse channels were historically subject to general 352
betting duty (GBD), which stood at 9% in the 1990s. The GBD generated revenue for the government and was used to pay The Levy, funding for UK horse and dog racing in return for data rights for their events. Betting Products on Offer The traditional range of betting products available in the UK were described in the Budd Report (DCMS, 2001) as follows: Fixed Odds: This still makes up the vast majority of betting in the UK and involves betting at predetermined odds, for example £100 at 3-1. Pool Betting: This is a traditional form of betting which is used all over the world, also known as pari-mutuel, whereby the winners share the amount staked – the investment pool – minus the deductions of the operator. This type of betting is only significant on-course in the UK where it is controlled by the monopoly operator, the Tote. Spread Betting: An innovation in betting was the emergence of spread betting companies, who offered markets in ‘uncertain outcomes’1. The relative complexity of spread betting and greater risk, as potential loss is not predetermined, meant that it remained a niche product in the sector. A relatively small proportion of its activity centred on horseracing, thus limiting its threat to the fixed odds bookmakers (Ashforth, 2002). The Imperfect Market Levitt (2004, p223) considers why traditional fixed odds betting markets are organised differently to financial markets when they have much in common; investors using information who seek to gain through uncertainty, exclusive outcomes with a winner and a loser, and large amounts of money at stake2. However, while the neutral financial market maker seeks to equate supply and demand between players who can buy or sell (for example shares), the market maker in fixed odds betting markets, i.e., the bookmaker, is an active player who takes positions against the punters. Thus the fixed odds betting market is a seller-controlled market where punters can only ‘buy’ – bet that something will happen – whilst ‘selling’ (taking bets) is the preserve of the bookmaker. Odds for a horserace are set considering the estimated probability of an outcome occurring, which add up to 1. However, bookmakers make money by setting less generous odds, illustrated by a concept known as the over-round; how much greater than 1 the probabilities add up to, which represents their theoretical margin. The actual margins – the difference between the amount staked and the amount paid out, called the gross win – were traditionally in the range of 15–20% in the UK (Bowen, 2002). European Management Journal Vol. 23, No. 3, pp. 351–359, June 2005
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Betting Turnover in the United Kingdom 35,000 30,000
£ Millions
A further key characteristic of UK betting markets was the use of the final odds available on-course – known as the SP (starting price) – to set odds in the LBOs for horseracing. This was an effective mechanism as over 80% of bets placed in betting shops were made at the SP (DCMS, 2001). Moreover, the ‘‘Big Three’’ would intervene if they felt the odds were too generous, and feared a large liability on a particular race, by placing a heavy bet with an oncourse bookmaker to force the odds downwards (Monopolies and Mergers Commission, 1998).
25,000 20,000 15,000 10,000 5,000 0 1999-00 2000-01 2001-02 2002-03 2003-04
The Initial Impact of the Internet on Betting The emergence of the Internet as a business medium in the 1990s appeared to be well suited to the industry given that betting is based on the exchange of information. The share of Internet betting would rise from 1% of the market in 1999 to 5.5% in 2003 (National Audit Office, 2005). The low set up costs of the Internet saw the emergence of new entrants, for example BlueSquare.com and UKBetting, expansion by independent bookmakers as well as the development of Internet channels by the Big Three. Along with the lower search costs for punters in finding the best odds, for example by use of comparison services such as http://www.oddschecker.co.uk, this made the Internet betting sector a more competitive environment than the LBO sector. However, the established firms were able to hold their own and grew significant Internet revenues, whilst their grip on the LBO sector was not challenged.
The Move Offshore A more dramatic change was the setting up of offshore operations by the large UK bookmakers – which operated mainly through the telephone, but also through the Internet – in order to avoid the general betting duty (GBD). This threatened the taxation the UK government accrued from betting, some £500 million in 2000 (Paton et al, 2002). After advice from UK based academics Paton, Siegel and Vaughan Williams and negotiation with the major bookmakers the UK government replaced the GBD in 2001 with a tax and levy on the gross win of bookmakers which effectively halved the incidence of tax (Paton et al., 2002). This, together with further liberalisation of the gambling laws, led to a boom in UK betting as illustrated in figure 1.
The Emergence of Person-to-Person (P2P) Betting What is P2P Betting? After the industry had adjusted to the impact of ecommerce and the end of the GBD a more radical application of Internet technology was starting to European Management Journal Vol. 23, No. 3, pp. 351–359, June 2005
Figure 1 UK Betting Turnover 2000–2004 Source: National Audit Office (2005)
develop, namely P2P betting. Its main innovation was that it allowed users to set their own fixed odds against an outcome – known as ‘laying’ – and invite others to place bets, something which had previously been the preserve of bookmakers. The user would state on the website the odds and what amount of bets they were prepared to take – for example, £100 at 3-1 – and deposit funds to cover this liability with the website, i.e., the stake the user was willing to accept multiplied by odds offered, in this case £300. Those wishing to bet in the normal way, or back, are able to see the bets that have been laid. In the above example someone could accept the bet and deposit their £100 stake with the website, which is termed a matched bet3. Backers can also request better odds and the amount they wish to bet, which will then be left available on the system, an unmatched bet, which a layer can accept. In facilitating betting as a neutral intermediary the website does not take on the risk function of the bookmaker and generates revenue by taking a commission from the winner. This means that a wide array of events can be bet on as the website does not manage the setting of odds. This neutral position enables the P2P websites to offer stakes only limited by market liquidity, and to promise not to ban successful punters, something bookmakers would reserve the right to do. The trust role of the P2P website as an intermediary is also vital, holding deposited funds of both backers and layers which after the outcome are transferred to the winner’s account. Allowing users to lay their own odds enables a competitive market with different odds on the same outcome offered, which has become a major attraction of P2P betting. The P2P betting websites Betfair (www.betfair.com) and Betdaq (www.betdaq.com) state that odds on their respective sites are consistently 20% better than betting through bookmakers. Furthermore, the P2P sites would usually offer far more generous odds on outsiders than bookmakers. Better odds are possible because layers do not have 353
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the same overheads to cover as a traditional bookmaker and do not pay tax or levy. They also have far lower risk than bookmakers as they can lay selective outcomes in contrast to the bookmaker who is expected to lay all participants and as a consequence suffer large short term losses on certain events4.
The Importance of Liquidity to P2P Betting
The Main Early Players in the P2P Market: Flutter and Betfair
However, success in this new market crucially depended on achieving liquidity, in this context the ability to back and lay outcomes to the desired value quickly5. In simple terms if a punter visits a P2P site and is unable to place the bet they want they are less likely to return. Betfair achieved liquidity by delivering a far superior product to Flutter and was achieving market dominance over its rival, who were left with just 4% of the market in December 2000 (Ashforth, 2003b). So how did Betfair achieve this liquidity?
The new millennium was to see a number of entrants to the P2P market in the UK, the most significant of whom were Flutter and Betfair. Flutter – the term is British slang for a bet – was founded in February 1999 by Bain management consultants Joshua Hannah and Vince Monical. After deciding to launch a P2P venture they left the United States because of its prohibition of Internet betting, instead setting up their headquarters in London to take advantage of the UK’s liberal gambling environment (Red Herring, 2000). Betfair was the idea of Andrew Black, a colourful character whose work experience included financial trading, software development, and professional gambling. He used this experience to team up with Edward Wray, a former Vice President at the Investment Bank J.P. Morgan, to form what would later be known as Betfair in May 1999 (Thomas, 2003). Financing For such innovative ventures as P2P betting funding is most likely from ‘risk capital’ sources, in the form of cash for equity, rather than traditional sources of finance (Audretsch and Thurik, 2001). The major sources of risk capital are venture capitalists, professional investors who manage funds on behalf of others, and wealthy individuals who invest directly. In the 1990s venture capital investment had boomed in Europe, although not coming anywhere near American levels, increasing from €10.6 billion (Euros) in 1999 to €19.6 billion in 2000 (European Venture Capital Journal, 2001). Flutter secured a first round of venture capital funding from Europ@web, an investment fund set up by the French billionaire Bernard Arnault, worth $5.2 million (US Dollars) in October 1999 (Red Herring, 2000) which enabled them to launch their website in April 2000, to coincide with the biggest annual betting event in the UK, the Grand National horserace. Betfair were unable to attract venture capital funding, but after presenting their idea to wealthy individuals via contacts in the London financial community raised £1 million (UK pounds) (Thomas, 2003). The Betfair website then opened for business on 7th June 2000, the date of one of the major events of the racing calendar, the Epsom Derby. 354
With the vastly superior finances of Flutter – a second round of venture capital funding worth $33 million was arranged in June 2000 involving elite firms such as Benchmark Capital, UBS Capital and J.P. Morgan Chase (Fast Company, 2000) – it appeared that the odds were stacked in their favour.
System of Matching There was a significant difference between the P2P betting models of Betfair and Flutter which enhanced the liquidity of the Betfair site. Flutter in its original design required a complete match between a single backer and a single layer, which made betting a cumbersome affair. In contrast Betfair’ created a far more efficient system which aggregated backers, and layers, stakes into pools which could be matched. This was achieved by Andrew Black using his experience of the traditional ‘‘open outcry’’ financial market (also called pit or floor trading), where traders would buy and sell through physical interaction shouting their bid and ask prices to reach an agreed price, to create what would become known as a betting exchange (Thomas, 2003). As an example if 3 separate punters offered odds of 4-1 against a horse with stakes of £100, £200 and £300 this would be shown as £600 available at 4-1, of which a punter could back any amount6.
Industry Knowledge Flutter made another crucial error, a belief that they could thrive by attracting punters who participate with friends for social reasons, rather than professional punters who were banned (Red Herring, 2000). This betrayed their lack of industry knowledge as these players would bring liquidity, a matter exacerbated by further policy mistakes such as setting the maximum betting stake of £100 and placing a limit of 50 bets per month (Racing Post, 2000). In contrast, the betting experience of Andrew Black enabled Betfair to develop a more innovative European Management Journal Vol. 23, No. 3, pp. 351–359, June 2005
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product range, which included allowing the highly popular betting in-play, i.e. after an event has started. This is a much higher risk product for a bookmaker to offer as uncertainty about the final outcome can swing wildly, although some now offer such facilities, albeit not on racing events. Betfair have stated that for some events they have matched up to ten times more in-play than beforehand, showing the appeal of this product (Arnold, 2003).
This success inspired a vast number of copycat websites, all based on the exchange model, with the two most well known the Ireland based Betdaq and the UK rival Sporting Options. However, the liquidity of the enlarged Betfair was a formidable barrier to entry, illustrated by the inability of the new players to grab market share with lower commission rates – Betdaq even ran with no commission for the first year of operation.
After failing to match the Betfair product Flutter moved to an exchange model. This had a dramatic impact as market share increased to 16% in July 2001 and 30% in December 2001 posing a serious threat to Betfair (Wood, 2002).
Profiling Exchange Customers Number of Users In January 2004 Mark Davies of Betfair when being questioned by a UK Parliament Committee on Gambling legislation revealed that his company had ‘‘around 200,000 registered clients of whom about 30,000 are active on the site in any given week’’ (United Kingdom Parliament, 2004). Although growing in popularity the exchange concept was a niche product, as shown by a 2004 survey which found that less than 1% of the UK population had spent money on a betting exchange in the last 12 months compared to 11% who had done so via betting with a bookmaker on horseracing (Creigh-Tyte and Lepper, 2004).
Winner Takes All In December 2001 the two companies announced that they were merging. There were different views on what motivated the merger, with Wood (2002, p2) suggesting that whilst ‘‘the received wisdom is that Betfair saved Flutter from oblivion’’, an alternative view is that Betfair were feeling increasingly threatened and bought Flutter ‘‘to close them down’’. However, Flutter had spent heavily and their funders took the opportunity to acquire a 25% share in the enlarged merged company. Given that the new entity was called Betfair, and that Edward Wray of Betfair was its CEO, it seems that in practice this was a takeover.
Attracting Customers Through Value and Innovation
The enlarged company’s growth now accelerated rapidly as it gained further liquidity from the influx of ex-users of Flutter. The new users had the opportunity to bet larger amounts on a wider array of events, which led to rapid growth of the business in 2002. This is illustrated by figure 2 as the figure of £50 million of bets matched in a week was reached in August 2002.
The betting exchange concept was attracting ‘‘value punters’’ through the better odds on offer for traditional backing, and those drawn by its ‘‘product innovation’’ – laying, place betting and in-play. Whilst the exchange customers were a minority of UK betting customers they were generally seen as more sophisticated higher value customers, with the average stake being 3 times that of the LBO customer (Stanley, 2003). In addition to this the unlimited stakes were drawing in the ‘‘high rollers’’, those prepared to stake enormous sums, who bookmakers
Growth in the value of Betfair's matched bets 2001-2002 60,000,000 50,000,000 40,000,000 30,000,000 20,000,000 10,000,000
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The emergent Betfair now had an effective monopoly with an estimated market share of 98% (Wood, 2002).
Figure 2 Bets Matched by Betfair. Note figures from January 2002 are for the merged entity Source: Developed using Betfair press releases
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would often refuse to take bets from, wary of their more sophisticated betting strategies or suspecting the use of inside information. The amounts such punters are prepared to stake was shown by the largest bet offered on an exchange to date; a Betfair user ‘‘backed’’ a greyhound for £900,000 in May 2004 (Kay, 2004). This type of bet confirms the reliance of the exchanges on a small number of punters.
Changing the Nature of Betting However, the exchanges were also seeing the emergence of behaviour normally seen in financial markets, and identified in the spread betting sector of betting markets (Vaughan Williams, 2004). This behaviour can be categorized according to Arnold (2002) – writing at the time about users of the derivatives markets – as speculation, hedging and arbitrage.
Speculation This speculation is not about whether a horse will win, but upon movements in the prices on offer. For example, someone might back a horse at 4-1 with a stake of £1,500 before the race. During the race the horse is leading and its odds shorten to 3-1, so that the punter can lay at £1,875 at 3-1 ‘in-play’, thus producing a guaranteed win situation, as shown in Table 1. As with the derivatives market these speculators bring considerable liquidity to the Betfair market. They are encouraged to back and lay on the same event, as commission is charged only on net winnings from an event, meaning that losses can be offset, and are encouraged to bet greater sums of money by a sliding commission scale. The requirement for constant access to a betting exchange, television coverage of sports events and the time to engage in such speculation limited the number who could take part in such activity. However, evidence given in 2004 to the UK Parliament Gambling Bill confirmed that some users (i.e., speculators) would make large numbers of bets during an event to make relatively small profits on a single event as described above (United Kingdom Parliament, 2004). This sophisticated trading approach was in stark contrast to the primitive nature of many Table 1 Speculation Scenario using P2P Betting, Backing an Outcome at 4-1 with a Stake of £1,500 and Laying at 3-1 with a Stake of £1,700
Return (before commission) Loss Net profit (before commission) Source: Author
356
Horse wins
Horse Loses
£6,000 £5,625 £375
£1,875 £1,500 £375
of the LBO customers, who would make their decisions on irrational grounds, such as ‘‘the colours worn by a jockey, or the name of a horse’’ as Mark Davies of Betfair states (Stanley, 2003, p2).
Hedging The betting exchange concept has offered a useful hedging mechanism to the on-course bookmakers, as risk can be offset. Historically, on-course bookmakers would have had to do this through specialist bookmakers at unattractive odds. The 20% better odds of the exchanges make hedging more viable.
Arbitrage The exchanges have also enabled arbitrage by oncourse bookmakers laying to punters and then backing on Betfair simultaneously to make an instant profit by exploiting price differences. This arbitrage opportunity exists through the lower costs of layers on Betfair and the existence of on-course punters who are either unaware of exchanges or not comfortable with the process, the former is inherent to the economics of the different models, whilst the latter may be curtailed over time. For an on-course bookmaker who had instant access to Betfair arbitrage became possible, and the scenario of Table 1 could be achieved. However, as in financial markets such activity is not without risks, in particular synchronisation risk, that the odds available in the Betfair market alter, or trading volumes fall when the bookmaker tries to exploit the disparity between the two markets. For the ‘‘Big Three’’ hedging and arbitrage activities had serious implications, interfering with the starting price mechanism, covered in Section 2.2.2. Risks for on-course bookmakers were reduced (UK Parliament, 2002), so they could make their odds more attractive which in turn reduced the margins of the LBOs. The ability to manipulate the starting price was also removed, as on-course bookmakers could recycle the ‘‘Big Three’s’’ money on betting exchanges to lock in a profit as above.
Market Size The commission income generated by Betfair, accepted as the overwhelmingly dominant player, is in the public domain and detailed in Table 2. When compared to the gross win (stakes minus money paid out in winnings) of £722 million in 2004 by William Hill, it would appear that the betting exchange concept has had little impact. HowEuropean Management Journal Vol. 23, No. 3, pp. 351–359, June 2005
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Table 2 Betfair Commission Income 2001–2004 (Year ending April 30th)
Commission Income £ thousands
2001
2002
2003
2004
480
6,090
32,319
66,725
Source: Betfair Annual Report 2004
ever, the commission of exchange betting vastly understates its impact as it is a low margin model. As betting losses in an event can be offset against winnings the actual margin made on the volume of turnover (matched bets) is far lower than the advertised commissions of 2–5%. Estimates for Betfair’s turnover (matched bets) range from £2.5 Billion to close to £6 Billion for 2004 whilst in comparison, William Hill had a turnover of £8.3 Billion in 2004. However, it is very difficult to compare exchange turnover to that of a traditional bookmaker, as most of the activity on betting exchanges is generated through products not available at a traditional bookmaker.
Challenges Faced by the Betting Exchange Model Technical Challenges Running a betting exchange poses a demanding set of problems. At peak times Betfair matched 1 million trades per day, 4 times that of the London Stock Exchange (Phillips, 2003). Betfair’s website was not always able to cope with such demands leading to the site crashing on occasion causing major problems given that in-play and new forms of betting activity were such a major part of their business.
Security In 2004 it was reported that many betting sites were facing extortion threats from criminal gangs based in Eastern Europe (Nuttall, 2004). Unless payments were made denial-of-service attacks would be launched, whereby a website is overloaded with requests for data, causing it to crash. With the dependence of revenue on major events and the need for real-time service to facilitate in-play this was a particular threat to the exchanges. Such attacks were to bring down the Sporting Options and Betfair sites in 2004.
against betting exchanges, claiming that the model was illegal. To quote David Hood of William Hill ‘‘If I stand in the high street outside a betting shop and offer to lay a bet which you take, I am breaking the law, because I am not a licensed bookmaker. If we both boot up laptops in the street and strike the bet using a betting exchange, I am not breaking the law. What is the difference?’’ (Phillips, 2003, p2) They went on to argue that individuals, some of whom were already bookmakers, were trading such large sums on betting exchanges that they were using it to run a business. This was taking money away from UK horseracing, as conventional bookmakers had to contribute towards The Levy and the horseracing establishment thus argued that layers should be licensed and also liable for the same charges as bookmakers, measures which would severely affect betting exchanges. Betfair and the other betting exchanges responded by claiming that they rather than their clients were the bookmaker, that the exchanges paid tax and levy, and their clients were punters who either backed or laid a selection. Race Fixing A fundamental danger of the exchange model is abuse of the system by those with insider knowledge. A layer may offer attractive odds against an outcome that has been fixed or when they know the horse is carrying an injury. Although there had been earlier allegations of race fixing this became national news in the UK in March 2004 when high profile jockeys Kieren Fallon and Sean Fox lost races in controversial circumstances. On both these races the odds for the horses had moved significantly with Sean Fox’s horse Ice Saint ‘drifting’ from even money (1-1) to over 5-1, with large amounts available for backers. Whilst horse racing has a long history of corruption, meaning that it would be unfair to blame betting exchanges for the existence of underhand deals, the innovation of laying certainly makes race fixing far easier as in conventional betting throwing a race only leads to a definite gain if all other horses in the event are backed.
Challenges from the Established Order
On the other hand, exchange betting can provide evidence of corruption as all users are registered, in contrast to the mostly anonymous cash bets of the LBOs. Such audit trails were used by the Jockey Club, who regulate horseracing, to bring disciplinary enquiries against leading owners in 2004. As a result of this Miles Rodgers, who had traded £4 million on a Betfair account in one year, was banned from racing for two years for laying his own horses to lose (Lees, 2004).
Are Layers Bookmakers? After initially ignoring the emergence of exchanges the bookmakers started a concerted campaign
The Legislative Battle The issue of betting exchanges was considered in the Gambling Bill, designed to modernise Britain’s laws
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in this area. In 2004 a UK government report stated that whilst it welcomed the transparency brought by the exchange model it presented new risks and those layers using betting exchanges to run a business should be licensed (UK Parliament, 2004). However, this presented problems of definition and also failed to deal with the issue of overseas users of betting exchanges, who would be outside regulation. Because of these problems the UK government decided not to implement the recommendations.
The Future of Betting Exchanges Developments in the UK The difficulty of challenging Betfair in the UK market was shown by inability of Sporting Options or Betdaq to make inroads into their dominance. This was confirmed by the exit of Sporting Options in November 2004. The P2P concept did start however, to initiate change in UK bookmaking, at least at the fringes as some of the new Internet and telephone bookmakers, such as Bet365.com, started to give their customers limited opportunities to lay outcomes. There were also rumours that the ‘‘Big Three’’ were going to launch exchanges, offering zero commission in an attempt to challenge Betfair. From the experience of Betdaq and Sporting Options such a challenge would be difficult given Betfair’s enormous market liquidity. In the short term as part of their wider strategy the bookmakers’ main focus has been on offering risk free (for the bookmaker, if not the punter!) gambling products in the LBOs, at the expense of betting on horseracing.
Growth of Exchanges Overseas The sizeable betting exchange turnover generated by overseas accounts – press releases regularly quote 25% for Betfair and 60% for Betdaq – illustrated the potential for the export of the betting exchange model. However, many jurisdictions were either hostile to the idea of Internet betting in general, or disliked the concept of betting exchanges. But even in jurisdictions where Internet betting is illegal there was still enormous demand. The United States generates huge Internet betting turnover (McCoy, 2002) and The Hong Kong Jockey Club, which has a local monopoly on betting, was blaming Internet betting operations including betting exchanges for its 30% fall in turnover since 1997 (Hong Kong Jockey Club, 2003).
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Conclusion In conclusion this paper has looked at the growth of P2P betting in the UK and the meteoric rise of Betfair and their exchange model. What is particularly striking is the manner in which the experiences of the founding entrepreneur enabled the development of a superior betting exchange model which defeated a rival with an overwhelming financial advantage. The paper has also drawn out some specific lessons for P2P betting. There is a need for scale to achieve liquidity – the ‘‘network externalities’’. Today, given Betfair’s overwhelming control of this market, it is difficult to see how other P2P exchanges can compete effectively with them. However, these lessons can be learnt by firms in the booming P2P poker market, where liquidity is again crucial. There are also a number of key challenges faced by betting exchanges due to their unique nature. The regulatory issues will not go away, but neither will betting exchanges, if only because of the innovation and choice they offer customers.
Notes 1. As an example the spread betting firm could offer a spread of points for the UK Football Premiership of 60–65 points for Liverpool. The punter could buy points if they think Liverpool will get more than 65 points and sell if they think Liverpool will get less than 60 points. The punter specifies a unit stake, for example £100, and then wins or loses this amount multiplied by the number of points Liverpool finish above or below the top or bottom of the spread. 2. One major difference, however, between financial markets and the fixed odds betting market are the definite losses incurred through activity in betting markets. 3. The matched bet is used as the basis for P2P turnover. The main measure given has been the backer’s stake multiplied by two, as in contrast to the traditional bookmaker there are layers as well as backers. 4. Examples of these short term losses are provided by a quote from Tom Kelly, Chief Executive of the Association of British Bookmakers, speaking in January 2004, ‘‘The industry lost some £20 million at last year’s Cheltenham Festival and some £30 million when Frankie Dettori rode all seven winners at Ascot [in 1996]’’ (UK Parliament, 2004). 5. This is a form of network externality whereby the more users there are of the product the more valuable it becomes (Shapiro and Varian, 1999). 6. The success of the exchange model was rather ironic as it was made possible by the advent of websites, when open outcry markets across the world were in decline due to the introduction of electronic trading.
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DES LAFFEY, Kent Business School, University of Kent, Canterbury, UK, CT2 7PE, E-mail: D.J.Laffey@kent. ac.uk Des Laffey is Lecturer in E-Commerce at Kent Business School. His research interests include new ventures enabled through ecommerce, online advertising, website quality and the betting industry.
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