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Donovan: Will Companies Cash in On Internet Gambling?

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In 2006, Congress passed the Unlawful Internet Gambling Enforcement Act (UIGEA), which effectively shut down online wagering in the U.S. by prohibiting businesses from accepting payments for - or otherwise funding - Internet gambling.

Last September, unrelated to UIGEA, the Department of Justice effectively reversed its previous interpretation of the 1961 Interstate Wire Act, which prohibited the operation of certain types of betting businesses in the U.S. This reversal appears to have opened the door to legalized online gaming on an intra-state basis.

The Internet gaming restart will likely create a far more complex series of changes than some observers imagine, and implications for casino owners could be momentous and unexpected. Here is how I see the issues:

Issue #1: Making Internet gaming workable could take some time. Although a host of states are in the process of legalizing online gambling, the regulatory framework has not yet stabilized. Much of that regulation will in turn require technological solutions for compliance that will require development.

For instance, given current technology and policies, card associations and/or acquiring banks will decline the majority of online credit card transactions requested by interactive gaming sites. While VISA and MasterCard have established programs to allow for registration of legalized operators of online wagering such as state lotteries and pari-mutuel horse racing, it remains to be seen if these programs will work effectively when applied to internet gaming operators.

State regulations for interactive gaming create other compliance challenges. For example, Nevada's current technical standards would make withdrawing funds from internet gaming accounts difficult to scale. These standards require that any withdrawal of funds from the player's interactive gaming account to the player's bank account verify that the name registered on the bank account matches the name on the interactive gaming account. This can currently only be achieved via manual means such as phone calls and faxes before funds can be deposited into the player's bank account. So, getting money out of the system in a low cost electronic manner is not possible today.

Issue #2: More of the same may be less than you think. Many forecast rapid growth in internet gaming, but just how much growth will there be? Twenty years ago, if you wanted to gamble legally, most people had only three choices: go to Las Vegas or Atlantic City, bet on the ponies, or buy a lottery ticket. Since then, the supply of gaming product has grown. Based on DiamondStream's analysis, 69% of casino patrons that take cash withdrawals at casinos live within 50 miles of a casino. As supply has grown, demand has flattened with 2011's total gaming revenue lower than 2007's. Growing supply and flat demand created winners and losers. For example, horse racing tracks were marginalized or pushed out of business. In some states like Illinois, the legislature takes some casino taxes and transfers them to subsidize horse racing. Our research at DiamondStream shows that the growth of regional gaming has reduced demand for gaming services in Atlantic City, Reno and Las Vegas. Regional resort casinos and innovative Las Vegas concepts have been winners during this period by taking share from weaker concepts.

In this environment, will creating new casinos online that offer similar games to those that exist in current casinos lead to vast increases in overall gaming industry spend? Easier access to gaming might increase overall spend, but as we have seen, land-based casinos have good penetration in most of the initial Internet gaming states. On balance, it seems likely that with the same customer base the Internet channel's growth will primarily cannibalize existing land-based gaming.

Issue #3: Disruptive technologies unleashed by internet gaming could create opportunities for explosive growth. According to the Entertainment Software Association, the average age of online gamers is 30 vs. the casino industry average age of 50. The games younger players play in both the casino gaming and skill-based gaming worlds look very different than those in a traditional casino.

The closest relative to a land-based casino's games are the social casino games offered by companies like Playtika, DoubleDown and Phantom EFX. These games look like regular casino games at first glance, but have Zynga-style meta-games behind them that help keep user interest high over long periods of time.

Many big players are betting these relationships can be managed to good effect, and are paying big money to do so. Caesars Entertainment reportedly spent $90 million to acquire Playtika, an interactive social gaming site that started up about two years ago. International Game Technology (IGT) spent $500 million to acquire Double Down Interactive, a "play for fun" casino gaming site that also was less than two years old (perhaps at a revenue multiple of more than eight times. WMS Industries bought Phantom EFX, a game developer specialized in casino entertainment. Bally's and others are taking action as well.

Competing for a new generation of customers with new game formats in the Internet channel will challenge existing land-based casinos that choose to enter the channel. The customers are different and the games, even when they look the same like the casino social games, have subtle differences that will take time to master. It will take new marketing skills, new product skills and different types of customer service reps to win in this space. The large Vegas and Regional resort casinos possess many strengths and have shown resourcefulness in the past dealing with challenges, but this may be the biggest yet.

The risks and rewards look like they are growing. Let the games begin…

Dean Donovan is co-founder of DiamondStream, which works with casino industry payments data to track top patron behavior, casino market shares and drive lifecycle marketing programs. He received an MBA from the University of Pennsylvania's Wharton School of Business.

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