HORSE RACING’S SUSPECT PROFIT MODEL

Two facts about horse racing in North America are not in dispute.  First, pari-mutuel wagering is in a long-term decline; with the exception of 2006, handle has decreased every year since 2003.  Handle fell from $15.2 billion in 2003 to $10.9 billion in 2013, not accounting for inflation, and has not improved in 2014.  Second, racetracks have resisted significantly lowering takeout rates, over a protracted period of time, to make the pari-mutuel wagering product more competitive with gaming, and in some cases have inexplicably raised takeout rates in the face of weakening handle.

Assume for purposes of analysis that racetrack executives are correct in their implicit assessment that reducing takeout rates won’t provide enough of a catalyst to handle to boost profitability.  If this is the case, then a key component of horse racing’s business model dooms the entire industry.

What ails horse racing is the profit model component of the business model.   Many people erroneously use the term business model interchangeably with profit model.  In fact, an industry or company’s profit model is only one aspect of its business model, along with its value proposition and various systems, such as the unrivaled distribution model that makes Wal-Mart a winner.  Likewise, advanced deposit wagering is part of horse racing’s business model.

North American horse racing is a niche sport, but one with a value proposition that appeals to millions of people, as evidenced by the number who watch the Triple Crown races and the amount of money bet.  While pari-mutuel wagering is ebbing, it is still a nearly $11 billion business annually and this amount exceeds annual ticket sales for American movie theatres.  Moreover, horse racing’s convenient delivery system provides a competitive advantage in that it is the only legal form of gambling on the Internet in the United States.

Nonetheless, the trend in pari-mutuel wagering is negative.  One hypothesis is that racing’s profit model is unfixable.  It is conceivable that pari-mutuel wagering can’t compete because of its inordinate brick-and-mortar overhead, as opposed to slots, for example, similar to how conventional bookstores have been eviscerated by Amazon and music retailers were killed off by iTunes.

Whether racetracks can alter their profit model, via takeout rate reductions, and thereby make themselves more competitive and more profitable is impossible to know definitively unless track executives are willing to experiment to find out.  If they don’t experiment, the prognosis is continuing declines in handle.

_________________

In a future article, I will focus on what a vastly downsized North American horse racing industry might look like.

Copyright ©2014 Horse Racing Business

MORE ON TAKEOUT RATES

Consider a very simplified illustration of takeout rates (with zeros left off handle and handle set at a round figure).  Assume that a racetrack’s current takeout rate on win, place, and show bets is 17%.  Further, assume that the racetrack generated $100,000 in handle on such straight bets in the past year, providing it with $17,000 in revenue.

The following tabular presentation illustrates how much handle would need to increase in dollars and percentages for the racetrack to continue to receive $17,000 in revenue should it lower the takeout rate on straight bets.  In other words, what would be the break-even point at various reduced takeout rates.

Takeout Rate    Handle to Yield $17K     % Increase

17%                      $100,000                                NA

16%                      $106,250                                 6.25%

15%                      $113,333                                13.33%

14%                      $121,429                                21.43%

13%                      $130,769                                30.77%

12%                      $141,667                                41.67%

11%                      $154,545                                54.55%

10%                      $170,000                                70.00%

Would a 1% percent reduction in the takeout rate generate at least a 6.25% increase in handle, or would, say, a 4% reduction boost handle by 30.8%?

There is no way to determine the answers without experimentation over a representative period of time, perhaps a year.  Bettors are not automatons who respond immediately to changes in incentives.  Moreover, it takes time for word of pricing modifications to disseminate to people who are not avid gamblers.

In my view, the top executives at racetracks are reluctant to experiment for two reasons.  First, they fear that reduced takeout rates won’t result in enough additional handle, especially in the short-term.  Second, they are concerned about criticism and negative publicity from raising rates back to old levels if reduced takeout rates prove not to be successful.  These issues can be addressed, of course, by limiting experiments to test markets and/or certain bets, as one need not go all in by reducing rates across the board.

The view here is that the vast majority of racetrack executives, especially at racinos, are working under the strategic assumption that pari-mutuel wagering is a cash cow to be milked as long as possible while receiving as little time, effort, and money as possible.  The bloodstock side of the industry has its fate tied to individuals who increasingly tend to view pari-mutuel wagering as a sideline.

Copyright © 2014 Horse Racing Business

ABOUT HORSE RACING’S SLIDE TO ECONOMIC OBSCURITY

The future of the horse racing industry continues to be depicted by continuing declines in pari-mutuel handle.  Yet upper-echelon racetrack executives carry go on just as they have in the past, as though the patient is just fine and the prognosis is bright.  In fact, the prognosis is grim, and people whose livelihoods depend on the racing enterprise—from trainers to grooms to breeders to veterinarians, etc.—are the casualties.

The uncompetitive takeout rates in horse racing are, in my view, the leading cause, by far, of the decline in pari-mutuel handle.  Yet racetrack executives appear to be incapable of intellectually addressing the problem.  Following are two recent examples.

Immediately before the 2014 Kentucky Derby, Churchill Downs racetrack raised the takeout rates on straight bets and exotic wagers.  A spokesman for the track explained that it needed to take this action in order to maintain purse levels.  In other words, he was saying that demand for Churchill Downs’ wagering products is inelastic, meaning that pari-mutuel handle is to some degree insensitive to changes in takeout.

To be specific, the simplest mathematical formula for price elasticity of demand = % Change in Quantity Demanded)/% Change in Price.  Thus Churchill Downs was acting under the hypothesis that the loss of pari-mutuel handle, expressed as a percentage, would be less than the percentage increase in price.  What transpired was the opposite:  pari-mutuel handle, excluding Kentucky Derby and Kentucky Oaks betting, declined in a big way.  The Churchill Downs pricing doctors violated the first principle of solving difficult problems:  do no harm.

Consider another example.  In an interview with The Racing Biz, the president and chief executive officer of the Maryland Jockey Club, which runs Laurel and Pimlico, said:

“Every year we look at the takeout.   At different times over the past years we’ve tried to change and modify.  We try to do a balance between what’s fair and equitable for the horseplayer and still allow us to proceed forward…   I would never recommend raising the takeout rates here at all.  The balancing act is to provide the best service and be sensitive to the players’ issues — but we still got to make a buck.   In a perfect world, if money wasn’t an object, you would lower and lower the takeout rate, but I still have to pay the bills, I still have to pay the salaries, and find money to do that. “

This statement connotes that takeout rates are optimal.  The CEO says he would not raise takeout rates and he would not lower them either because he has to “make a buck,” implying that reducing rates would not improve profitability.   If he has not experimented by significantly lowering rates over a protracted period of time, he is only conjecturing that the takeout rates are optimal.  Moreover, “what’s equitable and fair for the horseplayer” is an empty and patronizing statement.  Bettors who no longer wager on horse racing have decided on their own, without the help of the powers that be at Laurel and Pimlico, what is “equitable and fair”…and they have decided in a negative way.  That’s how things work in a free-enterprise economy where customers decide whether to buy or not.

The forgoing examples vividly illustrate the endemic problem of economic illiteracy in horse racing regarding takeout rates.  Churchill Downs erroneously acts as though demand is inelastic and the Maryland Jockey Club boldly insinuates that it has arrived at optimal rates.  The fact is that these two premier racing organizations don’t know and are evidently unwilling or fearful to conduct long-term experiments to determine profit-maximizing rates.  The fact is that racetrack executives’ refusal to try new approaches is condemning horse racing to a slow and painful and obvious descent to obscurity.

To my knowledge, no one knows for sure whether markedly reduced takeout rates can reverse the downward trend in pari-mutuel handle.  But at least give it a try over, say, a year’s time rather than passively standing by while the sick patient expires in front of your eyes.

Based on past actions, the prospects for change are, sadly, remote.

Copyright © 2014 Horse Racing Business