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Good Thursday Morning. Here’s the rundown of this week’s Sports Business Playbook:

• 📰 This Week’s Topic: The US sports betting market is now five years old. In part 1 of our two-part series on the industry, we dig into the winners of the first market cycle and what made them successful.

• 🍸️ Impress Your Friends at Cocktail Party: Want to show off your sports knowledge in a public setting but don’t have time to read the deep dive? Hit the “Impress Your Friends at Cocktail Party” section at the bottom for a CliffsNotes of this week’s topic

• 🤯 “Whoa of the Week”: Sports’ dominance in the TV ratings through the first half of 2023.

• 💪 Weekly Reminders that Sports are Awesome: ESPY’s edition

Hey team,

May 2023 marked the five-year anniversary of the Supreme Court’s landmark decision that overturned the Professional and Amateur Sports Protection Act (PASPA), which had previously banned most legal sports betting at a federal level.

The ruling returned the decision on whether to allow sports betting to the states, and many legislatures quickly moved to legalize the activity. Since PASPA’s repeal:

• Over two-thirds of all US states have legalized sports betting

• Americans have bet more than $220 billion over the course of five years

• The sportsbook operators ($17 billion) and state and local governments ($3 billion) have reaped significant revenues as well

The numbers tell the story of a rapidly ascending industry with more room to grow as additional states are expected to join the fold, including the looming presence of three of the country’s most populous states (California, Florida, and Texas) that still have not legalized the practice.

This heightened demand for legal sports betting in the US has been met with a number of sportsbook operators jumping into the fray and seeking to provide supply. It’s led to a wild five-year run.

This week, we’ll talk further about the business model of sportsbooks and how the market leaders have won the day thus far.

Sports Betting 101

(Editor Note: If you would like to learn more about the different types of bets and how/why sportsbooks adjust odds, I’ve included a primer in the “Impress Your Friends at a Cocktail Party” section below!)

Key Metrics for Sportsbooks

First up, handle. Handle refers to the total money wagered by customers at a sportsbook over a given period.

A subset of that handle is “gross gaming revenue” (GGR), which is the amount that the sportsbooks keep — these winnings come at the expense of the customers who are losing bets. The formula is simple: Handle - winning bets.

Finally, we come to net gaming revenue (NGR), which is the actual profit the sportsbooks make. The calculation is GGR - promotional bonus costs - taxes. Note that the bonus costs are variable depending on the promotions being run and the taxes that change from state to state (more on both later).

Why Do the States Care

Putting aside the morality of gambling, the reality for the states is that their citizens are sports betting whether they like it or not — the American Gaming Association estimated in 2022 that even with the legalization in so many states, $63.8 billion was still wagered via illegal bookies and offshore sites. This number was probably exponentially higher prior to the PASPA ruling.

So, the solution for the states is a pragmatic one. If the people are going to do it anyway:

1. Try to regulate it as best as possible so the practice is somewhat safe

2. Collect the tax revenue from the operators, which will hopefully end up improving the state’s services and benefitting the broader community.

There is risk with legalizing this, of course, so the states have applied strict compliance rules to prevent illicit activity and ensure customer protection, and there are requirements around responsible gaming that all licensed operators must adhere to.

Gold Rush

Back to 2018.

Once PASPA was repealed, there was a rush of companies jumping into the industry in the hopes of capitalizing on the initial swath of states who would legalize it.

They had to tackle two main problems: market access and customer acquisition.

Some operators chose to address these problems conservatively and grow at an incremental pace. Others took the path of a VC-backed tech firm: get market share at all costs and figure out profitability later.

Five years later, it appears the latter method won out.

Problem #1: Market Access

Because the decision to legalize sports betting was returned to the states, it meant a patchwork set of rules and regulations began to develop across the country.

Each state came with its own laws about how many licensed operators could exist, the tax rate on GGR (8% in Kansas; 51% in New York), and other stipulations around responsible gaming, reporting, and compliance.

Outcome:

Larger companies with deep war chests 1. quickly built scalable platforms that could be tweaked to meet the patchwork regulations and 2. could lobby for licenses were able to quickly snap up the initial states.

This created a flywheel, which made it easier for them to secure licenses in the next round of states that came online.

Problem #2: Customer Acquisition

This is a two-part problem. Once they got access, the sportsbooks had to build brand recognition and credibility.

But here’s the kicker: sports betting is inherently a low-margin business where most of the odds set for games are comparable across all platforms, which means it’s relatively commoditized and the switching costs for consumers is low. The challenge is ultimately figuring out how to get customers onto a platform and keep them there.

Outcome:

Once access was established, operators began to spend exponentially on partnerships with leagues, teams, and sports media organizations in order to get their brand in front of fans.

And the ads.

You all know what I’m talking about — hundreds of millions of dollars are spent annually on TV/digital advertising, and we as sports fans are then subjected to some of the worst commercials on TV. GTFOH, Patton Oswalt!

To the second part of the problem, how do you incentivize fans to use your platform in this type of industry?

There is the noble path, which is building a great product and customer experience. And there is data to suggest that it’s critical for retaining customers.

But what did most sportsbooks also do? Rained free money down on customers!

In conjunction with the obnoxious ad spots, consumers were offered hundreds of dollars in “risk free bets” and other gimmicks (I was once offered a free $100 if Patrick Mahomes threw for one yard) that were meant to incentivize customers to jump on a platform and stay.

This became the industry norm. At one point in 2020-2021, $116 million (35%) of the $337m GGR in the state of Pennsylvania was coming from these types of “free bets.”

Absurd? Yes. But the thought was that while the customer acquisition costs were high at the outset, the customer lifetime value would make up for it in the long run.

And the practice became self-perpetuating. As with most commoditized markets where price matters most, other firms couldn’t afford not to also offer these aggressive promos if they wanted to keep pace. So, they too began doling out the dough.

While unsustainable, a couple of operators rode this model to the top.

Winner Winner, Chicken Dinner

Fast forward to now and the sports betting market has consolidated, with a select few holding most of the market share.

While there are over 50 legal online sportsbooks across the US, 90% of the overall market share is dominated by four firms, with two really leading the way:

• FanDuel: 46%

• DraftKings: 25%

  ****

• BetMGM: 12%

• Caesars: 6.7%

The common thread amongst these sportsbook oligarchs: they’re all well-capitalized, and they all were pre-PASPA market leaders in either gambling or something that is considered sports betting adjacent — daily fantasy sports (DFS).

The upshot: they have the money, the brand equity, and the existing customer base to reign supreme.

In practice, these factors have enabled the the top firms to deploy the unsustainable but self-fulfilling customer acquisition model that has squeezed a number of the smaller competitors in the existing legalized states and created an almost immediate moat for them in new states where fresh market share is up for grabs.

For example, FanDuel’s ability to quickly pivot into a new state and spend their way to first or second gives them an exponentially higher chance of success than a smaller operator. Plus, it’s not like people in states where sports betting is not legalized yet are Sandra Bullock in Bird Box and have no idea of what’s happening outside their state. When it does get legalized, they will gravitate towards the bigger players that are trusted and can also offer a more lucrative promo deal.

Because of this challenging environment, a number of lesser operators have finally chosen to rein in their spending and accept being a smaller fish, and some have even left the market all together via acquisition or are just straight up shutting down. This leaves the market share firmly in control of those big four for now.

But it’s not all gravy for the leaders. While this model has gotten them to where they are now, the market is signaling that they need to evolve.

Heavy Lays the Head that Wears the Crown

With maturity in the market comes expected maturity in the company — I think Uncle Ben from Spider-Man would have said something like that if he worked on Wall Street, but I digress (a couple of out of left field movie references for you today).

Growth at all costs is a great mindset, but an inflection point is always on the horizon, and few companies (see: recent tech unicorns) adapt in a timely manner. That inflection point came recently for sportsbooks.

In conjunction with some of the macroeconomic headwinds over the last few years, investors have begun to pressure sportsbooks to shift from a growth driven mindset to a profitability mindset. This change has been a major challenge and some of the operators have taken harder hits than others as they try to make the switch.

There has been less M&A activity as of late, but the main area of focus has been on reining in those customer acquisition costs referenced in an earlier section. DraftKings, for example, has pulled back significantly on its paid partnership presence with leagues and teams, and many of the operators have scaled down their promotional deals. The expectation is they can be more frugal there and rely on the brand equity built up elsewhere to have an impact.

And it appears the big players are starting to turn a corner.

FanDuel became the first to report a profitable quarter in the second half of 2022 and expects to be profitable for the fiscal year 2023. BetMGM is forecasting profit in the second half of this year, and DraftKings, despite its roller coaster run in the public markets, expects its first profitable quarter at the end of 2023.

While this is one challenge potentially overcome, there are additional obstacles on the horizon. A new market cycle is emerging, and despite the current leaders’ dominance after five years, success for the next five and beyond is not guaranteed.

Consumer preferences are changing, well-capitalized market entrants await, and new, more reasonable customer acquisition models may be required to grab and retain market share.

In part 2 next week, we will unpack the key questions dictating the future of the industry.

Impress Your Friends at a Cocktail Party

Want to show off your sports knowledge in a public setting but don’t have time to read the deep dive? This section is the CliffsNotes of this week’s topic

• Opener: Since 2018 when the Supreme Court gave states the choice to legalize sports betting, two-thirds of all states have implemented the practice and Americans have wagered over $220 billion.

• Shot: The “gold rush” of states coming online led to a flurry of activity from sportsbooks, which meant an insane, “grow at all costs” customer acquisition strategy was implemented.

• Chaser: Five years later, and the US sports betting market has consolidated — 90% of the market share is controlled by four market leaders.

• Chaser: While successful in this first cycle, profitability is a major focus for these leaders now, and there are a number of new developments in the market that are shaping a potentially uncertain future.

Sports Betting 101: Types of Bets

Betting the spread is the most common bet. For example, a Bills/Bengals game is Bills -5.5 pts. Choosing the Bills, the favorite, (“laying the points”) suggests that you think the Bills are going to win by 6 or more.

Choosing the Bengals, the underdog (“taking the points”) means they’re either going to win or lose by 5 or less. These bets are usually -110 on both sides but the points will move based upon the money being wagered. The BUF/CIN line moved from 5.5 to 6 at some books today.

Moneyline. Who you think is going to win straight up. The odds will be dictated by how heavily favored the team expected to win is. Favorites will usually be -150 or more and the underdog will be +150 or more

Totals. How many points will be scored in the game. The total for the BUF/CIN game is 48.5. “Taking the under” means you’re betting that there will be 48 or less points scored and “taking the over” means there will be 49 or more points scored.

Prop bets. These are unique events occurring during the game, and they can be almost anything. A few NFL examples are taking a player to be the first touchdown scorer, over/under rush yards for a RB, or over/under total number of penalties accepted.

These are really popular in the Super Bowl, where people bet things like the over/under on the amount of time the national anthem takes and the color of Gatorade that will be dumped on the winning coach in celebration.

Parlays. The bettor combines multiple bets on multiple things occurring into a single overarching bet with a set of odds. They can be on anything, across multiple games, and even across sports. Example: taking the points and the over, or a QB to pass for 2.5+ TDs and the WR to be an anytime TD scorer.

Sports Betting 101: How Sportsbooks Work

All bets come with odds. A quick way to think about odds is to base it on how much money needs to be wagered to win $100.

The standard odds a sportsbook offers is -110, which means a bettor needs to wager $110 to win $100. That $10 difference is called the vig, or the “juice.”

Moving it further into negative (i.e., -200) means it will take more money ($200) to win $100. Moving it into positive (i.e., +200) means it will take less money ($50) to win $100.

Why do they do this? Sportsbooks don't like too much money on one side of a bet because it means exposure (risk). Too much winning means too much money paid out. To balance this, they move the lines and the odds around.

If big money is coming in on a certain side, the house will often move the line in the inverse direction to incentivize competing bets, thus mitigating exposure. A spread can move from +4 to +3 or the moneyline odds from +225 to +175 because of too much exposure for the sportsbook.

So, the optimal scenario is when more money loses because the sportsbook collects not only the lost wagers but also the vig. This setup is industry standard but puts the bettor at an inherent disadvantage.

Why? Probabilities.

In traditional casino terms, the sportsbook is the “House.” And as we all know, the “House" is incentivized to have consumers win just enough to stay engaged but lost more than they make over the long haul.

Assuming a bettor uses the same betting amount ("unit"), the bettor will need to hit ~52.5% to make money instead of 50%. Even the best professional bettors ("sharps") are only between 55-60% correct, so it's a thin margin game and the House is set up to win.

“Whoa” of the Week

Insane, mind-blowing things constantly happen in the sports business world. Here was my favorite of the past week.

1. Why sports valuations continue to go up and to the right

Weekly Reminder that Sports are Awesome

This newsletter is, of course, mostly centered on the business side of sports and the things that happen off the field. That being said, it’s important to remember why we fell in love with sports in the first place, though.

This section is meant to highlight the amazing things that happened in sports this week that serve as that reminder.

1. Chicago White Sox pitcher Liam Hendriks with a moving speech talking about his cancer journey

2. Travis Kelce continues to do whatever Travis Kelce wants

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Until next time, sports fans!

-Alex