The unit economics conundrum
Or how to reset an industry that knows the price of everything and the value of only some of it
Wynn Interactive has had enough. Faced with the madness of spending levels in the US online gambling market it is pivoting to a “measured and long-term focus”. Or to put it another way not setting fire to massive piles of cash on the daily.
Bearing in mind they’ve only been in the online market for five minutes it’s easy to dismiss their opinions, but that would be a mistake. Because there is a storm brewing here in the honestly super interesting and not fiercely dull world of unit economics.
Online gambling is a simple business at heart. You spend X to acquire a customer, you generate Y value from them and you hope that Y » X. The bigger Y gets the bigger X can be, and the bigger X gets the bigger Y has to be to compensate. Least it needs to be said the first one of those is way, way better than the second.
In the US it’s a weird mixture of the two, while in the UK (we will get to that shortly) it’s more Y getting smaller and X not being that keen to move. But what does all this mean for the future of a sector absolutely addicted to the scent of burning money?
The US market - burn baby burn!
The US. Where revenue is for sale, profit is for losers and everything is running so fast the blur makes it hard to see what is going on. But don’t be fooled, it’s not really any different to any other market - everything is just super sized. Yes player acquisition costs are insane, but so are player values.
While in the UK you might be looking at say $100 CPA and $300 LTV for a sportsbook player, in the US this could easily be $300 CPA and $1200 LTV. When you add in retention curves that look closer to a straight horizontal line then you really are not in Kansas anymore.
DraftKings talks of 70% of gross profit payback by year 1 with 254% by the end of year 2 with retention >80% from year to year. Those are very strong numbers for anyone used to the more flighty European market with lower ARPUs and much lower retention levels. And we’ve seen similar from FanDuel.
FanDuel actually talks of not spending enough money at first and missing some player acquisition opportunities with its modelling and results to-date suggesting player values remain very strong across the board. But, and this is a pretty important point, that will not be true for everyone.
Look at what Wynn Interactive said.
It's making sure that every first deposit or that you drive, or every cohort of first depositors that you drive are ultimately profitable on a lifetime value basis. So that's where we're focused.
In other words, that’s is not what is happening right now for them.
Where does the money go?
Wynn obviously does not have DK and FD’s DFS acquisition funnel to soften overall CPAs. These $250 CPAs are blended averages remember and include a ton of zero cost DFS cross-selling, just as all these nine-figure media acquisitions provide “free” customer acquisitions.
But it will also be due to capturing less of the player’s overall wallet even when they do get them to sign-up and deposit. Flutter alluded to this recently in their 3Q21 results. People might go and flirt at the bar and kiss some randoms but they always come home to…
The point is the Y»X scenario differs by operator, and sometimes to quite a large degree. So this is all further evidence of the duopoly model, the big boys can just spend everyone else out of existence and eventually they make all the monies yes?
Well maybe yes, maybe no. Some UK operators I have asked saw a similar issue when looking back at their data, with players proving much more loyal than they expected and CPA limits seeming a little conservative in retrospect.
If you build scale fast at this critical time then you can outcompete by having better tech and product. And it’s not quite as simple as CPA vs LTV - if that customer goes to you rather than your competitors then your competitors may never get momentum and in 2-3 years you clean up. Obviously there is execution risk here but I think it’s a logical strategy at least for the big US players.
But, and this is a big one, these dynamics mostly played out at a much later stage in the UK. The US market is still super early. There is also a question as to how much of a lead any of them have in tech and product. And unit economics are absolutely going to change as the market matures.
There are some positive factors in play at this point too as one European marketing expert tells me.
They’re spending like drunken sailors today, but in theory CPAs should decrease as marketing efficiencies improve and ARPUs also increase as product improves and the offering expands. That all sort of feels likely over the next 3-5 years?
More becomes less
But what is likely is the first adopters in each state will be replaced by less engaged lower spending players in time. The trouble is advertising and marketing costs are not quite as easy to adjust downwards once they do fall.
Eventually, honestly, you are going to run out of DFS players. You’re also unlikely to find those retention levels always remain quite as high once your competition gets closer to product and UX parity. The gap is still pretty big right now.
Now obviously FanDuel, DraftKings and pretty much every operator knows this.
They’re not dumb. I would wager every single person in both of those businesses is smarter than me. But there is a difference between knowing something and knowing it. It’s so hard to see yourself when the only true picture of you is in the attic slowly turning older.
So fewer cheap acquisition channels, less share of wallet, more churn and lower average player revenues for the players you acquire to replace them. But that’s fine because advertising costs will come down to compensate right? And there is nothing else that will happen is there?
Lolz.
Well let me tell you a little bit about a place called Great Britain…
The UK - Player value infernos!
Once upon a time there was a magical land where the growth of online gambling would never stop, share prices were rocketing and the only sound you heard was the thud of celebratory pats on the back. And then…the big bad regulator woke up.
In truth the market was already softening, a ceiling level of revenues being reached and the competitive environment was moving from start-up to M&A with some speed. But the regulator really cranked things up.
Operators suddenly faced with having to do enhanced due diligence checks on high-value customers, lead to player values taking a dive off a very large cliff over the course of roughly four years from 2017 to 2021, particularly in casino.
There are a bunch of pending potential changes to UK regulations that could push them even lower (that’s for another newsletter another week). Operators had pushed down affiliate costs, quite markedly in some sectors, notably poker and to a lesser extent sports betting as the balance of power shifted.
But social arrived to eat up some marketing cash while TV advertising costs remained high and that was increasingly where the big brands needed to be to keep the acquisition funnel stuffed with new players.
When the wheels come off…
This industry has a habit of ramping up around the most aggressive version of unit economics it can find and then sticking to them until everything begins to collapse. In Europe we’ve seen a sector raised on tax-free revenues barely budging from those numbers when 25% tax and maturing market dynamics kicks in.
But now, particularly in online casino, everyone is left looking at a model that really doesn’t make any sense anymore. Paying £400 PPC for online casino feels like an act of self-harm post gambling act review, but there might still be people willing to pay it.
Will a gambling advertising ban actually save the UK industry? In a funny way it might, although good luck controlling digital marketing costs in that new world. But the reality is the industry in the UK needs to radically shift its thinking about “typical” CPAs and LTVs and reimagine what the new world of safer gambling driven online gambling looks like in unit economics terms.
And will this happen in the US? Probably not? But I wouldn’t say it’s a zero possibility outcome. Although the truth is it doesn’t need to happen for some similar day of reckoning to arrive. How long do we really think $2000 LTVs will last? How long can sites be paying $700 CPAs to affiliates for?
It’s possible the answer is for quite some time yet, as our marketing expert suggests.
I can’t see how the broader marketing blitz tapers down. The prize is too large, funds too easy to come by, and marketing is still the differentiator today. Like the UK, the regulators will probably be the ones to pump the brakes, and I’d say those who are leading in market share will be secretly relieved when that day comes.