The value of everything...

Taking another look at US unit economics and the answer to "will profitability happen"

The outlook for the US online gambling sector has changed. The markets no longer care about growth alone, they want to see proof sky-high CPAs and OPEX can translate to profitability. And they want to see it soon.

This is placing new pressures on operators. Stop the cash burn and start proving the model. It’s a problem that is hard to solve while continuing to invest in new markets, the exact pressure that depresses profitability in the first place.

This is a very simple business. All that matters is what you can get a player to spend. Everything else is noise. And that spending needs to be balanced against your acquisition and retention costs.

To be profitable you need retained players to outweigh newly acquired players. That’s the game. It’s not more complicated. But while this will happen at the state level in some more mature states it won’t happen for the total market in 2023.

And crucially it might not happen for everyone.

A path to rationality

Not all players, and not all operators are created equally. The key metric is average revenue per player (ARPU) and this will vary dramatically between operators, based on product and cohort mix. But it will also vary depending on how sticky your site is for those players you’ve expensively acquired.

In irrational markets where you are trying to trade blows with the big players you can really come unstuck. If your CPA is $700 because the tier 1 operators can get players to spend $1500 in the first 18 months and you can only get them to spend $500 then that is a problem.

The solution? Simply pay less for advertising. But that’s impossible? You can’t pay less when others are willing to pay more. OK, but you don’t have to compete in the same way, with the same product for exactly the same customers. Honestly, you really don’t.

What truly is the value of being a slightly less good version of Fanduel in today’s market? It is close to zero as many firms are finding out now. Could you instead focus on a more local strategy? A different iteration of the core product? A more niche marketing approach? A more targeted demographic approach?

We are starting to see all of these and other strategies beginning to emerge in the US. Think of Betr or SI Sportsbook or Fanatics. And the knock-on impact of this will be helping to rationalise the markets, because markets don’t and can’t remain irrational forever.

Is the juice worth the squeeze?

CPAs are not as high in other markets due to basic supply and demand issues. And as the likes of Fanduel run out of high value FTDs those CPAs will start looking high even to them. Affiliates in particular are a very adaptable bunch, not least when they start to run out of potential new clients, and will begin to adjust pricing.

PPC is another channel where there is a direct operator input on the pricing structure. Eventually even the smaller more reckless firms will lower their bids after getting hit too often by low value customers for high rates. Social media advertising is a little slower and broadcast media is much slower to move but brand building is always expensive.

This isn’t to attempt to do marketing 101, but more to show that common sense does, eventually, prevail. To an extent at least. The key number is ARPU (or LTV) and other costs eventually have to adjust around that. The operators who most quickly adjust their acquisition and retention spend around their ARPU are the ones that come out on top.

To that end, the most important aspect of the industry in 2023 is going to be retention. The most important part of any online gambling business is retention, but this will be increasingly apparent in 2023 and investors will need to get comfortable with analysing the key metrics around this.

This hasn’t been the approach of most operators in the market to this point. That has been more products = more revenue. But there are only so many products your customers actually want. And while cross-selling sports into casino is a well proven path most others are real shots in the dark.

Turning gambling sites into the new Amazon remains a fever dream for some parts of the sector, but the most profitable and scalable thing you can sell them is still gambling. And to do this you need to have a strong end-to-end proposition with great retention marketing, great product and great customer service. Easy right?

Retaining the crown

So, when will we see profitability in the US market? We’re told this year from the big players and that feels more than probable. There is not much doubt Fanduel is already a profitable business. Expansion costs and re-investment in marketing is masking an extremely good-looking underlying business.

This is likely also true for some other firms in the market for whom the question is when to ease back on the acquisition and expansion spend to feel the benefit. The basic concept is fairly solid. You acquire high value customers, keep them happy and keep them spending and see OPEX and marketing spend scale back proportionally.

It’s not a complicated model. It works almost everywhere. And 2023 is likely to be the year when it starts to work in the US too. But it won’t be true for all, or even most. Because while acquiring customers is, relatively, easy. Retaining customers is not. Maximising spend from retained customers is even harder still.

This is the true secret sauce in online gambling. It’s a big reason why the top tier and the bottom tier are in their respective places in 2023. And it’s probably both the least explained by management and the least understood both inside and outside the sector. Breadth and quality of product, sophistication of player communications, brand and a number of other factors all come into play here.

But to-date the KPIs on how to measure retention performance have been very highly guarded. This is unlikely to change in the near-term, and we will probably have to keep using market share and revenue numbers to make a best guess at how most operators are doing. And that’s particularly true around one last super important point: cohort concentration.

The fly in the ointment

Because ARPU isn’t really a representative number is it? It does not truly represent the “average” spend at most operators, it is simply the result of adding up all the high value players revenue, adding on the much smaller revenues gained from the rest and dividing it by the total number of players. In truth it can hide a lot of sins.

An ARPU of $250 can, and often does, mean you have a top 5% generating an ARPU of $3,500 while you have the large majority of your player base generating <$100 per player. In an industry where significant high value player concentrations are the norm, not the exception this can lead to some very top-heavy businesses.

There is nothing inherently wrong with this, but it does create a high dependence on a very small percentage of the player base. And as we’ve seen in some European markets it can leave you vulnerable to any regulatory pushback around player spend levels. There is a lot of debate around if these types of controls will ever be imposed at the state level, but the reality is they may not need to be.

States are already beginning to sharpen their focus on responsible gambling and they will be increasingly aware of the monitoring tools available to operators outside of the US and their associated intervention policies. Putting roadblocks in the way of customers depositing five figure sums would be impactful on revenues for all operators, but could be catastrophic for those with a very high VIP concentration.

If ARPU is the most important metric for the future of the online gambling sector in the US, then player cohort concentration is a very close second. It speaks to the very heart of potential profitability and sustainability. And it’s probably time investors in the sector started to take a much closer look at both.