Saturday, April 26, 2008

The Horse Racetrack Industry Analyzed Using Porter's Five Forces Model


Professor Michael Porter of Harvard first postulated the Five Forces Model to help explain the influences that shape industry competitiveness. The diagram above depicts the forces and their source. The entities that can impact an industry participant are:

New Entrants

Others analyzing the Porter model identify that entities such as complementers and governments are missing. In this exercise, complementers will be discussed along with suppliers. Governments, particularly in any wagering business, need to be considered.

We’ll study the US horse racing industry viewed from the perspective of race track operators (tracks). Each entity will be examined to determine the extent of the entity’s leverage upon on the tracks. The objective of the analysis will be to assist the tracks in positioning. The concept of positioning is the key point of Porter.

Suppliers and Complementers

Suppliers provide the inputs which the firm uses to create its product or service. In horse racing the key input is, of course, horses, provided by breeders (horsemen). The majority of horses used in US horse racing are Thoroughbreds and Standardbreds. Other horses used include Quarter Horses, Arabians and Palominos.

The power of horsemen is lessened to the extent that:

§ horses of sufficient quality are plentiful;
§ tracks can offer wagering on the races of other tracks; and,
§ tracks have additional revenue streams, such as slot machines.

The power of horsemen is increased to the extent that:

§ horsemen exercise their right under law (Interstate Horseracing Act of 1978) to restrict the ability of tracks to offer wagering of races across state lines;
§ tracks providing economically viable purses are plentiful and accessible; and,
§ horsemen have the ability to forwardly integrate into the track business.

Typical complementers to the tracks are the off-track betting (OTB) establishments, Advance Deposit Wagering (ADW) providers and race information services such as Equibase. With regard to OTBs and ADWs, these entities can also be viewed as competitors, particularly if they cannibalize patrons that would ordinarily travel to the track to wager.

Buyers (Customers)

Buyers are the wagering customers of horse racing. Horse racing enthusiasts attempt to analyze various factors in an attempt to predict the winning horses. Handicapping allows skilled players the ability to increase their chances of selecting the winning horse. Unlike other gambling activities like lotteries, slot machines and craps, there is an element of skill in predicting the outcome of a horse race. That cerebral activity is an attractant and a detractor from horse race wagering, depending upon the customer preference.

The power of buyers is increased to the extent that:

§ buyers are large or few in number or purchase (wager) in large quantities;
§ buyers wagers are a significant portion of the tracks selling revenue; and,
§ tracks provide a standardized offering such that buyers can find alternative tracks and switch at low or no cost.

Pari-mutuel wagers, either on- or off-track, are the key driver of track revenue. No wagers, no need for tracks or horses. Some tracks have incorporated slot machines and have become racinos, but the horse race wagering remains the lifeblood of the industry.

The amendment in 2000 of the Interstate Horse Racing Act of 1978 permitted betting on horse racing over the internet. This spawned the emergence of ADWs. ADWs generally offer wagering on many racetracks, both in the US and internationally, allowing buyers the choice of alternative tracks at zero cost of switching.

New Entrants

If an industry is lucrative and the entry barriers are low new entrants may enter, increasing the level of competition. For this industry, new entrants can include other tracks, off-track betting (OTB) facilities and ADWs.

Substantial barriers to entry exist with regard to creating a new track. There are significant capital outlays as well as various governmental land use and gaming regulatory permissions required. Depending on the jurisdiction, referendums may be required as well.

Tracks have the following revenue streams common among them: on-track wagering, off-track simulcast wagering on other tracks’ racing, parking, admission and concessions. For those with approvals, slot and table casino game revenues are also available.

Tracks have several revenue streams and high barriers to entry. They seem to be in a good position, but it is an illusion. Of the common revenue streams, the pari-mutuel wagering is the item of interest. Any new entrant only needs to craft a solution to capture pari-mutuel wagering. The large capital outlay to build a track is not necessary to capture pari-mutuel wagers.


Substitutes are products and services that are similar in customer benefit, but are not just the same product provided by a competitor. Substitution can become more prevalent as:

§ buyers find available alternatives;
§ legal and regulatory barriers are removed;
§ technological change reduces the benefit of the product or service; and,
§ buyers’ behavior changes.

Substitute products to horse race gambling are other gambling products such as lotteries and casinos, both physical and online. Since horse race handicapping applies a certain level of knowledge and skill, online sports betting may be considered a substitute. With the takeout or “vigorish” on sports wagers generally less than that for horse racing, sports betting may be an attractive alternative.

There are US statutes that severely restrict the offering of sports wagering by firms in the US. However, several offshore firms continue to offer sports wagering to US customers, regardless of US law. Online gambling may become more prevalent if US law is liberalized, increasing any substitution effects.

Competitors (Rivalry among Tracks)

Rivalry among tracks tends to be regulated by state racing agencies. These agencies divide the available racing days among the various tracks in the state. In many cases, tracks do not have a close physical competitor offering races at the same time. Or, if they do, it may be a “fair circuit” track that generally offers lower quality horses, of hopefully lower wagering interest.

Tracks in general offer the same basic product, horse race wagering and OTB horse race wagering, with the exception of those tracks that are allowed to offer casino games, such as slot machines. With respect to rivalry for off-track handle, tracks with history of high purses tend to attract better quality horses, which tend to stimulate more wagering interest. However, there also is a correlation between the number of horses in a race and the wagering interest on that race. With field sizes of less than 8 horses, the wagering handle tends to drop off quickly.

There is an aspect of indirect rivalry, which is more lack of coordination rather than rivalry. In the US, tracks do not coordinate their race start times such that bettors can have the opportunity to bet on all races. Many races in the US may run within a minute or two of each other, not giving bettors a chance to cash winning wagers on a race on Track A and then betting on the upcoming race on Track B, for example. In other countries, such as Australia, tracks coordinate their start times to maximize the availability of races for betters to reinvest their winnings, maximizing overall wagering handle.

Who Has Power in the Value Chain


Buyers have great power. With the advent of ADWs, buyers have a wide selection of racing, both domestic and international, with no switching costs. In addition, buyers can gamble on state lotteries and patronize land-based casinos in many states. Buyers can also use the internet and patronize dozens of online gambling websites that cater to US customers.

Unlike the old days, horse racing isn’t the only game in town when it comes to legalized wagering. Other forms of US gambling have increased in sales, where horse wagering handle is flattening. Although not true in all cases, on-track wagering handle is stagnant to declining. If inflation is taken into account, overall wagering handle growth looks even worse.


Horsemen currently have moderate power, but potentially have great power. Horsemen provide the core input. They also have statutory power to allow various interstate outlets access to track signals and pari-mutuel pools.

Until recently, horsemen have not been aggressive in utilizing this power, but that is changing. They may run the risk of becoming too aggressive if their demands for a greater portion of the horse wagering takeout extend to areas such as track parking, concessions and slot machine revenue. Horsemen also have the ability to move the highest quality horses between tracks to enhance and/or detract various tracks’ race offerings or boycott tracks with substandard purses, amenities, etc.

Horsemen have the potential to forwardly integrate into ownership and operation of race tracks and ADWs. As the manufacturer of the core input, horsemen have the potential to construct a completely vertically integrated offering – horses, venues and wagering outlets. The only barrier to this vertical integration is governmental regulation and antitrust restrictions.


Depending upon jurisdiction, amount of nearby tracks and served population area, tracks have low to moderate power. Tracks provide the venues that horses need to race. Tracks and horsemen provide the key inputs to the industry.

Tracks have the ability to limit the access to other outlets to wager on its races. Generally, that isn’t done as off-track wagering is much greater than on-track wagering. Tracks do have the ability to forwardly integrate into the ADW space, which has occurred with Magna Entertainment and Churchill Downs. Tracks theoretically can backwardly integrate into the horse breeding space as well, but complete integration will not be able to compensate for a track located in a market that has a small population, nearby competition and onerous government regulation.

New Entrant OTBs and ADWs

OTBs and ADWs should have minimal power. The current structure of the industry allows OTBs and ADWs to enjoy more power than they may deserve as they are in reality nothing more than a retail channel. OTBs and ADWs have no role in the actual manufacture of the racing product.

ADWs are just websites that tie to the various track pari-mutuel pools. They do need to be approved in the various jurisdictions which they desire to offer wagering services and they do need to pay simulcating and other fees to tracks. Offshore ADWs may or may not be licensed to operate in the US, but may do so anyway. In addition, offshore ADWs are more likely to offer rebates to large-volume wagerers. An ADW is more expensive to develop than a typical website, in the hundreds of thousands of dollars versus hundreds of millions for a racetrack.

ADWs can offer convenient wagering from a customer’s home or office, allowing the customer to avoid having to travel to a track or OTB facility. If the ADW is an off-shore entity, they may offer rebates to large-volume customers. ADWs are new entrants that are a threat to tracks’ on-premises business. It is likely that they do not have as high a margin as tracks, but their overhead is significantly lower, which may make them potentially more profitable.

OTBs are location-based, so they are only as powerful as their overall attractiveness. If an OTB is just a place to wager on horses, it is less attractive than an OTB located at an Indian casino, or Las Vegas casino race and sports book.


Mishra, Sam. (2006), Michael Porter’s Five Forces, Retrieved April 26, 2008, from:

Porter, Michael. (2008, January), The Five Competitive Forces That Shape Strategy, Harvard Business Review, Retrieved April 26, 2008, from:

Silbiger, Steven. (1993), The Ten Day MBA, William Morrow, New York, 319-323.

Tiffany, Paul. (2006, March), Corporate and Product Strategy, Product Management Program 2006, UC Berkeley Center for Executive Development. (2008, April), Horse racing, Retrieved April 25, 2008, from: (2008, April), Online gambling, Retrieved April 25, 2008, from:

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Thursday, April 24, 2008

Churchill Downs Files Suit Against Horsemen's Group

Today, Churchill Downs, Inc., the operator of several racetracks, filed a lawsuit related to its dispute with the Florida horsemen's group and its negotiating agent, the Thoroughbred Horsemen's Group. This dispute centers around money - as in who gets how much. The link to the article is here.

The horse racing industry has had problems for quite some time. It was really only a matter of time before all out civil war commenced. Not counting the regulators, the three key parties are the horsemen, the racetracks and the wagering outlets. Each party is "jockeying" (sorry, had to put that in) for the biggest cut of the pari-mutuel takeout. Depending on jurisdiction and type of bet, the takeout for pari-mutuel wagering typically varies from 15% to 25%. With approximately $15 billion in annual horse racing betting, there's over $2.5 billion in money to be divided up among the parties.

The horsemen have the legal ability to withhold permission for racetracks to send their track television signals to out-of-state outlets (to include wagering outlets, known as Advance Deposit Wagering or ADWs). The vast majority of wagering on a races occurs off-track. So, approximately 18 state horsemen's groups have formed the Thoroughbred Horsemen's Group (THG), which is acting as a negotiating agent to form a uniform sharing mechanism for revenue from ADW wagers. That doesn't seem so bad at first glance, but frankly, this industry is screwed up.

A couple of the largest racetrack owners, Magna Entertainment and Churchill Downs, formed a joint venture, TrackNet Media Group, which negotiates on behalf of both companies and their ADWs, and Churchill Downs seems to have no problem having TrackNet Media Group negotiate on its behalf and, on occasion not allow other ADWs to wager on its races, as was denied access to the Kentucky Derby last year. However, it seems to have a problem with the Florida and other horsemen's groups using THG to negotiate on their behalf, such that it filed suit.

It will be interesting to see how this plays out in the courts, but the real losers will be the horse racing industry in general. Customers, you see, can spend their money betting on races outside of the US, or use off-shore wagering providers that do not share any revenue with horsemen or the tracks.

A future post will apply Porter's Five Forces Theory to the horse racing industry to determine which participants in the value chain have power and which don't.

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Sunday, April 13, 2008

Is Online Poker Sustainable?

It is an understatement to say that poker has become much more popular in recent years. The online version helped spark a new wave of growth in the online gambling industry. One online company, PartyGaming, catapulted to a multi-billion dollar market capitalization at its IPO and joined London's FTSE 100 index.

With the passing of the Unlawful Internet Gambling Enforcement Act (UIGEA) in the US, a large portion of the internet gambling customer base was put off limits to online poker operators (at least those that someday have hopes of legally serving US customers). These operators have refocused on European and Asian customers and are expanding to other games; however, the US impact is still large.

This is not the only challenge facing online poker operators, regardless of whether they still take US customers. At minimum, three major challenges face online poker operators: legal/regulatory, competitive, and game security. With these challenges, the question is whether the current online poker industry is sustainable.

A key point regarding poker is that the majority of the players don't win. For online poker, the estimate is that 90% lose. So, for an operator, the need is to maintain a sufficient inflow of inexperienced players ("fish" in poker slang) to feed the existing base of experienced players, either to grow the business or just to maintain the business. This is somewhat similar to a pyramid scheme, where approximately 90% of the participants lose money. As poker players become more experienced, it can be viewed that they move up the "pyramid." Unlike the pyramid scheme however, those at the top of the poker pyramid are expected to stay and receive a recurring payout, rather than receiving a terminal payout and exiting. This increase of experienced players increases the number of inexperienced players required, which puts a greater strain on the system than a typical pyramid scheme. A good description of pyramid schemes is found in this link to Wikipedia. Each of the challenges to the online poker operators directly impacts the number of new players available.

Legal/Regulatory Challenges

The US UIEGA statute was a huge blow to the online gambling industry, costing publicly-traded online gambling companies billions of dollars overall in market capitalization. Other highly publicized prosecutions of online sportsbook operators and payment processors also chilled the online gambling sector. Up to 2006, the US was approximately half of the online gambling market. This activity has not totally disappeared, but only a fraction of online gambling companies still actively service US customers. For the poker operators that have exited the US, all are competing for the smaller European and Asian markets.

Competitive Challenges

As discussed previously, most poker sites are now competing for European and Asian customers, rather than US customers. Additionally, there isn't a barrier to entry for other poker sites to emerge. So, a larger number of poker sites are competing for a given customer base. Typically, marketing efforts become more lucrative to the player and/or the operator marketing affiliate, reducing operator profitability. The operators need to address the reality of facing more competitors all vying for the new players required to feed the experienced players that generally profit from playing.

Game Security Challenges

The online poker sites have done a good job at identifying players operating in collusion, which was the initial massive game security threat. The current poker sites with upgraded software and oversight are better at detecting suspicious behavior. However, being an online game operator facing off against intelligent human adversaries, it would be impossible to say that all collusion is extinguished from internet poker.

The newer and more serious threat to game security is the increasing use of sophisticated automated software programs that play nearly flawless poker. These programs, known as "bots," turn the advantage toward the bot user and for a price of less than $100, can turn a "fish" into a "shark." This, if not countered, could be the issue that brings the end of the current online poker craze. Actual cheating software won't be discussed, but that is available as well. For an example, see

A bot, unlike a human player, does not tire or play based on emotion. Also unlike a human player, the bot can make thousands of calculations per second in order to play more efficiently than a human. If programmed properly, the bot doesn't make mistakes. In addition, bots can scale -- simply obtain more computers and computing power.

Assuming a bot that can generate a profit of $10 per hour per table, the bot can handle four tables simultaneously and a computer that can run two bots concurrently. At full capacity, that computer player would generate a profit of $80 per hour for as long as the bot was up. Want more money? Add another computer. This is a huge problem for online poker operators. What's the counter for the player? You get your own bot.

Software upgrades will come on the scene (if not already) that will analyze for perfect play and use that as an indicator that a bot is being used. The easy counter that operators use to scan a computer hard drive for bot software is beaten by having a second computer with the bot software that reads the poker software on the computer that is actually logged into the game. How bot users will beat the play analysis is that they will program inefficiencies into the bot as a governor, to diminish the profitability of the bot and to masquerade as a human player.

Using technology to gain an advantage is really a big flaw with online casino games that aren't random number generator-based (slots, etc.). In a physical poker game, you easily detect collusion and someone pulling out a laptop would be a bit conspicuous. But in the online world, with hundreds of poker sites, bots can flourish. This is what will likely cause the big decline in online poker and be another impact to the online gambling industry.

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