General economic observations on gaming industries of the European Union

The commercial and government owned gaming industries of the European Union are organized under a wide variety of ownership regimes and market structures. Ownership and market structures are affected by numerous factors, including Member State laws and regulations; restrictions on product types, characteristics, points of sale, availability, and marketing effort; economies of scale; network effects; and impacts of new technologies.

Generally speaking, most EU commercial gaming industries are significantly constrained by law and regulation, as well as by ownership structures and statutory objectives. As a result, they operate in ways that – in comparison to what unrestricted free markets in gambling services with reasonable allocations of property rights and provision of legal protections would bring about – adversely affect the quality, quantity, price, and availability of gambling services.

Different sectors of gaming services possess different economic characteristics. Those that are most important in terms of welfare implications are:

1. Monopoly franchises. In order for a supplier to have an effective monopoly, there must be substantial barriers that would prevent potential competitors from legally or economically servicing that same market. Furthermore, in the eyes of consumers, there can be no close substitutes, i.e. there are no other products or services available that can be purchased that meet the same needs as the product or service in question. With a monopoly franchise, a service provider potentially can capture monopoly profits (economic rents) through a strategy of offering available products or services at prices that are high relative to marginal costs of production.
2. Absence of competition. In more competitive environments, the presence of abovenormal profits would attract other product or service providers who would attempt to capture market share by following strategies of price reductions, market segmentation, product differentiation, or broader offerings. Established product or service providers would then have to respond to such competitive efforts with their own product positioning and pricing strategies. Generally speaking, moving from a monopoly situation to an increasingly competitive one has the effect of benefiting consumers (increasing so-called “consumer surplus”) by lowering prices, increasing quality and variety, and expanding market volumes of the goods or services being offered. Profit rates in competitive environments tend to get bid downward, and consequently economic rents accruing to the aggregate of providers diminish or disappear.

The absence of competition for gaming related services created by legal restrictions or prohibitions – as has been the case in many EU Member States – has the dual effect of limiting choice to consumers and insulating service providers from a variety of competitive pressures. Furthermore, because of the absence of effective competition, service providers typically do not have to be – and often will not be – as diligent in catering to the wants and needs of consumers with respect to the quality or variety of offerings.

Thus, as a result of a legally mandated monopoly and competitive restrictions or prohibitions in gambling service offerings by alternative service providers, this has the effect of keeping prices higher than they otherwise would be; limits the variety and quality of choice available to consumers in the marketplace; and encourages the producer to be less diligent in responding to consumer wants and needs. Furthermore, a monopolist has less incentive and ability to note and act upon changes in either production technologies or consumer trends.

1. Welfare implications: In general, the welfare implications of monopoly for society at large include a loss of consumer well-being as a result of reduced consumer surplus due to higher prices and dead-weight losses; as well as additional dead-weight losses caused by inefficiencies associated with monopoly, partly from resource misallocation caused by the differential between the marginal cost of providing additional commodities in comparison to the marginal value of the commodities, and partly from inefficiencies associated with monopolists not being as diligent as competitive organizations would be in monitoring inputs relative to outputs in the provision of gambling services. The extent of welfare loss is a function of a number of factors, some of which are empirically measurable, including price elasticities of demand, crosselasticities of demand with respect to related products and services, and the extent of waste of resources in the production of the goods and services.
2. Network effects: For some products or services, the value to the individual consumer is enhanced when a greater number of consumers purchase the product. When this occurs, the phenomenon is known as a “network effect.”

Network effects are found with a number of modern products and services, such as telecommunications systems, where the greater the number of participants, the greater the number of possible linkages to others, and therefore the greater the value to any individual consumer; widely understood languages that enhance communication; software platforms, such as Microsoft Windows, that allow for efficient sharing of computer-generated files; and network systems that permit the linking of computers within a company or among a broader interest group.

With respect to gambling services, the presence of pari-mutuel wagering pools such as those offered in Lotto – where the top prize offered grows in proportion to the number of customers participating in purchasing the offering – enhances the value and attractiveness of the gaming offering. Competitive tournaments become more popular with greater participation because of the greater ratio of prizes to the price of participation that can be offered. Betting exchanges benefit with larger numbers of participants because participating in any particular betting market will likely be greater, insuring more transactions can be covered. Lotto games are generally more successful when they have larger populations into which to sell their offerings, because the increased number of customers purchasing chances for a fixed odds, very low probability prize allows game designers to offer even longer odds contests that will drive up the amount of money in the prize pool. The greater value of the prize pool in turn makes the product more attractive to other customers, creating a “virtuous circle.”

1. Economies of Scale: It the average cost of producing a commodity decreases as the volume of production increases, then that particular commodity experiences economies of scale. Many industrial sectors in modern economies are characterized by economies of scale. This implies that the greater the volume of commodities sold, and the larger the organizational network that provides goods or services, the lower will be the average cost of production. Economies of scale can be created by large production facilities, multi-plant operations, extensive distribution outlets, the ability to allocate overhead expenses over a larger volume of output, and the streamlining of such activities as marketing, accounting, security, and personnel. Industry consolidation is often a sign of the presence of economies of scale.

Some gaming services sectors are particularly prone to economies of scale. For example, there is compelling evidence that economies of scale have long prevailed in the casino industry, especially in the United States.(Eadington, W. R. (1999), “The Economics of Casino Gambling,” Journal of Economic Perspectives, 13(3), 173-192.). Recent consolidation and the growing trend toward concentration of ownership in casino industries, gaming machine manufacturing, and even the emergence of multi-state or multi-nation lotteries in the United States, the European Union, and elsewhere lend further evidence to the strength of this factor.

1. Geographic constraints: Some Member State laws and regulations restrict the regions into which gambling services can be sold, or prohibit the marketing of gambling services of their own or other Member States’ gambling services within their borders (i.e. the advertising of casinos in an adjacent Member State; sales of lottery tickets cross-border.) These constraints have the effect of limiting product offerings and the information available regarding alternatives to consumers, thus restricting choice, lowering competition, and thwarting the extent of network effects and economies of scale that would otherwise take place. For government owned and operated lotteries, for example, exclusive franchise privileges granted to a Member State’s national lottery imply consumers within that jurisdiction are only able to purchase lottery services from that one entity.

Interestingly, recent strategic cooperative agreements among a number of national lotteries in Europe has resulted in the creation of a multi-country lottery product called EuroMillions. This product, which was launched in February 2004, is the result of cooperative agreements initially among the United Kingdom, Spain and France, and now also including Austria, Belgium, Ireland, Luxembourg, Portugal, and Switzerland (not an EU Member), which permit marketing EuroMillions to their citizens along with a sharing of the lottery’s net revenues. This lottery product (as with the multi-state lottery services Power Ball and Mega Millions in the United States) has the capability of overcoming the disadvantages for lotteries inherent in constraints against cross-border marketing and sales of their services. EuroMillions has apparently been successful; in 2005, it generated gross sales (before payment of prizes) of over €3 billion, and GGRs of about €1.5 billion (nearly 3% of total GGRs for all EU Member States.)

1. Regulatory constraints: In general, commercial gaming industries throughout the world operate under regulatory regimes that are designed to protect the general public from a variety of real or perceived threats that could occur as a by-product of legally sanctioned gambling activities. Many regulatory constraints are motivated by law enforcement considerations, i.e. to assure that gambling takes place within a legally safe and protected environment, that the likelihood of criminal activities within gaming operations is minimized, that a variety of consumer protections against fraud are in place, and that individuals and organizations associated with gambling enterprises are “fit and proper persons” to provide such services. Such regulations often deal with background investigations of owners and key employees of gaming enterprises, permitted practices and reporting/audit responsibilities for enterprises, and rules governing the fairness and integrity of games and wagering opportunities offered. One justification sometimes used for government ownership of gaming enterprises is to ensure greater control over the fit and proper nature of owners and key employees.
2. Cross subsidization: In many countries, gambling services industries – when privately owned – are taxed at relatively high rates either to generate revenues for state, regional, or local governments, or to direct revenues to “good causes” or to other identifiable beneficial purposes. Alternatively, ownership of gambling services companies by State enterprises is often structured so that the residual profits are earmarked either for general fund revenues or for specified purposes. In this manner, the constraints that are put into place to limit supply of gambling services and/or to grant exclusivity to particular entities have the effect of creating economic rents that can then be directed to support publicly desirable programs or initiatives. The desirable programs or initiatives could include sporting organizations, national Olympic committees, cultural activities, education, or medical research. The extent of such crosssubsidization is determined by the political decisions within the various Member States.

Another set of regulatory constraints, more relevant to this particular analysis, are intended to provide protections for gambling consumers from adverse consequences related to excessive gambling. Within this context are many of the restrictions that dampen demand, limit competition, and otherwise affect price, quality, variety and availability of the gambling services options available to consumers. Of particular importance to the issue of whether legal monopolies with exclusive franchise privileges to offer certain gambling services, restrictions on other Member State organizations or enterprises from offering their services in a particular Member State, and other conditions inimical to the principles of “free and fair trade” under general EU principles are whether particular regulatory constraints have any mitigating or otherwise beneficial effects in terms of protecting gambling consumers from adverse consequences related to excessive gambling. For the most part, such constraints are usually put into place based on the beliefs or prejudices of the policy makers, rather than well-developed scientific evidence. This is largely because of the absence of significant social science research that would establish a causal relationship between certain kinds of regulatory constraints and actual reductions in adverse impacts such as problem and pathological gambling. This issue is addressed later in the Literature Review section of this report.

Another area where the extent of commerce and resulting allocation of resources can also be affected is with respect to tax policy. Tax structures can cause pricing and output distortions with respect to gambling services. When operated by privately owned companies, and especially when gambling services are offered in a protected market environment, there is a tendency in the EU for government imposed excise taxes to be exceedingly high, in comparison to standards that are applied to other entertainment and leisure industries, or in comparison to other commercial offerings in general. One rationale for such tax treatment is the belief that gambling is a commodity that carries with it inherent socially undesirable attributes, and therefore its consumption should be discouraged.

By charging high tax rates on suppliers of gambling services, the economic effects are to reduce profitability, increase product price, and therefore limit the aggregate consumption of such services. This has sometimes been offered as a “consumer protection” rationale for justification of such tax rates. Gambling should be kept relatively unattractive, so it is argued, because if it is made more attractive, more people would get into trouble because of excessive spending on gambling. Of course, high tax rates on gambling services can also create substantial revenues for governments, which suggest that it may be difficult to separate the government’s motivations for such policies.

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