News analysis: If at first you don'€™t succeed...

The state of Illinois is looking for a new private firm to run its online lottery platform. Brad Allen examines why the change was needed and what it means for the US iLottery landscape

In late July, the Illinois Governor Bruce Rauner announced the release of a Request for Proposal (RFP) for a new private partner to run the state’s lottery programme.

The announcement was meaningful for several reasons, not least because Illinois had been the first US state to enter into a private management arrangement and the first to ask its private partners to take the lottery online, albeit with disastrous results.

The previous contract was won by Northstar Lottery Group – a partnership between lottery giants GTECH and Scientific Games, but the consortium was sacked halfway through the 10-year agreement for failing to deliver on its promises. The JV said it would generate $4.8bn in net income over the first five years of the deal, but never came close to hitting those targets, falling half a billion dollars short, according to some estimates. It had also promised 5% of sales over the internet, but never got close to that, reaching 0.6% penetration.

But perhaps the failures could have been expected, because according to a source close to the bidding process, the way Illinois went about the original RFP was “really naïve”.

“They didn’t align the contract with incentives,” the source says, “so bidders could put out all these gaudy numbers and unrealistic targets without repercussion if they didn’t hit them.

“Why on earth would you appoint Northstar? It’s a technology company. They have no operational experience whatsoever and how on earth would they know how to run a lottery? Their online figures show how poorly run it was.

“Another problem was that Northstar came in as a consortium and just started awarding themselves contracts. There was a real conflict of interest. Even though they were meeting their sales targets, they were paying out huge sums to vendors and suppliers, which was themselves. There was no incentive for them to be operationally optimised in any way because they were still making a lot of money.”

Indeed Governor Rauner alludes to this issue in his statement calling for RFP’s this time around, saying: “With this proposal, unlike the last contract, conflicts of interest will be eliminated”.

Northstar did not respond to a request for comment.

Incentives

The Illinois Lottery acting director Tim McDevitt admits that mistakes were made last time around, particularly with the way the tender was structured.

“The previous model absolutely encouraged unrealistic profit projections because the private manager (through its affiliates) was also making money off of the supply contracts,” he says.

“There was therefore a risk that companies would make promises on profit that it would never deliver on because the company instead was focused on driving top line growth, since incentives for the supply contracts are based on revenues, not profits.”

McDevitt claims the state has learned from the process, and this time around the private manager will be excluded from being a supplier as well. He also claims the new model is “very much along the lines” of the one used by Ireland when it was looking for a private manager for its state lottery.

A key difference is that the Irish Government asked for an upfront payment (a hefty €405m) which “stimulated strong competition and ensured that the Irish State would benefit from day one,” according to William F. Weld, the former Governor of Massachusetts, writing in an op-ed on Forbes.

The Ireland contract also remunerated the operator based on a share of the net revenue rather than overall sales, helping align the incentives of the operator and the state, while it also called for the operator to embrace new interactive technologies.

Internet-first

So the state has fixed its RFP model, but what does it want from its new partner? According to the statement from the Governor’s office, the new private manager will be held more accountable in several ways.

“First, the private manager will be heavily evaluated on its ability to grow the Lottery through innovation,” the statement said. “There will be an emphasis placed on finding a partner that can develop new products and reach new customers.”

Further down, the Governor outlines seven guiding factors for a selection including the ability to “incentivize lottery to innovate and grow online sales”.

Put another way, the state is unwilling to settle for 0.6% internet penetration, when it is about a third in the UK for example. McDevitt says that neighbouring Michigan, which has its online platform powered by NeoPollard Interactive, is a feasible target in the short term, with 6% of sales taking place online.

“Even to get to their level of online sales would translate to over $100m in additional sales in Illinois,” he says. “Hopefully, we could eventually replicate the levels seen in the UK, which exceed 30% of sales online in some instances.”

McDevitt also says the state has learned a lot from its experience, not least that “the mere authorization for online sales isn’t sufficient to drive growth”. The state has just two kinds of online games under the current regime.

“The lottery also must offer products online that are desired by its customers and market to those customers to create awareness of those offerings,” McDevitt adds. “These are some of the capabilities we’ll be looking for in a new private manager.”

Powerful influence

If Illinois gets it right, the impact on the rest of the US lottery landscape could be huge, especially on states like Massachusetts, which is battling to get iLottery legislation passed, but have failed to get over the hump just yet.

“Success here would force other states to look at revenue opportunities and follow Illinois’ lead,” says a source familiar with the bidding process who requested anonymity due to a conflict of interest.

“There’s never enough money to go around in state budgets. Illinois is important because if it can show there’s serious money to be made through iGaming revenue, then other states cannot ignore it. It becomes a tangible example that can be held up and politicians can say ‘they made this amount of revenue from these type of offerings, and we have a duty to our constituents to do a similar thing.’”

While the latest Illinois RFP may not be perfect – one source said the timeline was impossibly ambitious – it represents another step toward widespread internet lottery in the US. As Eilers & Krejcik Gaming put it in a recent report: “We find the adoption of internet-based sales to be an inevitable evolution in lottery.

“Longer term, we believe iLottery sales could conceivably represent 5-10% of total lottery sales in the US, or around $3-$6bn, assuming the majority of states participate and offer both instant tickets and draw-based lotto games.”

The Illinois RFP closes on October 26 and the winner will be announced at the start of the new year. The timeline could be rushed in part because the law allowing online lottery sales is set to expire on June 30, 2017. However, a new private partner driving online sales would go a long way to ensuring a renewal of that law, while it could also help drag the rest of the US lottery industry into the 21^st century.