Using Complexity Theory to Help Navigate the Future of iGaming Regulation

The online gaming industry regulatory debate has received significant media attention recently following the German court ruling between bwin and Westlotto, with bwin CEO Norbet Teufelberger calling for “modern regulations for online gaming” to ensure “suitable standards of gambler protection”. From a player protection perspective much debate has centred around whether more open regulated markets offer players greater protection compared with either monopolistic or unregulated markets.

But what exactly are “modern regulations” and how can they be applied to the online gaming industry to ensure players are suitably protected? Because of the increasingly complex operating and regulatory environment in online gaming answering this question is not straightforward. I attempt to frame an approach as to how the industry can best embrace “modern regulations” to protect players using the concept of Complexity Theory, which has been used to help large organisations, which are inherently complex, to produce effective results from complex interactions.

Today’s regulated markets (highlighted in green in the diagram below) offer a range of player protection requirements, approaches and codes of conducts developed either by regulators or by industry bodies (e.g. eCOGRA). Such codes of conduct have broad agreement across the industry and are relatively easily implementable and enforceable. These are necessary, and even strict regulations, as long as they are aligned to player needs, should be encouraged. Debate continues regarding the justification of monopolies on the grounds of player protection, with accusations from the commercial operators that this is being used a political weapon to justify the maintenance of state monopolies (a debate that I won’t get into in this blog). Either way, whilst necessary, key draw-backs of today’s regulated markets are i) regulations remain static for too long, ii) whilst responsible gaming standards can be met on paper, the players’ experience can differ widely, and iii) international operators are having to provide different levels of player protection due to a player’s nationality because of differing national requirements.

At the other end of the complexity theory paradigm is where I place the current unregulated markets (highlighted in red). Whilst some argue over-regulation can lead to less sustainable practices in that regulations can create the opposite of the intended outcome as organisations look to find ways around the rules (e.g. banking), the vast majority of regulators, academics and operators believe that leaving player protection in the sole hands of market forces is wrong. I agree.

So where does this leave us? Well, how about complexity, ambiguity, uncertainty and turbulence? Without doubt there is no ‘silver bullet’ approach as to how to address the limitations of today’s current regulated markets. It’s also quite clear that nobody really knows where we are heading as change is constant and unpredictable and technological innovation is explosive and on a steep gradient. However, at the heart of this chaos, complexity and uncertainty lies an enormous opportunity to build more safe, informative and fun experiences for online gamblers. Grasping this opportunity however requires vigorous debate, innovation, research, experimentation and collaboration (this is highlighted in blue). Whilst we won’t always be right first time, we will be heading in the right direction. And we are now seeing evidence of the industry increasingly taking the lead in this space.

“Modern regulations to suitably protect players” in online gambling therefore requires not just an adaptation of existing regulations, but a new approach that in parallel encourages industry self-regulation, collaboration and innovation. It’s not a straightforward answer but it’s not a straightforward problem to solve. Despite the challenges, I’m encouraged to see continuing innovation within the industry and believe we will find the right direction, as in the words of Dimitri Kondratiev, the economist, “progress is an irreversible trend”.

The Forces Shaping the Online Gambling Industry

Whilst the online gambling industry has witnessed tremendous growth in the past 10 years it remains a very young industry, currently capturing c.6% of the gambling industry’s total gross gambling yield of c.$336bn (Barclays Capital). As the industry continues to grow and mature, an increasingly complex operating environment is presenting both challenges and opportunities to operators. This blog entry seeks to examine the key forces that are shaping the online gambling industry today.

Regulation

The regulation of online gaming markets is opening up opportunities for legalised online gambling in European markets, which is primarily being driven by the need for governments to effectively manage the taxation of the online industry. The regulatory map in Europe remains complex and in flux following a series of European Court of Justice rulings during the past 2 years. The spectrum of regulation across Europe is wide, ranging from online gambling being banned, such as in Germany, to liberal regulatory regimes like in the UK. In between are countries that have regulated online gambling with varying licensing and taxation regimes.  Whilst growth of the online market in Europe will continue with the further opening of markets, online gambling in all forms remain illegal in the USA.  Despite opposition to legalising online gambling in the US, it is expected that the trend towards regulation will continue over the next 2 years.  Whilst a more uniform regulatory playing field in Europe remains at least 5 years off, Michel Barnier’s Green Paper on European online gambling is due to be published at the end of this year and is being eagerly awaited by the industry.

Technology

At the 2010 EIG product development was highlighted by Mark Blandford (Sportingbet founder and Valhalla Investments) as more important than marketing as players demand richer, more varied and more mobile gaming experience. Advances in technology is allowing game developers to take 3D gaming to new levels, and this trend of enriching the user experience will spread to the online gambling sector. The number of mobile broadband subscribers is rapidly increasing i.e. there were 257m subscribers in 2009, which is predicted to expand to 2.5bn by 2014. Operators are also investing heavily in developing advanced analytics solutions to better understand customer behaviours to make marketing campaigns more targeted and meaningful. Whilst there has been a large focus on customer acquisition in the past 5 years, operators are now focused on reducing player churn during key phases of the customer lifecycle. No one operator will be able to develop market-leading technology capabilities across all these areas in isolation therefore best-practice collaborations with specialists will be required to remain competitive. Potential new competitors are emerging as social media technology platforms mature and attract more users and gamers, with the distinction between legalised gambling and gaming with virtual currencies becoming increasingly blurred.

Consolidation and Convergence

The industry is now entering a phase of consolidation as brand, capital and scale become key levers to entering new markets and attracting customers through competitive prizes, odds and gaming variety and experience. The biggest moves in the market in 2010 included PartyGaming and bwin’s merger to create the world’s largest listed online gaming firm and Betfair’s recent flotation on the London Stock Exchange, signs that access to capital and scale will become increasingly important to succeed. Sportingbet and Unibet are also in discussions regarding a £600m tie-up. As well as revenue generating synergies, consolidation will provide vital cost reduction opportunities through economies of scale which will become increasingly important. Sales and marketing costs typically make up between 30-40% of an online operator’s costs and it is likely that retaining these budgets will remain an important weapon in the battle for market share. Further competitive pressures will result from the continuing trend of convergence, with land-based operators looking to leverage their brands and gain market share in the online sector. Convergence within the industry between B2B and B2C will also continue as online operators look to expand their business models and find new revenue sources to augment existing revenues from players.

Corporate Transparency and Trust

Given numerous corporate crises across many industries over the past few years there is an increasing expectation that all corporations should be ‘whiter than white’ and operate in a socially responsible manner. The online gaming industry has in recent years increased its focus on delivering a socially responsible industry for players. The regulators who license operators have responsible gaming codes of conduct in place that operators must adhere to which are both prescriptive (e.g. age verification, self-exclusion) and open to interpretation (e.g. prevention of problem gambling). Whilst it is difficult to predict whether recent economic and corporate failures will result in a permanent change in the corporate attitude towards CSR or tougher regulations, focus from the media and policy makers will continue to grow on industries with perceived reputational issues, such as gambling. The internet also offers an unparalleled level of transparency to customers, whether it’s comparing operators’ odds, prizes or which organisations they are accredited by. Given increasing competition and very low switching costs associated with online gaming, customer loyalty cannot be guaranteed solely by brand awareness marketing and customer inertia. Brand equity will remain incredibly important and nurturing customer loyalty and trust will play a key role in growing an online operator’s brand value.

Can Loss Chasing be explained by Behavioural Economic Theory?

Research by Xuan and Shaffer (2009) from The Division on Addictions (a Harvard teaching affiliate) sheds interesting light on our perceptions of loss chasing in relation to behavioural economic theory. Xuan and Shaffer analysed the play patterns of 226 online bwin gamblers who closed their accounts due to gambling problems. Their findings state that whilst players experienced increased monetary loss and increased their stake size prior to closing their accounts, they did not chase longer odds.

The authors frame their findings in the context of the work in the 1970s by Kahneman, Tversky and Slovic who analysed behavioural concepts and decision making, with Kahneman and Tversky’s paper in 1979, Prospect Theory: An Analysis of Decision under Risk, arguably one of the most important to be published in this field (Kahneman was awarded the Nobel prize for economics for his work in this field).

The group of gamblers in the Xuan and Shaffer study tried to recoup losses by increasing their stake on events with higher probabilities of winning i.e. they become more risk averse and, therefore, they bet more conservatively. However, the players did continue to bet with a greater stake size, albeit with less risky odds. Therefore whilst choosing less risky odds supports the theory of loss aversion, the fact they continued to bet using a different betting pattern perhaps adds less weight to the theory.  So I have an alternative theory that builds on this.

An additional explanation for the gamblers’ behaviours in this study could be the influence of cognitive biases such as regret theory, self-deception, over-confidence, and the sunk cost fallacy, rather than loss aversion. Jacobsen et al’s (2007) analysis of the influence of cognitive biases demonstrated that they play an important role in the development of problem gambling behaviour.  A study by Shefrin and Statman in 1984 that focused on loss realisation provides interesting insight into why investors tend to hold on to stocks that continue to lose value whilst selling performing stocks. One theory relates to avoiding regret, in that investors may resist realising losses as it is proof that their judgement is wrong. Their research also examined other emotional and psychological factors, such as mental accounting, where professional traders use heuristics, such as never letting their losses reach 10%, as a benchmark or anchor when to sell falling stocks.

Xuan and Shaffer’s paper provides a great insight into the gambling patterns of problem gamblers and their reference to loss aversion to explain gambling behaviours is very interesting and carries weight. In addition to loss aversion, other cognitive biases could have played an important role in the decision making process for gamblers as if they were truly loss averse, one can make the case that they would seek to limit their losses (like Shefrin and Statman’s traders) rather than to continue betting. Whilst many people today think there is very little difference between an investment banking trader and a casino gambler, I appreciate a direct comparison is too simplistic. One thing for sure is that this highlights the complexities involved in trying to get beneath the mind of a problem gambler.