To determine if revenue sharing games are worth the space on the slot floor, operators first need to calculate the true cost and real returns of the controversial devices

Authors’ Note: In this third article of our 12 part series on customer centric gaming floors, we tackle participation games and how casino operators can maximize potential returns. Please note these articles are meant to stimulate thought and that we are using some deliberately provocative metaphors and examples which should be taken with a grain of salt.

One of the biggest challenges facing any slot manager is determining the proper level of participation or revenue sharing games to put on the floor.

This participation game conundrum is a matter of much debate and underpins an enormous rift between manufacturers and operators. Manufactures might say that these games bring incremental revenue, while operators question if revenue sharing games are just reallocating monies that the casino would have otherwise collected.

We’ve decided to wade into this debate and outline some real ways that, by measuring customer behavior, we can discover the true value of a participation game. To start, let’s introduce the two extremes of operator types when it comes to revenue sharing: the 2 percent and 10 percent operators.

The “2 percenter” operator believes that participation games should be less than 2 percent of the total gaming floor, and in many markets there are very successful operators where this low number is effective. Of course, games such as Wheel of Fortune are still a must, but the performance benchmark needed for the 2 percenters to introduce a participation game is extremely high. If the games are 20 percent revenue share and perform at double house average, then the cost of these games in manufacturer fees is 0.8 percent of the overall gaming revenue.

Meanwhile, the “10 percenter” operator has huge numbers of participation games that dominate the gaming floor and are a central part of the overall gaming strategy. An operator with 10 percent of its gaming floor showing participation games is paying around 4 percent of its overall revenue in participation fees.

THE TRUE COST

As we can see from the wide disparity between 2 percenters and 10 percenters, there is clearly much disagreement in the industry regarding the value of participation games, including wide-area progressives. The disagreement arises from the cost of operating one of these games. Most games have a fixed purchase cost (which can be paid either all at once or in daily increments), but wide-area progressive machines are priced based on a percentage of coin-in. Some of this percentage goes to increasing the progressive meter of the game (which is often more than $1 million) and some goes back to the manufacturer, but none of it goes to the casino. To understand how much more expensive a participation game can be, let’s look at an example.

First, let’s determine as a percentage of revenue. This cost is calculated as a percentage of coin-in, but the true cost to the operator needs to be calculated as a percent of revenue. To help us calculate the true overall cost of ownership for participation games compared to non-participation games, it helps to use some simplifying assumptions. For non-participation slots, we’ll assume that the cost to purchase the game is $20,000 and that over the course of three years the game theme needs to be converted once at a cost of $3,000. We’ll also assume the game is winning $150 per day. So the cost to own this nonparticipation game over 3 years is $23,000, and over this same three-year period the game will produce for the casino $150 x 365 x 3 = $164,250 in gaming revenue.

Thus, if we then leave aside considerations like cannibalization or consolidation of play, the investment cost as a percentage of net revenues is $23,000 / ($164,250 – $23,000) = 16 percent for this non-participation game.

Moving on to a participation game, we are still going to assume that it wins $150 per day, but we need some different assumptions: that the participation cost is 4 percent of coin-in and that the casino hold percentage of the game is 12 percent. Since the game does $150 per day in revenue, with a 12 percent hold it must do $150 / 12 percent = $1,250 per day in coin-in. Of this, the cost to own is 4 percent or $50 per day. So, over our three-year period, the cost to own the participation game is $54,750, with the same gross revenues of $164,250.

Thus, for the participation game the investment cost as a percentage of net revenues climbs to $54,750 / ($164,250 – $54,750) = 50 percent!  Our investment cost as a percent of net revenues has increased threefold with the participation game, and our gross expense has increased $31,750 over three years. Clearly participation games are very expensive, so operators need to know they are getting value for this expense.

IS THE COST WORTH THE RETURN

Now we get to the debate. Participation games tend to have average or better than average win per unit—and they are very popular with customers. But are they worth the increased cost to own? In the example above, the win per unit per day (or WPU) net lease fees for the non-participation game is $129 over the three year period, whereas the WPU net lease fees for the participation game is $100—a clear winner for the non-participation game.

The results are less clear when the participation game outperforms a non-participation game.  If instead the non-participation game is only making $100 WPU, then the WPU net lease fee becomes $79 compared to the participation game’s WPU net lease fee of $100.  Traditionally, operators look at those results and decide that the participation game is the better performing game and thus the better game to increase the casino’s bottom line results.

Let’s dig deeper into this example, now bringing in the concept of cannibalization. Whenever a slot machine provides a revenue lift (for example, replacing a $100 win per day game with a $300 win per day game); some of that lift is incremental and some of it is play that shifted from other games. The play that shifted from other games is called cannibalization. To understand if participation games are worth the increased cost to own, we explore two simple examples, one where the game has low cannibalization and one where the game has high cannibalization. For both of our examples, we will compare the value of a participation game that does $150 win per day versus a nonparticipation game that does $100 win per day. Thus, there is a lift of $50 per day driven by the participation game. We’ll also assume that the participation game has a 12 percent hold and costs 4 percent of coin-in. As we calculated previously, the cost to own a participation game is $50 per day. In comparison, the three-year cost of $23,000 to own our example non-participation game is just $21 per day.

In the examples below we want to see if we can justify the incremental cost of $29 per day to own the participation game.

The Low Cannibalization Game:First, let’s consider a participation game that is very popular and whose customers have shown a propensity not to gamble very much on other non-participation games. In this case, the cannibalization of this game from other games is low. If customers of this game don’t play many other games, there cannot be much play shifted from other games to this game. So let’s assume that the cannibalization factor is 20 percent—that is, of the $50 lifted from the participation game versus the non-participation game, only 20 percent (or $10) is taken from other slot machines on our floor. In this case, our truly incremental revenue from the participation game is $50 – $10 = $40, which is enough to cover the extra $29 in cost to-own expenses.

The High Cannibalization Game:In this example, let’s consider a participation game that is also very popular; however, the customers who like this game also like to play other non-participation games. In this case, the cannibalization of this game from other games is high. Let’s assume that the cannibalization factor is 70 percent—that is, of the $50 lifted from the participation game versus the non-participation game, 70 percent (or $35) is taken from our other slot machines. In this case, our truly incremental revenue from the participation game is $50 – $35 = $15, which not nearly enough to cover the extra $29 in cost to- own expenses. In other words, in this example, we actually lose money on our participation game, despite the fact that it is winning an extra $50 per day over our hypothetical non-participation game.

MARKET CONSIDERATIONS

Notice that there are many factors involved in this calculation. Cannibalization is one of the key factors, but the floor win per unit is another major factor. The cost to own a non-participation game is fixed, whereas the cost to own a participation game is variable. Thus, for low win per unit per day floors, the increased cost of a participation game is less relative to the non-participation game, making it more likely that it is worth paying the participation fee. For higher win per unit per day floors, the cost to own a nonparticipation game is very small compared to a participation game, making it less likely that paying the increased expense will be profitable. Thus, market performance affects return on investment. For example, in a low-revenue market, say $100 per machine per day, the simple economics of revenue sharing games can make a lot of sense. Quite simply, the revenue share may be less than a capital purchase. Daily fee games are a different matter, however, and in high-value markets, say $500 per machine per day, these games are more affordable as a percentage of total revenue (see Table 1).

Now let’s look closer at participation games’ cannibalization, as it is the major determining factor in our calculations of worth today. Unfortunately, trying to determine the effects of a new product on existing products can be daunting. Can we ever measure whether a specific customer’s $20 wager was meant for another machine or was in addition to their normal gaming spend on a “typical” trip? First, let’s take a look at the player’s behavior using an unnamed but real customer database. When we attempt to determine the growth of a player’s worth, one metric we use is their ADT (average daily theo). This metric works fine when you are measuring trip worth over a period of time, for example, to see the effects of your marketing efforts. But if we use ADT as a baseline to measure a player’s incremental spend on a single day, the results could be disastrous. In a three month sampling of data for the core customer base, we found that only 14 percent of all trips made by players were within a +/- 10 percent of their ADT. More than half of all trips made fell below the 90 percent mark of their ADT and 34 percent of all trips were above 110 percent of the player’s ADT. Nearly one-fifth of all trips didn’t even meet 25 percent of the player’s ADT. The variance in our player’s trip theo to his actual ADT is enormous, and we could easily miscalculate whether or not a $20 single session increased or decreased his trip’s theo win in comparison to his ADT.

This real world example highlights the complexity involved in trying to measure what a customer would have done on a removed game vs. what they did do on a new game that replaced the removed game.  If we cannot count on a metric like ADT, which is not only simple but is also the bedrock of many casino marketing programs, what can we do?

BRINGING IT ALL TOGETHER

As long as there are participation games there will be debate on the value of this business model. Clearly the key to unlocking the true cost of the games is to find the cannibalization numbers for each of the games. While it is not an easy calculation, you can see the impact of cannibalization to the slot results are startling and will shine a new light on the true cost of revenue sharing.