The Game Theory of the Seed Stage = Pay Upp
My Two Year Old is Smarter Than You
Why I’m Betting The House On eSports, Part II
Why I’m Betting The House on eSports – Part I
Game Over: Why Daily Fantasy Has Already Been Won

The Game Theory of the Seed Stage = Pay Upp

Yesterday Hunter Walk published a post entitled: Seed Stage VCs Compete With Each Other But Not How You Imagine, which argued that in spite of the explosion of seed/MicroVC funds, the environment remains more collaborative than competitive. While, anecdotally, I agree with most of his thoughts, I do believe that from a game theory perspective the seed stage world should look far different.

In addition to Hunter,  Semil Shah recently reflected that he’s seeing increased downware pressure on seed valuations as investors (and LPs) tire of ballooned entry prices – especially with the lack of any material M&A.

If these trends are true, that top tier “branded” seed funds with institutional LPs will be increasingly subject to valuation discipline, it should (in a game theory optimal world) create an opening for a new generation of seed funds.

Here’s why –

Everyone Likes Storytime, Right?

In early 2015 I got extremely excited by a company involved with an exclusive group, that, well, rhymes with “I see.” I started speaking to this company about a week before their demo day via a referral from a founder in their class. As I recall they were trying to raise some money at a valuation cap of $5M.

It took me a few days to track down the people I wanted for diligence and we spoke the morning before demo day. They offered me an allocation at that moment but told me that after demo day, the entry valuation would double to $10M. I see this tactic a lot, and while I always find it a bit off-putting, I do respect their trying to incentivize closing some money early to build momentum.

For whatever reason, a few diligence points I was waiting on didn’t come in until later in the afternoon, but came back positive. I called the founders and told them I’d write them a check at the $10M valuation. They told me that they’d quickly filled their raise at $10M (and told me the rather seductive list of investors who’d joined at that price), but would be happy to have me at a $20M valuation. They wouldn’t budge.

Irrespective of whether this healthy or atrocious for the ecosystem, what would you do?

I passed citing “valuation discipline.” And in turn missed on one of the hottest companies I’ve seen this year. I later heard through the grapevine that the valuation ballooned as high as $30M for some investors. I sacrificed brand for valuation discipline.

Game Theory Optimal

Yesterday, Kauffman Fellow and all-star blogger/LP Samir Kaji responded to Hunter’s blog post asking if explosion in seed funds is lifting valuations?

@Samirkaji IMO multistage firms coming downstream causes more pricing pressure than lots of small investors. At least for our deals.

— Hunter Walk (@hunterwalk) August 4, 2015

What’s interesting to me about Hunter’s response is that it actually suggests that growth firms moving downstream understand the lifeblood of competing at the seed stage: Brand.

These growth firms want access to opportunities that founders aren’t traditionally considering them for. To become convincing they need to pay up. Upstart seed funds face the same dilemma.

Being branded affords certain advantages:

  • Theoretically it allows you to convince founders to take your money at lower valuations because you bring more value and more positive signaling.
  • It improves dealflow, thereby improving ultimate returns.
  • Your investments have more positive signaling associated with them, leading to less susceptibility towards the Series A crunch, and therefore improving returns.

If this is true, fund strategy should be largely centered around brand.

If I had to summarize what founders have told me they want in a Big VC Firm, it would be: 1. Brand name 2. Trust 3. Ability to follow-on

— Semil (@semil) July 23, 2015

In my mind, brand can be developed in a couple of ways: (a) A long track record of successful investments/exits (b) A more recent track record of well known investments alongside strong syndicates (c) Thought leadership/strong publicity/founder references. In my view, many entering seed funds – looking at A16z’s astronomical rise – believe that “services” are what matter most. Services are merely a means to building a brand – VC has always been a rolodex business, and services/help are pre-requisites to even compete in the game.

Here’s My Logic And the Cycle of Venture Disruption:

  1. Venture has proved to be a Winners Take Most business where the top few funds in each category produce the outsized returns. In order to become a top decile fund, it is vital to find yourself in this category.
  2. Becoming a top fund is a function of brand.
  3. Brand is a function of several variables, some of which are long-term – returns – and others which can be influenced near-term: syndicate partners, relationships, marketing, founder testimonials.
  4. Because quality of investments can be “influenced” by paying higher valuations for access, funds without brand equity should be willing to do so.
  5. Because of the increased number of seed funds, this logic should cause considerable upward pricing pressure – forcing prior “branded” funds (now more return/institutional LP sensitive) to pass and exercise discipline.
  6. After some duration of exercising discipline – and missing good opportunities – the first wave of funds will return to paying inflated prices to gain access but several from the second wave will have emerged.
  7. Over time, unbranded funds or funds that exercise extreme discipline will lose access to top opportunities, not perform well and will die out.
  8. Taking a very long term approach, as these funds die out, valuations will recede to lower levels as competition lessens and as branded funds are able to sell their “value” better than newer competitors.

It’s using this logic that leads me to believe that as long as seed funds continue to enter the market at record pace – those who are fortune to be backed by LPs with a long term view of the world – will continue placing upward pressure on startup valuations – but may also emerge victorious and as powerful players in the still maturing seed environment.

If you’re curious….

My logic assumes the following assumptions to be true (many of which are debatable). If you spot more, please let me know:

  1. Markets are game theory optimal and rational (obviously untrue)
  2. Venture stages operate similarly to WTA
  3. Founders remain largely valuation sensitive and will mostly optimize valuation while fundraising.
  4. Brand is a leading factor in access to top investment opportunities.
  5. Paying higher prices correlates to better deals


My Two Year Old is Smarter Than You

Because he is continually, persistently, (aggravatingly) asking “why.

And that is vital in a world mostly focused on the what.

One of the things I’ve noticed in many of the decks I see, entrepreneurs I speak to, even decisions I’ve personally been making is a disproportionate focus on the what of a business or market. How many customers does a company have? How much do they spend? How frequently are they purchasing? How much do they spend? How many times do they open an app? What is their workflow within the app? Which color drives conversions better? Those are all questions that answer the what. And they don’t tell you a darn thing about the why.

I don’t know how this defaulting to questions defined by what started. I joined my first startup in 2007 and it sure feels like we thought about why all the time. Part of me wonders if it has to do with the surge in A/B testing and “Growth hacking.” Both are important functions of a startup, and can answer a lot of questions about what is working better – which design, what affiliate channels, etc. But again, they mostly ignore the why.

Phin Barnes from First Round Capital has a very nice piece – Growth is Not a Hack – so can we please stop saying Growth Hacker – where he demands of a business to understand the why:

It’s tempting to just throw stuff at the wall and see what delivers the most users. Don’t fall into this trap. Hacks can lead to empty-calorie, engineered distribution that isn’t sustainable…At the First Round Community companies I work for, growth is a strategy based on observation of the market and understanding of the consumer. The most successful companies have frameworks and data to understand their users, engagement and acquisition. They can explain why growth is happening, see the business impact, and accelerate growth based on what they learn.

The truth is we’re all guilty of defaulting to the what: I’m guilty of this too. Last week I published a well read post on eSports that stated a lot of bullish facts about the eSports industry, its insane growth, engagement, etc. But I offered very few insights into the why. The why is the toughest question to answer, because in a world dominated by (or one where we ceaselessly laud) engineers and data analysts, it is often unquantifiable.

But the why is also often the most exciting question we ever ask: breakout writers Malcolm Gladwell, Steven Levitt, Jonah Berger and others have made a career out of taking the “what” we see around us in the world and explaining why it is so.

In a world where storytelling is becoming a determining factor of success, understanding why your market or customers are acting/reacting the way they are is crucial. As Bill Gurley recently noted, the importance of narrative is paramount. But it’s hard to build an exhilarating narrative on facts alone. I once asked one of my professors (and current Groupon CEO) Eric Lefkofsky how he knew he wanted to make an investment. He answered that if, while discussing a business with its founders, the case they were making was so compelling that he simply needed to jump out of his chair with excitement, that was the tipping point. Growth can pique interest, but only a exhaustive conceptual understanding of why can truly close the loop about a narrative.

Maybe it’s a bit didactic  of me, but I have been underwhelmed by the number of founders with a deep understanding – or even an infectious curiosity – for the why of their business. When I reflect back on the entrepreneurs I’ve been most excited to work with, it’s those special leaders who have a methodical understanding of why now, why this market, why this strategy, why this team, why we win, why this is working.

I can’t help but wonder if in a marketplace dominated by software intended to answer only questions of what (most BI dashboards, big data, etc) there is a massive opportunity for platforms that can begin to synthesize the why. On the enterprise side, it feels like we’ve gone from data aggregation towards predictive and actionable analytics. That shift has been accepted because those actions produce results – yet it leaves us dependent on variables we fundamentally don’t understand. I hope this changes. From what I’ve seen, Directors or VPs of Customer Insights typically don’t get hired until a startup exceeds 100+ people…I would challenge that habit and I wonder how much faster product/market fit could be discovered if the current growth versus understanding model were inverted.

Why I’m Betting The House On eSports, Part II

For the past nine months or so, I had written off fantasy eSports (Vulcun, Alphadraft) as an uninteresting niche in the potential betting markets around gaming. My hesitancy was twofold: (a) I didn’t see why incumbent platforms such as FanDuel or DraftKings couldn’t also service eSports & (b) Given my time in the poker industry – where there were ample poker celebrities yet fantasy poker never materialized – I didn’t think it could yield a sustained, large market. I assumed that gamers would only want to bet on their own game-play, not others’.

I was 100% wrong and it’s a painful mistake. Here’s why -

When you consider the evolution of betting markets, a given industry has historically supported only a single dominant betting experience: either observer or first person. Here’s how I define those terms:

  • Observer/Fantasy – In this betting model, you are betting on the outcome of a third party(ies) against either a group of people or against a market maker (casino/house). However, the outcome of your bet is entirely dependent on the actions of others. For example, if you are betting that $GOOG will have a good quarter or that the Cubs will win the World Series, you have zero direct involvement in that outcome. In fact, in these markets, manipulation of the outcome is often considered illegal.
  • First Person – In these models, the outcome is entirely dependent on your own actions. For instance, when playing poker, you are not betting on the outcome of some player in another room, you are betting on your own decisions of what cards to play, when to stay in and when to fold. Assuming that the “luck” of the cards breaks even long term, your performance is entirely dependent on your own actions, not a third party’s.

Because my experience in betting markets was biased by 6 years in the poker industry (both as a professional player and then as an executive at CardRunners Gaming), I naively assumed that betting markets were strongest as first person experiences. What I didn’t realize at the time is that if you look historically at betting markets, online poker is actually the rare anomaly, not the norm.

In fact, the “observer” angle being the dominant form factor is actually intrinsically logical. Why? Because betting markets fundamentally must be built to scale. But First Person markets are unnaturally constrained by time – namely, that an individual can only earn the rewards of his or her own performance. Part of what makes the stock market such a brilliant, liquid, market is that you can generate rent from the hard work of millions of people. In the poker world – the opposite – you were limited by your own efforts.

Further, the truth is that at a theoretical level, poker could well have supported the “observer” model as well. Meaning that there’s no fundamental reason that fantasy poker (or betting on the performance of 3rd person players) could not have become a scaled market. The reason that market never emerged is because online poker lacked an “enabler:”

Fantasy eSports has excelled because of the presence of an “Enabler” – most notably, Twitch – which live streams desktop and console games for enthusiasts to watch. So important is Twitch to the fantasy eSports experience, that it is in fact directly integrated into Vulcun’s platform. Poker never had a similar enabler.

The First Person: Anyone Can Be a Pro

What gets me so excited about eSports is the potential flywheel affect between the observer and first person sides of the eSports betting market. Here’s what I mean –

I still remember the 1997 NBA Finals when Michael Jordan, playing with an awful flu, hit a buzzer beater over the Utah Juzz. It was such an exhilarating moment that literally all my friends on my block, without any formal coordination, ran outside to the alley to play a game of basketball…we simply couldn’t only watch the game, we needed to play.

A decade later, I was sitting in a glitzy hotel with the top executives at Full Tilt Poker pitching an unprecedented partnership between CardRunners and the gaming giant. They seemed unimpressed by our brand – mostly doubting the value a group of college aged poker whiz kids could add to their platform when compared to their TV poker celebrities such as Phil Ivey, Chris Ferguson and Mike Matusow.

I disagreed. I told them their position was flawed – that their high volume players were disproportionately represented by college aged or young adult males who had enough disposable time to invest hours a day on their platform. For these players, old school road gamblers simply were not relatable. Our college whiz kids, I countered, represented a “relatable fantasy experience.” They are the same age, with similar backgrounds, and no discernable difference in intelligence – they would serve as a relatable inspiration for the aspiring pros to work towards their goals of being great.

The argument worked. We inked what was then, one of the largest partnerships ever with an online gambling operator.

That argument applies to eSports as well. Unlike the NBA or NFL where professional performance is largely constrained by genetics to maybe a few thousand individuals in aggregate, becoming an eSports professional is theoretically available to the vast majority of the 208M gamers worldwide. Of course it requires immense hard work, and tens of thousands of hours of gameplay – nevertheless, becoming great at eSports remains one of the most democratic opportunities of any sport in existence.

It’s for these reasons that I’m also bullish on the First Person side of the betting market. While I’ve seen recent estimates put the total number of gamers who’ve played eSports for real money at sub ten percent, I expect that number to increase greatly as prize pools expand, media coverage increases, and low budget qualifiers enable recreational players to compete on arena stages with professionals.

Because eSports is unique in that its structured to provide liquid markets across both fantasy and first person, there is a real flywheel potential – that fantasy eSports and spectator style viewership will drive enthusiasts towards betting on first person games while first person gamers – constrained by their own time – will want to scale their earnings across the fantasy markets. It’s this flywheel effect – the first I’ve ever seen in a betting market – the leads me to believe eSports could become the highest monetized gaming market in history.

And Now For The Counter:

There are basically three big reasons why eSports from a “First Person” betting market perspective might well outright flop:

But not all volume is the same. Online poker sites were able to extract disproportionate revenue per player by enabling “multi-tabling,” in effect allowing players to play many simultaneous games of poker. Although the option was available to all players, only professionals had the dexterity to manage 12 simultaneous hands of poker profitably.

Daily Fantasy Sports offer a similar experience known as “multi-entry” where players can (often without manually even inputting the same lineup) replicate their desired lineup across multiple tournaments of varying buyin-size instantaneously and without friction.

Both multi-tabling and multi-entry enhanced two things: (a) platform liquidity – enabling more games to run, and (b) generated increased revenues per player.

As far as I can tell, first person eSports lacks a parallel infrastructure – meaning that no single gamer can provide liquidity across multiple games simultaneously. And while I don’t think it’s a pre-requisite for a healthy ecosystem, it does make me wonder if it’ll be harder for First Person betting platforms to scale. I can envision some creative solutions to this problem, but nonetheless, it worries me.

  • Skill Gap – In poker as in fantasy sports, there are mathematical long-run winners and losers. However, in the short-run (small sample sizes), the skill gap between an amateur and a professional is not insurmountable. The effect of this delta in skill (let’s call it 65/35 to keep it simple) means that a complete amateur will still emerge victorious from a poker tournament or DFS match a reasonable percentage of the time.

The intrinsic issue for eSports is the skill gap: namely, that a professional gamer will beat a new or amateur player pretty much 100% of the time. That makes it difficult for amateurs to have an enjoyable experience when entering the market. It also makes it difficult to market a betting platform to recreational players (because it is therefore fundamentally impossible to have a “Moneymaker” moment or replicate FanDuel’s aggressive marketing of averages Janes winning DFS tournaments).

All that said, this problem is not unique to eSports. For example, boxing solved a similar problem with defined weight classes. The “handicap” system introduced by the PGA allows an expert and a rookie to play a competitive game in spite of skill differences.

That said, where there is a lot of money on the line, there is a huge incentive for players to misrepresent themselves as inferior to their actual skill. I don’t know if the skill gap question is ultimately the Achilles heel for eSports but it could be the factor that forces external regulation of the industry.

  • Platform Integration – eSports first person betting requires players to engage an off-platform third party to wager, settle bets, and track tournaments because the game providers do not have betting functionality built in. In a practical sense, what this means is that unlike the fantasy eSports platforms that have integrated Twitch directly, there is a lot of friction in first person tournament betting in that a bettor must: (a) Join a third party betting provider (b) Fund Wallets (c) Select match from a 3rd party lobby (d) Then connect to Game directly and play.

For competitive gamers, that level of friction is irrelevant: they are already regularly engaged with multiple third parties: gamer forums, gaming news sites, existing tournament platforms, etc. The unknown questions really are: (a) Will game developers respond to demand and open their platforms to enable direct integration by tournament facilitators and aggregators or (b) Will recreational players be comfortable multihoming between platforms in the same way we engage with other sports (ie, we watch a game via television/stream while betting or playing fantasy on a 3rd party such as Yahoo!, Fanduel or Bodog).

Parting Thoughts

In my opinion, eSports betting markets aren’t yet even in the first inning of their journey. For comparison sake, at the time of this publishing:

  • PokerStars regularly eclipses 100k active players on its platform during off-hours (that number can spike to 250k+ on Sundays)
  • Although FanDuel/DraftKings don’t report simultaneous players, FanDuel did report 1M players who placed an active bet in Q4 2014. I think it’s a safe assumption that on peak NFL Sundays, a good 20% were likely DAUs meaning they hit 200k players on peak days.
  • Vulcun reports players “Online Now” and I’ve personally never seen more than 2,000 simultaneous logins. **I have no scientific way of tracking this, but I check occasionally and gives a rough size of scope.
  • Kickback reports “Players Online” and I’ve never seen more than 150 simultaneous logins. **Again I have no scientific way of tracking this, but I check occasionally and gives a rough size of scope.

These stats reflect that the industry is in its absolute infancy, but with the potential to saturate exceptionally quickly, especially given the viewership of Twitch and Youtube.

I’ve written a lot so will leave it there for now. If you are building any platforms in the eSports space or have some great resources to check out, please e-mail me or post in the comments. Thanks!

Special thanks to Taylor Caby for his feedback on this post

Why I’m Betting The House on eSports – Part I

After last Wednesday’s post on why I think the Daily Fantasy Sports market is largely locked up, I thought it would be interesting to compare it with the eSports market – one which I’m actively looking to place some real venture bets in. Part I is basically a primer on eSports whereas Part II (to be published on Thursday) will define some theses around the space and examine its underpinnings from a betting perspective.

From a venture perspective, eSports is by almost all definitions, nascent. But given the speed at which consumer and especially millennial/Gen Z targeted industries have proven to develop (in fashion and food, for instance), I don’t expect that nascency to last long.

Some quick background stats on eSports as an industry. First, market size:

So by all accounts, eSports is actually kind of small. In an age of unicorns, it’s hard to build a billion dollar business in an industry barely the size of half a unicorn.  All the more so, when the majority of eSports interest is in Asia.

The largest exit to date in the eSports world is Twitch, with trailing twelve month funding to eSports companies barely cracking $50M (Vulcun, Alphadrat, Unikrn, Mobcrush, Kamcord, Skillz, Battlefy, DingIt, Kickback, and I’m sure I missed a few.) By comparison, in the same time frame, a dozen or so daily fantasy sports companies have raised over $750M (13x eSports).

And yet, eSports has the potential to be the largest gaming industry to date, across fantasy sports, casino games, and mobile gaming. Here’s why: using North America as a proxy, engagement across games currently looks like -

  • Fantasy Sports: 41M players
  • eSports: 28M
  • Online Poker: 10M
  • Mobile Gaming: 48M

** For clarity sake, traditional eSports are defined by bulge bracket desktop/console gaming such as League of Legends, DOTA2, CS:GO, Call of Duty, Halo, and Minecraft, as opposed to known mobile games like Clash of Clans by publishers such as Zynga or King Digital.

Even though eSports isn’t (yet) the largest category, here are a few reasons I’m extraordinarily bullish:

  • New eSports enthusiasts entering the market are growing at over 20% per year versus 11% year/year for fantasy sports. Online poker is contracting significantly year/year (approximately 10-15%).
  • Gamers are becoming more engaged with time spent playing up nearly 25% from 2011-2013 from 5.1 to 6.3 hours/week.
  • Consumption of eSports amongst spectators has grown 300% over two years from 1.3Bn hours/year to 3.7Bn hours/year. It’s worth noting that while overall viewership in aggregate has increased 3x in 2 years, the majority of that increase is driven by power engagement of existing enthusiasts as average time watching eSports/enthusiast has risen from 22.4 hours/year to 41.6 hours/year. This likely reflects that content is improving, distribution is improving, and channels are becoming stickier.

  • There is also a growing degree of overlap between traditional eSports enthusiasts defined above and mobile gamers, especially as quality of the latter continues to improve and trend more towards MMO (Massive Multiplayer Online Games) than RPGs (Role Playing Games).

Consider that a good primer on eSports and why despite its small size (from a revenue perspective), I believe it will open up massively in the next 24-48 months. I’ll leave you with some additional good resources to get up to speed on eSports and we’ll do Part II on Thursday:

Why The Next Sports Empire Will Be Built on eSports

eSports: The Biggest Sport You’ve Probably Never Heard Of

eSports is Massive and Growing…

eSports: The Future of Entertainment

Game Over: Why Daily Fantasy Has Already Been Won

I debated posting this because it could bruise some egos and kill my dealflow. But with the recent DFS news, Fanduels $275M round & Yahoo’s entry into the space, I felt like the timing was right. I know a lot of people have strong opinions one way or another on this so happy to engage in some debate. I also chose to post it because I’m hopeful that forcing entrepreneurs to rethink the existing models, look at the historical realities of betting markets, and therefore reimagine the fantasy sports space entirely could yield some interesting outcomes. Here goes:


In late 2007, I invested in and helped my friend Chris Fargis launch Instant Fantasy Sports, what I believe was the second ever daily fantasy sports (DFS) site. The product was created by and invested in by online poker players, drawing inspiration from the wildly popular “sit-n-go” format of online poker sites.

We did a few things right and a lot of things wrong and were fortunate to be acquired by NBC Sports, where they subsequently re-branded the product as Snapdraft, jacked up the rake to 20-30% and effectively killed any interest.

In the summer of 2011, I invested in DraftDay, my former business partners entrant into the then (mostly uncrowded) daily fantasy sports space. Leveraging our contacts in the poker industry and the consumer trust from our CardRunners brand, we quickly vaulted into the #3 position in the DFS market, behind Fanduel. In fact, as of Spring 2013, I believe we were still the second or third largest DFS site. That, of course, all changed when DraftKings & Fanduel raised (what was then) massive rounds of funding and blew past our traction. We sold the company to MGT Capital (NYSE: MGT) in 2014.

Here are my thoughts having watched the betting industry (from poker to DFS to esports) for more than a decade.

DFS Has Already Been Won

Given my experience in DFS – and I’m not hard to track down on LinkedIn – I’ve received no fewer than two dozen pitches in the past year for startups in the space. Most of these pitches are for incremental improvements – a better drafting system, or new scoring procedure. Some are platform focused, for example designing new experiences around mobile. Some are geography focused. Others have creative approaches to low cost customer acquisition.

It’s my opinion that they will all fail.

Why? Because nearly every entrepreneur I’ve spoken to in the space gravely underestimates the liquidity advantage of existing incumbents. In betting markets, liquidity is simply everything.

Much like traditional marketplaces, where suppliers need to see real economic returns to justify becoming power users, betting markets are a VIP driven business where the sharks need to be able to earn a living to drive volume on the platform.

And Fanduel and DraftKings simply have this market locked up.

It’s not that I’m biased against daily fantasy, it’s that I have demonstrable evidence of this extraordinary “lock-in” from a comparable market: online poker. As of this writing, PokerStars has more players concurrently on its site than every other poker site on earth, combined (and there are thousands). Even five years ago, when the market was more volatile, there were only three dominant platforms: PokerStars, FullTilt and iPoker (Playtech).

To illustrate my point, here’s some research I performed on the online gambling space about its formative years of 2008-2011 (Y-axis is revenue in $Ms & X-axis is reporting period):

The first graph reflects all betting markets across the six publicly traded gaming platforms at the time (excluding Full Tilt & Pokerstars):

But while platforms #3-8 would suggest the poker market was contracting year over year, the two market leaders proved that it actually grew nearly 50%over a two year period. They were, in fact, simply building share as their ecosystem improved:

*The significant dip in Q2 2011 is due to Black Friday, the day the US government shuttered PokerStars and Full Tilt from US players.

One further constraint against new entrants: my golden rule of customer acquisition in real-money gaming is that it will never again be cheaper to acquire a customer than it is today.

The logic is really quite simple:

1.     Each incremental improvement in ecosystem liquidity yields higher customer LTV as high volume players have more places to put money to work and recreational players have a more entertaining experience.

2.     Platforms with a climbing LTV can afford to pay more for customer acquisition. The effect is that a customer that is highly unprofitable for platform X at $80 might be highly profitable for DraftKings with their existing ecosystem. Platform X can then elect to acquire this customer at a loss (hoping their LTV expands in the future) or pass the customer to DraftKings.

3.     Because of the LTV divide between entrants and incumbents, the higher LTV incumbents can afford to offer larger sign-up bonuses or VIP programs.

4.     Because of the LTV divide, an incumbent platform can afford to reach upwards for “guaranteed payout tournaments” (such as Fanduel’s Fantasy Football Championship.) Often the sites expect to take a short-term loss on these guaranteed tournaments with the hope that the resulting new customers will net a positive long-term return.

The effect is that as long as the DFS industry continues to grow (unlike poker, which is now contracting globally) customer acquisition cost grows accordingly. So while it may have theoretically cost FanDuel $5M to attract 100,000 real money customers in 2012, it might (for example) cost $25M to attract the same 100,000 customers in 2015. That provides a strong moat around these already liquid markets.

The Psychology of Sharks

Best in class online poker sites earned fifty cents in rake (revenue) for every dollar deposited on the site. And the high volume players (defined by a few variables I won’t go into here) held a Life Time Value approximately 500% higher than an average recreational depositor.

As mentioned, power players will drive your business. With that in mind, let’s explore some specific scenarios of how upstart (but failed) poker sites tried to attract player pools:

  • Prize Pools – Large prize pools are important as they attract recreational players hoping for a score, which in turn attracts sharks. But remember – sharks care about profitability, the ability to earn a living. A large prize pool is largely insignificant if the skill level gap is too small.

The problem with artificially creating large prize pools prior to cultivating a healthy ecosystem is that the people paying closest attention to industry advertising, or industry forums looking for new guaranteed tournaments are the sharks. But they are looking for expected value advantages. They will opportunistic cross platforms for large guaranteed tournaments, but will depart if the value isn’t there.

  • Lower Rake – In the online poker world, a number of entrants tried to compete on price. Most famously, WSEX offered large periods of rake-free poker to attract players to its room. Those offers served to attract the most price sensitive of players – sharks – looking to earn a living. As soon as they recognized the skill difficultly, they moved platforms.

Recreational players, who make up the bulk of the player base, but don’t drive the volume, are not price sensitive in this industry. Unless rake is simply usurious (20%+) its largely imperceptible on a one-off basis.

When you compete on price, you attract the sharks. The sharks will give the platform liquidity, temporarily. But even if a new platform is able to begin attracting recreational players (via advertising/marketing), the pro:amateur ratio remains highly imbalanced, causing the fish to lose at an accelerated pace. They won’t re-deposit or tell their friends and the sharks will soon leave.

  • Geographic Differentiation – Many operators have tried (and some succeeded) in building geographic focused real money gamingplatforms. LatAm focused. Or South African focused. Frankly, these do work – especially if you actively constrain non-local players from entering – which keeps opportunistic USA or Western European pros out. But they simply don’t scale to become large businesses.
  • Celebrity Endorsements – They don’t seem to work for upstarts but are an effective tool for dominant players. Pamela Anderson failed. Iconic poker star Doyle Brunson failed. And while PokerStars sponsors Rafael Nadar and Full Tilt allegedly offered Michael Phelps $5 million/year for an endorsement deal, these deals serve to bring additional recreational players into a healthy environment where they can thrive. They don’t work for a nascent platform where new players do not experience delight upon first engagement with the platform.

I am also skeptical of the emerging class of peer-to-peer, “bet your friends,” variants of DFS. While they provide for cheaper, accelerated customer acquisition (just sync your contacts list, for example), it violates the cardinal rule of online gaming: that high volume sharks will drive power-law style revenue, because it negates the theoretically infinite pool of players that tournament style apps offer. It is also exceedingly harder to scale a 1:1 betting game than a 1:many, and harder to create large, recurring prize pools. Even in the hyped run-up to Zynga’s 2013 $10 billion IPO, Words With Friends was only acquired for $50M while Draw Something saw a $210M exit. Neither became platforms.

Oh, BTW, Why I Might be Totally Wrong

Having written all that, here are the scenarios under which I might be wrong -

  • Black Swan Event – In 2006, Congress passed the Unlawful Internet Gambling Enforcement Act (UIGEA), a last minute attachment to the homeland security focused SAFE Port Act. The law formally forbade online gaming operators to service USA players, which forced then market leader (and publicly traded) PartyPoker to exit the USA market.

Privately held PokerStars elected to continue servicing USA players. Concurrently, Full Tilt Poker, then a mostly nascent platform, began marketing aggressively to US players on ESPN, Fox Sports and online.

The UIGEA was a cataclysmic Black Swan event which provided room for PokerStars to vault to market dominance and allowed FullTilt to emerge as a clear #2 player within 18 months, leveraging a huge advertising spend.

I personally see no comparable Black Swan on the horizon for DFS, but its occurrence could certainly change the status quo of the industry.

  • Media Distribution – PartyPoker wasn’t always the dominant poker platform pre 2006. From 1999-2002, Paradise Poker was the clear market leader.

What changed? In 2001, The Travel Channel began airing broadcasts of the increasingly popular World Poker Tour. In addition to sponsoring entire events on the tour, PartyPoker became a highly integrated and blanket sponsor of the Travel Channel and World Poker Tour. It worked.

I view this as the most likely opportunity for new entrants to DFS – especially if the games can be repurposed as a spectator sport. But that’s also why ESPN’s exclusive partnership with DraftKings is so valuable – because it closes off the most engaging sports media channel in existence.

Yahoo and Pokerstars (Amaya) had both made clear their intentions to enter the space for some time, with Yahoo in fact launching their DFS platform last week. Their existing footprint might enable them to quickly scale a healthy ecosystem.

  • Platform Change - Although Fanduel & DraftKings have rolled out mobile apps, they were neither conceived nor built for a mobile world. As I noted above, I am skeptical of the mobile challenge a friend apps but I admit there could well be an opportunity to build a healthy business in this niche – though I do believe it would be a smaller outcome, than the existing, multi-player tournament style offerings.

Or, frankly, the stage of the DFS market might simply far more nascent than I estimate it to be. If that were the case, it might only take $20-25M to attract a sufficient number of players to an entirely new platform. But I wouldn’t bet on that scenario.

Ultimately, the emergence of DFS will be the latest case study in building liquid betting markets. And although money continues to flow in at the seed stage, I believe the game has already mostly been won.

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