Tag - daily fantasy sports

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On Being Early and Being Right
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Debunking The Skill Gap Myth in Daily Fantasy
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Game Over: Why Daily Fantasy Has Already Been Won

On Being Early and Being Right

Over the past ten years or so, I have been relatively early to three highly nascent, wild wild west style industries: online poker, daily fantasy sports and bitcoin. In two of them – poker and bitcoin – I experienced significant professional and financial successes. In the other, daily fantasy, I lost my shirt. With bitcoin’s recent rise I figured it could be instructive to briefly explore the analogies between the three and develop a framework for spotting the emerging markets of the future.

On Being Early and Being Right

Jeremy Liew, General Partner at Lightspeed Venture Partners has repeatedly said that if one wants to spot emerging modes of communication and behavioral change, look to the products and services teen and tween girls are adopting. Similarly, I would argue that when it comes to emerging professional industries or financial markets, one should look towards how college aged kids are spending their time as well as the long-tail of the internet’s forums (including Reddit).

I believe this is the case for two primary reasons: (a) college aged kids have a substantial amount of disposable time and some variable amount of disposable income and (b) they are highly incentivized to increase their amount of disposable income – at a time in their lives when losing what little they have is not a significant loss. This combination pushes college students towards higher risk, higher return opportunities, some small percentage of which will materialize into mainstream markets and industries.

For example, although I’d played poker with my friends in high school, I found my way into online poker in a professional capacity my Sophomore year of college as the World Series of Poker was beginning to expand. It was the ideal format for a college student: success demanded thousands of hours of gameplay and continual learning and discussion via online forums. Very few adults with either part-time or full-time jobs could afford that much disposable time. My first startup, Cardrunners, where I ran marketing, had thousands of college students as customers, and many of the site’s pros were poker players who had made their millions during college.

You’re seeing a similar evolution in the world of professional gaming, or eSports; except that in eSports, the pros are often even younger, some still in high school. It is for the same reason: an adult with a full-time job, even one who loves gaming, will struggle to put in the tens of thousands of hours it requires to become great. These industries that demand obsessiveness are highly biased towards youth.

I discovered bitcoin in 2012 after the poker industry’s Black Friday as it was one of the few mechanisms to deposit and withdraw money from online poker sites. From there, I gradually became more interested in the technology, and began actively writing about bitcoin in 2014 in publications such as the WSJ and Recode as well as attending and speaking at Bitcoin conferences. I was also the first mainstream writer to publicly predict Mt. Gox’s insolvency, although, by that time, it was largely too late for most customers to withdraw their money.

During my poker years, I spent hours each day learning and communicating through the Two Plus Two Poker Forums. I still frequent them occasionally although only lurk at this point. They have a thread, over 850 pages long, all about bitcoin (there is an additional long thread about altcoins). You can watch the discussion evolve throughout the years. If you’d been paying attention to the forums back then, April 2011, and made even a small investment in bitcoin, you’d surely be a millionaire by now. [I love the first response given that it’s the same thing, verbatim, that bitcoin minimalists say now, even though it’s now trading at $3,400.]

On Being Early and Being Right2

There are other gems of niche industries and markets hidden throughout the Two Plus Two forums, although none have become as mainstream as bitcoin. You’ll likely find similar insights if you scour Reddit. We all know that one day another technology market will emerge that rivals or leapfrogs the attention and excitement given to cryptocurrency. I have a strong suspicion that early adopters will discover it through forums such as Two Plus Two or Reddit. I do worry that if that discussion moves to Slack or Telegram that it will be harder for the average person to find. I wrote about that concern here.

Daily fantasy sports, where I struck out both professionally and financially, was an industry where I simply wasn’t as personally passionate. In retrospect, I feel that my interest was a bit opportunistic. I still remember discussing at length with my friend Chris, who at the time was building the first ever Daily Fantasy site, Instant Fantasy Sports (in which I invested), about how we could port the functionality from the online poker sit-n-go format into fantasy sports and make an equivalent sit-n-go draft. I thought there were a lot of parallels, but I ultimately wasn’t excited by watching sports games all day nor obsessing over player statistics. This made it difficult to be credible either as a player (gamer) or an operator. I suspect that’s the reason I failed.

When it comes to being early and being right, I believe that passion is the ultimate insight. We humans have a lot in common. If you are passionate about an emerging industry, odds are that many other people are equally as passionate, or have the potential to become passionate if awareness is raised. Not all passions will materialize globally like bitcoin, but niche industries matter – even cosplay has developed into a $5-10 billion market. These emerging interests, industries and professions will continue to accelerate as the internet increasingly democratizes communication and awareness. It’s a fun time to be alive, and if you bet on your passions, odds are that you will discover others who feel similarly.

Debunking The Skill Gap Myth in Daily Fantasy

Daily Fantasy Sports are under a full on assault: allegations of “insider trading,” a hyper aggressive (if not overwhelming/annoying) advertising strategy, and multi-directional claims that DFS can’t be beat because it involves too much skill.

There are lots of legitimate concerns which I will address in future posts over the coming weeks. But the most damning – that DFS suffers from “too much skill” – is inherently flawed.

Here’s why:

Too Much Skill

A McKinsey study from September is making headlines after it noted that 1.3% of DFS players – the sharks – account for 91% of the winnings.

mckinsey

One of my favorite daily reads, Ben Thompson of the newsletter Stratechery, used that data to note the following:

In fact, as the McKinsey article concludes, the fact that Daily Fantasy does require skill is one of the biggest threats to DraftKings and FanDuel: the flipside of a few players earning most of the money is that there must be a counterweight — some number of big fish willing to lose and lose substantially.

Here’s the thing: while these numbers make for a great click-bait headline, in actuality it’s a non-issue. Why? Because betting markets fundamentally demand winners and losers.

One could make the claim that in a fairer world, the winners would win less and the losers would lose less. But let’s unpack that: for starters, the headlines are deeply skewing the numbers. While it’s true that the “Big fish” are losing 44x more than the “Minnows,” they are also playing stakes 66x higher. Keeping in mind that Fanduel spreads daily games with $1,035 buyins, the idea that affluent bettors regularly playing $300-$1k buyin lose $1,000 over the course of “half an MLB season” is not that surprising. If anything, based on my experience, it appears light.

Let’s also not forget that for the “minnows” who lose a full 50% of the money they deposit – $25 of $49 deposited – that wagering on DFS is entertainment. It’s a little known fact that traffic to online poker sites during the late 2000s was inversely correlated to new airings of American Idol: when the show came on across time zones, traffic would accordingly drop in those geographies. Low stakes betting is entertainment. And given the low buyin amounts (down to $1) I’d be shocked if, on an hourly basis, it were more economical for these players to go to the movies than lose at DFS.

I had a former member of the Full Tilt Poker Board of Directors in my office a couple of weeks ago. I asked him to verify the often-cited statistic that approximately 95% of online poker players were losers. He confirmed this. Going back to those McKinsey results…a full 15% of DFS players appear to winning – currently 3x the rate of online poker players.

But let’s take a step back and all agree on something else: DFS is in its absolute infancy. The level of scrutiny being placed on DFS, especially given its youth, is unparalleled by any other betting market (skill or pure gambling) in the history of the world. That means that a lot of the less salacious factual realities – though entirely normal in the adolescent development of any market – are being distorted as structural flaws. When in reality they are fundamental pre-requisites to building a healthy ecosystem.

As always, I draw a lot of inspiration from my years in the poker industry. And here’s what I observed: when markets are imbalanced, with strong financial incentives on either side, unless those markets demand some genetic prerequisite to entry, the financial opportunity will move those markets closer to equilibrium.

And here’s what I mean – in plan English. As an example, there are millions of brilliant, hungry, deeply incentivized college student with lots of disposable time and some disposable income. Many will experiment with DFS. Most will lose; some, however, will recognize that only 1.3% of players are using advanced statistical modeling and will hunker down for weeks building their own models until they start winning. The effect of this is that win-rates for the top 1.3% of players will begin to decrease. And instead of 1.3% of players winning 91% of all the payouts, the market will move towards 5-10% (my guess) winning 91% of the payouts.

The Historical Ecosystem Cycle:

In a recent Bloomberg Masters in Business podcast featuring Nate Silver, the most frequently used word when responding to questioning was: “historically.” History is paramount. And in the case of DFS, we have precedent of ecosystem evolution by looking at the history of financial markets, poker, and gaming. As noted my analysis is primarily influenced by the evolution of online poker.

Slide1

Two major trends will begin to develop: (a) A formalized, professional ecosystem of third party DFS training apps will begin to emerge, (b) The sites themselves will invest in educating players and normalizing skill levels. Case in point is that we’ve already begun to see this with Fanduel’s acquisition of Numberfire.

Here’s a breakdown of what really happens in these stages –

Stage One – Early Adopters:

  • DFS is currently holding somewhere between Stage One and Stage Two.
  • Early adopters – those who understand the game theory of lineup assembly and experimented early have a significant skill edge in DFS. The winners have benefitted greatly from the influx of players to the ecosystem.
  • An increased focus on DFS – between its media coverage, heavy advertising, and mainstream profiles of large winners (especially if they can build a spectator/televised component) – will cultivate an aspirational user base and begin to inspire players of all skill levels to improve their lineup performance.

Stage Two – Third Party Apps:

  • Consumer grade player analytical software and lineup generators will begin to make their way to market (I would know I’ve been pitched on several).
  • Subscription training sites, founded by pro DFS players will begin to emerge offering unique insights into lineup formation (I would know I helped to build Cardrunners – a similar business in the poker world). RotoAcademy is one example but there will be more.
  • Peer to peer coaching marketplaces connecting DFS pros directly with recreational players willing to invest in their lineups will emerge.

Stage Three – Platform Sponsored Education:

  • As platform growth slows because market expansion slows, the site operators will re-prioritize on maximizing customer revenues rather than raw customer acquisition.
  • The platform operators, cognizant of the increased revenues/rake as average skill level improves will launch their own efforts to draw the ecosystem closer to golden mean (where everyone breaks even long-term).
  • The operators will either: (a) Launch their own, recreational player focused, free to learn, educational platforms just like Full Tilt Poker Academy, (b) Will subsidize learning on third party applications such as Truly Free Poker Training and/or (c) Purchase late night programming slots on mainstream television channels such as Fox Sports to air informercial-like educational programming.
  • The effect of all this sponsored education is that the baseline performance of even low volume recreational players increases.

Stage Four – Platform Defection:

  • With the skill gap closing across the board two important shifts begin to take place:
  • Lesser winning players, who had previously fed off utter amateurs, no longer find it time-effective or profitable to drive volume on the platform. They are economically incentivized elsewhere and will leave the platform.
  • The winningest players on the platform who have built bankrolls of winnings in the millions of dollars will no longer be able to drive large ROIs on the platform because the stakes are not high enough. They will divert their attention off platform, either to professional sportsbooks or private markets that open.
  • These two defections serve to actually increase the skill gap on the platform as the winningest players and breakeven or lightly winning players leave the platform. In an ideal world where the market continues to grow and customer acquisition remains stable, this shift actually creates an opening for the next generation of players to move from “minnow” to “shark,” replicating the cycle of the ecosystem.

The Structural Issues:

There are legitimate structural claims against DFS, most importantly that novice players receive no protection from high stakes sharks in that multi-entry allows for lineups to be replicated without friction across buyins.

That said, this blog assumes (and I am taking for granted) that those structural issues (which are real) can be solved, either by limiting the number of entries per day (as Fanduel has done) or by creating a more dynamic pricing system or by eliminating identical lineups. Or, in reality, by some solution I haven’t even considered.

I don’t know how they’ll be solved, but I believe they can be. The purpose of this blog is to disprove the detractors who believe DFS’s skill gap is permanent. It is not. It will evolve.

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:

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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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