Driving sustainable growth for Thoroughbred racing and breeding: Findings and Recommendations
Dan Singer Dan Singer - Director, Media and Entertainment Practice, McKinsey & Company

Michael Lamb Michael Lamb - Principal, Media and Entertainment Practice, McKinsey & Company Dan Singer: Thanks very much, Jim.

As you heard from Jim, The Jockey Club recognized earlier this year that racing is at a critical juncture. The Jockey Club asked us to analyze racing's economics for the next 10 years and recommend initiatives that could significantly improve the outlook for the sport.

Now, as you're going to hear, the current situation is very tough. We will take you through the numbers. I'll start here but I want you to know that about halfway through, we'll shift over to the growth strategy for the industry, which we believe passionately in and think will address some of the issues we're going to start with.

By any measure, Thoroughbred racing has declined over the last decade. In our view, the primary reason is a failure to innovate fast enough and well enough to compete for new fans and bettors. But let's take a look at the numbers: handle is down 37% in the last decade, attendance is down 30%, starts per horse and race days are both down 14%.

Now on the other hand and for context, the situation in racing is similar to most other professional sports, many of which we work in as Jim mentioned. As you'll see here, all sports face changing distribution models and fragmentation of fan interest: NBA finals TV ratings are down 24% in the last 10 years, Major League Baseball's All Star game TV ratings down 38%, and NASCAR's Daytona 500 and US Open Men's tennis finals TV ratings are also down. These are just some examples.

The core values of racing are still strong, notwithstanding the numbers we just showed you:

  • The premier events in racing are still popular: Kentucky Derby attendance is up by 8% since 2000; television ratings for Breeders' Cup are up 6% since 2006.
  • The best racing is still compelling: Grade I and Grade II handle per races is up 23% per race over the past decade. This is consistent with the "flight to quality racing" that was discussed at last year's Round Table and which Jim just also mentioned a minute ago.
  • Race betting is still extremely exciting: When we asked fans what they like about the sport of racing, they responded with what they love about gambling. For example, fans of Thoroughbred racing are most attracted to the sport by the sense of camaraderie at the track (45%), respect from others while on a winning streak (37%), and the chance to win "big money" (34%).

Finally, we recognize the many significant innovations in racing over the past decade — for example, new bet types, such as the Pick 6 and "Favorite vs. the Field," online wagering, dedicated digital television networks like TVG and HRTV, enhanced access to handicapping data, upscale off-track betting locations (such as at Woodbine)..., and event-based night racing such as "Downs After Dark" (at Churchill Downs).

But even with all of these innovations and improvements, we have projected that Thoroughbred racing is losing fans at a rate of about 4% a year. Let me repeat that: 4% per year. The reason that's such a big number to us is if you simply look forward through 2020, the fan base will only be 64% of what it was last year. The component's there, as you can see: every year, 2% of the fan base dies, 5% lapse... now that's replenished by 3% new fans so there is some new fan acquisition but the net of those numbers is a 4% loss per year.

Michael Lamb: This shrinking fan base, which is causing the decline in handle, is the core issue facing racing, and we spent three months this spring analyzing both root causes and potential solutions. During that time, we:

  • Ran extensive regression analysis on a database of over 600,000 races spanning 11 years
  • Developed a model of the industry and its likely evolution
  • Conducted more than 150 interviews with industry stakeholders
  • Launched and analyzed a quantitative consumer survey of 1,800 current and potential fans, along with more than 30 in-depth consumer observations, both on-track and in-home, some of which we'll play back to you today
  • Launched and analyzed a Thoroughbred owners survey with more than 900 respondents
  • Polled over 200 regulators and opinion leaders

Dan Singer: From our research, we have identified five major causes of the decline in racing.

The first is intense competition from other types of gambling. The past 10 years have seen a major expansion in gaming availability and revenue outside racing. Here are some numbers:

Commercial casinos grew 34% between 2001 and 2010. Racinos have grown along with them, and now account for almost $7 billion in wagering, which is mostly slots, and that number is more than half the total handle on Thoroughbred racing in American now. There are 854,000 slot machines in 939 casinos across 38 states. Casinos now outnumber Thoroughbred racetracks by a factor of 6-to-1. So we have to recognize the really intense competition for gambling dollars that we're facing.

Also, poker — while illegal in its online form — was particularly innovative over the last eight years. Poker revolutionized its television coverage — financed by particularly two of the biggest online poker sites — its pricing via rakeback and rebate programs and its promotions and membership rewards programs. For a new bettor, online gambling and casino gambling offer significant advantages over Thoroughbred racing: they are available 24/7, and the games are typically very easy to learn and very quick to play.

The second major cause of racing's decline is brand perception. Our research with fans and non-fans alike has revealed that racing suffers from a negative perception relative to competition. Let's look at the numbers:

  • Only 22% of the general public has a positive impression of Thoroughbred racing
  • What to us was even more stark and surprising was only 46% of racing fans would recommend the sport to others... and for comparison for baseball fans is 82% and for football fans is 81% and for poker players is 55%.
  • Thoroughbred fans are almost twice as likely to recommend baseball (81%), football (73%), or basketball (77%) to others as they are to recommend Thoroughbred racing.
  • We think there is a stigma associated with racing... only 35% of Thoroughbred racing fans consider themselves "proud to be a fan," and that number is 66% for other sports. Let's hear some examples of the fan reactions from our research. [audio quote from consumer]
  • We have heard from new fans that racing — with complicated jargon and complicated racing forms — has too much complexity. Only 2% of consumers feel they have access to the information they need to know about the sport as compared to 71% for other sports. [audio quote from consumer]
  • The on-track betting experience can be particularly frustrating for new fans: they are embarrassed that they don't know the terminology, and become frustrated when trying to line up and bet alongside experienced fans. The betting process as we see it here is an artifact of 1940s and 1950s technology, when the technology simply required people to communicate in shorthand and it required the clerks to move as fast as they could to process the bet. The world and the technology has changed, but the on-track betting process hasn't evolved fast enough. [video clip]
  • Finally, racing has a relevance problem: Only 14% of consumers and only a minority of race fans feel that racing is "for people like me." Only 17% of fans feel that racing understands fans' needs, compared to 45% for other sports.
[audio quote from customer].

Michael Lamb: The third major cause is dilution of the best racing. So what do we mean by that?

  • First and foremost, horses are running less often. Annual starts per horse across all Thoroughbreds have declined from just over eight in 1990 to just over six today. Starts per horse among the top 100 trainers have declined from five to four over the same period. Perhaps most striking, the top three horses in the Kentucky Derby now start only eight times in their entire career, down from an average of 25 in 1990.
  • It has been well known in the industry that field size matters, but our extensive regression allowed us to quantify this relationship, from which we see a strong correlation between field size and handle. In this example, adding an eighth starter to a mid-sized race drives a handle increase of nearly 11%.
  • Another dilution problem is overlapping race schedules, which make it hard for off-track bettors and fans to follow the best races. For example, in 2010 more than 77% of races at top tracks — defined as those with average purses in excess of $200k — occurred within five minutes of a race at another major track.
  • These overlaps reduce handle. As an example, we analyzed three Grade I stakes races that occurred within 22 minutes of each other at Oaklawn, Keeneland and Aqueduct. Had these races been spaced out to occur at least 15 minutes apart they would have generated 6% more handle in total, with each participating track significantly better off.

The fourth major cause is the fan experience. New fans find many tracks to be out-of-date or in poor condition.

  • Despite the many innovations we mentioned earlier, just 19% of consumers think that the sport is entertaining to watch live versus 76% for other sports, and track visitors who did not have a good experience mainly cited the basics: dirty bathrooms (42%), unmaintained building (37%), food quality and availability (23%).

Dan Singer: The fifth major cause of the decline is fragmented distribution. Distribution of racing on television, online, and off-track is just too limited — particularly for reaching new fans. In our view, no other major sport has lost control of its distribution to the extent that racing has.

  • For sports and entertainment — even with the rise of the Internet — television is still the most effective way to reach new audiences, create awareness, and build an avid fan base. For example, the average American watches five hours of television per day contrasted with fewer than 10 minutes of online video, even now with the huge explosion in digital video distribution.
  • The exposure of racing on television is at a low-point: there are 43 hours of horse racing on national television in 2011, compared with 175 hours in 2003. Poker, by contrast, this year built up to over 150 hours of first-run coverage per year and even pro bowling will have 92 hours of coverage in 2011. The decline in televised racing has cut off an important source of new fan development: the number of new racing fans who discovered racing on TV was 9% 10 years ago, and the indirect effect of television on fan development then was far greater than that. When we look at fans who joined racing in the last year, virtually zero joined because of television. It was about 1 in 1,000 who said television was a reason they became race fans. That's virtually no fan development from television, and as a sports consultant, I can tell you that without television you're simply not going to reach and develop a new fan base.

ADWs have grown to 20% of handle, and at the current growth rate could reach 44% of handle by 2020. Yet ADWs are not attracting new fans: just 0.4% of new fans were introduced to the sport through an ADW. Now in part that's because the ADW sign-up process is regulated and therefore rather cumbersome. In fact, our research shows that only 53% of potential customers who attempt to sign up for an ADW actually succeed in funding the account and placing their first bet. ADWs have told us that they no longer attempt to attract new racing fans, and instead build the experience for core race bettors. The result is an ADW experience that, for a new fan, is difficult, as you will see here. [video clip]

Michael Lamb: At current course and speed, the five factors we have just described will translate into a continued downward trajectory for Thoroughbred racing over the next decade. This includes handle, which we forecast could decline by as much as 25% from this year's levels, the foal crop, where we anticipate an additional decline between 9 and 18%, and all of the other players in the industry. For example, the number of viable tracks will decline by 27% over that decade; state revenue and tax receipts from racing could fall by as much as a quarter; and the average owner losses will increase by 50%.

I should add there is substantial risk for the results to be even worse:

  • The negative feedback loop between foal crops, starters and handle could accelerate. The news that we've heard today about this year's foal crop would suggest that there is ample reason for concern in this regard.
  • What's more, other forms of distribution that we rely on today, for example greyhound and harness tracks, are facing their own challenges and could very well collapse over that period. Fans who attend those venues may not be recovered by our other distribution outlets, which would further impact the handle trajectory.

Dan Singer: Now these projections are sobering...and some degree of consolidation is probably inevitable. Nonetheless, from all the work that we've done, all the stakeholders we've spoken to and all the analysis we've done, we're convinced that racing has the potential to innovate much faster than it has up 'til now. Racing has all the weapons it needs to compete in the battle for a new generation of fans and handicappers, including the unique advantage of being the only legal form of online betting in the country. Racing is in a fight against dozens of other sports for an oversaturated TV audience, and a fight against almost 1,000 casinos for the scarce dollars of American gamblers. Racing has to fight harder, faster, smarter and better, but we believe you have the tools to do it, and we'll take you through that now.

Before we do, I want to say that we are realists, and we know that you have lived this history for the last 10 years or, in some cases, more, and we went back with your help and studied that history. So don't be surprised if you have heard, tried, or even funded many of the growth ideas in our strategy before. The shift to online betting, online video, online gaming, smartphones, tablets, and mobile applications is changing the world of sports marketing in fundamental ways. We think that some of the same tactics that racing has used in the past and abandoned can be executed in totally new ways and with much more success. We also believe that success will come from individuals taking immediate action. We aren't relying on grand coalitions or universal consensus to move forward.

I said that we are realists, and that's partly thanks to the wake-up call we got very early in our research from many of you — some in this room — with regard to the challenges in racing. There were two constraints in particular that we wanted to highlight:

  • First, there is no single executive body in racing, nor does it appear feasible to create one. We heard over and over that change would be easier if there were a powerful commissioner who could sweep away misalignments and objections, but we see no way to make that happen. And even if we could, it is much, much harder than you might think for commissioners in other sports to align all the owners and interests, most of which happens in the background. So every element of the strategy that we're going to show you has to be voluntary, and in the self-interest of the principal parties.
  • The second constraint is that the industry is capital-constrained, with few untapped reserves and no mechanism for cross-subsidies. So major improvements and initiatives will need to pay for themselves in a reasonable timeframe.

We are going to walk you through the nine initiatives in the growth strategy now. We said before that racing is losing 4% of its fan base every year — but if racing can execute all nine elements of this strategy successfully, we can eliminate those fan losses and stop the slide in handle.

Michael Lamb: The first initiative is fewer, better races along with better scheduling to increase field size and showcase the best product.

We have seen in practice that decreasing the number of races can actually increase total handle — Monmouth in 2010 provides a case in point. They cut summer race days by 47%, resulting in a 26% increase in average field size, a 117% increase in total handle and a 58% increase in revenue. There may well be larger challenges for Monmouth's economics, but this experiment with fewer, better races was clearly successful in its own right.

A key takeaway from our database analysis is that a large number of races and race days simply do not pay for themselves. According to our calculations — based on the most optimistic of assumptions — 28% of all races don't generate enough takeout, after taxes, to cover the cost of the purse; and nearly 50% of race days fail to generate enough takeout to cover the purse and the variable cost of putting on the race.

Eliminating these races can be profitable for both tracks and horsemen, as cutting a race and redistributing the purses and the starters to other races in the meet has a positive effect on the handle of the remaining races. For example, our analysis suggests that eliminating one race a day at Beulah Park and redistributing the purses and starters across the rest of the week at that track would result in a net handle increase of nearly 7%.

This opportunity also extends to race days. Enabling track executives and regulators to optimize their schedule for bettors will benefit both tracks and horsemen. For example, our model suggests that moving a race day at Delaware Park to a nearby day with 25% fewer competing races would result in a handle increase of more than 10%.

Fewer, better races will produce benefits for tracks and horsemen alike. However, to make this clear to all, and to ensure that the benefits are shared by all horsemen rather than just those with the best chance of winning on the day, such changes should be supported by new purse structures that pay all finishers. As an example, in 2009, Churchill Downs restructured its Kentucky Derby day purses to pay all horses in a race and found that field sizes increased despite a drop in total purse.

Our economic findings in this regard are very strong, and very general. I can assure you across the 600,000 races there are very few exceptions. However, we recognize that scheduling decisions are complex, and therefore that the best way to drive change here is to put this information into the hands of the people who are making the decisions every day, who can then balance profitability against all of the other considerations. With this in mind, The Jockey Club is working to incorporate our predictive models into their suite of scheduling tools to allow tracks to optimize race schedules.

Dan Singer: Our second initiative addresses innovative wagering platforms.

The core bettors we talked to expressed several concerns relating to wagering platforms in Thoroughbred racing. And I just want to emphasize how important core bettors are in the sport. One group of handicappers that we looked at who are members of a pretty large rewards program ... 1.6% of the handicappers accounted for ... 50% of the handle, which is just an extraordinary degree of concentration. So we take very seriously the feedback we got from core bettors in this process. The perception of past-posting is an important issue and core bettors would much prefer systems that would allow them to see odds in real time. Others told us that the majority of races don't have enough liquidity to be of interest to them.

We evaluated three possible ways to address these concerns: single-pool wagering, exchange wagering, and additional tote security:

  • First, let's start with single-pool wagering. That's a technology that would allow tracks to combine all wagers into a single pool for each race. Single-pool wagering can provide decimal odds, limit betting, and increased liquidity, while also facilitating new bet types. It's very interesting technology. There are still a few technological and business model issues to iron out, but we think that single-pool wagering is quite promising.
  • Exchange wagering is the second. The exchange wagering experience in the UK has shown some promise also. For example, it appears to appeal to younger fans. However, we should recognize that the UK context is different from the U.S. because the prevailing system in the UK was already fixed-odds, as opposed to the pari-mutuel system here in the U.S. We believe a United States pilot of exchange wagering should closely monitor the ability of exchange wagering to attract new fans, as well as the degree of cannibalization of pari-mutuel betting. From our analysis, we believe that exchange wagering in the U.S. is unlikely to be profitable for the industry at any takeout rate below 10%.
  • Finally tote security: The tote security system, which is under development by the TRPB, promises to improve the security of posted odds by allowing for enhanced monitoring of wagers and real-time odds updates. We believe that technology has huge potential to address core bettors' concerns in this area while still working within the installed base of tote systems. We did consider consolidating all totes into an industry consortium but the capital costs to acquire the totes and to redevelop a new platform appear to be simply prohibitive.

We mentioned capital constraints facing the industry before. These initiatives to innovate wagering platforms have the advantage of mobilizing outside capital and tapping into technologies, talent, and business models from outside the industry, which we think is in their favor.

Michael Lamb: Our third initiative is an integrated rewards system.

We are going to speak here about the evolution of the ADW market. We'd like to introduce this very controversial topic by discussing one that perhaps is even more controversial — takeout and rebates.

I should say as preface that we recognize these are inherently complex issues. We are going to share with you today the results of our research and analysis, but I ask that you please don't shoot the messenger if some of our findings don't match your intuition and personal experience.

Our research shows that takeout is a major issue for core fans — 26% of heavy bettors we surveyed ranked takeout as one of the top two concerns affecting the sport. And in the course of our interviews, many longtime fans expressed intense frustration with today's takeout levels and the difficulty of finding attractive handicapping opportunities, given the cost of race betting.

To put this in context, let's look at player costs (which is takeout or rake, net of rebates) for typical casual and heavy bettors for a variety of gambling activities. You'll see ... that for a casual racing fan betting $50 per race for 2 races an hour, the hourly cost of racing after rebates, and by this we mean the takeout or rake, is $19 per hour, which is roughly in line with slots at $32 per hour and poker at $12 per hour.

Even though takeout as a percentage is significantly higher in racing than in these other gambling activities, in our research we found that fewer than 20% of Thoroughbred racing fans know that fact, and that only 1% of fans who stopped following racing in the last year cited takeout as a reason they left the sport

For a core fan, however, the picture is quite different. The hourly cost of race betting can be much more than for other gambling activities. The top 20% of horseplayers, who bet an average of $12,000 per month on Thoroughbreds, pay a takeout per hour of entertainment that is much higher than for heavy sports, poker, or slots bettors.... This is in large part because the prevailing rebate rates for race betting are lower than those for slots and online poker. As again you can see on the chart, online poker and casino slots offer rebates between 30% and 45%, whereas racing typically offers 5% to 15% of takeout back as a rebate. Casinos and online poker sites dedicate significant resources and sophisticated systems to determining the optimal levels of rebates and rewards and to creating incentives for more volume and to retain their core fans.

We strongly prefer rebates as the method to address the price-sensitive bettor. This is especially true since regulation of takeout denies tracks the latitude that typical retailers have to address concerns through experimentation with different price points.

Now back to ADWs. As we said earlier, online platforms represent the future of Thoroughbred wagering, although they have not yet met their potential for new fan development. We believe that ADWs also represent the best platform for more effective rebating and rewards programs.

For that reason we would like to see tracks — who still have many of the most important customer relationships in this business — embrace the ADW business. A track-integrated ADW, built on a strong at-scale technology platform, and with real investment to deliver world-class customer database marketing, could provide an unmatched experience for the best bettor, while also investing in and benefiting from new fan development. The recent deal between Keeneland and TwinSpires, for example, is a step in this direction which we applaud.

Dan Singer: Our fourth initiative is improved television coverage.

We spoke before about the widely acknowledged scarcity of racing on national television today — yet television is still essential for fan development. We are really heartened to see recent efforts to put more racing on television, including eight race days this summer right here from Saratoga. However, so far racing has struggled to find an economically sustainable TV model, outside the Triple Crown and the Breeders' Cup.

We have seen rapid innovation in other types of sports programming — just a few examples here, reality shows such as "The Ultimate Fighter" for UFC, new television technologies such as NFL's "Passtrack" and MLB's strike zone, and online companions, which are designed to be played along with a televised sport such as NASCAR's TRACKPASS.

In order to compete for new fans, racing should take a page from other sports and experiment with a wide range of format and technology innovations. For example:

  • Turning everyday fans into celebrities, as poker did with Chris Moneymaker
  • Creating a rooting interest by developing compelling rivalries and recurring characters, whom fans can follow across an entire season of racing
  • Use new camera angles and computer animation
  • Get more celebrities on camera as you saw in the clip earlier from Saratoga
  • Speed up the pace with multiple races per hour
  • And finally, make a multi-year commitment to these new formats and stake out a consistent time and day. That's very, very important. Racing is still a live experience — almost all sports are. It's important to stake out a consistent time and day and give audiences time to find the programs.

Television is expensive and, in our view, will not break even from ad revenue or increased handle on the televised races alone. What television can do is to raise awareness of racing, and develop new online players and new track visitors who, in turn, can be converted into new fans and new handicappers. We believe online properties ... such as a free-to-play handicapping site, a social game, and ADWs can also provide a revenue engine for television that's never been there in the past, as Mike will talk about now.

Michael Lamb: Our fifth initiative is a free-to-play online game to help simplify race wagering for new fans. In our research, 20% percent of consumers — so this is not race fans but 20% of the American public — told us that the reason they don't bet on Thoroughbred racing is that it's too complicated.

The good news is we now have a mass-reach vehicle we can use to address that concern.

Free-to-play ".net" sites in other industries — for example, online poker — have been successful at teaching consumers how to play and attracting new fans, especially in conjunction with television promotion. As we have seen with Play Keeneland and Play Saratoga, a key advantage of free-to-play sites is that it takes less than a minute to register and begin playing.

There is a real opportunity for Thoroughbred racing to launch a free-to-play site to capture new fans. Some 37% of the American public we surveyed have indicated that they would compete on a free-to-play site. It's likely that such a site would also deliver a substantially younger demographic than racing enjoys today.

A free-to-play site could be different from handicapping competitions tried before: it would have more social integration through Facebook to allow you to compete against and also enlist your friends; it would be backed by prominent marketing on television; it would have links to ADWs to convert free-to-play consumers into paying horseplayers; and it would have an emphasis on on-boarding the new fan into the sport. The goal will be to enable viewers of a nationally televised race series to play along at home almost immediately, even if they have never bet on a horse in their lives.

Dan Singer: Our sixth initiative is a social game based on Thoroughbred racing. While the free-to-play site that Mike just described seeks to serve as a welcome mat to the sport for new handicappers, a successful social game can build racing's brand and relevance, especially among women. For those of you not familiar with social games, the average social game player is a 47-year-old woman — a little different from our core fans at Aqueduct — and a social game can reduce the stigma around race betting significantly.

Just a quick introduction to social games: Powered by Facebook, social gaming has become a major entertainment platform from virtually nothing five years ago. Facebook now accounts for 12% of all consumer Internet time in the U.S. — up from 7% just two years ago. Zynga, which you may have heard of in the news recently, is the leading social game developer. Zynga now has 230 million unique monthly users, about 5% to 10% of whom spend real money on virtual goods, which is their revenue model. At its peak, Zynga's popular game Farmville had 85 million virtual farmers —some of them may be annoying you on Facebook even today — 30 million of whom played every single day. At 34 million players, Zynga Poker is currently the biggest free-to-play site on the web. A top social game can generate revenues of over $25 million per year. So if you can create a very popular social game, it's a great business.

A social game for Thoroughbred racing could allow players to raise and train horses, race them against their friends, and compete on historic tracks. When we tested that game concept with consumers — we're talking about the general public, not race fans — 24% said they would be excited to try the game, which is a good number.

While there may be no direct conversion from social gaming to real-money betting, a social game could still promote major races in conjunction with a televised series; it could provide new prospects for the track, free-to-play, and ADW promotions; and it could be a stand-alone revenue generator.

Now finally, in addition to the fan development strategies we just talked about, we believe racing can strengthen its brand and create more value for stakeholders through three last initiatives, which we'll just summarize here...

  • First, safety. Up to now, we have been emphasizing initiatives to grow fans and handle, but we presume racing will also take action on the Thoroughbred safety reforms discussed earlier by Mr. Janney and the Thoroughbred Safety Committee. Those reforms will help to create a foundation for growth and eliminate major risks to the brand and health of the sport.
  • The eighth initiative is ownership tools, which is to encourage more ownership through databases and tools to give greater transparency into the economics and performance of the sport.
  • Ninth and last is disseminating best practices from tracks around the country. We showed you some examples of innovations before. The sport can benefit a lot by moving those innovations from track to track much more rapidly.

Collectively, these nine initiatives and the strategy we just walked through can accelerate the pace of innovation; they can address the legitimate concerns of fans and handicappers; they can position racing for a new generation; and they can return racing to economic stability and, ultimately, long-term growth. These strategies can be successful without the creation of a commissioner and without any new regulatory interventions or mandates. Finally, they can be financed within the capital constraints facing the industry.

The Jockey Club is already starting to take action on some of these initiatives and Jim will describe now what is underway.

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