Betting exchanges: the future of sports betting?

Koning, Ruud H. ; van Velzen, Bart

Introduction

Sports and betting have always been strongly connected. In fact, some sports derive their very existence from the popularity of its associated betting market (e.g., horse racing). Traditionally, betting markets have been cleared by bookmakers, who accept (or not) the bets on a certain event. Different forms of betting markets are discussed extensively by Sauer (1998) and Buchdahl (2003).

Recently, a new type of betting market has appeared, where punters bet directly with each other (peer-to-peer betting). These markets are known as betting exchanges. Similar to the model of a stock exchange, the user can buy ('back') or sell ('lay') bets at the price ('odds') he or she wants. Only if the offer is matched by another user, the bet has 'action.' An example of a typical market is shown in Figure 1.

One of the first, and by far most successful, betting exchange is named Betfair (http://www.betfair.com). Betfair was launched in June 2000 by Andrew Black, a professional gambler, and Ed Wray, former vice-president of JP Morgan. The company has grown astronomically to become the largest online betting company in the United Kingdom, and has been widely recognized as one of the more successful entrepreneurial innovations of recent times, being awarded the British Ernst & Young Emerging Entrepreneur of the Year Award in 2002.1 Also, in 2003 Betfair won the British Queen's Award for Enterprise, in the category Innovation. (2)

Following the footsteps of Betfair dozens of new entrepreneurial online betting exchanges have seen the light, especially of a Scandinavian (e.g., http://www.betsson. com), British (e.g., http://www.wbx.com), and American (e.g., http://www.matchbook.com) origin. This has led to intensive competition between not only the exchanges themselves, but also between the exchanges and the traditional bookmakers, whose market shares are increasingly under pressure.

In this paper we provide a SWOT-analysis of betting exchanges. The tool of a SWOT-analysis is not new, of course, but this particular application is. Issues like competitiveness and survival of betting exchanges are addressed. Also, we compare the most important players in the market. We will argue that liquidity is a prime determinant of long-term success.

Sector Analysis

A SWOT-analysis, which identifies the Strengths, Weaknesses, Opportunities, and Threats, is an often-used tool of situation analysis, and can be used to determine whether a firm's business position (or in this case, a sector's business position) is fundamentally healthy or unhealthy (Thompson III & Strickland, Jr., 2001).

In this paper the SWOT-analysis of the betting exchange has been performed by doing a literature study, including both academic studies and recent news articles about gambling in general and the betting exchange in particular. The results of the SWOT-analysis of the betting exchange are shown on page 44.

Strengths

Better odds/higher average pay-out to customers

Most authors agree the most important strength of the betting exchange is they offer customers better odds than the online bookmaker. Jones et al. (2004) writes about the betting exchange "the odds on offer are generally much more competitive." Griffiths (2005) confirms this statement, "they [the betting exchanges] provide excellent value for the gambler. There is no [...] bookmakers' mark-up on odds." A study by Ozgit (2005) that compares the returns of Betfair to the return of two bookmakers also showed considerably higher returns, although the sample chosen by Ozgit in his study was admittedly limited.

Betting exchanges themselves regularly claim they offer customers up to 20 percent better odds than the online bookmaker. (3) Whether this claim is accurate has been the subject of our own study, which took place in 2006. In this study odds offered by a large sample of bookmakers were compared to odds offered by betting exchanges in different intervals during every fixture of four major sporting events in 2006 (World championships soccer, ice hockey and floorball, and the European u21 Championships soccer). The odds were taken from the Match Winner-market, with three possible outcomes: home win, draw, and away win. Odds were measured in terms of payout, a number that reflects the percentage of the original amount of money staked a bettor would be returned if he would place relatively equal bets on every possible outcome. The payout offered by betting exchanges was revised for the commission on winnings betting exchanges charge their customers, which is necessary to be able to make a fair comparison.

In Figure 3 the measured payout is shown during the biggest of the four events that were part of this study, the World Championships Soccer of 2006 in Germany. The figure shows the payout offered by six different major betting exchanges (Betdaq, Betfair, BetonBet, Betsson, IbetX, Parbet, and TradeBetX), as well as the average payout offered on average by a sample of up to 72 different bookmakers ("Bookm. AVG"), and the maximum payout offered by any of the bookmakers ("Bookm. HIGH"). (4)

Figure 3 shows odds offered by betting exchanges are indeed most of the time, but not always, higher than odds offered by bookmakers. In the earlier intervals, when the match is still a relatively long time away from kicking off, payout varies from betting exchange to betting exchange and in some cases is below maximum, and even below average payout offered by bookmakers. However, as the match approaches, the payout offered by betting exchanges increases, while the payout offered by bookmakers remains more or less constant. In the final minutes before the event starts, a bettor would have been better off betting with any of the six betting exchanges.

[FIGURE 3 OMITTED]

While, as already mentioned, Figure 3 only shows the results of one of the four studied sporting events, other events showed roughly identical findings. (5) Nevertheless, the study should, next to the study of Ozgit, be regarded as a pilot study. To be able to make a definitive statement as to when to what extent the betting exchange offers better odds than the bookmaker, more research is needed.

Less operational risk

A fundamental advantage of the business model of the betting exchange to the business model of the bookmaker is the fact the exchange (normally) is not a party in any of the betting transactions that take place on their website. Therefore, according to Davies et al. (2005),"Betfair has no interest in the outcome of any event it makes available." Unlike the bookmaker, the betting exchange typically does not take any trading position and consequently makes money regardless of the outcome of the event. Laffey (2005) writes "in facilitating betting as a neutral intermediary the website [of the betting exchange] does not take on the risk function of the bookmaker and generates revenue by taking a commission from the winner." As long as bettors make use of an exchange, bettors will pay commission to that exchange, and the exchange is guaranteed to earn a steady flow of income.

Lower transaction cost

Davies et al. (2005) argue an important strength of the betting exchange consists of the fact the betting exchange considerably reduces transaction costs in comparison to the bookmaker. In economic literature Dahlman (1979) identifies three different types of transaction costs: search and information costs, bargaining and decision costs, and policing and enforcement costs. (6) In analyzing the role of the betting exchange in reducing transaction costs, the focus should be on search and information costs.

According to Dahlman, this factor only exists as a consequence of "imperfect information about the existence and location of trading opportunities or about the quality or other characteristics of items available for trade." In sports betting traditional bookmakers also incur search and information costs. According to Davies et al. "traditional bookmakers need to be well informed (studying horse racing and sporting events carefully) in order to make odds, and need to monitor market changes constantly in order to avoid being taken advantage of, or of being over-exposed."

Unlike a bookmaker, the task of the betting exchange does not include actively monitoring a certain market. Markets for sporting events need to be created, and, when the event has taken place, settled according to the result, but that is where the responsibilities of the betting exchange end. The betting exchange does not need to hire a specialist to determine the odds on the probabilities of any of the parties winning, and adjust odds if necessary, but the betting exchange, as Davies et al. writes "simply provides the platform." The concept of the betting exchange can therefore significantly reduce search and information costs (and therefore also reduce total transaction costs), in comparison to the traditional bookmaker.

Increase of market completeness

The business model of the betting exchange allows its users to bet (back), but also to offer (lay) money, against whatever odds they like, at whatever time they like, on whatever event they like. Laffey (2005) writes "its [the betting exchange] main innovation was that it allowed users to set their own fixed odds against an outcome [...] something which had previously been the preserve of bookmakers." According to Davies et al. (2005) "with a click of the mouse they [the bettor] can essentially do what Ladbrokes or William Hill [the bookmaker] does." Also, the bettor has the opportunity to adjust his own betting position at a later time; for example, buying or selling back his own bet at different odds, thereby possibly even securing a profit before the event he was betting on has even started. In short, the betting exchange has opened up a whole new range of betting strategies for the bettor, which were not possible while betting with a bookmaker. In economical terms, it is therefore safe to say betting exchanges have increased market completeness. A "complete market" is defined by Figlewski and Webb (1993) as "one in which, for each possible state of the world, an investor can create a strategy that has a positive pay-off in that state and zero in every other state." Although Figlewski and Webb admit markets are "bound to remain far from complete", they have found, while studying traditional financial markets, a higher level of market completeness tends to improve market efficiency. There is no reason why the same mechanism should not also apply to betting markets, which is also consistent with findings concerning a study about betting exchange market efficiency by Smith, Paton, and Vaughan Williams (2006).

Winning customers welcome

A customer that bets with a bookmaker is not only restricted to the prices offered by the bookmaker, but also to the maximum stake that is accepted by the bookmaker. However, it's a different story for a customer that manages to 'beat' the bookmaker by actually making a profit in the long term. Most bookmakers will soon limit their maximum stakes for this particular kind of customer and he will therefore typically only be able to bet small amounts. The betting exchange, for obvious reasons, does not much care whether a customer actually wins or loses; the more money any customer bets, the better. Laffey (2005) writes "this neutral position enables the P2P websites [the betting exchanges] to offer stakes only limited by market liquidity, and to promise not to ban successful punters, something bookmakers would reserve the right to do." Laffey adds "[the betting exchanges] were drawing in the 'high rollers', those prepared to stake enormous sums, who bookmakers would often refuse to take bets from." Of course, as Laffey emphasizes, also in the betting exchange bettors might not always be able to bet the amount of money they want to stake; not because the betting exchange will limit them, but because it is possible there is simply just not enough liquidity available at the betting exchange to match larger bets at the requested odds.

Weaknesses

Effects of Metcalfe's Law

Probably the most important potential weakness of a betting exchange is not having enough users (and liquidity) to be able to attract new users. According to Davies et al. (2005) Metcalfe's Law, a law related to the concept of network externalities, is an important factor to explain the success or failure of a certain betting exchange. Metcalfe's Law predicts that network value is proportional to the size of the network, and that individual user's utility is a linear function to network size (Swann, 2002). Applied to the case of the betting exchange, Metcalfe's Law predicts that the more users a betting exchange has, the more offers will be made, and the bigger the chance will be that any individual player at that exchange will find a reasonable offer to his liking. As a result the likelihood that the user will join the exchange and start making offers for himself will also increase.

However, Metcalfe's Law can also be applied the other way. In the start-up stages of a new betting exchange, the number of customers may be limited, and as a result the number of offers will also be relatively small. Potential customers will for that reason be less inclined to join that specific exchange. The exchange should, because of the effects of Metcalfe's Law, have a very hard time achieving a scale large enough to become profitable, especially when the competition has already been more successful in the past. As Mainelli and Dibb (2004) comment "liquidity, once established, is hard to shift." For obvious reasons, a start-up bookmaker does not face any of these liquidity problems, because the bookmaker is by definition the only party making offers on its own betting platform, regardless of the number of customers.

To overcome the effects of Metcalfe's Law new betting exchanges often try to 'seed' their own markets; in other words, to start making attractive offers themselves (and in the process sacrificing the previously mentioned strength of less operational risk). Betting exchange Sporting Options even went bankrupt, partly because of the losses incurred in seeding its own markets. The managing director of the company told The Guardian in 2005 "it became immediately clear that to develop [it would be necessary] to seed the markets to create liquidity and attain a critical mass of clients to support the business model." Seeding could indeed be a solution to creating more liquidity at a betting exchange, but needless to say it is also a financially very risky solution. Bettors' aversion to risk

After identifying a number of important strengths of the betting exchange in the first part of this section, especially the important strength of better odds, it raises an important question as to why online bookmakers continue to be profitable, despite the arrival of the betting exchange. Ozgit (2005) calls the fact "bookies attract a lot of betting although better returns are available elsewhere" the 'bookie puzzle.' A solution to the bookie puzzle could very well be bettors' aversion to risk. In the betting industry the success of a bookmaker has always been dependent on its ability to build a reliable track record. This can be explained by the fact that a bet placed with a bookmaker, in almost every country in the world, is very hard to enforce by the bettor. For example, in the United Kingdom, seen by many as one of the most liberal countries in the world with regards to betting, a bet is not legally enforceable (and therefore often referred to as a 'gentleman's agreement'). As Pitt et al. (2005) puts it,"even with a valid betting slip, the bookmaker is not obliged to honour a winning bet." Mainelli and Dibb (2004) conclude that in the absence of legal enforceability, the concept of trust is essential in the betting industry.

Since the betting exchanges have not been around for long, unlike some of the online bookmakers who have a long history of offline bookmaking behind them, the possibilities for building a decent track record have been limited. To make matters worse, some betting exchanges (e.g., Sporting Options and Play121) have had to file for bankruptcy in recent years, while others (e.g., Back2Bet and The Soccer Exchange) have vanished, taking the funds of customers with them.

These kind of stories are obviously particularly bad for the image of the betting exchange and could induce risk averse behavior from bettors. Counterparty risk seems to be non-negligible and bettors take that into account. If a bettor would question the reliability of a betting exchange, he might very well prefer to keep on betting with the bookmaker he has been betting for years, if that bookkeeper is perceived to have a lower counter-party risk. It's therefore essential for the betting exchanges to gain the trust of the bettors. Betfair, as well as other exchanges, have addressed this issue by making a promise to customers all funds will be held in so called ring-fenced subsidiaries, to prevent the company funding itself by customers' deposits (Hoare, 2002). Also, in some cases of bankruptcies, other betting exchanges have stepped up to help victimized customers. The most notable example of this is the rescue package offered by Betfair, after British betting exchange Sporting Options had to cease operations. (7)

Opportunities

Less restrictive legislation (Europe)

In many European countries it is only possible to bet on sports through a state-owned subsidiary. Any other betting company is restricted from offering betting services to the citizens of that country, and risks legal action if the company does not comply with national regulations. Recently betting companies, both betting exchanges and bookmakers, have filed complaints with the European Commission to overturn these national laws. (8) Betting companies have argued that in many cases national legislation is in contradiction to policy of the European Union (EU) regarding free movement of services, as well as the goal of the EU to create one single European market.

The EU has repeatedly stated it does allow member states to restrict the access of sports betting operators on a national level, but only to maintain public order (e.g., to prevent fraud), to protect consumers (e.g., to prevent gambling addiction), and to ensure maintenance of the social order. However, any measures taken by member states must be necessary, proportionate, and non-discriminatory. According to a study ordered by the European Commission and published in 2006, members states that restrict sports betting must have a "desire to bring about a genuine diminution of gambling opportunities."

Betting companies complain this desire from national governments is clearly lacking, as state betting operators often even encourage gambling by making use of aggressive advertising campaigns. (9) The European Commission seems to have taken these complaints seriously and has recently been investigating national gambling legislation in no less than nine different EU member states. (10) While most of these investigations are still under way, some of the member states have already been threatened in 2007 by the European Commission they will have to face legal action before the European Court of Justice if they do not change their gambling laws in the very near future. (11)

Although the European Commission is quick to emphasize in press releases this investigation as such has no implications for the liberalization of the sports betting market, it does seem to be a small step in that direction. The liberalization of the European betting market would offer a great growth opportunity for the entire betting industry, including the betting exchanges. To underline the potential, according to the previously mentioned study ordered by the European Commission, in 2003 the gross gaming revenues, the winnings of the operator minus payments of prizes, in European member states reached a level of approximately 51.500 million (compared to 60.700 million in the USA), of which 17.2% was generated in activities related to sports betting.

New markets (Asia/Australia)

Whereas online betting companies have previously targeted Europe and the United States as their primary sales region, Asia and, to a lesser extent, Australia, seem to have been overlooked up until recently. Especially Asia offers huge growth potential, if simply because of the enormous size (and growth) of the population. However, this is not the only reason. Asian and Australian bettors also seem to be betting more money per person. According to Mark Blandford, founder of online-bookmaker Sportingbet, the average bet size of their Australian and Asian customers in 2003 reached an impressive 226 per bet. In comparison, the average bet size of European and American customers over the same year amounts to 'only' 22 and $59 per bet respectively. (12) These results are in line with findings of the OECD, The Economist Intelligence Unit, and Merrill Lynch, who have performed research into the propensity to gamble as a percentage of consumer spending. Australian bettors showed a tendency of betting up to 5.5% of consumer spending, while Asian bettors were inclined to bet 1.8%. These findings differ significantly from the rest of the world. The propensity to bet in the United States amounted to 1.0%, in the United Kingdom to 0.9% and in the rest of Europe to 'only' 0.4%.

For now, Australia and especially Asia are pretty much unexplored territory for betting exchanges. A first move was made by Betfair, which managed to acquire a license to enter the strictly regulated Australian betting market in the beginning of 2006. (13) As Betfair's co-founder Andrew Black told the newspaper Scotland on Sunday in 2005: "Geography is an absolute priority. It's a land grab right now."

Technological progress

The internet itself, the channel through which the betting exchange operates, has worldwide already become an accepted factor in the daily life of many people. However, the internet has also created many new possibilities for other, related innovations, like the invention of the betting exchange. Moore's Law, an observation that dictates that the speed of microprocessors, at a constant cost, doubles every 18 to 24 months, predicts this trend will continue in the future. As Davies et al. (2005) write, "experts today generally agree that Moore's Law will continue to govern the industry for another fifteen years, at least." As processing power continues to grow, new innovations will be made possible. For example, some betting exchanges have, in cooperation with mobile phone companies, recently started offering customers the possibility to bet by making use of their mobile phone. (14)

Many innovations are focused on trying to simulate the environment of the old-fashioned brick-and-mortar betting shop, which to many was (and still is) a social meeting point, but also offered live television coverage of many sporting events. Therefore, betting exchanges are searching for ways to encourage the customer to interact with other customers during the betting process, for example, through internet forums. (15) Also, betting exchange Betfair has recently started an experiment offering customers free live-stream coverage of football and tennis matches through its website. (16)

Expansion to related sectors

Like many online bookmakers, more and more betting exchanges are investing in broadening their product offering with other gambling products. An example of an expansion into sports betting-related products is the offering of live-betting. In live-betting it is possible for bettors to not only place their bets at the exchange before a game starts, but also during the game as the match is being played. According to Laffey (2005) "Betfair have stated that for some events they have matched up to ten times more in-play than beforehand, showing the appeal of this product."

Betting exchanges are also expanding into other gambling products, completely unrelated to sports betting. By offering customers a one-stop shop for all of their gambling needs, exchanges hope to profit from the growth in other gambling sectors; for example, the enormous growth of online poker. (17) For that reason a number of betting exchanges have already started offering their customers the possibility to play poker, blackjack, and casino games through their own website. By expanding the offering to customers, the betting exchange hopes to not only increase the total number of customers, but also to increase the spendings per customer.

Migration of technology to unrelated sectors

In 2003 the CEO of Betfair, Stephen Hill, told British magazine New Media Age in an interview he doesn't see Betfair as a gaming company, but mainly as a "internet technology company." Hill announced in the interview he plans to take Betfair "into entirely new areas of business." He emphasized the technology that is needed to run a betting exchange, could be used for several other internet concepts that are completely unrelated to gambling; for example, an online auction site.

Also, there's an increasing interest of polling and news agencies in the exchange-technology. In the past prediction markets have proved to predict future events better than traditional opinion polls. The Iowa Electronic Markets have been successful in predicting outcomes of American presidential elections and are more accurate than 'regular' polls (Stix, 2008). For that reason some agencies start operating their own future predicting betting market to be able to more accurately predict a certain future event. For example, the Dutch newspaper De Volkskrant started an exchange during the Dutch elections of 2006, by using technology of American exchange solutions supplier Newsfutures.com, to help predict which party would win the elections. Also, betting exchange Intrade has focused exclusively on offering its customers prediction markets on current events.

Threats

More restrictive betting legislation (USA)

In October 2006 President Bush signed a law, called the Unlawful Internet Gambling Enforcement Act, which makes it illegal for American-based banks, credit card companies, and online payment systems to process payment to online gaming companies. (18) While betting through the internet, as in many countries, has always been a 'grey area' in American law, and rules on gambling vary greatly from state to state, the American betting industry has shown enormous growth in the last couple of years. Because the Gambling Enforcement Act, that came as a big surprise to the betting industry, makes it almost impossible for bettors to deposit or withdraw winnings from their betting accounts, industry experts believe the Act could mean the end of most of the off-shore online American betting industry. (19) Not unexpectedly share-prices of publicly traded betting companies lost up to 70% of their value following the news of the Act. (20)

Although betting exchanges are still a relatively uncommon phenomenon in the United States, a few particular betting exchanges had already built a solid American customer base. While some betting exchanges, including Betfair, did not accept American customers even before the Act was introduced because of unclear legislation, others, like Mansion, had to turn down a large part of their clientele because of the Act. For this reason Mansion decided to terminate its exchange business altogether in October 2007. American betting exchange Betbug had already decided to cease operations in February of that same year, while TradeBetX ceased operations in November 2008.

Currently, only three betting exchanges, Matchbook, EHorseX, and Intrade, still accept American customers, but will constantly need to keep thinking of (legitimate) ways to being able to accept deposits and process withdrawals from and to American customers. Clearly, the passing of the Gambling Enforcement Act has had big consequences for the entire gambling industry, including the betting exchanges.

There have been attempts by American congressmen to repeal the Act, as well as an effort by the country of Antigua and Barbuda to make the United States change its laws by filing an official complaint to the World Trade Organization (WTO). (21,22) Despite national and international concerns (e.g., Shaker, 2007), as well as a ruling by the WTO indicating the Act is in fact in violation of existing free trade agreements, it doesn't seem likely the United States government will be taking action to overturn the Act soon. (23) During the U.S. presidential elections of 2008 neither presidential candidate showed an interest in repealing the Act, and in November 2008 the Federal Reserve Board and Department of the Treasury announced the release of a final joint rule, forcing U.S. financial firms to establish and implement policies and procedures to prevent payments to gambling businesses. (24,25)

Nevertheless, it's important to emphasize while the Act has blocked a large part of gambling-related financial transactions in the U.S. itself, it hasn't stopped the possibility to bet with betting exchanges on sporting events taking place on American soil. Besides Matchbook, that specializes almost exclusively in offering markets in U.S. sports, also Betfair, and other betting exchanges, are still accepting bets on, for example, NBA basketball, NFL football, and MLB baseball placed by their non-U.S. customers. However, these offerings are generally not as well developed as the offering for European sports, with markets being characterized by below-average liquidity. It is likely this will remain to be the case for as long as American citizens are not allowed to bet using these betting exchanges.

Political lobby by bookmakers (UK)

The rise of the betting exchanges has not gone unnoticed by their main competitors, the bookmakers. Many of these bookmakers claim that bettors that 'lay' a bet at a betting exchange are in effect taking the role of the bookmaker, and therefore should be subject to the same regulations as the bookmaker. In the United Kingdom bookmakers need to apply for a (costly) license to operate legally, and also pay 15 percent tax on their winnings. Of course, if every bettor that has ever laid a bet at a betting exchange would be obliged to follow these same regulations, this would pose a very serious threat to the business model of the betting exchange.

David Hood, a spokesman for leading British bookmaker William Hill, commented on this issue in 2003 in the International Herald, "if I stand [...] outside a betting shop and offer to lay a bet which you take, I am breaking the law, because I am not a licensed bookmaker," but "if we both boot up laptops in the street and strike the bet using a betting exchange, I am not breaking the law? What is the difference?" Betting exchanges have defended themselves by claiming not the bettor, but the exchanges themselves are in fact acting as a bookmaker, because they are the ones who collect the deposits and pay out the winnings. Therefore they claim only they should be obliged to acquire a license and pay taxes on their winnings, not their customers.

A British parliamentary commission investigated this issue in 2004 and overthrew the argument of the betting exchanges in their report. They advised the government to start considering bettors that lay a bet at a betting exchange as a bookmaker and therefore to subject them to the same rules. To the dismay of the bookmakers' lobby, at that time the British government decided to ignore the advice of the commission, because of practical problems implementing the proposed measures. According to Laffey (2005) there were problems of definition and also problems enforcing British legislation on the foreign users of the exchange. However, beside there being no guarantee the British government in the future will not again attempt to tackle these practical problems, it remains unknown how other countries in the world will decide and possibly impose restrictions regarding this subject.

"Discount" bookmakers

At about the same time as the business model of the betting exchange was introduced, another new, less radically different, business model was born. In 1998, online bookmaker Pinnacle Sports was founded, a company that operates from the Netherlands Antilles. Pinnacle, as well as a number of Asian-based bookmakers with a similar business model, and can best be described as a 'discount-bookmaker' since the company has managed to offer extremely competitive odds on almost every sport. According to Musumeci and Peterson (2004), who performed a study on betting on American football with two possible outcomes, most (American) bookmakers tend to offer their customers payout books of 0.955 in these markets. Pinnacle manages to offer it customers payout books of 0.976. Musumeci and Peterson calculated that a bettor betting on an event with two equally probable outcomes would need to win 52.4% of his bets to break even with a typical bookmaker, while a winning rate of "only" 51.2% would suffice to break even while betting with Pinnacle. As a consequence of the competitive odds Pinnacle is offering, Musumeci and Peterson conclude "Pinnacle's margins are smaller." These smaller profit margins are responsible for the fact the discount-bookmaker is, like a typical betting exchange, very dependent on volume to survive and therefore needs to attract not only a large amount of customers, but also attract professional bettors, who will typically shop around to find the best odds available for a certain event. Like betting exchanges, Pinnacle uses the argument of better odds as its main selling point to attract new customers, advertising on their website with slogans like "we take on the high margin operators" and "Pinnacle is where the pros play." (26)

A betting exchange and a discount bookmaker have a lot in common, and are very much targeting the same kind of bettor, although both are operating in entirely different ways. Although a betting exchange can in theory offer a payout of 100 percent to its customers, commissions on winnings (especially if these commissions amount to as much as five percent) will make it likely the betting exchange in practice will not be able to offer better odds than the discount-bookmaker. This would obviously pose an important threat to the most important strength of the betting exchange: offering better odds than the bookmaker.

New entry from bookmakers

The previous two threats have shown traditional bookmakers have so far challenged the betting exchanges to both a legislative battle, and by developing a new business model focused on increasing payout. However, bookmakers have not yet challenged the betting exchanges 'heads on.' The future might be different though. Mainelli and Dibb (2004) predict "a future with exchange(s) at the centre as mechanism for price formation." As the concept of the betting exchange will become more and more familiar to the big public and will keep on growing in size at the expense of the bookmakers, it is not hard to imagine this will attract outside interest. This is why Mainelli and Dibb estimate it's "extremely likely" traditional bookmakers will in the future open their own betting exchange. Mainelli and Dibb write "despite frequent attacks on the exchange model, traditional bookmakers would be commercially naive, if they were not also looking into opening their own exchange." Furthermore, there has been talk of British bookmaker-giant Ladbrokes being interested in the take-over of Irish betting exchange Betdaq.27 Also, according to Laffey (2005) there have been rumors regarding a possible launch of one or several new betting exchange(s), offering down to zero percent commission, by the 'Big Three,' the three biggest British bookmakers William Hill, Coral, and Ladbrokes. Mainelli and Dibb rate such a possible venture as 'a formidable challenger' to in particular Betfair, if only because of its "established customer base, resources and marketing skills."

Match fixing

Since the beginning of sports betting, there have been many examples of bettors trying to influence sporting events to secure a favorable outcome. These practices have always been seen by sports governing bodies as a serious threat to the integrity of sports, but have also been very difficult to prove. Recently though, both online bookmakers and sports governing bodies have claimed the rise of the betting exchange has made it easier for bettors to profit from insider trading. For example, Owen Byrne of the Jockey Club commented on this issue "there is a threat to the integrity of racing" (Stanley, 2003). According to Jones et al. (2004), while a betting exchange allows bettors to bet against a certain outcome, "unscrupulous horse racing trainers and jockeys, for example, could lay their horse to lose, [...] securing winnings for themselves."

The suspicion of match fixing is of course particularly damaging to the public image of the betting exchange. Betfair has therefore decided to take matters into its own hands. It writes in its annual review of 2006 "a series of 'MoUs' (Memorandum of Understanding) have been signed with sports bodies over the year." These Memorandums, which Betfair has signed with among others, the Jockey Club (horseracing), the ICC (cricket), the FIFA (soccer), and the ATP (tennis), include Betfair reporting suspicious betting patterns to the relevant sports governing bodies, thereby making an investigation into match fixing possible (which has already led to several suspensions and lawsuits). (28)

However, as sports betting in general will grow worldwide, it is likely the number of incidents of match fixing will also increase. Only in the last couple of years several big betting scandals have been discovered, reaching up to the very highest level of professional sports, for example, in horse-racing, soccer, and recently possible match-fixing in tennis. (29)

Increase of gambling addiction

According to an article by Griffiths et al. (2006) the popularity of gambling through the internet is becoming more and more of an issue for concern regarding problematic gambling behavior. In an earlier publication Griffiths (2003) already pointed out why gambling through the internet could lead to a rise in gambling addiction. The most important arguments made by Griffiths include the fact the internet makes gambling much more convenient than betting in the casino (the bettor does not even have to leave the comfort of his own home), the much higher event frequency of gambling opportunities on the internet, and the asocial and anonymous character of internet gambling. Griffiths also suggests the concept of electronic money will likely not be perceived to have the same value as real cash, which could cause the bettor to risk more money than he would have done in the offline world.

In his article Griffiths made a list of recommendations for Internet gambling service providers to act 'socially responsible,' which have been for a large part picked up by both online bookmakers and betting exchanges. However, although the online betting industry is showing its willingness to fight the problem, gambling addiction not only poses an important threat to the image of the betting industry, but could also in the future remain the most important reason for national governments worldwide to restrict their citizens the possibility to gamble online.

Individual Analysis

After reviewing the business climate for the betting exchange sector as a sector, in the this section the major betting exchanges worldwide will be identified individually and compared on a number of characteristics. According to gambling-review website Bookmakersreview.com in August 2007 there were 31 different online betting exchanges in business. Most of these exchanges are based in Europe, either in the United Kingdom or Ireland, or in tax-friendly locations like Gibraltar or Malta. Figure 4 shows the home-countries of 21 of the major betting exchanges.

[FIGURE 4 OMITTED]

In Figure 5 these betting exchanges have been compared on a number of important characteristics, with regards to commission charged on winnings, reliability, legal issues, and product offering.

As can be seen in Figure 5 most betting exchanges are privately held and do not disclose financial information. Therefore, it is difficult to make an accurate estimate as to the worldwide size of the betting exchange market. Experts agree, however, that Betfair is by far the biggest betting exchange in the world, having obtained a market share that is estimated to be around 90%. (30,31) The company has obviously benefited greatly from its first mover advantage, and has since its founding never allowed any threat to its leading position. In the current market it seems Betfair has grown to such a scale there's hardly any serious competition the company needs to take into consideration. As Martin Oelbermann, a director of German research-firm MECN, told press agency Bloomberg in 2005, "You can't beat the first-mover advantage. [...] Nobody will be able to beat Betfair unless the management makes a massive mistake." (32)

The success of Betfair has left other betting exchanges fighting for tiny marketshares. Most authors doubt whether these exchanges will be able to take market-share from Betfair in the near future: Mainelli and Dibb (2004) point out that even if the competition of Betfair would succeed in offering better service or value, "the propositions needs to be a great deal better to compensate users for the loss of liquidity."

It is clear Betfair's competitors will have to come up with something special to be able to survive in the long term. Some betting exchanges have tried creating a unique selling point by trying to be different with regards to, for example, the percentage of commission charged on winnings. A notable example was the effort by Mansion, which cut commission on winnings to as little as 1%. However, the company decided to close down its betting exchange in October 2007. Another betting exchange, Matchbook, does appear to have been successful in creating a unique selling point. The company is focusing its efforts on offering a wide selection of North American sports, an area in which Betfair has never been particularly strong. The Unlawfull Internet Gambling Enforcement Act has effectively created a protected market for Matchbook. As a consequence, though, liquidity in this markt needs to be provided by American bettors. The prices offered by Matchbook may not reflect all information that is available globally.

Nevertheless, Matchbook seems to be an exception. Figure 5 of this paper shows a majority of betting exchanges appear to be focusing their offering on soccer, which also happens to already be one of the strongest and best developed sports on offer at Betfair. In combination with a commission rate of the standard five percent, these exchanges are in effect offering customers very little (if not nothing) Betfair is not already offering with much better liquidity. Mainelli and Dibb (2004) have noted "existing competitors all have business models and value propositions similar to Betfair" and therefore conclude "it's hard to see why they [these betting exchanges] should succeed in the future when their efforts to date have largely fallen short."

It seems likely, due to reasons of liquidity, the future will only have room for a very limited number of betting exchanges. This prediction is confirmed by the relatively large number of betting exchanges that have closed in 2007 and 2008 (see Figure 5). Rather than trying to copy the Betfair business model, it also seems likely individual betting exchanges that will survive in the long term are the ones who will actually succeed in being different.

Conclusion

This paper investigates the situation betting exchanges are currently facing, both as a sector, as well as on an individual level.

Firstly, the sector-analysis is performed by making use of a SWOT. The analysis shows the betting exchange has a number of unique strengths over the "traditional" bookmaker, like, for example, the ability to offer better odds to customers. It also shows, however, that the betting exchange is very dependent on customers providing liquidity to succeed, since due to the effects of Metcalfe's Law a lack of liquidity will make it almost impossible for an exchange to attract new customers, and therefore to survive.

Furthermore, the analysis showed a number of interesting future growth opportunities; for example, the possibility to expand the product offering with other gambling related products, but also identified a number of factors that seriously threaten the position of the betting exchange, like entry to the market by much larger online bookmakers. Furthermore, it is worrisome several very important opportunities and threats that were identified the betting exchange itself has little control over, since these are of a legislative nature, like, for example, the gambling laws in both the United States and the EU member states.

Secondly, the betting exchanges are also analyzed on an individual basis. A remarkable finding is that it seems there is very little difference between the betting exchanges in terms of commission charged to customers and product offering. Given the very dominant position of Betfair, it seems unlikely the much smaller betting exchanges copying Betfair's business model will succeed, since it is impossible for them to match the liquidity Betfair's customers are used to. Betting exchanges that are successful in finding niches around Betfair, for example, by charging significantly lower commission to make up for the loss of liquidity, or focusing on different sports altogether, seem to have a better long term possibilities for survival.

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Endnotes

(1) Source: http://www.ey.com/global/content.nsf/UK/EOY_-_Awards_Recipients

(2) Source: http://www.queensawards.org.uk

(3) The claim of "up to 20% better odds" is made regularly by different betting exchanges. A few examples can be found at: http://www.betbull.com/UI/Default.aspx, https://secure.betonbet.com/portal/default.aspx?Redirect=1, and http://www.betfairpromo.com

(4) In 2007 betting exchange Parbet was renamed to MatchMyWager, before closing down in April 2008.

(5) The results of the complete study is available upon request.

(6) Dahlman has based his study on the work of Coase (1937), who first introduced the concept of transaction costs.

(7) Source: http://networks.silicon.com/webwatch/ 0,39024667,39125945,00.htm

(8) For example: http://fairplayers.com/en/magazine/ hot_news_fairplayers_11.html.

(9) Source: http://www.eu-ba.org/legislation.html

(10) Press announcements from the EC about this topic can be found at: http://europa.eu/rapid/

(11) Source: http://www.eubusiness.com/Competition/1182952802.06/

(12) Source: http://www.themanufacturer.com/britishindustry/ content_page.html?article_id=146

(13) Source: http://www.betfaircorporate.com/pdf/australia_licence.pdf

(14) For example: http://www.betbull.com/HelpCentre/help_centre.htm# mobile_site.htm

(15) For example: http://forum.betfair.com/

(16) For example: http://livevideo.betfair.com/

(17) Source: http://www.betfaircorporate.com/pdf/2006_10_16_casino.pdf

(18) Source: http://www.usatoday.com/news/washington/ 2006-10-02-internet-gambling-usat_x.htm

(19) Source: http://www.law.duke.edu/journals/dltr/articles/ 2003dltr0016.html

(20) Source: http://www.bloomberg.com/apps/news?pid=20601087& sid=a6BTLrSohXn0

(21) Source: http://.www.online-gambling-insider.com/online-gambling/ ogi-Barney-Frank'sOnline-Gambling-Bill-Gathers-Momentum-07-24-07.html

(22) Source: http://www.antiguawto.com/index.html

(23) Source: http://www.gambling911.com/WTO-Antigua-Ruling-033007.html

(24) Source: http://www.casinoonline.co.uk/articles/ us-presidential-elections-race-gambling

(25) Source: http://www.federalreserve.gov/newsevents/press/bcreg/ 20081112b.htm

(26) Source: http://www.pinnaclesports.com

(27) Source: http://www.businessworld.ie/livenews.htm?a=1613598

(28) Source: http://news.bbc.co.uk/sport1/hi/other_sports/horse_racing/ 3616748.stm

(29) Source: http://news.bbc.co.uk/sport2/low/football/europe/ 5215260.stm

(30) Source: http://www.smh.com.au/news/business/ betfair-out-to-conquer-the-world/2006/02/05/1139074110158.html

(31) Source: http://en.wikipedia.org/wiki/Bet_exchange

(32) Source: http://quote.bloomberg.com/apps/news?pid=nifea&& sid=a8Y11XQeIcyY

Ruud H. Koning [1] and Bart van Velzen

[1] University of Groningen

Ruud H. Koning is a professor in the Department of Economics & Econometrics. His research interests include competitive balance in sports, market efficiency, and applied econometrics applied to sports phenomena.

Bart van Velzen obtained a master's degree in economics from the University of Groningen in 2007. He is currently self-employed and betting on sports professionally.

Figure 1: Screenshot from http://www.betfair.com, 24-08-2007 15:00h.

Man Utd v Tottenham

Change: Express view | Full view

Matched: EUR 206,072 Refresh

Selections: (3)   100.4%                      Back

Man Utd           1.56         1.57           1.58
                  765 [euro]   17998 [euro]   4524 [euro]
Tottenham         6.8          7              7.2
                  419 [euro]   309 [euro]     108 [euro]
The Draw          4.1          4.2            4.3
                  291 [euro]   1012 [euro]    722 [euro]

Selections: (3)   Lay                         99.1%

Man Utd           1.59         1.6            1.61
                  806 [euro]   11320 [euro]   6816 [euro]
Tottenham         734          7.6            7.8
                  91 [euro]    232 [euro]     599 [euro]
The Draw          4.4          4.5            4.6
                  680 [euro]   501 [euro]     1227 [euro]

Figure 2: SWOT-analysis of the betting exchange

Strengths:                          Weaknesses:

--Better odds                       --Effects of Metcalfe's Law
--Less operational risk             --Bettors' aversion to risk
--Lower transaction costs
--Increase of market completeness
--Winning customers welcome

Opportunities:                      Threats:

--Less restrictive betting          --More restrictive betting
  legislation (Europe)                legislation (United States)
--New markets (Asia / Australia)    --Political lobby by
                                      bookmakers (UK)
--Technological progress            --"Discount" bookmakers
--Expansion to related sectors      --New entry from bookmakers
--Migration of technology to        --Match fixing
  unrelated sectors                 --Increase of gambling addiction

Figure 5: Individual analysis of 20 major betting exchanges
("Y" = "Yes", "N" = "No")

                                  Reliability     Legal

Name               Commission      (2)   (3)    (4)   (5)

BetandGame           4.25%          N     N      Y     N
(closed per
February 2008)

Betbull (*)       2.5% - 5.0%       Y     Y      N     N

Betcruise           0% (**)         N     N      N     N

Betdaq            2.0% - 5.0%       N     Y      N     N

Betfair           2.0% - 5.0%       Y     Y      Y     N

Betmate (*)       2.0% - 3.0%       Y     Y      N     N

BetonBet          1.5% - 3.0%       N     N      Y     N

Betsson               4.0%          Y     Y      Y     N

EHorseX           1.75% - 5.0%      N     N      Y     Y

IBetX             1.0% - 3.0%       N     Y      Y     N

Intrade          $0.00 - 0.15 /     N     N      Y     Y

                   lot (***)

Live-betting         5.00%          N     N      Y     N
                   per payout

Mansion           0.0% - 1.0%       N     N      Y     N
(closed per
October 2007)

Matchbook             2.0%          N     Y      Y     Y

MatchMyWager      1.5% - 4.0%       N     N      Y     N
(closed per
April 2008)

MyBet                 5.0%          Y     Y      Y     N

Redbet                4.0%          Y     N      Y     N

Supporterbet      3.0% - 5.0%       N     Y      Y     N

TradeBetX /           4.0%          N     N      Y     Y
Tradesports
(closed per
November 2008)

Winitoo               4.0%          N     N      Y     N

WorldBet-         0.9% - 5.0%       N     Y      Y     N
Exchange

                 Product offering

Name             (6)   (7)

BetandGame        N     Y    Limited selection of
(closed per                  major world sports;
February 2008)

Betbull (*)       Y     N    Selection of major world
                             sports; wide selection of
                             major and minor soccer
                             leagues;

Betcruise         N     Y    Limited selection of
                             major world sports;

Betdaq            Y     N    Selection of major world
                             sports; wide selection of
                             major and minor soccer
                             leagues;

Betfair           Y     Y    Wide selection of major
                             and minor world sports;
                             wide selection of major
                             and minor soccer leagues;

Betmate (*)       Y     Y    Selection of major world
                             sports; wide selection of
                             major and minor soccer
                             leagues;

BetonBet          Y     Y    Limited selection of
                             major world sports;
                             selection of major and
                             minor soccer leagues;

Betsson           Y     Y    Selection of major world
                             sports, as well as minor
                             European sports; major
                             and minor soccer leagues;

EHorseX           N     N    Limited selection of
                             American sports; focus
                             on American horse-racing;

IBetX             Y     N    Limited selection of
                             major world sports;

Intrade           Y     N    Selection of non-sports
                             political, financial and
                             current events;

Live-betting      Y     N    Limited selection of
                             major world sports;

Mansion           N     Y    Limited selection of
(closed per                  major world sports;
October 2007)                selection of major and
                             minor soccer leagues;

Matchbook         Y     N    Limited selection of
                             major world sports; focus
                             on North-American
                             sports;

MatchMyWager      Y     Y    Limited selection of
(closed per                  major world sports;
April 2008)                  selection of major and
                             minor soccer leagues;

MyBet             N     N    Selection of major world
                             sports;

Redbet            N     Y    Very limited selection
                             major world sports;
                             selection of major and
                             minor soccer leagues;

Supporterbet      N     N    Selection of exclusively
                             soccer;

TradeBetX /       Y     N    Selection of major world
Tradesports                  sports; focus on North-
(closed per                  American sports;
November 2008)

Winitoo           N     N    Very limited selection of
                             major world sports;
                             selection of major soccer
                             leagues and regional soccer;

WorldBet-         Y     N    Selection of major world
Exchange                     sports; selection of major
                             soccer leagues;

(*) Company operates as a "skin" of an established betting exchange;

(**) Reduced commission is part of a promotional launching campaign;

(**) Commission is calculated including both trading fee and expiry
fee;

(1) Percentage of commission charged by exchange on net winnings;
Promotional offers not included;

(2) Exchange is (part of) a publicly traded company, and/or is
disclosing full financial information, and therefore giving
customers insight into its financial "track-record";

(3) Exchange claims to hold and manage customers' funds in a
segregated account, to ensure customers' funds remains separated
from company funds (if unclear, listed as "No");

(4) Exchange is currently accepting customers from all nine
European member states, whose gambling policy is currently
under investigation by the European Commission;

(5) Exchange is currently accepting customers from the United States;

(6) Exchange offers its customers the possibility of live-betting;

(7) Exchange offers its customers a complete one-stop betting portal,
consisting of at least a casino and a poker platform;