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Markets for the Digital Generation

I’m about as far away from being knowledgeable about horse racing (and betting on horse racing) as you can get, so I might have this all wrong, but it would seem to me that their are remarkable similarities between the “starting price” (for a horse race) and a “fixing (price)” on an exchange. (Previous thoughts on gambling v. trading here.)

Historically, starting prices (for UK horse racing) were set by the big bookmakers and as was pointed out in the June 2004 BBC programme “Battle of the Bookies”, these were routinely subject to manipulation by the big high street betting shops; with a relatively small stake (in comparison to the total amounts staked in their shops) they could move the on-course prices used to determine the starting price, generally shortening the odds of the favorite(s). The programme pointed out that with the advent of Betfair, this was getting harder and harder to do as arbitrageurs popped up to trade the price discrepancy between what was available “on-course” at the prices trading on the exchange.

Indeed if you look at fixings on financial markets, these are highly regulated by the exchanges and regulatory authorities to eliminate and prohibit this kind of artificial price setting. (See for example the rules of the London Stock Exchange.)

Indeed, the starting price is nothing more than the strike against which the bookmaker sells his outcome options on the race. The closer the starting price is to the “true price” (all outcomes add up to a 100% probability), the lower the margin for the options writers. As is the case in financial markets as well, the “OTC” (over-the-counter) providers of derivatives are often loathe to see prices migrate to a (commoditized) exchange environment as the usual result is significant margin compression as prices become transparent. The parallels aren’t perfect but in this context it doesn’t surprise me that the traditional “dealers” (read: bookies) aren’t very happy with Betfair’s plans to publish its own starting price:

In early November 2007 it was reported that Betfair was set to make a big announcement regarding the publication of its own SPs. On 13 November 2007 The Guardian reported;

“Betfair has spent two years developing a robust system to allow bets to be placed at its own SP. As a result, three extra columns will soon be added to its display for every win market on its British and Irish racing service: one for bets on a horse at the Betfair SP, one for “lay” bets against it at SP, and a “guide” price in the middle showing what the SP is likely to be…..SP bets will have some differences from “normal” bets on Betfair. Whereas normal bets can be cancelled until the moment when a rival gambler accepts the other side of the bet, SP bets cannot be cancelled once placed. Punters can, however, specify a minimum price at which they are willing to back, and a maximum price for lay bets.”

In the table below we look at the November Handicap run at Doncaster on November 10 2007, and compare the official SP with the “Betfair SP”. The horses are listed in market order and not order of finish.

The first thing to note is that the SP over-round on Betfair, including commission, totalled 108.5 against an official SP over-round of 127.9.

Of course if your business model (as a bookie) requires a 20%+ gross margin, things could get a bit tough…The question then becomes one of (a) can I continue to innovate and go “up-market” (more complex products - ie exotic derivatives) to preserve margins and/or (b) can I make my (”flow”) operations more efficient so that I can profit from much thinner margins (but probably) higher volumes? I suspect the answer to both questions is potentially yes but requires a fundamental reappraisal of one’s business model: a new paradigm. Unfortunately something that successful incumbents (and their managers) in every industry often find extremely challenging if not impossible to do.

(It also raises the question as to whether the distinction made between businesses subject to regulation by the Gambling Commission and the FSA is more a question of semantics than anything else. Merger anyone?)

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