DraftKings & FanDuel, Fundamental Flaws Explained

Mainstream daily fantasy sports (DFS) operators such as DraftKings and FanDuel are fundamentally flawed. To understand how and why they won’t change, requires us to understand the history of DFS and how we got to where we are today. Once we understand where we’ve been, and the problems associated with current business models, we can better predict where DFS will go in the future.

DFS grew out of traditional fantasy sports. Back in the days before the internet, sports fans played fantasy sports using pens and paper. Contestants would typically draft teams of fantasy players “in person”; and the contest between friends would be played out over the course of a season. Sometimes they played for stakes, but more often, the contest was just for bragging rights. After the widespread adoption of spreadsheet software such as Lotus Notes and then Excel, it became easier to play fantasy sports in general and then online in particular. Eventually Yahoo! Sports became the most popular place to run a fantasy sports league. Up until this point, fantasy sports leagues were played over the course of a season, DFS had not yet been discovered by the year 2000.

At the same time as fantasy sports was developing online, other forms of gambling, such as poker, were also moving to the internet. Online poker exploded with the “Moneymaker Effect” and the poker industry thrived in the early 2000’s. As poker play grew online, the federal government in the United States decided to ban it domestically by passing the Unlawful Internet Gambling Enforcement Act of 2006 (UIGEA). This law banned online poker and banished leading operators such as PokerStars.  But curiously, the law excluded fantasy sports from the ban. The fantasy sports exclusion was based on the idea that fantasy sports was not explicitly a gambling game, and at the time was being played between friends. The law therefore categorized fantasy sports as a game of skill and therefore not gambling and subject to the prohibitions of UIGEA.

While it was easy to argue in favor of excluding fantasy sports from the online gambling ban in 2006 since most fantasy sports were not played for stakes at the time, and there were no DFS operators in existence when the law was passed, the development of DFS fundamentally changed the nature of fantasy sports. In hindsight, its somewhat silly to assume that DFS isn’t gambling. DFS is no more a game of skill as poker is or traditional sports betting is. The skills required to be good at fantasy sports are the same skills that make players successful at poker and sports betting. Someone with no prior knowledge of fantasy sports should surely view DFS as gambling if we define gambling as a playing a game for stakes. But the exclusion of fantasy sports in UIGEA was seized upon by DFS operators as a way they could operate in the United States so long as their games were considered a game of skill under the definitions in the law. DFS operators had found a loophole and they would attempt to exploit it.

This brings us to the point where game design becomes important. If DFS operators made their games too similar to sports betting, it would be easier for regulators to quash the legal argument that DFS is a game of skill and therefore deserves to be excluded from the prohibitions of the UIGEA. But if DFS operators could obscure the legal judgement enough to confuse regulators and the courts, by making their games esoteric enough to support the idea that DFS is a “game of skill” and not gambling, they figured it might be possible to carve out their legal justification. So that’s what they did. Leading DFS operators designed games that weren’t a direct corollary to sport betting. DFS points would be awarded by goals scored, touchdowns, and pass receptions, and not on direct game outcomes. DFS players also gravitated to these games because they also obscured the math enough to make them difficult for average players to statistically understand. The DFS games offered by DraftKings and FanDuel were obscure enough that the “average Joe” could still win from time to time, and this is essential to a good gambling game that relies on a pool outcome. The same is true of poker.  It has to be possible for a fish to win from time to time to keep them coming back.

So with a business model in place, and a legal justification, DFS companies such as DraftKings and FanDuel raised a ton of money from investors and started to exploit the opportunity. Legal Sports Report estimates that over $1 billion USD was raised by DFS operators since 2012, and the pace of funding rose dramatically since 2014. Its estimated that DraftKings and FanDuel raised more than 90% of the total $1 billion raised. With a war chest of almost $1 billion dollars, how would it be spent?  Marketing. Huge sums were spent by DraftKings and FanDuel on sports sponsorships, broadcast advertising, affiliate fees, etc, in order to attract new players.

But as advertising money was being spent, a dangerous legal tide was rising. As the public and governments began to notice the growth of DFS, they began to wonder, is DFS gambling?  Eventually, state by state, they realized that it is. But rather than simply ban DFS, state regulators have been persuaded that if the UIGEA allows fantasy sports, but prohibits other forms of online wagering, why not allow DFS in their state and collect the associated tax revenues? While some states have now created regulatory structures for DFS, others have taken the idea a step further. If DFS is going to be allowed, why isn’t sports betting similarly allowed?

In the meantime, DFS operators have painted themselves into a strange corner. Their games are designed in a way that requires the house to set the player odds. As explained above, this was done to obscure the relationship of DFS from gambling, but also to obscure the skills players require to win. Now that the business model is entrenched, DFS operators are facing some sobering problems. Its now clear that high volume DFS players represent the vast majority of total volume. DFS operators have started banning certain players and limiting their access to bots. Marketing expenses are rising too fast and its becoming too expensive to recruit new fish for the high volume players to beat. The high volume players are out handicapping the DFS operator’s internal handicappers, and leaving the fish as the source of profits. Eventually, recreational players will move on from playing DFS if they can’t win occasionally.

What’s the solution? DFS operators such as DraftKings and FanDuel need to admit that DFS is gambling, and change their business models. This will mean sacrificing near-term revenue for profitability in the long run. But DraftKings and FanDuel will have a hard time doing this since investors are expecting a return on their billion dollar investment, and admitting the current legal justification is flawed will surely cause tremendous upheaval.

I think the most likely outcome is DraftKings and FanDuel will become increasingly marginalized in the United States. This is already happening in Nevada where DraftKings and FanDuel have chosen not to be regulated as a gambling company would, and so DFS companies that have been created in Nevada and who are free to admit that DFS is gambling are emerging. I also think traditional online sports betting operators need to consider offering DFS. Amaya Gaming has done this with StarsDraft.  I expect this trend to continue as the lines between DFS and sports betting are blurred.

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