Paul Leyland, Co-Founder, Regulus Partners
Germany’s transition to regulated online gaming demonstrates the lesson of an old stockbroking adage: a share which has fallen 90%, first fell 80% and then halved. The point of the parable is there is a natural expectation that an initial big shock is a position from which to rebuild, but even the aftershocks can be devastating to rebased expectations. As we have flagged, the next big risk to Germany’s online gaming sector after tax and licensing requirements is the process of regulation itself. Germany’s overly bureaucratic regulatory approach is causing turmoil in a once near-lawless sector and it is likely to get worse before it gets better, in our view. Customers, tax receipts and locally licensed operators are the biggest losers.
Trying to establish a clear pattern in monthly tax returns for German’s Federally regulated online slots market is almost impossible. However, a shrinking market is implied from the data: the monthly average tax revenue in H122 was €36m, in the last three months to November it was down nearly 20% to €30m. Unless December turns out to be a big tax month as operators catch-up their returns, implied annualized revenue for Germany has fallen from c. €900m to c. €700m. However, this data is based on the pre-regulator period: before a critical mass of operators had to follow strict regulations was well as pay tax.
The new regulator has announced that it has started the New Year doing what regulators are supposed to do: enforce the law, with fabled German efficiency. GGL is already stepping up enforcement action against illegal operators, with 1,150 websites reviewed, 60 prohibition orders issued, and 30 criminal prosecutions already started. In theory, tough enforcement action should give encouragement that this trend can be reversed. After all, the black market is likely to be the key beneficiary of regulatory disruption and the GGL has promised to level the playing-field. However, there are two problems with this thesis.
The first is that black market enforcement against specific operators can only ever be a drop in the ocean. There are currently over 1,500 sites that offer gambling products in German, compared to 38 sports betting licensees and a sub-set of 22 gaming licensees; direct prosecution is whack-a-mole, especially given that a critical mass of heavy users in Germany will use simple workarounds like using English-language sites and crypto payments, while new options continue to pop up all the time (Wunderino, Germany's biggest regulated casino by some margin, was only founded in 2016). Enforcement will be effective in channeling mass market users because it prevents brand-building and makes UX more complex, but mass market customers represent only a tiny fraction of the current German market by revenue. This problematic dynamic for regulators should be well known by now, but it does not seem to be making an impact on the notion that ‘tough enforcement action’ will lead to tangible system-wide results rather than just a few relatively meaningless scalps. For clarity, we are not suggesting that enforcement is a bad idea: it is a vital component of any functioning legal-regulatory framework; we are simply stating that enforcement does not significantly move the channeling dial – it does not work on its own. Any number of enforcement victories will not win channeling wars, but problematically regulators look like they are doing their job by fighting them.
What does move the channeling dial is the quality of the product domestically regulated licensees can offer. Too many operators and commentators focus on price at this point and decry the negative impact of staking limits and turnover tax. As with enforcement, price matters, but it does not matter anywhere near as much as the industry believes or protests, as the vibrant sportsbetting markets of France, Poland and Portugal prove, as well as the restively successful initial channeling of the German slots market. Over-intensive price competition hurts revenue, but it does not empower or delight consumers outside a few relatively sophisticated players who over-index in operators’ worldview because they tend to have dozens of accounts each and interact with sites and apps very frequently. Awkwardly for licensees and regulators, price sensitive customers are also far more likely to find or deliberately seek out black market supply as they look for offers. Enforcement will not materially impact the behaviour of these customers and they generate enough revenue to tempt enough black-market operators into the German market to service them, by commission (targeting, offering 'workarounds') or omission (failing to check sufficiently where customers are from). Once the price sensitive customers establish a market, others can more easily find it. This is why enforcement battles do not win channeling wars.
For most gamblers, product quality means a combination of breadth and depth of game choice, site navigation, customer support, and sustainable operating practices (not ripping customers off with convoluted T&Cs, withholding winnings, a lack of safeguards, or exploitative incentives for example). This is where GLL and the licensing framework it is enforcing is shooting itself and its licensees in the foot. So far, an impressive 3,500 slots games have been submitted for regulatory approval in Germany, which represents c. 25% of all available slots content and is more than enough for a dynamic market. However, only 600 slots have been approved, or just 4% of all available slots content. In some cases, this is the fault of an operator and supply chain environment which has been too 'entrepreneurial' to follow basic instructions (like providing instructions in German), but a process that requires each game to be approved is dangerously time-consuming. Equally but with less room for manoeuvre, the GGL is progressing with a Central File system which hopes to enforce cross-provider player gambling limits on deposits (as required by law). While this has some prima facie logic, we remain concerned that the system will be neither responsive nor proportionate to the problems it is trying to solve, encouraging otherwise safe gamblers to use the black market as they trigger government-set limits and associate them with domestic licenses. A slow and overly bureaucratic slots approval process is starving the domestically licensed German market of content, causing the heavier users who value variety to seek it out in the black market. Further, a single player view which seeks to impose hard limits with complex, bureaucratic processes for recognising only some heavier users will only exacerbate this shift, in our view. These impacts will compound the already-lost table games and high value slots players, which is what caused the 70% revenue drop for licensees moving towards full compliance. As full compliance becomes mandatory, the market that has already fallen by c. 70% may well yet halve.
There is only one way the GGL can hope to fulfil its mission of levelling the playing-field to stop a structural shift to black market operators and that is to allow its licensees to provide sufficient breadth of content to engage most consumers most of the time, which is still possible for low-stakes slots players - in theory a big enough market to be attractive given Germany's population of 83m and well-established slots culture. If the slots approval bottleneck is resolved, then the domestically regulated German online slots market is likely to grow materially above €1bn, despite €1 stakes, 5% staking tax and other regulatory interventions; conversely, if the bottleneck continues, then the rate of channeling will sink further, in our view. Enforcement does not protect customers, responsibly-delivered domestically-regulated choice does. However, even with this product bottleneck fixed, the restrictive nature of the Inter-State Treaty is likely to keep the domestically licensed German market constrained relative to its potential, however responsive the GGL becomes. Despite a strong start, the GGL will lose its fight to enforce German gambling law because the legislative and regulatory framework is not fit for purpose, in our view.