The Fall of Fantasy Sports

Nevada legislators ruled Oct 15 that playing daily fantasy sports will now be considered online gambling, forcing websites such as DraftKings and FanDuel to immediately cease operations in the state. This recent legislation is perhaps the most critical blow to the daily fantasy sports industry yet.

Daily fantasy sports (DFS) websites operate under an exemption to the Unlawful Internet Gambling Enforcement Act of 2006, which has allowed them to rake in as much as $736 million in investments from Comcast/NBC, Fox Sports, Google, and many others. In 2014 alone, DFS raised over $1bn worth of tournament entry fees and attracted 1.5 million entrants, according to McKinsey and Company.

But Nevada’s decision is especially troubling for the DFS industry because the state is seen as the “bastion of legal gambling” whose decisions often influence those of other states, according to Joe Drape of the New York Times. This recent Nevada legislation may signal troubling times for the young DFS industry.

But aside from this most recent legislation, the DFS industry also suffers from inherent flaws that restrict profitability prospects.

In the Daily Fantasy Sports industry, websites host tournaments, in which players must pay an entry fee to compete. Most of the entry fees go towards providing the reward for the tournament, and the website takes in around 10 percent of each entry fee as revenue. As a result, the more players that participate in each tournament, the more profitable the tournament becomes. In some cases, though, when the DFS website does not fill up each tournament, the company may even lose money.

In addition, two companies, DraftKings and FanDuel, own 95 percent of the DFS market, which presents another set of issues. First, newcomers to the industry rapidly go out of business as they fail to gain a foothold in the consumer base. Additionally, the nature of the DFS industry favors a monopoly where one company captures as many consumers as possible in order to maximize the rewards; however, the reality is that the top two firms exist as a competitive duopoly. If FanDuel were to increase potential rewards for the same entry fee by cutting the amount of rake from 10% to nine percent, consumers would favor FanDuel over DraftKings, as the benefit to cost ratio for FanDuel outweighs that of DraftKings. If either DraftKings or FanDuel decides to lower entry costs or reduce their “rake”, the other must match such an action or risk losing business — a situation where profits fall even further.

This exposes another issue with the industry that reduces profitability: negligible switching costs. With season long fantasy sports, if a player utilized a certain company to enter a tournament, the choice lasted for the rest of the season. With the lightning fast nature of daily fantasy sports, switching companies is both simple and entirely possible. This constantly escalates the rivalry between FanDuel and DraftKings as they strive to earn and keep consumers.

A manifestation of this intense rivalry is the ongoing advertisement war between DraftKings and FanDuel. Ads for the two companies are everywhere — in stadiums, on buses, the metro, even the sides of buildings. Turn on TV, flip the channel to ESPN, and commercials for DraftKings and FanDuel seem to appear every few minutes. The downside to this “advertisement arms race” is the cost: Ads are extraordinarily costly for both companies.

Despite the explosive growth of the Daily Fantasy industry, prospects for long-term profitability do not look promising. Inherent aspects of the competitive oligopoly may continue to reduce profits as competition between the two main companies increases. However, the industry is still in early stages; there is still room for innovations and ideas that may enhance the viability of the industry. If either DraftKings or Fanduel decides to take their company public, stockholders may take the company in a new direction that creates sustainable long-term profit. But don’t bet on it.