The Future of Daily Fantasy Sports Industry and State-Operated Lotteries in the U.S.

The Future of Daily Fantasy Sports Industry and State-Operated Lotteries in the U.S.


On Sunday, October 4, 2015, DraftKings employee Ethan Haskell woke up in the morning and anxiously awaited a day full of watching National Football League (NFL) games. He had made many “daily fantasy” football lineups on popular rival site FanDuel that week and was very confident in his selections. The following night, he won $350,000 on the “daily fantasy sports” site, FanDuel. Haskell’s win, however, would not come without caveats. As an employee of rival company DraftKings, Haskell had access to proprietary data dealing with ownership percentage of certain players that would give him a competitive advantage over others in the contests he participated in. When Haskell accidentally posted this data onto an online forum the week before (September 27), many bloggers opened their eyes to the reality that employees at both DraftKings and FanDuel were playing and winning large sums of money in competitive “daily fantasy sports” contests. The New York Times caught wind of this oversight, where proprietary data was potentially being used to win large sums of money, and on October 5, 2015, the newspaper launched headlines across the Internet, titled: “Scandal Erupts in Unregulated World of Fantasy Sports.”1 This report disrupted the wildly unregulated framework of daily fantasy sports (commonly referred to as DFS) and sent the industry into a regulatory spiral.2

An Analysis of the Current State of Daily Fantasy Sports

While versions of fantasy sports started as early as the 1960s, the current version of fantasy sports was not possible until at least 2010. In order to understand the craze and gain a perspective of the complicated legal situation that DFS operates in it is important to understand the intricate intertwining of large businesses, professional leagues, and these sites. The two largest DFS sites, DraftKings and FanDuel, were both valued at over a billion dollars.3 They have managed to capture large amounts of venture capital and investment money from a variety of sources. FanDuel has raised over $360 million dollars from large companies such as Google, Comcast, Time Warner, and NBCSports. This is not to mention large partnerships with several professional leagues such as the National Basketball Association (NBA) and many NFL teams. DraftKings has had similar success raising capital, as it has raised over $375 million dollars from companies such as Fox, the Kraft Group, and many venture capital (VC) groups in Boston. In addition, DraftKings has partnerships with Major League Baseball (MLB), the National Hockey League (NHL), and Major League Soccer (MLS), while boasting sponsorships with multiple NFL teams. Their $150 million dollar investment from Fox includes a reported 11% equity stake and guaranteed advertising on the Fox channel.4

It is clear that DraftKings, FanDuel, and other fantasy sites have capitalized on the roughly 41.2 million fantasy sports players in the United States as of 2015. Despite this large number, both companies cite the fact that roughly only 1 to 1.5 million people were playing DFS as of 2015, causing there to be optimism across the industry of large growth potential. According to Eilers Research Chief Executive Officer (CEO) Todd Eilers: “Only a small subset of traditional players play daily fantasy, but we estimate that daily games will generate around $2.6 billion in entry fees this year and grow 41% annually, reaching $14.4 billion in 2020.”5 This crazy popularity has come on the heels of an ultra-aggressive advertising strategy employed by both companies across the first several weeks of the 2015–2016 NFL season. Through the first eight weeks of the NFL season, it was estimated by the Seattle Times that both firms combined had spent over $200 million dollars on advertising during NFL games. According to iSpot.TV rankings, in the seven days after the opening of the NFL schedule, DraftKings had spent $16.6 million in ad dollars, good for the number two spot nationally in ad spending, and FanDuel came in at number five with $13.7 million spent. In light of the revenues for both companies last year—$57.3 million for FanDuel and $30 million for DraftKings—these ad spends are astronomical. They contributed to significant brand awareness for both companies and thrust DFS squarely in the spotlight of the mainstream media by late September into October.6

Neither DraftKings nor FanDuel could anticipate the depth of scrutiny they would face in the aftermath of the Ethan Haskell scandal that rocked the legitimacy of the daily fantasy sports world. All across the Internet, people saw headlines referring to an “insider trading scheme” and “the wild west” of DFS. Immediately after the news broke of Haskell potentially manipulating proprietary information to benefit himself, DraftKings and FanDuel both released statements claiming that Haskell had committed no wrongdoing and they were investigating ways to maintain the integrity of their game offerings.

On October 6, 2015, DraftKings and FanDuel both received letters of inquiry from New York State Attorney General Eric Schneiderman, formally opening an investigation into the two companies in light of the charges of insider trading levied by prominent news outlets such as the New York Times and Wall Street Journal. About a week later, on October 14, 2015, the Federal Bureau of Instigation (FBI), in accordance with the Department of Justice, opened up an investigation into the legality of the DFS industry and the two biggest sites accounting for 90% of daily fantasy traffic, DraftKings and FanDuel. The FBI and New York State signaled a nationwide frenzy against the DFS sites, and now there are many other states considering bans on operations. On October 15, 2015 the Nevada Gaming Control Board ruled that daily fantasy sports constitutes gambling, and ordered all sites to cease and desist operations unless operating with a permit.7

Recently, the state of Massachusetts has introduced regulations to the DFS industry through a proposal from Attorney General (AG) Maura Healey. The consumer protection regulations were the first of their kind in America and focused on protecting minors, leveling the playing field, advertising and marketing, and protecting participants financially. Minors under the age of 21 are not allowed to participate, while no advertising or promotion is allowed on high school and college campuses. Company employees and those with access to insider information are banned from competing. Some games would be limited to beginners and forbid entry to more experienced players. Advertisements that mention average individual winnings must also disclose the average net winning of all players and deposits are limited to $1,000 a month. From a personal standpoint, I find the regulations implemented by the AG to be extremely fair while also not excessively hindering the industry. The age restriction limits younger participants from recklessly losing significant amounts of money to sharks and other experienced players. Banning company employees was a necessary step in order to stem the negative blowback from the DraftKings controversy in October. Beginner contests are a great way to introduce new players to DFS without them facing the risk of being preyed upon by sharks and may actually help the services gain new users. Finally, limiting deposits clearly will lower revenues for the industry but on a moral ground will prevent contestants from getting carried away and facing real financial problems due to DFS.8

However, as a result of all this regulatory and unwanted publicity, investors started to pull back on their investments in these fantasy sports sites. Both firms, realizing further competition would be ruinous, have decided to seek a merger.9 This merger has not been approved and many observers wonder why these two firms would be permitted to merge and in essence have a monopoly on fantasy sports.

Meanwhile, lottery sales throughout the U.S. were either flat or declining. Massachusetts, which operates the most successful lottery (in terms of spending per capita) experienced its first decline in sales in its history. Clearly state lotteries are desperately searching for new ways to raise revenue and interest in lottery sales. One state lottery that has shown interest in operating a fantasy sports site is Massachusetts. It should be pointed out that Montana is already operating a fantasy sports site but its success has not been overwhelming.10

A State-Operated Fantasy Sports Site

I will examine how the state of Massachusetts would implement regulation of the DFS industry as well as examine the impact that a state-run DFS service would have on the industry. My hypothesis is that the state will put in place regulations that will bring an increased level of parity between the sharks and fish of DFS. A state-run DFS service will cannibalize a portion of the lottery’s current revenues as well as siphon revenues from normal DFS services. This will elicit a competitive response from the DFS industry and a price war within the state will occur.


In order to answer the research questions, some time series regression analysis will be employed. DraftKings is notoriously secretive with its financial data, choosing to share this information solely with major investors. In past years FanDuel has released its financial reports, but based on the current state of the industry it is unlikely that this trend will continue in the near future. Once these estimates are established, further quantitative analysis will be performed to gain an idea of what the future financial statistics of the industry will look like, both with regulation being implemented and with the DFS industry remaining unregulated.

Sources of data

In order to formulate estimates on the current financials of the DFS industry, past financials will be needed. FanDuel has released its financial statements in the past. These will be utilized to discover the total industry financials by taking FanDuel’s market share percentage at the time and multiplying the data out to get the total market numbers. Once established, the financials will be extrapolated into the future to assess how the industry would progress without regulation. To account for regulation, the financials will also be extrapolated into the future based on regulation tax rates that could potentially be enforced. Furthermore, individual financial statements will be made for the large DFS services of DraftKings and FanDuel. This data will then be extrapolated into the future to assess the potential effect regulation and a state-run DFS service would have on the DFS industry.

AnalysisStudying the pro-forma statements reveals quite a bit of information about the effects that regulation could potentially have on the DFS industry. However, it is first necessary to explain how said statements were formulated. Historical data for the industry as a whole is scarce, but FanDuel provided quarterly revenue numbers from 2011 through the second quarter of 2014, as well as projected revenue numbers for the remainder of that year. Revenue is calculated as the total amount of entry fees received by FanDuel subtracted by the total amount of prizes paid out by the company. If a situation arises where the total entry fees are less than the prize pool, FanDuel accounts for this as negative revenue and subtracts it from its revenue totals. With these numbers in hand, the next step was to find projected numbers for 2015. Projected totals ranged from $200 million to $100 million. I chose to select the most conservative numbers for the pro-forma statements and thus chose $100 million.

Although not as in-depth as FanDuel, DraftKings also released revenue numbers for 2013 and 2014 of $4 and $30 million, respectively. Keeping with consistency, the most conservative numbers were chosen for DraftKings’ 2015 revenue numbers, which also were projected at $100 million. With the historical data obtained it was now possible to forecast industry revenue numbers.

Beginning in 2013, the first year that both DraftKings and FanDuel reported revenues, industry revenues were calculated based on FanDuel’s market share within the industry. In a market consisting of only FanDuel and DraftKings, FanDuel’s market share in 2013 and 2014 was 78% and 63% respectively. Leaving a small percentage of the market for alternative DFS services, these numbers became 75% and 60% for calculation purposes. In 2015 I conservatively gave FanDuel 45% of the marketplace. Even though the company had the same forecasted revenues as DraftKings, the sentiment during the 2015 football season was that DraftKings was being used more than FanDuel. As football is the “cash cow” for the industry it led me to believe DraftKings would have superior revenues when the numbers are eventually announced. Leaving space again for alternative DFS services made 45% appear to be a fair projection. With the 2013–2015 numbers settled, pro-forma projections could begin.

It is common sense to assume that the rapid growth of the DFS industry would have to eventually be curtailed. Therefore, I took the 2014 growth rate of 444% and divided it by the 2015 growth rate of 263% to determine the slowdown in growth between the years. This number was then used as a benchmark for all future years by assuming that the industry’s growth would continue to slowdown at this sustained rate. Thus, future growth rates were calculated by taking the prior year’s growth rate and dividing it by this benchmark. With the growth rates for every year calculated, physical revenue amounts were obtained by multiplying prior year revenues by the current year growth rate.

The calculated revenue numbers resulted in extremely impressive projected revenue for the DFS industry of just under $2.7 billion by the year 2020. However, this would only be the result if the industry were allowed to continue completely unimpeded by any sort of regulation. The unregulated revenue numbers are based on the DFS services taking a 10% rake, the amount of entry fees that aren’t paid out as prizes. Yet in other types of sports-related betting, this figure is closer to 4.5%. Accepting the fact that any type of regulation would have to place the rake amount above the 4.5% of sports gambling, I assumed a 7% rake if regulation were to take place. To forecast such an action, I took the 2016 non-regulated revenue projection, removed the 10% rake to get gross revenue, and recalculated net revenue based on a rake of 7%. Future years were projected with the same growth rates as the unregulated numbers, but the altered 2016 amount had a ripple effect throughout the projection and resulted in forecasted industry revenues of just under $1.9 billion in 2020. By changing the rake for DFS companies by 3%, total industry revenues dropped by $800 million in 2020. Furthermore, if a state-run DFS service accompanied this previous regulation, industry revenues would fall even further. Assuming that state-run services were up and running smoothly by 2017 and gained 20% of the DFS market, total revenue from the private sector of DFS would only amount to $1.5 billion, a far cry from the unregulated total of $2.7 billion. See Figure 1.

FIG. 1. Impact of regulations on projected revenue for daily fantasy sports, 2013–2020.

The data suggests that even with the potential of regulation, the DFS industry as a whole is in good standing. In a worse-case scenario where regulation is implemented and state-run services are introduced the industry still projects to have revenues of over $1.5 billion. It is even possible that this projection is conservative. By lowering the rake amount through regulation potential participants currently hesitant to enter contests may be drawn into the industry. With more participants, projected revenues would by association increase. When considering individual DFS services, the picture is more mixed. It is clear that smaller services would struggle mightily if regulation were implemented. But for DraftKings and FanDuel regulation has both its positives and negatives. Obviously, revenues are lowered for each company with regulation implemented. On the other hand, with smaller DFS services dropping out of the market due to increased regulation, potential market share is up for grabs between the two companies. Greater market share results in greater control within the industry and may potentially offset some of the initial setbacks of regulation. Finally, a state-run service would be bad for individual DFS services regardless of size. Not only does it shrink the market of participants, lowering revenues and company valuations, it also creates a multitude of other considerations. It would be expected for the states to do whatever is necessary to have their services gain a strong footing in the industry, and any actions taken could only hurt the private sector. For this reason, it would not be surprising for the industry to accept regulation without much of a fight if it meant that state-run services would be prohibited.


DFS is an industry that has been disrupted by regulation. As Figure 2 shows it is one that has evolved from no regulation at all to one that will most likely be regulated and in most jurisdictions prohibited completely.

FIG. 2. Views toward regulation of industry.

Many states such as New York are basing their regulation of DFS off of Massachusetts, which is a positive for the industry. The combination of a tech sector in dire need of a success story and city politicians hoping to support such a situation may have figured in more lenient regulations being issued by Healey than many people anticipated. With this being a first-of-its-kind regulation, a precedent was set for other states to use as a base for their own regulations. This moderate precedent is huge for the DFS industry, and may lead to less stringent regulation throughout the country, which would be a major victory for the industry.

Clearly, regulation within the industry is a foregone conclusion. The amount of states that have already implemented regulation combined with those in the process of doing so make any movement away from regulation too tedious and burdensome to occur. DFS is on a very complicated path in which it is legal in some states, illegal in others, and facing different rules and regulations in all. For the customer’s sake, an overarching set of regulations will be simplest for all parties. I expect these regulations to mirror those of Massachusetts, although it wouldn’t be surprising if they were slightly more restrictive.11

As the above analysis shows, it makes sense that some sort of state-run DFS services will be formed. The worry that potential lottery money is instead being spent on DFS will lead state legislatures to create such services in order to maximize revenues. However, such a service would have to be established in convenience stores throughout the state, much like the lottery. If states tried to launch online sites for their DFS services, the backlash from convenience store owners would be severe. I predict that state-run services will exist for a short period of time and result in the cannibalization of state lottery revenues. Ultimately though, people who wish to participate in DFS will not want to make the trek to convenience stores in order to participate and elect to use either DraftKings or FanDuel instead. A requirement to be at a specific location to play limits significant strategic aspects of DFS. Late edits based on lineups, injuries, or postponements are a staple of DFS, but if you are filling out a roster at noon you can’t make these changes unless you elect to make another trip to the store. As people are turned off by this state experiment, revenues will nosedive and state-run DFS services will fold.

Looking at individual services, I think that regulation of the industry will be a positive for the newly combined DraftKings and FanDuel. People will be more willing to participate in a regulated industry, thinking they have a greater chance of winning. With more active users in the industry, company revenues will pick up, even if they are forced to lower their rake amount from the current level of 10%. The regulation will most likely knock out alternative DFS sites as well, further adding new users to DraftKings and FanDuel and raising revenues. In the future, the merger of DraftKings and FanDuel will probably be approved. This merger will allow the combined companies to explore new and innovative ideas to further evolve the DFS industry. But it will also provide a rationale for state lotteries to host their own DFS games in order to allow for competition in this industry.

In conclusion, the cozy world of fantasy sports has been disrupted. It is the start of what has the makings of a long drawn out process. Future decisions have the ability to drastically alter the forecast of DFS. Regardless of how everything is ultimately resolved, it will be an entertaining storyline to follow.

Source: The Future of Daily Fantasy Sports Industry and State-Operated Lotteries in the U.S.