Message from the Chairman

Transcription

1 Business Plan

2 Message from the Chairman On behalf of the California State Lottery Commission, I would like to thank Director Borucki and all the employees of the California State Lottery who, both directly and indirectly, contribute to the success of the Lottery and the development of this Business Plan. It is evident from the thorough research and thoughtful analysis that the Lottery is poised to meet the challenges ahead. I am proud of the growth we have achieved despite operating under restrictions that are unique in the lottery industry. Fiscal year marks the seventh consecutive year we have contributed over $1 billion dollars to California s public schools. This amounts to over $140 per kindergarten through 12th grade student every year. We have accomplished this by returning an astounding 95% of every dollar back to California in the form of contributions to education, prizes for winners, and compensation to retailers. However, our work is not done. We have all committed to maximizing supplemental revenue for public education because we believe we make a difference for many children in our communities. As I have learned from many of you, this means a relentless commitment to innovation and plain hard work. I have also learned that this organization is up to the challenge. The days of Scratchers growth are coming to an end. With declining draw game sales and no additional funding sources, we can no longer increase Scratchers prize payouts. As a result, our business has decreased from record setting sales of nearly $3.6 billion in fiscal year to projected sales of over $3.3 billion in fiscal year We are not alone in this decline; states across the country are reporting similar challenges and financial results. This decline and, more importantly, the causes of this decline signal a pivotal year in our journey. It is a call to action. The Lottery has tremendous capacity for creativity and innovation. The ideas that come from Lottery staff from every division speak volumes about the dedication that resides within the organization. It is clear that we must call upon these values and invest our energy and resources to long term strategic growth. I believe that these actions will further establish the California State Lottery as a valuable community partner and meet the challenge of continuing to maximize supplemental revenue for California s public schools. The initiatives presented in this Plan will achieve this goal. The Commission is pleased to present the Business Plan. I believe that these actions will further establish the California State Lottery as a valuable community partner and meet the challenge of continuing to maximize supplemental revenue for California s public schools. John M. Mass

3 Commissioners JOHN MASS, of Los Angeles, was first appointed to the State Lottery Commission by Governor Schwarzenegger on December 13, 2004 and was reappointed by the Governor on December 28, 2006 and has served as Commission Chair since December 13, Chairman Mass is Executive Vice President and head of Corporate Development and New Ventures for the William Morris Agency, LLC, where he oversees strategic planning, acquisitions and investments. Chairman Mass is also a member of the company s Board of Directors. Prior to joining William Morris, Chairman Mass was an Associate in the Investment Banking Division at Bear, Stearns & Co., Inc. RACHEL MONTES, of El Monte, was appointed to the California State Lottery Commission by Governor Schwarzenegger on March 30, Commissioner Montes has been a businesswoman for over 38 years in sales and consulting. Commissioner Montes served as Community Liaison for the Mountain View School District for 10 years. She was elected as City Clerk of El Monte and later was elected as the first Latina Mayor of El Monte in Currently, Commissioner Montes serves as Cultural Commissioner for the City of El Monte. Additionally, she has been recently asked to join the Board of Directors of L.E.O. Affiliates and Enough, both nonprofit organizations which benefit her community. MANUEL ORTEGA, of Yorba Linda, was appointed to the California State Lottery Commission by Governor Schwarzenegger on March 29, Commissioner Ortega served as Chief of Police in three different communities. Most recently, he retired from the City of Bell Gardens in December 2005, after serving five years as its Chief of Police. In addition, Commissioner Ortega was appointed to the Commission of Peace Officer Standards and Training (P.O.S.T), served as Chairman of the P.O.S.T. Commission for one year in , and served on the Board of Prison Terms from 1997 to 2000.

4 Director JOAN M. BORUCKI, of Sacramento, was appointed Director of the California State Lottery by Governor Schwarzenegger on February 15, Borucki has more than 25 years of experience in California state government, and has served as Chief Deputy Director and Acting Director of the California State Lottery since April From 2005 to 2006, she was Chair of the Unemployment Insurance Appeals Board. Prior to becoming Chair, Borucki served as Director of the Department of Motor Vehicles from 2004 to 2005, a Team Leader for the California Performance Review in 2004 and Chief Deputy Director of the California Transportation Commission from 2002 to She began her state service in 1980, joining the Department of Transportation where she served in various capacities before becoming Deputy District Director for Planning in 2002.

5 Table of Contents Introduction Business Overview 1.1 Creation and Purpose of the Lottery Beneficiaries Distribution of Funds Business Model The CSL Game Portfolio Organizational Structure Key Events in California State Lottery History Integrity, Security, Honesty, and Fairness 2.1 A Winning Experience Security and Law Enforcement Audits and Compliance Social Responsibility Problem Gambling Market Analysis 3.1 Customer Demographics and Playership Trends Consumer Product Sales Comparisons Consumer, Retail and Technology Trends Lottery Industry Trends and Best Practices Performance Assessment 4.1 Overall Sales Evaluation Benchmarking the California Lottery Draw Game Performance Scratchers Game Performance Retailer Network Assessment Efforts to Improve the Business Model Retailer Recruitment and Optimization Administrative Operations Assessment Marketing and Communications Assessment Barriers to Success Strategic Vision 5.1 Focus on Long Term Planning Improve Our Brand Image Shift the Jackpot Paradigm Modernize Operations Key Strategic Initiatives

6 Introduction

7 M issi o n To implement the public s mandate to maximize supplemental funding for public education through the responsible sale of lottery products. V isi o n To be a responsible and respected organization that has a broad base of community support and that maximizes supplemental funding for public education.

8 Introduction In order to fulfill the California State Lottery s (CSL s) mission and vision, this plan lays the foundation for consistent, long-term growth. It establishes a structure from which we can optimize sales from our game portfolio and more successfully introduce new products and gain new customers. Past Strategy The CSL has achieved significant success since it began in In 21 years, the CSL has managed to double sales from $1.7 billion in fiscal year to $3.6 billion in fiscal year CSL s growth over the last decade was largely due to a singular strategy. The CSL reduced administrative expenses, increased efficiencies, and invested more funding into Scratchers game prizes. As a result, the CSL has been able to return greater and greater amounts to public education over the years. The CSL accomplished this growth despite what many in the lottery industry believe to be the most onerous restrictions in the nation. The CSL s growth over the last decade was largely due to a singular strategy. The CSL reduced administrative expenses, increased efficiencies, and invested more funding into Scratchers game prizes. As a result, the CSL has been able to return greater and greater amounts to public education over the years. However, the CSL s growth is significantly less than those states with the flexibility to maximize revenue through even higher payouts which in turn fueled their tremendous Scratchers sales growth. Unfortunately, the CSL s strategy has reached its peak. There are no further significant sources of funding that can be redirected toward higher Scratchers prizes. In the fiscal year, the CSL is forced to reduce Scratchers prizes from 57.5% of sales to 56.5% of sales. Draw game sales have been relatively flat over the last few years. The CSL and the lottery industry have been using new games and larger lotto jackpots to maintain sales, as opposed to growing sales. This is why nearly all states have joined a multi-state lotto game such as MEGA Millions or Powerball. Reliance on large, jackpot-driven lotto games is risky because year-to-year sales can fluctuate significantly depending on jackpot amounts. The CSL must determine if there is a more consistent source of sales that would minimize reliance on jackpots.

9 Future Strategy The CSL has undertaken a year-long process of gathering data, commissioning research studies, consulting lottery industry leaders and experts, evaluating CSL history, and conducting internal planning sessions. In the last year, the CSL began selling lottery products in over 90 Sears stores throughout California, piloted an industry first alternative business model with CVS Pharmacies, introduced innovative ticket packaging never before used in the lottery industry to appeal to mass merchandise and super stores, and introduced the Million Dollar Raffle game. Given our extensive research and assessment of the current environment, the CSL is confident that the best opportunity for growth lies in four key strategies: Long Term Planning The CSL s history of short term planning is keeping it from achieving its full potential. The organization needs significant change if it is going to thrive in today s marketplace. Much of this change will need multi-year implementation strategies before return on investment is achieved. The CSL has undertaken a year-long process of gathering data, commissioning research studies, consulting lottery industry experts and leaders, evaluating CSL history, and conducting internal planning sessions. Improving the CSL s Brand Image As the CSL has been focused on administrative savings and higher prize payouts, it has neglected to develop its brand image. Research shows that, in the absence of CSL communications, players and the public do not know how ticket revenues are used, have not heard about lottery winners, and express a poor opinion of the CSL. A key component of the most successful companies is positive brand image and brand image awareness. A positive brand image will allow us to more successfully introduce new products and attract new customers. The success of this campaign hinges on the CSL s ability to send a consistent message through all channels and commit to the campaign for the long term. Changing the Jackpot Paradigm Given the volatile nature of lotto games and their dependency on large jackpots, the CSL must focus its marketing and game development efforts on games that encourage regular play and provide more winning experiences at lower prize levels. This effort requires less marketing

10 focus on huge jackpots and more focus on entertaining games that create more winners. More regular play will help the CSL provide more predictable and consistent revenue for education and will be a key to future growth. Modernizing Operations While the CSL has focused on increasing Scratchers prizes, many parts of the CSL have gone neglected. The CSL must invest in systems and processes from its gaming systems to its distribution warehouses if it is to maximize revenue. These investments will create additional efficiencies and provide the foundation for a flexible and nimble business enterprise that can quickly take advantage of opportunities as they arise. These strategies are fully achievable, but require dedication, commitment, and a concerted effort by all employees. We believe the CSL s employees are up to the challenge and can make significant strides in reinforcing the CSL as a well-regarded contributor to public education. In 2002, the CSL rolled out new Altura terminals at 19,000 retailers statewide. The Altura terminals were a significant equipment upgrade which provided our retailers enhanced management functionality, better sales tools, customer service capabilities, and enhanced security.

11 Business overview

12 1.1 Creation and Purpose of the Lottery In 1984, voters passed Proposition 37 and created the California State Lottery. The purpose of the CSL is to provide supplemental funding for the benefit of public education without the imposition of increased taxes. The Lottery Act (California Government Code Section 8880 et seq.) provides that net revenues of the CSL shall not be used as substitute funds, but rather shall supplement the total amount of money allocated for public education in California. The Lottery Act provides that the CSL shall be initiated and operated so as to produce the maximum amount of net revenues to supplement the total amount of money allocated for public education in California. The Lottery Act also provides that the CSL shall be operated to promote and ensure integrity, security, honesty, and fairness. CSL revenues are distributed as follows: as nearly as practical 50% must be returned to the public as prizes; at least 34% must be distributed to public education; and no more than 16% may be used for administrative expenses. The Lottery Act provides that funds shall be used exclusively for the education of pupils and students and that no funds shall be spent of the acquisition of real property, construction of facilities, financing of research, or any other non-instructional purpose. The Lottery Act provides that none of its provisions may be changed except to further its purpose by a two-thirds vote of the membership of both houses of the Legislature and approved by the Governor. The Lottery Act specifies that the CSL is overseen by a five-member Commission appointed by the Governor and confirmed by the Senate. A Director, who is also appointed by the Governor and confirmed by the Senate, serves as the chief administrator of the CSL. 1.2 Beneficiaries The CSL s mandate is to provide supplemental funds to public education on all levels from kindergarten through higher education plus several specialized schools. The educational institutions which receive lottery funds and the approximate percentage of overall lottery funds they receive are shown in Figure 1.1 California schools put lottery funds to a variety of uses including funding field trips, special education, classroom technology, staff development, and the purchase of specialized equipment for disabled students.

13 Figure 1.1 Distribution of Lottery Funds Kindergarten 12th Grade 80% Community Colleges 14% California State Universities 3.4% University of California 2.2% Other Educational Entities* 0.4% (As reported by the California Department of Education for FY ) * Other Educational Entities include the California Youth Authority, California Schools for the Deaf, Blind, and Neurologically Handicapped, and the California Department of Mental Health. All public schools receive the same per pupil funding level from the CSL based on the average daily attendance of students in each school district. The CSL has contributed over $19.5 billion to education since the CSL began in This contribution currently represents about 1.5% of all funding allocated for the state s public schools. These funds give schools the flexibility to maintain and expand valuable programs and services that are priorities in their local communities. The CSL has contributed over $19.5 billion to public education since it began in This contribution currently represents about 1.5% of all revenues received by the state s public schools. Local education administrators, elected school boards, and administrators of higher education decide how lottery funds are spent in their schools. The CSL is not involved in the decision-making process. The Lottery Act provides that lottery funds shall be used exclusively for the education of pupils and students and that no funds shall be spent for the acquisition of real property, construction of facilities, financing of research, or any other non-instructional purpose. In addition, the Cardenas Textbook Act of 2000 (Proposition 20) provides that, after fiscal year , half of any increase in the amount of funds above the fiscal year level must be used for instructional materials. For the fiscal year, approximately 15% of all lottery contributions are required to be spent on instructional materials. Public education uses lottery contributions to attract and retain teachers and to fund everything from computer labs to arts and music programs. The Budget Act requires the California Department of Education to collect data on the amount of lottery funds received by K-12 schools and how these funds were used. Figure 1.2 shows the categories and percentages for Lottery fund expenditures.

14 Figure K-12 Percent of Lottery Fund Expenditures by Category* Salaries and Benefits 64.9% Books and Supplies 19.2% Services and Operations 13.1% Capital Outlay and Other* 2.8% * As reported by the California Department of Education 1.3 Distribution of Funds For every dollar the CSL receives in sales, it returns approximately 88% to schools and players. The Lottery Act only requires the CSL to return 84%. Figure 1.3 details how lottery dollars are spent. Figure 1.3 Allocation of CA Lottery Revenues FY 05/06 54% 34% 12% The CSL uses just 12% of the allowed 16% of ticket sales to cover its operating expenses, with most of these costs dedicated to retailer compensation. Prizes Education Operating Expenses The CSL is allowed to use 16% of ticket sales to cover its operating expenses; however, through efficiency efforts, the CSL has reduced its expenses and only uses about 12% of the money made from ticket sales to cover administrative expenses. It should also be noted that the largest subcategory of administrative expenses is retailer compensation. 4% of administration expenses are allocated to prizes. Figure 1.4 shows how this 12% was spent in the fiscal year.

15 Figure 1.4 Detailed Breakdown of the Administrative Budget FY 05/06 2% 6.7% 1% 1.2% 1.1% Gaming Contractors Personnel Expenses Retailer Compensation Advertising and Communications General Operating Expenses 6.7% Retailer Compensation Retailer compensation includes all money paid by the CSL to retailers as sales commissions and cashing bonuses. In the fiscal year, the typical CSL retailer had ticket sales of approximately $14,500 per month, and received associated compensation in excess of $1,000 per month. 2.0% Gaming Contractors Costs Gaming contractors costs include payments for the operation of the gaming system and Scratchers ticket development and printing. Also included within this category are costs for distributing Scratchers tickets to retailers. 1.0% Advertising and Communications Costs Advertising/communications costs include television and radio advertising, retailer point of sale materials, internet, billboards, and retailer and consumer promotions. 1.2% Personnel Costs Personnel costs for employee salaries and benefits.

16 1.1% General Operating Expenses General operating expenses include a collection of miscellaneous operating expenses such as general operating costs, contracted services, asset depreciation, State Controller s Office support expenses and facilities maintenance costs. 1.4 Business Model The CSL has been operating under the same basic business model for 20 years. This business model is based on partnering with retailers for the sale of lottery products. This business model is still used, with only minor variations, by every state lottery in the United States. The basics of the CSL s business model are as follows. With few exceptions, players must purchase lottery tickets from authorized CSL retailers. The CSL has been operating under the same basic business model for 20 years. Retailers earn sales commissions, cashing bonuses, and miscellaneous incentives for performing a range of activities associated with selling and cashing tickets. There are two basic categories of lottery tickets: draw game tickets and Scratchers tickets also known as instant games. Draw game tickets can only be sold through either retailer clerk-operated terminals or player-operated self-service terminals, and all purchase transactions must be recorded in a central computer system to be valid. Scratchers tickets are sold directly by retailers and through self-service vending machines, and no computerized recording is required for these sales transactions. All cashing activities must be authenticated through the central computer system. Retailers can pay prizes up to $599 larger prizes must be paid directly by the CSL. Scratchers tickets are printed by a handful of specialized vendors who follow prescribed industry standards. Draw game contractors typically provide and maintain all gaming system software, data center operations, gaming terminals, retailer hotline support, and telecommunications services.

17 Retailer Compensation As previously noted, retailer compensation represents the largest share of the Lottery s administrative budget. The following provides a high level summary of this compensation. Compensation Type Amount Sales Commissions 6% of the retail sales price of the tickets sold Cashing Bonuses Between 2% and 3% of the value of the prizes cashed Incentive Bonuses 0.5% of prizes of $1 million or more sold at the retailer s location In addition, retailers receive sales commissions for tickets that are sold from Lottery self-service vending machines in their stores as well as handling fees for issuing free ticket prizes. Retailer Network The backbone of the CSL is our extensive retailer network. With over 19,000 retailers across California, lottery products are available throughout the state. The CSL s retailers can be segmented as follows. Convenience Stores With or Without Gas The backbone of the CSL is our extensive retailer network. With over 19,000 retailers across California, lottery products are available throughout the state. This is the CSL s most prevalent trade style with over 7,500 retailer locations. Circle K and 7-Eleven are the dominant chain accounts, although most retailers in this category are independent mom and pop shops. Overall this category of retailers outsells every other major trade style that currently sells lottery products. Liquor Stores Liquor stores also make up a large percentage of the retailers in the CSL s retailer network. Sales performance of liquor stores is similar to that of convenience stores. There are approximately 4,200 retailers in this category. 10

18 Supermarkets Although supermarkets have high foot traffic, their lottery sales are below average. Most retailers in this category are part of a major chain, and the vast majority of these retailers utilize self-service vending machines. It should also be noted that the majority of the CSL s 1,400 draw game self-service terminals are installed in chain supermarkets. Like most multi-lane retailer accounts, supermarkets tend to be concerned with the perceived high labor costs associated with selling lottery tickets, especially those costs associated with handling Scratchers ticket inventory. There are about 1,900 retailers in this category. Grocery Stores These stores are smaller than supermarkets and defined as having fewer than five cash registers per store. As a trade style, grocery stores are declining in numbers as competition from supermarkets and mass merchandise retailers such as Costco and Sam s Club have been increasing their market share for decades. Grocery stores tend to be among the weakest CSL retailers. There are fewer than 2,000 retailers in this category. James Scott, (right) Santa Fe Springs District Sales Supervisor, helps celebrate as a lucky player shows off his winning ticket. Bars, Restaurants, and Other Sit-Down Locations These are sit-down locations where customers tend to stay for 30 minutes or longer. The most popular lottery game in these locations is Hot SPOT. Most of these retailers have special television monitors that show Hot SPOT draw results every 4 minutes. The CSL has approximately 1,700 retailers in this category. Other Retailer Trade Styles The CSL s remaining retailers fall into dozens of different retailer trade styles, with 430 drug stores representing the single biggest trade style. Other retailer trade styles include bowling alleys, tea houses, gift shops, donut shops, gift stores, and hardware stores. It is clear that the CSL has done an outstanding job in recruiting convenience stores and liquor stores. However, given consumer and retail trends, the CSL must translate this success into the recruitment of other trade styles as well. Figure 2.5 displays the number of retailers in California by trade style and the number that sell Lottery products. 11

19 Figure 1.5 Lottery Retailer Coverage by Trade Style Trade Style Total Stores Lottery Retailers 2006 Percent Coverage C-store/Gas 9,239 7, % Liquor 5,129 4, % Grocery/Supermarket 15,680 3, % Drug Stores 4, % Bars 3, % Warehouse, Superstores, Mass Merchants, Department Stores 6, % TOTAL 45,508 17,212* Source: GTECH Corporation *This figure does not represent the sum total of all Lottery retailers, which number over 19,000 retailers. This figure only accounts for the total number of retailers as listed by major trade style in the chart. Major Business Partners The CSL has critical business partners in three different areas: (1) gaming and telecommunications systems, (2) Scratchers game development and ticket printing, and (3) product advertising and promotion. The CSL has critical business partners in three different areas: (1) gaming and telecommunications systems, (2) Scratchers game development and ticket printing, and (3) product advertising and promotion. The most predominant of these business partners is GTECH, with a multiyear contract in the order of $50 million per year. GTECH is a lottery industry leader in gaming systems management. They provide and maintain all CSL gaming equipment and software, a variety of retailer support and hotline services, two geographically remote data centers and all retailer telecommunications services. GTECH also provides a variety of research and game development services. Because about 90% of all GTECH contract income is paid in the form of a sales commission, GTECH management is financially motivated to help the CSL increase sales. There are several different companies that develop Scratchers games and print tickets for the CSL. The CSL s primary printer is Scientific Games and secondary vendors such as Pollard Banknote and Creative Games are used if they offer unique products or if Scientific Games cannot meet the volume of tickets the CSL needs. Like GTECH, Scientific Games is paid based on a percentage of sales and is financially motivated to help the CSL increase sales. The CSL contracts with two main advertising agencies. BBDO West handles all general market (English language) advertising, while Casanova Pendrill 12

20 handles all Spanish language advertising. Advertising services include the development of different messaging strategies for different games, oversight over media production services, and the actual media placement of advertising messages. The CSL also has smaller contracts for point of sale advertising and African American and Asian advertising. 1.5 The CSL Game Portfolio The CSL offers a diverse portfolio of games that cater to the entertainment needs of a broad consumer base. Our product portfolio consists of two primary types of games: draw games and Scratchers games. Draw Games Draw games involve players purchasing paper tickets which contain certain numbers (or symbols) according to the game s play style. The tickets are issued by store clerks or by stand-alone self-service terminals. In all cases, the terminal transmits the player s numbers to a central system computer, which logs the wager. The CSL offers a diverse portfolio of games that cater to the entertainment needs of a broad consumer base. At the time tickets are issued, they have no prize value. However, at some point after the purchase, the CSL conducts what is called a draw where winning numbers are selected randomly. Players win prizes by matching the numbers on their tickets to the winning numbers drawn by the CSL. Draw games include SuperLOTTO Plus, MEGA Millions, Fantasy 5, Daily 3, Daily Derby, and Hot SPOT. Scratchers Games Scratchers tickets, also known within the lottery industry as instant tickets are issued in a variety of distinct games which have unique play styles and themes. The CSL typically orders between 20 million and 30 million tickets for each game. Games are packaged in groups of 80 or 250 tickets which are sold to retailers for sale to the public. Scratchers games have a latex-covered play area that is removed by scratching to reveal various numbers and symbols. Players typically determine if they won by achieving some specified winning outcome like uncovering three identical dollar amounts or by matching some master set of numbers or symbols. Elaborate security measures are used to ensure that no one, including CSL employees, contractors, or retailers can determine where any of the winning tickets are located before they are sold. 13

21 Game Profiles SuperLOTTO Plus Value Proposition: Offers the opportunity to win a life altering prize. FY 06/07 Sales: $630,786,207 (estimated) How it s played: Pick five numbers from 1 to 47 and one MEGA number from 1 to 27 for each play. Cost is $1 per play. Draw times are Wednesday and Saturday at 7:57 PM. SuperLOTTO Plus Facts SuperLOTTO Plus jackpots typically range from $7 million to $100 million with an average jackpot of $27 million. Sales for this game currently range from $10 million per week to over $20 million per week once the jackpot exceeds the $80 million level. The game originally started as a pick 6 of 49 and has evolved over the years. MEGA Millions Value Proposition: Offers the opportunity to win a life altering prize. FY 06/07 Sales: $393,431,768 (estimated) How it s played: Pick five numbers from 1 to 56 and one MEGA number from 1 to 46 for each play. Cost is $1 per play. Draw times are Tuesday and Friday at 8:00 PM. MEGA Millions Facts MEGA Millions is a multi-state lotto game in which 12 states currently participate. California became a MEGA Millions state in June In March of 2007, MEGA Millions hit a record jackpot of $390 million. Jackpots typically range from $12 million to $300 million with an average of $66 million. CSL sales range from $5 million per week when jackpots are between $12 million and $30 million to over $20 million per week once the jackpot breaks $200 million. 14

22 Fantasy 5 Value Proposition: The better odds daily lotto game FY 06/07 Sales: $146,977,719 (estimated) How it s played: Pick 5 numbers from a field of 39 per play. Cost is $1 per play. Drawings are held daily at 6:59 PM. Fantasy 5 Facts Typical top prize ranges from $50,000 to $500,000. The game offers better odds at the 2nd and 3rd prize levels than any other lotto type game the CSL currently offers. Fantasy 5 features a second chance draw option. When players purchase 5 plays of Fantasy 5 on a single ticket, they automatically receive a coupon that can be mailed in for an opportunity to appear on the Big Spin Show and play the Dream Machine for up to $150,000. Daily 3 Value Proposition: The best odds at winning a $500 prize every day, twice a day. FY 06/07 Sales: $152,351,791 (estimated) How it s played: Players pick three numbers from 0 to 9, with repeat numbers allowed. Players can choose one of three play options. The first play option is straight, meaning if the player selects 529 as their number and 529 is drawn in exact order, the player wins. The second play option is box meaning the player can match 3 numbers in any order. The third play option is to play both straight and box options. Cost is $1 per play. Daily Derby Value Proposition: A daily game with a horse race theme FY 06/07 Sales: $11,046,311 (estimated) How it s played: Players choose three horses from a group of horses represented by the numbers 1 through 12, with each individual horse designated to take first, second, and third place in the race. Then players choose a finish time which can range from 1:40:00 to 1:49:99. Cost is $2 per play and the drawings are held daily at 6:59 p.m. 15

23 Hot SPOT Value Proposition: Flexible play style and draws every 4 minutes FY 06/07 Sales: $143,424,765 (estimated) How it s played: Players select from two to five or eight numbers from a field of 80 numbers. The Lottery draws 20 numbers from the same field. Depending on the numbers matched, players win different prizes typically ranging from $1 to $10,000. Players can choose how much they want to wager per draw and prizes are multiplied by the amount wagered. Each play costs a minimum of $1 and drawings are held every four minutes. Winning numbers are displayed on TV monitors that the CSL installs in retail locations throughout the state. Scratchers Tickets Value Proposition: Huge variety and instant winning opportunities FY 06/07 Sales: $1,827,049,782 (estimated) How it s played: Players select from as many as 40 different games with unique themes (e.g., money, wealth symbols, gaming, licensed properties, etc.) and play styles (e.g., match 3, key number match, bingo, crossword, etc.). By scratching off the play area, players can determine instantly if they have won a prize. Prizes range from a free ticket to $3 million. One of the key benefits of these games is the ability to offer immediate gratification to players. One of the oldest games is The Big Spin Scratchers. This game, first introduced in 1986, gives players the opportunity to appear on the CSL s Big Spin TV Show. Scratchers tickets cost between $1 and $5 each. 16

24 1.6 Organizational Structure of the Lottery The CSL is organized into the following six divisions which report to the Director: Executive, Finance and Administration, Corporate Communications, Security and Law Enforcement, Information Technology Services, and Sales & Marketing (see Figure 2.6). The CSL is currently staffed with 620 permanent budgeted positions, and includes a headquarters facility, nine district offices and the Southern and Northern Ticket Distribution Centers. Approximately 380 employees work at headquarters and 240 employees work in the field locations. Figure 1.6 California Lottery Organizational Chart CALIFORNIA STATE LOTTERY COMMISSION Executive Division Director Chief Deputy Director Special Projects Legal /Contract Services Office Internal Audits Office Business Planning Office Leg/Education Office Product Dev. Office Finance & Administration Division Deputy Director s Office Corporate Communications Division Deputy Director s Office Security & Law Enforcement Division Deputy Director s Office Information Technology Services Division Deputy Director s Office Sales & Marketing Division Deputy Director s Office Finance Department Corporate Productions & Customer Service Field Operations Department Planning Office Sales Department Human Resources Department Public Relations Office Headquarter s Operations Department Program Management Office Marketing Department Business/Facilities Services Department Administative Services Office Claims & Player Services Department Gaming Application Management Office Application Services Department Infrastructure Department Client Service Department 17

25 Description of Lottery Commission The Lottery Commission, whose members are appointed by the Governor, is charged with the authority and responsibility to oversee the Lottery and to ensure its integrity, security, and fairness. The Commission meets at least once a quarter and the meetings are open to the public. Description of Organizational Divisions Executive Division The Executive Division is responsible for directing, managing and administering the CSL under the provisions of the Lottery Act. The Executive Division is comprised of seven offices which have different organizational responsibilities including special projects, legislation, outreach legal services, auditing, business planning, and product development. Finance and Administration Division The Finance and Administration Division is responsible for conducting the financial, accounting, budgetary, personnel, training, and facilities management activities of the CSL. The Finance and Administration Division is comprised of four departments: Finance, Human Resources, Business and Facilities Services, and Claims and Player Services. Corporate Communications Division The Corporate Communications Division manages external communications activities on behalf of the Director and the Lottery Commission. This Division provides the media, education community, and general public with accurate information on the CSL and its activities. This Division also provides various types of information in response to routine requests from the public. Security and Law Enforcement Division The Lottery Act requires that a Director for Security and Law Enforcement be appointed by the Governor and charged with the responsibility for assuring the integrity, honesty and fairness of the operation and administration of the CSL. The Security and Law Enforcement Division is comprised of two departments, Field Operations and Headquarters Operations. Staff is located both at Sacramento headquarters and at the nine district offices throughout California. Information Technology Services Division The Information Technology Services Division (ITSD) provides all information technology services for the CSL. This includes servicing and maintaining computer applications, desktop and laptop computers, printers, telephones, and other related technology tools. ITSD works closely with all CSL divisions to identify opportunities to use technology to improve operations. 18

26 ITSD consists of four offices and three departments: Information Technology Planning Office, Program Management Office, Information Technology Administrative Services Office, Gaming Applications Management Office, Application Services Department, Infrastructure Department and Client Services Department. Sales & Marketing Division The Sales Department s activities are focused on creating, supporting, and maintaining a viable retailer network. The Department coordinates retailer network development, manages Scratchers ticket distribution, and maintains the key account program for large chain retailers. A key Department responsibility is to manage a sales force responsible for servicing all retail accounts and selling-in new lottery products. The Sales Department is comprised of four distinct, but closely related, sections: Key Accounts, Southern Field Operations, Northern Field Operations, and Retailer Network Management. The Marketing Department s activities are focused on assessing long-term market potential; creating marketing plans and budgets; implementing marketing plans; coordinating marketing activities with all CSL departments and multiple contracted agencies; and conducting ongoing advertising research and analysis. The Marketing Department is comprised of the Consumer Marketing and Advertising Sections. Lottery Offices and Facilities The CSL has nine district offices, a central headquarters facility in Sacramento, and distribution warehouses in Northern and Southern California. The nine district offices service the regions shown in Figure 1.7. Figure 1.7 District Offices Sacramento District San Francisco District East Bay District Central Valley District Van Nuys District Inland Empire District Santa Fe Springs District Santa Ana District San Diego District 19

27 1.7 Key Events in California State Lottery History October 14, 1986 Lotto 6/49 is introduced as first draw game February 1, 1992 Fantasy 5 Introduced April 2, 1992 Daily 3 Introduced July 10, 1994 Fantasy 5 drawings changed to 5 days a week November 16, 1992 Keno introduced November 6, 1984 California voters approve constitutional amendment to create California State Lottery June 21, 1990 Lotto 6/49 changed to Lotto 6/53 March 5, 1990 Decco 6/52 Lotto game introduced October 3, 1985 California Lottery initiated and first Scratchers ticket goes on sale April 10, 1991 Little Lotto 6/39 introduced October 1993 First Scratchers priced higher than $1 introduced 1993 Multiple Scratcher strategy introduced September 30, 1987 Lotto 6/49 begins two draws per week December 15, 1991 Lotto 6/59 Changed to SuperLOTTO (6/51 matrix) 20

28 July 1996 California Attorney General issues an opinion that the Lottery s instant ticket vending machines are illegal August 7, 1996 Fantasy 5 drawings changed to 7 days a week 2004 Legislation to increase prize payouts fails February 5, 2007 Million Dollar Raffle introduced June 24, 1996 California Supreme Court rules Keno illegal September 16, 1996 Hot SPOT replaces Keno 2001 Legislation to increase prize payouts fails 2003 Legislation to increase prize payouts fails June 22, 2005 California joins MEGA Millions with a 5/56 plus 1/46 matrix Legislation passed to allow instant ticket vending machines but with restrictions 2002 Legislation passes to allow Bingo themed games November 23, 2003 Daily 3 begins two draws a day 1998 Lottery establishes California first problem gambling helpline June 4, 2000 SuperLOTTO with a 6/51 matrix is replaced by SuperLOTTO Plus with a 5/47 plus 1/27 matrix October 2003 New gaming contract saves Lottery $40 million per year January 20, 1998 Daily Derby introduced 2003 First $5 Scratcher game introduced 21

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30 Integrity, Security, Honesty, and Fairness

31 2.1 A Winning Experience We are proud to be a part of California and the exciting experiences that come with living in or visiting this great state. To us a winning experience isn t just about prizes, it s about our customers feeling confident that we are ensuring the integrity of our games and knowing that they are helping to contribute supplemental funding to our schools. In the lottery business, maintaining the public trust is the foundation of a successful lottery. Maintenance of the public trust ensures players that games are operated fairly and winning tickets will be honored. Without the public trust, there can be no lottery. The CSL was founded on the principles of integrity, security, honesty, and fairness. In every product we sell and every communication we have, we challenge ourselves to reinforce the public trust. The CSL was founded on the principles of integrity, security, honesty, and fairness. In every product we sell and every communication we have, we challenge ourselves to reinforce the public trust. The CSL is operated by nearly 600 dedicated employees throughout the state. Our employees are a part of their communities and are proud of their contributions to public education and responsibility to maintain the CSL s integrity. While the general public knows that the CSL sells lottery tickets, most are unaware of our efforts to ensure our integrity, security, honesty, and fairness. 2.2 Security and Law Enforcement The Lottery Act provides for the appointment of a Deputy Director for Security with law enforcement experience. The CSL s Security and Law Enforcement Division is one of the most well-regarded security divisions in North America. In fact, the CSL s Security and Law Enforcement Division has been consulted on a number of occasions by other lotteries throughout the United States and Canada on security and investigation best practices. Over the years, these sworn peace officers have ensured the CSL s integrity. However, their day-to-day activities, while paramount to the organization, often go unnoticed. For example, every prospective and current employee, retailer, vendor, and supplier must go through a rigorous background investigation performed by the Security and Law Enforcement Division. This involves obtaining fingerprints and checking criminal histories with the California Attorney General s Office and the Federal Bureau of Investigations. This is critical to ensuring that our products are not compromised at any point from initial design to ultimate purchase. The CSL s Security and Law Enforcement Division is one of the most wellregarded security divisions in North America. 23

32 The CSL not only employs internal auditing staff, but contracts with the State Controller s Office and independent auditing firms to further ensure the integrity of all operations and transactions Additionally, the Security and Law Enforcement Division works to ensure our players have a total winning experience. In a recent case, Bob Sehested of Camarillo took his winning ticket to a retail clerk who cashed the ticket for $4. The clerk subsequently tried to claim Mr. Sehested s winnings as his own. CSL law enforcement personnel routinely investigate large claims to ensure the rightful owner is paid. When questioned in this case, the clerk could not identify when or where the ticket was purchased or whether he had used his own numbers or used the quick pick feature to pick random numbers. Lottery Security and Law Enforcement personnel acted quickly, and with the help of the retailer and the local media, they were able to provide security camera footage of the actual winner to the public in an effort to track down the true winner. Luckily, Mr. Sehested heard about this on the news and went to the CSL s website wondering if a friend or relative was the winner. Mr. Sehested identified himself as the person in the video on the CSL s website and subsequently claimed his $530,858 prize with great appreciation to those who had worked so hard to locate him. With the help of the Ventura County Sheriff s Department, the Ventura County District Attorney s Office and the CSL s Security and Law Enforcement Division, the clerk is now serving a 5 year prison sentence. In addition, the CSL s Security and Law Enforcement Division conducts internal and external criminal, civil, and administrative investigations, establishes the security systems and procedures for our games, and trains retailers in loss prevention. The CSL believes it is important for the public to know that behind every ticket we sell there is a team of dedicated peace officers and civilian staff who ensure its security and integrity. 2.3 Audits and Compliance The CSL maintains a meticulous and comprehensive audit program. The CSL not only employs internal auditing staff, but contracts with the State Controller s Office and independent auditing firms to further ensure the integrity of all operations and transactions. The CSL s independent auditing firm performs annual financial audits of our financial statements and works with the Finance and Administration Division to complete quarterly reviews of various accounts. The CSL is proud to have had 21 years of unqualified opinions. In addition, an auditing firm witnesses and reviews every lottery draw to ensure accurate completion of the draw procedures, including the verification of technology systems, draw machinery and draw items such as lotto balls. Every two years, the CSL utilizes an independent auditing firm to conduct a comprehensive study and evaluation of all aspects of security in the operation of the CSL. This security study addresses CSL personnel, 24

33 retailers and vendors, manufacturing operations, ticket counterfeiting, drawings, computer operations, data communications, database protection, building security, distribution, validation and payment procedures, unclaimed prizes, and any other aspects of security applicable to the CSL and its operations. Upon completion, the report containing the overall evaluation is provided to the Lottery Commission, the Governor, the Controller, the Treasurer, the Attorney General, and the Legislature. Additionally, the State Controller s Office conducts quarterly and annual post-audits of all accounts and transactions of the CSL including quarterly transfers to education, vendor claim schedules, and all prize payments. In recognition of our financial reporting, the Government Finance Officers Association of the United States and Canada has awarded a Certificate of Achievement for Excellence in Financial Reporting to the CSL for the fourth consecutive year. 2.4 Social Responsibility In 1984, California voters decided that California should have a state operated lottery. The voters agreed that the lottery should 1) maximize supplemental funding for public education through the sale of lottery products; and 2) be operated with integrity, security, honesty, and fairness. The CSL has a continuing responsibility to balance these two mandates. As part of this responsibility, the CSL must strive to be a good community partner. To this end, we strive to manage our business to produce an overall positive impact on California. Ultimately, the CSL must operate in a manner that is responsible and respectful of what has been built over the past 22 years. Our Employees Social responsibility begins with staff. It is the responsibility of every employee and must be a consideration in every decision and action we take. Whether answering phones or running a commission meeting, every action must reflect a responsible work environment. Managerial and supervisory discretion is paramount to the organization. Managers and supervisors are obligated to encourage and enforce responsible outcomes with decisions they make. This includes on-going training to ensure staff act responsibly and are abreast of issues that affect our business, defining guidelines and communications channels to minimize confusion, ensuring a fair and competitive hiring process, and maintaining a code of conduct to better address our expectations of one another. In recognition of our financial reporting, the Government Finance Officers Association of the United States and Canada has awarded a Certificate of Achievement for Excellence in Financial Reporting to the CSL for the fourth consecutive year. 25

34 Day-to-day decision making within the CSL is a foundation of our social responsibility. We have an obligation as internal stakeholders to act with integrity at all times. All employees are ambassadors of the organization to those outside of the CSL and must provide positive examples for those they interact with. Every action must be considered in the context of the whole organization. To that end, the CSL will continue to require ethics and sexual harassment training of all staff. The CSL will continue our efforts to increase communication between management and staff and will work to create a mechanism for any employee to voice concerns or ideas confidentially. Employee recognition efforts will be expanded to acknowledge employees who go above and beyond to promote the integrity of our products. Integrity Fundamental to our success is our relationship with our customers. We continually strive to offer fun and entertaining products within a fair and secure framework. We recently introduced Check-A-Ticket devices that allow customers to scan their own tickets to determine not only if the ticket is a winner, but also the amount won. We are also developing a consumer protection website to help players and retailers find the resources they need to ensure a safe and enjoyable gaming experience. We strive to market our products responsibly in a manner that targets those over the age of 18. Recently, we began a program to ensure that our retailers are not selling lottery products to minors. We will expand this program statewide during the coming fiscal year. Good Community Partners While customers and retail partners are our most obvious stakeholders, we feel a responsibility to reach out and create dynamic relationships with local communities, philanthropic organizations, elected officials and community leaders. Given the reach of the CSL and its objective of providing an entertaining way to create supplemental revenue for public education, we work daily to expand the knowledge of the CSL, its people, and its products in every community we touch. 26 This lucky office pool won a $72 million jackpot 10 years after starting their player group. The group leader bought the winning ticket at Sacramento s lucky retailer Lichine s Liquor and Deli. We hope to instill a sense of ownership in our mission with our staff, vendors, retailers, and neighbors. We have a sense of pride in our state and work to balance business and community.

35 Since its inception, the CSL has worked to be a good community partner whether through sponsorships or staff volunteering their time. Lottery products are available in nearly every community in the state, but our relationship with the community must extend beyond the next exciting game. Our staff and retailers live and work in these communities and have a vested interest in the community as a whole. Lottery staff volunteer their time as individuals and as an organization. We mentor, we walk, we build and we raise funds for the causes that are important to our communities. Last year, CSL staff alone raised over $15,000 for the State s United Way campaign. In the coming year, we will challenge ourselves again as we participate in the California State Employees Charitable Campaign and California State Employees Food Drive. Additionally, we hope to create a mechanism for CSL employees to log their volunteer hours in order to better acknowledge the staff who give their time in the community. The CSL also helps ensure that winners meet their financial obligations. The CSL participates in a program that checks Franchise Tax Board and State Controller s Office databases to confirm that winners of $600 or more have no unpaid child support, alimony, taxes, or state or local fees. A Partner in Conservation We recently introduced Check-A-Ticket devices that allow customers to scan their own tickets to determine not only if the ticket is a winner, but also the amount won. The CSL is a partner in the environmental efforts of the state. While much of our infrastructure and day-to-day activities are performed electronically, we constantly assess avenues where we can improve. Recently, the CSL has identified areas where paper forms are being used for functions that can be effectively performed electronically. The CSL is moving toward streamlining many of its functions in order to be a more responsible environmental partner. Much of the environmental effects of the CSL s business occurs at both ends of the supply chain with our retail partners and our customers. Legislative restrictions regarding the delivery of our games effectively require that we use paper tickets. We will continue to seek opportunities to create alternative forms of responsible gaming. While gaming generates waste in the forms of play slips, promotional or information materials, Scratchers tickets, and terminal receipts, the CSL makes every effort to print these using recyclable materials and encourages our end users to recycle. Additionally, our field offices and headquarters facility participate in a recycling program. We believe there are additional ways the CSL can be a partner in improving the environment and will continue to work with our partner state agencies, retailers, and vendors to minimize waste in the state. We look forward to growing our social responsibility program in the coming years and continuing to maintain an open dialogue about our ongoing efforts and future plans. 27

36 2.5 Problem Gambling Although not required by the Lottery Act, the CSL has been a leader in problem gambling awareness. In 1998, the CSL created a problem gambling awareness program that included funding a helpline. This was the first helpline of its kind in California. The CSL s program has grown over time and continues to ensure that education and awareness of problem gambling resources are included in its communications with the public. Since 1998, the CSL has spent over $1 million to address the issue of problem gambling. In 1998, the CSL created a problem gambling awareness program that included funding a helpline. This was the first helpline of its kind in California. In 2003, the California Legislature created an Office of Problem Gambling (OPG) at the Department of Alcohol and Drug Programs within the Health and Human Services Agency. This office was tasked with developing a statewide problem gambling prevention program including a toll-free helpline and referral service, a public awareness campaign, empirically driven research programs, and best practices in prevention and treatment. The CSL has had a strong relationship with the OPG since its inception and looks forward to expanding that relationship. In the coming year, the CSL will transition its gambling helpline number ( ) to the number now used statewide (800-GAMBLER). We will continue our commitment to printing problem gambling warnings and providing the new phone number on our tickets, brochures and advertisements, and on our terminals throughout the state. We will also take steps to expand our current program of distributing problem gambling brochures in order to bring the program in line with the statewide efforts, ensuring message continuity statewide. Since 2003, the CSL has sponsored Public Service Announcements (PSAs) on both television and radio that air during National Problem Gambling Awareness Week. In 2006, the Lottery expanded this effort and aired PSAs throughout the entire month of March. We look forward to working with OPG to create a fresh PSAs that can be used by all gaming entities throughout the state in a year-round rotation in order to raise awareness. We also hope to expand the distribution of the PSA and offer it in languages other than English and Spanish. As a first step in continuous employee training, a problem gambling presentation was given at this year s sales conference. We look forward to expanding the presentation to a more complete training program for all CSL staff in the field. Additionally, we will regularly update our retailers via our retail newsletter on current events and issues surrounding problem gambling. 28

37 Last year, the California Problem Gambling Helpline received over 4,700 calls related to gambling problems. Of those who called the helpline last year, almost 28% had played the CSL at some point and 2.2% of callers indicated that the CSL was their primary gambling preference. The helpline has made a difference to those with a gambling problem in the state. We are hopeful when we see that of the callers surveyed, nearly 97% claimed that their call to the helpline helped them recognize their problem and nearly 65% were able to quit gambling after their contact with the helpline. The CSL will continue to assess funding opportunities at the community, county, and statewide level by sponsoring organizations which raise awareness or provide treatment for problem gambling. The CSL has been recognized for pioneering problem gambling awareness efforts in California and will continue its efforts to educate players about the hazards of problem gambling and the resources available to them. Research on this important topic is ongoing. Efforts are underway to examine the creation and expansion of problem gambling treatment programs in California. As more information becomes available, the CSL will look for ways to contribute through staff time, funding, and contributing other resources as appropriate. An Assembly Resolution was presented recognizing National Problem Gambling Awareness Week by Assemblyman Alberto Torrico to, Left to Right: Anna Carr, Deputy Director of Legislation of the California Gambling Control Board; Terri Sue Canale, Manager, Charitable & Responsible Gambling Programs, California Department of Justice, Division of Gambling Control; Alexandra Vuksich, Commissioner of the California Gambling Control Commission; Assemblyman Alberto Torrico; Joan M. Borucki, Director of the California Lottery; Steve Hedrick, Deputy Director of the Department of Alcohol and Drug Program s Office of Problem Gambling; Sue Ross, Legislative Coordinator of the California Horse Racing Board; Bruce Roberts, Executive Director of California Council on Problem Gambling. 29

38 30

39 Market analysis

40 3.1 Customer Demographics and Playership Trends Over the years, the CSL has used various tools to capture customer demographics including an ongoing player tracking study and various commissioned studies. This data helps us identify our customer segments, their purchasing habits, the effectiveness of our marketing, and overall performance. Most importantly, ongoing demographic research helps us identify consumer trends, tailor our product development efforts to parallel these trends, evaluate the effectiveness of our distribution channels, and respond to the needs of our customers. The demographic data below is from a study conducted by professors from the University of California, Los Angeles that was commissioned by the CSL. While this data is currently in draft form and being reviewed for accuracy, no material changes are anticipated. The majority of California s adult population is between 25 and 54 years of age, while the majority of lottery sales are to players between 35 and 64 years of age. Age Figure 3.1 Total Sales by Age Group vs. California Population by Age Group 30% 25% % of Adult Population % of Total Annual Lottery Sales by Age Group 20% 15% 10% 5% 0% Age Population Data Source: 2005 American Community Survey Figure 3.1 compares total Lottery sales by age group to California s adult population by age group. The majority of California s adult population is between 25 and 54 years of age, while the majority of lottery sales are to players between 35 and 64 years of age. Our player base continues to age and shrink every year. This creates a growing imperative to reach new customer segments. 31

41 Ethnicity The following charts show how lottery sales vary by ethnic classification and game, with the percentage of the California adult population shown on each chart. Only the four major ethnic classifications are shown. Percentage of Game Sales Attributed to Caucasians 60% California Adult Caucasian Population 50% 40% 30% 20% 10% 0% Scratchers SuperLOTTO MEGA Millions Daily 3 Fantasy 5 Hot SPOT Percentage of Game Sales Attributed to Hispanics 35% California Adult Hispanic Population 30% 25% 20% 15% 10% 5% 0% Scratchers SuperLOTTO MEGA Millions Daily 3 Fantasy 5 Hot SPOT 32

42 Percentage of Game Sales Attributed to Asians 18% 16% 14% 12% 10% California Adult Asian Population 8% 6% 4% 2% 0% Scratchers SuperLOTTO MEGA Millions Daily 3 Fantasy 5 Hot SPOT Percentage of Game Sales Attributed to African americans 14% 12% 10% 8% 6% 4% California Adult African American Population 2% 0% Scratchers SuperLOTTO MEGA Millions Daily 3 Fantasy 5 Hot SPOT Some notable observations from these charts include: Caucasians, relative to their population tend to be light players, with the only exception being SuperLOTTO Plus where sales match the relative population. Hispanics, relative to their population tend to play slightly more and have a preference for Scratchers and Daily 3. Asians, relative to their population tend to play slightly more and have a preference for Hot SPOT. African Americans, relative to their population tend to play slightly more and have a strong preference for Daily 3. 33

43 Gender The household income of past month lottery players is similar to the household income of the general California adult population. Although California s population is almost evenly divided between males and females, males tend to be more prone to make lottery ticket purchases. This is shown in Figure 3.6 which depicts the relative percentages of past month lottery players by gender. The following series of charts come from the CSL tracking study. Figure 3.6 Current Players: Gender Male 55% Female 45% Source: Continuous Tracking Study 3rd Quarter, March 2007 Household Income The household income of past month lottery players is similar to the household income of the general California adult population as shown in Figure 3.7. Figure 3.7 Household Income of Lottery Players Income Level CA Adults Players Under $ 20,000 24% 21% $ 20,000 to $ 35,000 21% 22% $ 35,000 to $ 50,000 15% 16% $ 50,000 to $ 75,000 14% 15% Over $ 75,000 26% 26% Source: Continuous Tracking Study 3rd Quarter, March

44 Education The education level of past month lottery players also tends to mirror the statewide population as shown in Figure 3.8. Figure 3.8 Education Level of Lottery Players Education Level CA Adults Players Some high school or less 15% 13% High school graduate 25% 28% Some college 23% 26% College graduate or more 37% 33% Source: Continuous Tracking Study 3rd Quarter, March 2007 Playership Trends Past year play has been declining in recent years as shown in Figure 3.9. Figure 3.9 Playership trends 70% 60% 50% 61% 58% 53% 52% } 9% Past year play has been declining in recent years. 40% 30% 20% 10% 0% FY FY FY FY Source: Continuous Tracking Study 35

45 3.2 Consumer Product Sales Comparisons Figure 3.10 shows the United States lottery industry s annual sales in comparison to some other common products. It is interesting to note that the movie and music industries pale in comparison to the lottery industry, with combined total sales of $21.5 billion in comparison to lottery industry sales of $47 billion. Figure 3.10 United States Consumer Product Comparison $45 $40 Movies Music $43.0 $45.0 $47.0 Total Sales in Billions $35 $30 $25 $20 Salty Snacks Soft Drinks Wine & Spirits U.S. Lottery $32.5 $15 $10 $9.4 $12.1 $5 $0 Sources: 2004 Estimated Total Annual U.S. Sales (MarketResearch.Com), 2004 Estimated Total Annual U.S. Sales (US Census), Calendar Year Sales 2005 According to a report issued by the California Research Bureau in May 2006: Over a ten-year period, from 1994 to 2004, the gross gambling revenue earned by the legal gambling industry doubled in the United States. In 2004, consumer spending increased by seven percent from the previous year to $78.6 billion. This was more than consumers spent on movie tickets, recorded music, theme parks, spectator sports, and video games combined. 36

46 3.3 Consumer, Retail and Technology Trends The following are significant trends in consumer behavior, the retail industry, and technology. Consumer Shopping Habits Continue to Change Consumer shopping habits are constantly changing. The direction of these changes indicates that consumers are increasingly: Time starved Value oriented Moving toward new shopping venues Developing new shopping habits Figure 3.11 compares the percentages of households that visited different trade styles for 1999 and for Dollar stores, warehouse stores, super centers, and online shopping are gaining significant market shares. Figure 3.11 Consumer Shopping Trends Household Penetration by Tradestyle 100% 70% 70% Percent of Households 70% 60% 50% 40% 30% 20% 10% 0% Grocery Convenience Drug Dollar Warehouse Supercenters Online Shopping Source: GTECH Corporation Most of the CSL s existing retailers are not well positioned to address changing consumer needs. Recruitment efforts must be directed at retailers that provide the shopping experience that consumers prefer. 37

47 Technology Trends All of these technology trends point to a society that is moving toward easily accessible and customizable content, consumer conveniences, and digital interactions. Major technological developments are occurring in wireless communications and mobile computing. High-speed wireless networks are being established in numerous locations to allow everyone access to this service. This will expand society s ability to communicate in different ways than in the past. Mobile phones are becoming increasingly sophisticated with additional functionality being introduced regularly. Text messaging continues to grow and is increasingly used to provide personalized marketing. Mobile phones and personal digital assistants can now be used to play MP3 music files, watch television and videos, support network gaming, and make purchases. Information is readily available and often customizable to meet user s needs. Technologies like Rich Site Summary (RSS) allow for syndicating news and the content of news-like sites to be personally delivered to consumers. More services are being made available that allow people to subscribe to services and receive information and updates on specific topics at their convenience. All of these technology trends point to a society that is moving toward easily accessible and customizable content, consumer conveniences, and digital interactions. 3.4 Lottery Industry Trends and Best Practices In the United States, lotteries operate in 42 states and the District of Columbia. The following is a brief overview of some significant industry trends and best practices over the past 10 years. Higher Payout Scratchers Bolstered by the success of state lotteries like Massachusetts and Texas in the 1990s, virtually all state lotteries have been increasing their Scratchers prize payouts and enjoying significant sales and profits gains. The CSL has also followed this trend and enjoyed major sales gains, although to a lesser extent. Higher Price Point Tickets In the 1980s, all lottery Scratchers tickets sold for $1 throughout the country. In the early 1990s several states experimented with $2 tickets, and their success led to the introduction of $3 tickets and $5 tickets. In most cases, the more expensive tickets were also large in size and they featured higher 38

48 prize payouts. The trend toward higher priced, higher payout tickets continues today. In fact most lotteries now offer Scratchers tickets at $20 price points, with Texas recently introducing $50 tickets. Because consumers expect higher cost tickets to provide more prize value, more prize money is needed to fund higher cost tickets. Unfortunately, the CSL does not have this prize money available due to statutory restrictions, so our highest priced Scratchers games are $5, and even these games can only be released occasionally when prize funds are available. Multiple Scratchers When the CSL first started selling Scratchers tickets in 1985, the industry norm was to issue a single $1 game at a time. When this single game sold out or sales dropped to unacceptable levels, a replacement game would be introduced. In the late 1980s, a few state lotteries started experimenting by simultaneously selling two or three Scratchers games at the same time, and the results were positive. Before long, the multiple Scratchers marketing strategy became the industry norm, and the trend moved to increasing the frequency of game introductions. The CSL now issues about 40 games each year. In recent years, this trend seems to have peaked with state lotteries averaging about 50 Scratchers game introductions each year. Multi-state Lotto Games and Bigger Jackpots Recognizing that higher lotto jackpots trigger higher sales, a number of state lotteries decided to organize into consortiums in the 1990s so prize money could be pooled to fuel larger jackpots. Two consortiums emerged: Powerball with 29 current member states and MEGA Millions with 12 current member states, including the CSL. With multiple state participation, jackpots soared with the industry record being a $390 million MEGA Millions jackpot in March The industry continues to focus on increasing jackpot sizes with ongoing discussions revolving around changing game designs to worsen the odds of winning, increasing annuity periods to advertise higher jackpots, and establishing national and international lottery games. With multiple state participation, jackpots soared with the industry record being a $390 million MEGA Millions jackpot in March Jackpot Fatigue It has long been known within the lottery industry that large lotto jackpots stimulate incremental sales, and very large jackpots create a condition called lottomania or lotto fever where millions of players willingly stand in line to buy tickets for a chance to win huge jackpots. Lotteries now depend on these occasional players, who only play when jackpots 39

49 are large, to maintain sales in lotto games. However, as lotteries have strategically sought to maximize jackpot amounts over time, the playing public has continually modified its definition of a large jackpot. As a result, occasional lotto players wait longer and longer before participating. Jackpots of $30 million or more were enough to trigger the lotto fever phenomenon in the 1980 s. In 2007, the lotto fever threshold is about $200 million. For the CSL, jackpots of $30 million or more in the 1980s were enough to trigger the lotto fever phenomenon. In the 1990s, the lotto fever threshold increased to jackpots of $100 million or more. In 2007, the lotto fever threshold is about $200 million, with the recent $390 million jackpot raising the lotto fever bar yet again. Because it is difficult to fund larger and larger jackpots, player interest in lotto-style games is waning across the lottery industry. Consequently, an argument can be made that state lotteries have maximized large jackpot games, and that future sales declines for these games are almost inevitable. It is interesting to note the Ohio State Lottery recently began a campaign to encourage play at lower levels to address jackpot fatigue. Player Loyalty Programs Various lotteries offer lottery clubs that allow players to sign up and receive benefits such as s on winning numbers and jackpots, chances to win free merchandise, promotion notices, birthday coupons, and text message notices. Some lotteries provide videos of daily draws and lottery commercials, web-based interactive games for fun, and subscriptions through the Internet. Draw Game Stagnation The last significant draw games to be introduced in the lottery industry were fast draw keno and cash lotto games (e.g., Fantasy 5) in the early 1990s. Since that time, the industry has struggled to find entertaining new draw games. A number of state lotteries experimented with novel draw game concepts, but the results have been consistently disappointing. The CSL s only attempt to introduce a novel draw game occurred in 1998 with the launch of Daily Derby, a $2 draw game with a horse racing theme. This game also proved to be disappointing, as it never exceeded 1% of the CSL s total sales and it now languishes at about three-tenths of 1% of total sales. In recent years, draw game sales have been declining across the lottery industry and state lotteries are still looking for a major new draw game success story. Recently, lotteries in about 20 states have found success with raffle style draw games. However, by their nature, raffle style draw games can only be offered for limited time periods and they do not provide the type of revenue a permanent and ongoing draw game can provide. Nonetheless, raffle games have provided some excitement and novelty in the lottery industry. 40

50 Performance assessment

51 Introduction In FY 05/06, the CSL reported the highest sales in its history at $3.58 billion and transferred $1.28 billion to education. This marked the sixth consecutive year the CSL contributed more than $1 billion to education. In fiscal year the CSL is poised to finish the year with $3.3 billion in sales. While the CSL is proud to record its seventh consecutive year with over $1 billion contributed to education, sales have declined from the previous year. Although the CSL, as is true of any business, has historically experienced growth and decline from year to year, it is important to undertake a thorough analysis to determine the causes of the recent decline and predict future performance. This entails careful examination of the CSL s historical efforts to build sales, the current state of its business, and an assessment of the industry and marketplace. 4.1 Overall Sales Evaluation Given the continued downward trend of draw games in California and across the nation, it is necessary to determine how this trend can be reversed or to develop new strategies for long term growth. While the CSL has managed to increase sales and contributions to education over a 10-year period from 1997 to 2006, virtually all of this growth was fueled by higher Scratchers game payouts which increased from 51.52% in to 58.32% in The CSL is dependent on using administrative funds from draw game sales to supplement higher payouts on Scratchers. As is evident from the current fiscal year, poor draw game performance has limited our ability to fund Scratchers payouts and consequently affected overall sales significantly. In fiscal year , the CSL suffered a series of low jackpots due to jackpots being hit at lower levels than statistically expected in both SuperLOTTO Plus and MEGA Millions. In addition to poor rollover luck, there are a number of other factors contributing to the sales declines. Jackpot fatigue is also a factor behind the recent SuperLOTTO Plus sales declines. Given the continued downward trend of draw games in California and across the nation, it is necessary to determine how this trend can be reversed and to develop new strategies for long term growth. This is more imperative in California, where the CSL s ability to fund Scratchers prizes has peaked and is likely to decline as draw game sales decline. 41

52 Historical CSL Sales Historically, CSL sales have increased and decreased from year to year, but overall sales levels have grown significantly since the inception of the CSL. As shown in Figure 4.1, since 1986 CSL sales have grown from $1.7 billion to $3.5 billion a year. Figure 4.1 Historical lottery sales by fiscal year Since 1986 CSL sales have grown from $1.7 billion to $3.5 billion a year. $3,500 $3,000 $2,500 $2,000 $1,500 $1,000 $500 $ Sales in Millions Public education has used Lottery money for new equipment including establishing computer labs in schools. 42

53 Figure 4.2 is a list of some of the key events which have impacted CSL sales since 1986: Figure 4.2 KEY SALES EVENTS OVER TIME Scratchers sales begin on October 3, 1985; sales are more than $ 10 million per day, but quickly drop as expected based on the experiences of other new lotteries. Fiscal year sales end up at over $ 1.7 billion Scratchers sales drop as expected, but the introduction of Lotto offsets much of the sales decline to Lotto sales grow, aided by the introduction of twice weekly draws. Scratchers sales gradually decline to Scratchers sales decline over this time period for unknown reasons, while Lotto sales soften. Lotto is modified to a 6/53 matrix (players pick 6 numbers from a field of 53 numbers instead of 6 numbers from a field of 49 numbers) which appears to accelerate the game s sales decline to Lotto is re-launched with a 6/51 matrix and sales rebound. Three successful draw games, Fantasy 5, Daily 3, and Keno are introduced. All three games help fuel sales increases. The Lottery implements a multiple Scratchers strategy and installs vending machines. Scratchers sales almost double in the next four years Keno is terminated on June 24, 1996 as a result of a California Supreme Court ruling. In addition, vending machines are removed from retailer locations based on an Attorney General s opinion to Keno is replaced with Hot SPOT; the Legislature approves the reinstallation of vending machines; and Lotto is again modified with positive results. The Lottery implements a policy of redirecting funds into additional Scratchers prizes. Sales increase significantly to A State Controller s Office recommendation results in unclaimed Lotto jackpot annuity prize money reverting to education as a lump sum, rather than over the term of the annuity. This results in a one time revenue windfall of approximately $36 million in fiscal year to New gaming contract saves the Lottery about $ 40 million per year. These funds are invested in Scratchers prizes and sales again increase significantly Sales reach a record level at just under $ 3.6 billion. 43

54 4.2 Benchmarking the California Lottery Individual state lottery performance can be benchmarked against the performance of other state lotteries. Presented below is a comparison of the CSL s performance as gauged against other state lotteries in terms of the most common performance benchmarks in the lottery industry. Figure 4.3 Sales and Net Transfers to Beneficiaries Per Capita, FY $400 $350 $300 Sales per Capita Net Transfers to Beneficiaries per Capita $250 $200 $150 $100 $50 0 NY NJ GA PA MI FL OH IL TX CA Source: La Fleur s 2007 World Lottery Almanac California has the lowest per capita sales and per capita net transfers to beneficiaries amongst the ten most populous lottery states. 44

55 Figure 4.4 Overall PRIZE PAYOUTS and Scratchers Game Prize PayoutS as a Percentage of Sales Fiscal Year Comparison of Ten Most Populous States 75% 70% Scratchers Games Overall Prize Payout 65% 60% 55% 50% 45% 40% GA PA NY OH TX MI NJ IL FL CA Source: LaFleur s 2007 World Lottery Almanac, TLF Publications, Inc. Fiscal Year ends June 30 except New York (March 31), Texas (August 31), and Michigan (September 30) Data represents only revenue from traditional lottery games (e.g. VLT sales are not included) Prize payouts do not include VLT prizes paid As shown in Figure 4.4 California has the lowest prize payout percentage amongst the ten most populous states, in terms of both total prize payouts and Scratchers prize payouts. 45

56 Figure 4.5 U.S. Lottery Sales and Prize Payouts by Per Capita Rank Fiscal Year Source: LaFleur s 2007 World Lottery Almanac, TLF Publications, Inc. Fiscal Year ends June 30 except New York (March 31), Texas (August 31), and District of Columbia and Michigan (September 30) Data represents only revenue from traditional lottery games (e.g. VLT sales are not included) Prize payouts do not include VLT prizes paid ***No information available Rank Lottery Sales Per Capita Overall Prize Payout Instant Game Payout 1. Massachusetts $ % 76% 2. District of Columbia $ % 68% 4. New York $ % 68% 4. Georgia $ % 69% 5. Maryland $ % 69% 6. Connecticut $ % 68% 7. New Jersey $ % 65% 8. South Carolina $ % 70% 9. Pennsylvania $ % 69% 10. Rhode Island $ % 66% 11. Michigan $ % 65% 12. Florida $ % 64% 13. New Hampshire $ % 65% 14. Ohio $ % 67% 15. Virginia $ % 66% 16. Kentucky $ % 68% 17. Maine $ % 65% 18. Vermont $ % 67% 19. Texas $ % 66% 20. Missouri $ % 68% 21. Tennessee $ % *** 22. Illinois $ % 65% 23. Delaware $ % 65% 24. Indiana $ % 67% 25. West Virginia $ % 68% 26. Iowa $ % 61% 27. Colorado $ % 65% 28. California $ % 58% 29. Oregon $ % 65% 30. Wisconsin $ % 64% 31. Idaho $ % 66% 32. Minnesota $ % 67% 33. Kansas $ % 59% 34. New Mexico $ % 57% 35. Louisiana $ % 59% 36. Arizona $ % 60% 37. Washington $ % 67% 38. Nebraska $ % 65% 39. Oklahoma $ % 56% 40. South Dakota $ % 65% 41. Montana $ % 62% 42. North Dakota $ % *** 43. North Carolina $ % *** 46

57 Figure 4.5 shows that in terms of payout percentage, California ranks near the very bottom of all states. In fiscal year , California ranked 28th amongst state lotteries in terms of per capita sales. Figure 4.6 State Lottery Per Capita Sales by Rank WA OR NV CA ID AZ UT MT WY CO NM ND SD NE KS OK TX MN WI IA IL MO AR MS LA MI PA OH IN WV VA KY NC TN SC AL GA NH VT NY ME MA RI CT NJ DE MD DC East Coast states perform better than states west of the Mississippi. Cultural differences between the two coasts may account for these differences. Rank 1 14 Rank Rank No Lottery FL In Figure 4.6, state lotteries are color coded according to their per capita sales ranking from Figure 4.5. Looking at regional performance among lottery states, it is interesting to note that East Coast states perform better than states west of the Mississippi. Cultural differences between the two coasts may account for these differences. The East Coast has had a much longer history with lotteries and numbers games. Lotteries were used as early as the 1600s to raise funds to build schools and roads in the Colonies. Lotteries became widespread in the 1800s only to be banned by state constitutions in the late 1800s due to abuses by privately operated lotteries. In 1964, New Hampshire was the first to establish a modern state operated lottery. 4.3 Draw Game Performance The CSL is constantly looking for ways to increase draw game sales. It does this by monitoring the lottery industry to see what is working in other states; designing and testing new game and promotion concepts using both quantitative and qualitative research, and partnering with its gaming system and marketing vendors to identify the most promising new products. 47

58 The first lotto game offered by the CSL was Lotto 6/49. This game was introduced in October Since the introduction of Lotto 6/49, the CSL has taken numerous steps to improve lotto game sales with varying degrees of success. With the exception of raffle games, the CSL s draw games fall into two basic categories: lotto games and daily games. Lotto games are draw games that offer long odds of winning a very large, life-altering jackpot prize. Lotto games currently have only two prize drawings per week each. The CSL currently offers two lotto games: MEGA Millions and SuperLOTTO Plus. Daily games are draw games that offer good odds of winning a smaller top prize. Daily games have a prize drawing every day of the week. The CSL currently offers four daily games: Fantasy 5, Daily 3, Daily Derby, and Hot SPOT. Improving Lotto Game Sales The first lotto game offered by the CSL was Lotto 6/49. This game was introduced in October Since the introduction of Lotto 6/49, the CSL has taken numerous steps to improve lotto game sales with varying degrees of success. These steps include complete game redesigns and the addition of new game features. In addition to game redesigns and new game features, the CSL routinely runs special promotions aimed at increasing lotto game sales. Over the course of the last 15 years, the CSL has run about 28 such promotions. Some examples include the Match 3 Numbers for a Million promotion wherein a specified number of players who match 3 out of 6 numbers are randomly selected to win $1 million instead of the normal $5 prize and the Buy 10 SuperLOTTO tickets and Get 1 Free promotion that provides a purchase incentive by offering a free play with every $10 purchase. Improving Daily Game Sales The first daily game offered by the CSL was a card themed game called Decco. This game was introduced in March As with lotto games, the CSL has taken numerous steps to increase sales of daily games by redesigning the games, adding game features and supporting the games with promotions. Over the course of the last 15 years, the CSL has run about 19 promotions to increase daily game sales. Most of these promotions were aimed at the Hot SPOT game. Daily game promotions have also included cross promoting Fantasy 5 with SuperLOTTO Plus by offering a free SuperLOTTO Plus play with every Fantasy 5 purchase of $5 or more. 48

59 Raffle Games Raffle-style games are the newest draw games in the lottery industry. These games are designed to increase draw game sales by attracting new customers who normally do not play the lottery by appealing to people s familiarity with raffles. Raffle games offer a limited quantity of tickets for a limited time period. Prizes are normally awarded in one grand prize drawing that is tied to a holiday like New Year s Eve. The CSL launched its first Raffle game, Million Dollar Raffle, in February This game was tied to the St. Patrick s Day holiday. While the game did not sell out, it raised over $5 million in mostly incremental revenue for public education. The game was well received by the public, and lottery retailers are requesting a return of the game. The CSL plans to run more Raffle games in the future. Draw Game Assessment Aside from legal restrictions, the CSL faces the same challenge that all other lotteries in the nation are facing when it comes to improving draw game sales. As shown in Figure 4.7, draw game sales have been stagnant throughout the industry for the last several years despite numerous efforts in various states to improve sales. Figure 4.7 Industry Draw Game Sales: $20 $20 $19.63 $19.71 $19.22 $19.18 $20.11 $20.44 $21.75 $21.11 $22.71 Draw game sales have been stagnant throughout Total Sales in Billions $15 $10 the industry for the last several years despite numerous efforts in various states to improve sales. $5 $ Source: La Fleur s 2007 World Lottery Almanac 49

60 Figure 4.8 California Draw Game Sales: $1.6 $1.62 $1.53 $1.71 $1.71 $1.57 $1.60 $1.56 $1.62 $1.4 $1.40 $1.2 Total Sales in Billions $1.0 $0.8 $0.6 $0.4 $0.2 $ Figures 4.7 and 4.8 show that draw game sales across the lottery and California industry have been relatively flat over the last 10 years. Reliance on Lotto Games Of the ten most populous states, California is significantly more reliant on lotto game sales. This has certain disadvantages because lotto game sales are subject to jackpot fluctuation and jackpot fatigue. Figure 4.9 shows that, of the ten most populous states, California is significantly more reliant on lotto game sales. This has certain disadvantages because lotto game sales are subject to jackpot fluctuation and jackpot fatigue. Figure 4.9 Performance of Lotto Games and Multi- State Games as a Percentage of Overall Sales Fiscal year Comparison of Ten Most Populous States 35% 30% 25% 20% 15% 10% 5% 0% CA FL* IL PA NJ OH TX NY MI GA * Florida does not participate in Mega Millions or Powerball Source: La Fleur s 2007 World Lottery Almanac 50

61 Pursuant to section of the Lottery Act, the CSL has supplemented Scratchers prizes because it has proven to return $2 to our beneficiary for every $1 invested. On a marginal cost basis, both SuperLOTTO Plus and MEGA Millions can operate on 8% of their sales, leaving an identical 8% of sales within the CSL s 16% administrative spending allowance. Consequently, each game leaves about 8% of sales which can be allocated for Scratchers prizes. So if SuperLOTTO Plus and MEGA Millions fail to perform as expected, the CSL suffers a double hit: (1) we lose the sales from the lotto sales shortfall, and (2) we lose the 8% of sales that is used for Scratchers prizes. Accordingly, a 10% drop in lotto game sales causes a disproportionately larger drop in sales and contributions to education. With the uncertainty associated with projecting lotto game sales, the negative impacts are effectively compounded, subjecting the CSL to unpredictable swings in revenue. Daily Numbers Games Assessment While lotto games comprise the large majority of the CSL s draw game sales, its daily games are relatively weak when compared to the industry as shown in Figure Figure 4.10 Performance of 3-Digit and 4-Digit Numbers Games as a Percentage of Overall Sales Fiscal Year Comparison of Ten Most Populous States 35% 30% 25% 20% 15% 10% 5% 0% MI NJ OH GA IL NY PA FL TX* CA* * State has no 4-digit numbers game Source: La Fleur s 2007 World Lottery Almanac California s daily numbers game, Daily 3, accounts for a very small percentage of overall sales, at 4% of total sales. In sharp contrast, 7 of the 10 state lotteries shown in Figure 5.10 have numbers games sales which exceed 20% of total lottery sales. 51

62 4.4 Scratchers Game Performance Industry Growth Comparisons The United States lottery industry has enjoyed tremendous Scratchers game growth over the last decade as shown in Figure Figure 4.11 Industry Scratchers Game Growth from $30 $ $25 $ $ $20 $ In Billions $15 $ $ $ $ $10 $9.937 $5 $ Source: La Fleur s 2007 World Lottery Almanac Figure 5.11 shows that lottery industry Scratchers sales have almost tripled over the past eight years. This has been due to increased Scratchers prize payouts and higher priced tickets, although other factors such as increased game variety and improved distribution technology have helped fuel these increases too. The CSL has also enjoyed similar increases in Scratchers sales. As shown in Figure 5.12, the sales trend has been positive although sales have flattened in the last year. 52

63 Figure 4.12 CSL Scratchers Game Growth from $2.0 $1.737 $1.930 $1.827 In Billions $1.5 $1.189 $1.184 $1.212 $1.339 $1.0 $0.5 $0 FY01 FY02 FY03 FY04 FY05 FY06 FY07 How the CSL Maximizes Scratchers Sales The CSL s business practice since 1996 has been to channel available administrative moneys back into supplemental Scratchers prizes. The CSL does this because money added to Scratchers prizes generates an increase in sales which in turn produces additional revenues for education. The CSL s experience is that every $1 invested in Scratchers prizes results in $7 of sales and $2 for education. In other words, for every $1 the CSL can invest in Scratchers prizes, it can generate $2 for education. Largely based on this higher payout strategy, Scratchers sales have increased from just over $527 million in fiscal year to $1.93 billion in fiscal year During this time period, the Scratchers prize payout was increased from 51.52% of sales to 58.32% of sales. The CSL s experience is that every $1 invested in Scratchers prizes results in $7 in sales and $2 for education. It should be noted that there is a limit to this strategy, because there is an optimal amount that should be invested in prize payouts that will maximize total contributions to education. As shown by other state lotteries, this optimal amount is far higher than what the CSL can reach. Most state lotteries are able to offer significantly higher prize payout levels due to more flexible or nonexistent legal restrictions, and they have seen gains in Scratchers sales far in excess of California. Unfortunately, the $164 million in supplemental Scratchers prizes in appears to be the maximum amount that can be reached, with lesser amounts predicted for future years. 53

64 Other Strategies to Maximize Scratchers Sales The CSL has recently adopted a more aggressive approach to the use of callout messaging on Scratchers tickets. Callout messages seek to capitalize on a game s particular strength, such as a large top prize or good overall odds of winning. Over the past year, the CSL has added more ticket messages about top prizes, the number of prizes in a game, or the total amount of prizes in a game. While the results have been generally positive, the CSL has a need to better understand exactly how and why callouts drive consumers to buy a particular game. To answer these questions, the CSL formed a joint initiative with Scientific Games to determine the optimal number and type of callouts for the purposes of maximizing Scratchers sales. The end result of the research is a secure, interactive database containing detailed information about over 15,000 Scratchers games, over 500,000 weeks of sales data, and over 7,100 ticket images. All of this data is sorted and filtered to help us determine the optimal messaging strategies for different types of Scratchers games. In fiscal year , the CSL supported local businesses by paying retailers sales commissions of over $252 million. Another strategy the CSL has used to stimulate incremental Scratchers sales has been to increase ticket prices and providing a more involved gaming experience which takes longer to play. Again, this has been an industry best practice, but it effectively requires higher prize payouts to support the more expensive games where players have come to expect more value. Figure 4.13 Scratchers Game Price Point Distribution Calendar Year % 40% 35% 44.00% Industry California 30% 25% 20% 15% 13.80% 19.80% 25.20% 20.60% 24.00% 15.60% 19.70% 10% 8.60% 8.00% 5% 0% 0.00% $1 $2 $3 $5 $10 $ % Source: La Fleur s 2007 World Lottery Almanac 54

65 As shown in Figure 5.13, the lottery industry is introducing much higher price point Scratchers games than California. Most state lotteries offer both $10 and $20 Scratchers games and, in 2006, over 27% of all Scratchers game sales within the lottery industry came from $10 and $20 games. California has yet to introduce a $10 or $20 game, and can only occasionally introduce $5 games due to its limited prize fund. Portfolio Optimization One strategy that can be applied to both draw games and Scratchers games is the concept of portfolio optimization. Portfolio optimization requires aligning, positioning, and setting prize payouts for each game within the portfolio to maximize revenues. For every game of chance, including lottery games, there is an optimum prize payout level that maximizes the amount of revenue generated. For example, casino keno and bingo games tend to pay out in the range of 80% of the dollars wagered. This payout level is presumed to maximize casino profits, because if casinos could make additional profits by lowering these prize payouts, they clearly would. Slot machines tend to pay out at about 94% of sales and, again, this is based on business decisions designed to maximize profits. The CSL only has the ability to pay out just under 54% of total sales for prizes. However, this overall payout level can, and should, vary by individual lottery game. And, as is the case for casinos, the CSL should adjust individual game payouts to optimize revenue for education. Because the CSL s total prize payout capabilities are capped, the challenge is to optimize total profits, recognizing that we can never maximize revenue for education under current payout restrictions. For every game of chance, including lottery games, there is an optimum prize payout level that maximizes the amount of revenue generated. Historically, the CSL has introduced games on an ad hoc basis with little regard to the positioning of games within the portfolio. An assessment of all games within the portfolio may reveal that the CSL is not optimally distributing prize funds across games or positioning games within its portfolio. An example is the CSL s lotto game portfolio. SuperLOTTO Plus is in direct competition with MEGA Millions. Both games have similar play styles and offer large jackpots. 55

66 4.5 Retailer Network Assessment The backbone of the CSL is the strength of its retailer network. With over 19,000 retailers statewide, the CSL has an unparalleled distribution and marketing channel with respect to gaming alternatives in California. However, compared to the lottery industry, the CSL has fewer retailers per capita than the ten most populous states. Figure 4.14 Population per Retailer Fiscal Year Comparison: Ten Most Populous States 2,000 1,500 1, % CA IL* PA FL TX NJ OH GA NY MI * Previous fiscal year data Source: La Fleur s 2007 World Lottery Almanac Figure 4.14 shows that California appears to have a shortage of retailers because the population per retailer is the highest among the most populous lottery states. However, as shown by Figure 4.15, sales per retailer is a significant factor in determining the optimum number of retailers. Retailer of the Year, Donuts Galore, is recognized for its outstanding performance by the CSL. Left to Right: Joan Borucki, Director of the CSL presents the 2006 Retailer of the Year Award to owners Lang and Chun Sor. Daughter Miranda and son John were on hand for the celebration with Tricia Metzger, Lottery Sales Director. 56

67 Figure 4.15 Sales per Retailer Fiscal Year Comparison of Ten Most Populous States $400,000 $350,000 $300,000 $250,000 $200,000 $150,000 $100,000 $50,000 $0 NY NJ GA PA FL OH IL* TX MI CA * Previous fiscal year data Source: La Fleur s 2007 World Lottery Almanac Although California has fewer retailers per thousand of population than each of the other large states, it also has the lowest sales per retailer. While it may appear that sales may be increased simply by increasing the number of retailers, this would be effective only if demand for lottery products was sufficient to justify additional outlets. However, the data presented in figures 4.14 and 4.15 suggest that demand for lottery products in California is much lower than in the other states. Accordingly, additional retail outlets may simply cannibalize existing sales rather than increase overall sales. The CSL has conducted several studies to determine the impact of higher retailer saturation levels on net sales and profits, with inconclusive results. The CSL plans to continue studying this issue and conducting further tests. However, it is clear that the CSL must actively pursue trade styles that reflect consumer shopping trends. 4.6 Efforts to Improve the Business Model The CSL has been locked into the same basic business model since its inception. A major limitation with this model is that, in the absence of self-service equipment, selling lottery products is labor intensive, and many retailers and retail chains question the value of carrying lottery products. One of the most taxing aspects of being a lottery retailer is the requirement to carry and market 20 or more different Scratchers games at any given time. Currently, there are no automated systems to track and document 57

68 In an effort to break into additional multi-lane retailer trade styles, the CSL embarked on a special pilot test of a new business model in February 2007 Scratchers sales, so retailers are forced to reconcile ticket inventory changes to ticket sales reported by the CSL. For mom and pop stores with ample clerk time and centralized inventory control, these reconciliation challenges are manageable. For multi-lane retailers, these challenges are often considered too labor intensive and not cost effective. In an effort to break into additional multi-lane retailer trade styles, the CSL embarked on a special pilot test of a new business model in February Under the new business model, the CSL rents space for self-service terminals and performs all machine maintenance and Scratchers inventory management. Retailer activities are effectively limited to cashing winning tickets for which they receive standard handling fees and cashing bonuses. While retailer workload drops significantly under the new business model, the rental and cashing bonus income retailers receive is much less than under the conventional business model. The new business model is in the process of being evaluated for its financial feasibility, with pilot test evaluation results expected in December Retailer Recruitment and Optimization As noted earlier, retailers are the foundation of the CSL s business model. While the CSL is continuing to explore alternative product distribution opportunities, it must also continue to improve the current business model to be as cost-effective as possible. Retailer Recruitment Efforts to improve retailer recruitment include identifying and recruiting new retailers that show a high potential for sales, replacing consistently underperforming retailers with new retailers, offering retailer incentives, and providing new products that appeal to specific tade styles. Retailer Optimization The CSL has a program to help increase sales and efficiency of its existing retailer network. The CSL identifies underperforming retailers based on several criteria and visits those retailers to determine the causes and works with the retailers to improve sales. Recommendations include placement of terminals and equipment and better use of point of sale materials. During the past 10 years, the CSL has been providing better and more gaming equipment and improving the quality of retailer financial statement and billing information. For example, the CSL now provides 58

69 retailers with special Check-a-Ticket devices, which give players the ability to check their own ticket to determine if it is a winner. The CSL also created a special retailer web site which provides retailers direct access to automated billing statement information. This web site has been very much appreciated by our retailers, especially those in the supermarket and drug store trade styles. 4.8 Administrative Operations Assessment Administrative Costs as a Percentage of Revenues The CSL has always made a concerted effort to find operational efficiencies and reduce administrative costs. As a result, it ranks amongst the most efficient lotteries in the United States. Figure 4.16 Administative Expenses as a percentage of total revenue 25% 20% 15% 10% 5% 0% Massachusetts West Virginia (Traditional) Rhode Island (Traditional) Maryland New Jersey Florida New York South Carolina Georgia Pennsylvania California Missouri Connecticut Michigan Texas Ohio Virginia Illinois Tennessee Wisconsin Indiana New Hampshire Oklahoma Colorado Kentucky Oregon (Traditional) Washington North Carolina Arizona Minnesota Louisiana Maine Vermont Kansas Idaho Nebraska District of Columbia New Mexico North Dakota South Dakota (Traditional) Delaware (Traditional) Montana Source: La Fleur s 2007 World Lottery Almanac Since 1996 the CSL has, as a deliberate good business practice, reduced operating expenses from just under 16% of sales to 11.5% of sales for the fiscal year. Excluding retailer compensation, which is about 7% of total sales, CSL operating expenses as a percentage of total sales are about 50% lower than just 10 years ago. Figure 4.17 shows the decline in CSL administrative expenses. 59

70 Figure 4.17 General administrative costs as a percentage of total revenue Fiscal year thruough Current CSL staffing is about half of what it was in In , the CSL cut 30 positions from 650 to 620 positions. Percent of Total Revenue 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% Staffing Levels Fiscal Year Current CSL staffing is about half of what it was in In , the CSL cut 30 positions from 650 to 620 positions Figure 4.18 shows the numbers of CSL authorized positions since Figure 4.18 Number of personnel per fiscal year Fiscal Year

71 Gaming System Complexity The CSL s gaming system is very efficient in virtually all respects, with the exception being the computer applications environment. The CSL currently has four different computer domains that require separate logons, and the interfaces among these different domains can pose some operational challenges. At the present time, about one-half of the applications that CSL staff use have web-enabled interfaces while most of the balance of the applications have Windows server interfaces. The implications of this somewhat fragmented environment are that system programming changes take longer and are more expensive than would be the case in a consolidated environment, and there is a certain degree of staffing inefficiency as staff often must move from one computer environment to another to perform their daily job duties. Migration to a newer, more consolidated gaming system environment would reduce programming bugs, and make new programming more efficient and timely. The CSL s preference would be for all applications used by employees to have web-enabled interfaces. Migration to a newer, more consolidated gaming system environment would reduce programming bugs, and make new programming more efficient and timely. Outdated Back Office Systems and Business Rules The CSL s back office systems include the automated financial systems that are in use by the Finance and Administration Division. Organizational functions supported by these systems include procurements, general accounting, financial statement preparation, and investments management. In addition to these systems, CSL staff use some older generation systems for human resources activities, law enforcement investigations, and employee/contractor background investigations. While the back office financial systems are functionally adequate for the CSL s traditional business model, the interfaces between these systems and GTECH s gaming system are relatively poor, and it is not unusual for staff to manually key gaming system data into Microsoft Excel spread sheets for various financial applications. These manual processes increase the chances for error and, in a number of cases, there are automation opportunities that would reduce costs and increase efficiency. In addition to in-house computer system weaknesses, the CSL has a number of business rules which are due for reassessment. A business rule is defined as a policy for how a certain business process or function should be handled and, in the vast majority of cases, these business rules have remained unchanged for a decade or more. As we recently 61

72 learned when we implemented the pilot test of the new retail business model, the CSL s traditional retailer compensation structure is hard coded and any modifications or alternative structures require extensive programming or manual processes. Consequently, a thorough reassessment of these business rules will be conducted to determine if changing circumstances and new technology improvements have rendered the old rules either obsolete or in need of modification. Other Administrative Opportunities The CSL s in-house administrative operations have remained largely unchanged for the past 20 years. During the current fiscal year, the CSL will reassess the CSL s business operations. A review of the CSL s practices for distributing Scratchers tickets and point of sale materials was recently completed, and further reviews are planned for all internal operations. Additionally, the CSL has been hiring skilled analyst staff with strong technical skills and this practice will continue. 4.9 Marketing and Communications Assessment The success of CSL s marketing and communications efforts is difficult to gauge. In the past, most advertising dollars have been targeted at SuperLOTTO Plus and MEGA Millions. Despite receiving the bulk of the CSL s advertising budget, sales for these two games combined have dropped significantly in the last two consecutive years. The CSL has devoted little money in terms of marketing support of Scratchers, daily draw games, or the Hot SPOT monitor game. Despite this lack of advertising support, Scratchers sales have been generally good, while sales for the remaining games have been flat or, in the case of Daily 3, slowly increasing. The CSL has also devoted little money to develop and maintain its brand image, with most efforts in this area limited to brochures, newsletters, and annual reports. As shown in Figure 4.19, California trails the other states in dollars spent per capita on advertising. This is largely due to the fact that the CSL must choose between spending additional advertising dollars or supplementing Scratchers prizes. The CSL s decision to fund more Scratchers prizes accounts for much of the per capita spending differences shown below. 62

73 Figure 4.19 Budgeted Per Capita Advertising Expenditures Fiscal Year Comparison: Ten Most Populous States $4.00 $3.50 $3.00 Dollars Per Capita $2.50 $2.00 $1.50 $1.00 $0.50 $0 NY PA GA MI NJ OH IL* FL TX CA * Advertising expense from lottery s FY Financial Statements Source: La Fleur s 2007 World Lottery Almanac Positioning Research Study Findings From a public relations standpoint, the CSL tends to have a relatively poor and ill-defined public image. As will be explained, the general public and education groups both have a number of misconceptions which work against the CSL. In September of 2003, the CSL concluded a comprehensive research effort designed to measure public perceptions about the CSL (Positioning Research Study by Crestwood Associates). The research findings were disappointing, but not unexpected. Fifty percent of all educators believe that less than 10% of lottery ticket sales go to schools, and even 47% of our past month players and 45% of infrequent players shared this same dismal view. The actual percentage of ticket sales that is contributed to schools is much higher than 10%, at approximately 35% of sales. Thirty nine percent of past month players believed that no more than 10% of ticket sales are returned to players as prizes, and only 14% of these players correctly perceived that more than 50 cents of each dollar wagered is returned to players as prizes. As an overall finding, the interviewed groups think the CSL is spending approximately 45 of every dollar on operating and marketing expenses. The actual number is about 12 of every dollar. 63

74 When asked about their general perceptions of the CSL, 31% of all educators had a negative view, while only 11% had a positive view. Even among past month players, only 38% had a positive view of the CSL, with 62% having either a neutral or negative view. Only 8% of educators and school administrators believe the CSL is making a difference in the quality of education in California. Brand Image Evaluation Findings In today s competitive marketplace, consumers view a brand image as an integral part of their purchase decision. Companies continually work to differentiate themselves and connect with their customers in meaningful ways that build loyalty and understanding. A company s brand image exists only in the minds of consumers and is defined as what a consumer thinks and feels about the company. Brand image is developed through the impressions made by consumers encounters with our name, logo, marketing messages, and everything else that consumers see and hear about our business. In today s competitive marketplace, consumers view a brand image as an integral part of their purchase decision. Companies continually work to differentiate themselves and connect with their customers in meaningful ways that build loyalty and understanding. In January 2007, the CSL requested its marketing agency, BBDO West, to conduct a brand image audit to determine the state of our brand amongst Californians. The findings parallel the Positioning Research Study by Crestwood Associates discussed above. The following summarizes the findings of the brand image audit. Umbrella Brand The general public either feels nothing about the CSL, or associates it with either a big government bureaucracy or a big, profit-driven business. In general, the public does not have a good understanding of the benefits of the Lottery, where the money goes or what the money is being used for. There is a vague awareness of our mandate to provide funding for education; however, there is also a lot of skepticism as to whether this mandate is met sufficiently. Educators expressed negative feelings about the CSL because, even though they work within the education community, they do not know where the money goes or what it is being used for. CSL employees are passionate about the CSL s mission but in general, are discontent with the environment. Many employees feel that their work is not appreciated and their input is not considered. There is also a sense of apathy or lack of faith in the CSL s vision. Retailers have a positive perception of the CSL through strong relationships with our sales force and the contributions of CSL s games to their bottom line. However, they agree that there is inconsistency with CSL messaging. 64

75 There is an opportunity to reverse the negative image of the CSL brand and focus on demystifying the operations and purpose of the CSL. Besides specific tactics, a clearly defined positioning strategy is needed to invigorate the brand, create a rallying cry for employees and stakeholders and create synergy across the portfolio. In terms of consumer brand awareness by game, the results are somewhat mixed. SuperLOTTO Plus SuperLOTTO Plus is perceived as California s game. It has strong brand awareness and this is the reason why many consumers refer to the CSL as the Lotto. Consumers enjoy the simplicity and familiarity of this game. There is an opportunity to leverage the loyalty, provenance, and affinity of this game. MEGA Millions MEGA Millions is known as the big jackpot game amongst consumers. Unfortunately, it lacks a clear image and differentiation within the draw game portfolio and there is a false belief that MEGA Millions revenue leaves the state, because it is a multi-state game. MEGA Millions is a relatively new game offering and does not have the brand equity or loyalty enjoyed by SuperLOTTO Plus. Fantasy 5, Daily 3, Daily Derby, and Hot SPOT Fantasy 5, Daily 3, Daily Derby, and Hot SPOT continue to be niche games with a small core following of frequent players. Fantasy 5 is seen as the game most similar to the original Lotto 6/49 game. Daily 3 and Hot SPOT offer engaging play that is appealing to frequent players. After nearly 10 years, Daily Derby is still seen as confusing and out of place. This information, when combined with the popularity of these types of games in other states, shows there is an opportunity to expand the playership of most of these games. Scratchers Scratchers have the most compelling brand image of our product offerings. These games are seen as fun, interactive, and accessible. They provide tremendous variety and instant gratification. Due to their popularity, there is an opportunity to leverage Scratchers as a vehicle to increase playership of games within the draw game portfolio. 65

76 Other Communications Vehicles Big Spin Consumers like the idea of being able to purchase a Big Spin Scratchers ticket for an opportunity to win millions on The Big Spin TV show. The Big Spin Scratchers game continues to be one of the CSL s best performing Scratchers games. However, many consumers have to be reminded that there is still a TV show and their perceptions are driven by past experiences rather than recent ones. The Big Spin Show lacks entertainment value and is seen as being reminiscent of a 1950s game show. The Big Spin Show enjoys wide recognition and provides a communication vehicle that few businesses enjoy. There is an opportunity to contemporize the show and leverage it to reinforce a new brand image. Retailer Network The CSL s network of over 19,000 retailers is a powerful communications channel. Through their daily interactions with our customers, the CSL s retailers are the face of the Lottery. Generally, the message conveyed to our retailers is disjointed. There is a sometimes overwhelming amount of CSL materials sent to retailers, and some of these materials get outdated before they are removed. There is also no continuity of message or consistency of branding to connect the many point of sale materials we provide to retailers, and each different lottery game is given a unique personality that can confuse the overall brand image the CSL would like to project. Fortunately, largely through the efforts of our sales representatives, the CSL enjoys a very good relationship with its retailers. This relationship can be leveraged to more effectively utilize our retailer network as a tool to communicate our brand image. Website Our website will be key to connecting with our players and reaching new player segments in the future. Our website receives 5 million visitors and 19 million page views every month. If the search term lottery is entered into the Google search engine, the first result is the CSL website. However, the CSL s website is geared toward functionality, not marketing. It is functional and informative, but not engaging or interactive. Given the continuing growth of the Internet as an important tool to interact with consumers, it is imperative that our website be redesigned as an integral part of our marketing and communications efforts. Our website will be a key to connecting with our players and reaching new player segments in the future. 66

77 Public Relations and Outreach Our fractured relationship with our beneficiary and lack of political support has led to sporadic and haphazard public relations and outreach efforts. California s size and geographic and cultural diversity have also made it difficult and costly to reach consumers and stakeholders. Future efforts must promote the fact that millions of people win every year (winner awareness) and let consumers know where lottery money goes (proceeds awareness). Consumers need to know that people regularly win money playing the lottery. Otherwise, consumers will have fewer reasons to play. The CSL was created by the voters, and voters have the right to know where lottery money goes and how it is being used. At the same time, the CSL has a responsibility to put the funding in context it only accounts for less than 2% of the education budget in California. Future efforts must promote the fact that millions of people win every year (winner awareness) and let consumers know where lottery money goes (proceeds awareness). Winner awareness and proceeds awareness efforts should be focused at the regional and local levels. Attempting to cover the entire state of California has often proven to be inefficient and ineffective Barriers to Success Fractured Relationship with Beneficiary When the CSL was first established by Proposition 37 in 1984, it was pitched as the solution to all of education s needs. In reality, the Legislative Analyst estimated that the CSL would generate about $500 million per year for public education. The CSL has actually contributed over a $1 billion to public education for each of the last six fiscal years. As a result of this somewhat controversial start, the CSL has never enjoyed a good relationship with its beneficiary. The CSL no longer widely communicates its contributions to public education. In the absence of these communications, the general public has no knowledge of how the CSL benefits the state and is left wondering why California has a lottery. This has been detrimental to our ability to grow our player base, introduce new products, and connect with our customers. Education interest groups have consistently opposed efforts to increase prize payouts even though higher prize payouts would significantly increase contributions to public education. 67

78 The Lottery Effect The lottery effect can be described as the psychological effect that the lottery, although providing less than 2% of education funding, gives voters the illusion that it provides for most or all of education s needs. Although the lottery money has helped education, sometimes it s a double-edged sword, said CTA spokeswoman Sandra Jackson. There are those times you talk to people about the need for increasing funding for education, and they ll say I thought the lottery did that. Why do we need to give education more money? Los Angeles Daily News, June 17, 2006 The lottery effect has become a phenomenon so strong that it has even been used to prevent the passage of legislation unrelated to the CSL. Most recently, the lottery effect was used as a reason to oppose Proposition 88 in Proposition 88 proposed a $50 assessment on real property and would have generated nearly $500 million a year for education. The following quote from Proposition 88 opposition materials encapsulates the fear of the lottery effect. Proposition 88 could distract Californians from the real needs of our public schools by creating a new lottery effect, the illusion that schools needs have been met. In reality, rather than being a significant source of funding, lottery proceeds accounted for about 1.3 percent of the state education budget in Proposition 88 would provide about half that amount. Legal Restrictions Prize Payouts The CSL s enabling legislation contains prize payout restrictions which are the most stringent of any lottery in the United States. With one of the lowest prize payouts in the country, the CSL is simply unable to maximize revenues for public education. The negative implications of these payout restrictions have been addressed in more detail in other sections of this Plan. 68

79 Fixed Prizes The CSL is the only lottery in the United States that cannot pay out fixed prizes without limitation. This restriction was an outgrowth of a 1996 California Supreme Court decision which stated that the CSL must always have a predetermined prize liability for draw games. With these unprecedented restrictions, the CSL cannot guarantee specific prize amounts for specific winning outcomes in any draw game. This causes player confusion because wide swings in prize payout amounts are quite common. For example, in the CSL s Daily 3 game, payouts for picking three correct numbers in sequence range from a low of about $300 to a high of over $800. A particularly troublesome aspect of this restriction is the difficulty in marketing new draw games and attracting new players, as players cannot be told how much they can win. Prohibition Against Using New Technology In October of 1993, the State Legislature passed legislation which provided that: no changes in the types of games or methods of delivery of these games that incorporate technologies or mediums that did not exist, were not widely available, or were not commercially feasible at the time of the enactment of this chapter in 1984 shall be made without advance legislative approval [Lottery Act Subsection (b)]. This legislation effectively keeps the CSL in the dark ages of technology. The CSL cannot: offer either subscription play or interactive play through the Internet, permit cell phone wagering, or take advantage of a number of other new and emerging technologies that could otherwise be leveraged to attract new players and increase CSL sales and contributions to education. Due to the 1993 restrictions players must continue to visit brick and mortar stores to make purchases despite the fact that there is a growing trend towards online shopping. Due to the 1993 restrictions players must continue to visit brick and mortar stores to make purchases despite the fact that there is a growing trend towards online shopping. Prohibition on Certain Game Themes The CSL s enabling legislation contains a number of game theme restrictions which inhibit the CSL s ability to offer attractive games to the public. While some of these restrictions have been removed (e.g., bingo and horse racing), theme restrictions covering roulette, dice, baccarat, blackjack, Lucky 7s, draw poker, slot machines, or dog racing still remain (Lottery Act Subsection (a)(1)). Of these restrictions, the dice, blackjack, Lucky 7s, and slot machine restrictions pose the most problems, as these themes are successfully used by other state lotteries, especially for Scratchers games. 69

80 Ticket Dispenser Restrictions The restrictions are so broad that they prevent ticket dispensing machines from performing a function as simple as providing customers with change. In August of 1997, the State Legislature passed legislation which restricted the types of machines that can be employed to dispense lottery tickets to the public. These restrictions are quite technical. For example, the CSL is not allowed to show a facsimile of an actual ticket on the face of any ticket dispensing machine nor can the machine produce a Quick Pick ticket without querying a central system. In addition, the restrictions are so broad that they prevent ticket dispensing machines from performing a function as simple as providing customers with change. While a number of these restrictions are difficult to interpret, the CSL is generally prohibited from using any ticket dispensing machine that is not virtually identical to the machines used by the CSL in

81 Strategic Vision

82 Introduction A careful analysis of our recent sales decline, an evaluation of our business and its processes and strategies, and an assessment of our environment have resulted in the identification of four key strategic directives that we believe will substantially grow sales over the next few years. These directives will serve as our guiding principles as we establish priorities and allocate funding over the next three years. Implementation of this plan will establish the CSL as a valued partner in our community, provide a significant source of more consistent revenue, and establish an infrastructure to support future growth and new business opportunities. 5.1 Focus on Long Term Planning Several factors make it difficult for the CSL to plan for the long term. Government agencies with appointed executives are subject to regular, and sometimes frequent, changes in leadership. The CSL has been no exception. Since it began 22 years ago, the CSL has had 19 changes of Directors. The CSL is required to budget on a year-to-year basis and cannot retain funding for long term investment and planning. Taken together, these factors encourage short term planning. As a result, the CSL has reached the point where some core business functions have suffered. Our brand image is poor, our strategy for growth has come to an end, and our systems and business processes are in need of modernization. The key strategic initiatives presented in this Plan have all been developed with an eye toward long term and stable growth that will set the CSL on a course to realize its full potential. 5.2 Improve Our Brand Image Implementation of this plan will establish the CSL as a valued partner in our community, provide a significant source of more consistent revenue, and establish an infrastructure to support future growth and new business opportunities. The CSL s brand image has suffered in the absence of efforts to develop and maintain a positive brand image. Specifically, our games have been marketed, but our brand has not. As a result, consumers do not know what to expect from our products, do not know where proceeds go, and continue to believe that CSL revenue will take care of all of education s needs. In addition, there has been a shortage of stories about winners, leading many players to become discouraged about their chances of winning a meaningful prize. With a generally poor brand image, the CSL needs to reintroduce itself to consumers every time a new product or promotion is introduced. This 71

83 is not true of companies with strong brand images. For example, when Apple introduces a new product, consumers expect it to be innovative, cutting edge, user-friendly, and consistent with their lifestyle. Apple can then focus on the benefits of the product itself because consumers already know what to expect from the company. Similarly, when Lexus introduces a new vehicle, it does not have to spend time convincing consumers that customer service is a key selling point. Lexus is already famous for its exemplary customer service. In contrast, when the CSL introduces a new product, as we saw with the Million Dollar Raffle, consumers don t know where the money goes, don t believe that 50% of sales is returned in prizes, and haven t heard about anyone winning the Lottery in a long time. Accordingly, CSL sales representatives and retailers have difficulty selling new products, especially to new customers. The key to improving our brand image is to establish a cohesive, comprehensive, and understandable message about what the CSL represents and what to expect from lottery products. The key to improving our brand image is to establish a cohesive, comprehensive, and understandable message about what the CSL represents and what to expect from lottery products. The message must be given credibility through the products and services we offer. And, finally, the message must be conveyed effectively through the most appropriate communications channels. Some strengths of the CSL include the brand equity of SuperLOTTO Plus, the retailer network, the Big Spin Show, and the traffic of its public website. These existing communications channels are readily available to optimize our brand image improvement initiatives. 5.3 Shift the Jackpot Paradigm Reliance on large jackpots as the basis for draw game growth is a doubleedged sword. On the one hand, large jackpots can generate tremendous sales in a very short period of time. On the other hand, jackpot-driven games are subject to sales fluctuations caused by the luck of the draw and to sales declines caused by jackpot fatigue. These fluctuations are particularly risky for California where draw game sales are needed to fund higher Scratchers prize payouts. In the United States, the draw game industry has been focused, almost without exception, on creating larger and larger jackpots. In California, we went from Lotto 6/49 to Lotto 6/53 to SuperLOTTO to SuperLOTTO Plus and MEGA Millions to increase jackpot sizes and attract occasional players. Other state lotteries are already discussing ways to change game matrixes, increase annuity periods, create national lottery games, and even join international consortiums all in an effort to create larger and larger jackpots. 72

84 Unfortunately, increasing jackpot sizes invariably comes at the expense of worse odds and longer periods between what are perceived to be attractive jackpots. This further feeds into the belief that no one wins anymore, so jackpot fatigue combines with poorer odds to result in declining sales. The CSL may be the most vulnerable lottery in the country because, of the ten most populous states, we rely the most heavily on sales from our large lotto games. As we have seen in recent years, MEGA Millions has cannibalized SuperLOTTO Plus sales more than expected. These games were poorly positioned within our portfolio because they are essentially the same game with the same play style. Our billboards display jackpots amounts for both games side-by-side and invite consumers to make comparisons and choose between the two games. SuperLOTTO Plus sales were on a slight downward trend before the introduction of MEGA Millions, and a change or replacement game was certainly worth consideration. However, the introduction of MEGA Millions has dramatically hastened the decline of SuperLOTTO Plus to the point where it has become critical to begin the research and development effort to change or replace SuperLOTTO Plus before it is overwhelmed by the much larger jackpots of MEGA Millions. We must implement a strategy to rely less and less on large jackpot games. Shifting the jackpot paradigm entails less focus on large jackpot games and providing consumers with fun, entertaining games that are conducive to more regular play, and provide more winning experiences at smaller but meaningful prize levels. In assessing the sales of our daily draw games and Hot SPOT monitor game, it is apparent that there is room for significant growth. These games provide more regular play and more winning experiences than either SuperLOTTO Plus or MEGA Millions. There has been little to no marketing of our daily games due to their disparate personalities and relatively small player bases. By aligning these products into a single portfolio and creating synergy between these currently disparate products, we can begin to more effectively and efficiently market these games and build a stronger player base. Aligning this portfolio also allows us to cross-promote and cross-sell these games as a suite of games. This portfolio of games must also be analyzed to determine if prize funds are optimally distributed to enhance players experiences and maximize sales. We must implement a strategy to rely less and less on large jackpot games. Shifting the jackpot paradigm entails less focus on large jackpot games and providing consumers with fun, entertaining games that are conducive to more regular play, and provide more winning experiences at smaller but meaningful prize levels. 5.4 Modernize Operations Our goal is to implement a modern infrastructure that minimizes our reliance on manual processes so that we are in a better position to take advantage of new business opportunities as they arise. These improvements will also help the CSL keep up with changing consumer and retail trends. 73

85 Our goal is to implement a modern infrastructure that minimizes our reliance on manual processes so that we are in a better position to take advantage of new business opportunities as they arise. These improvements will also help the CSL keep up with changing consumer and retail trends. The CSL has been primarily focused on investing available administrative funds to increase Scratchers prize payouts. As a result, the CSL has not invested the resources necessary to improve and modernize its operations. The CSL can no longer ignore investing in modernizing its operations. The last concerted effort to modernize operations occurred in 2002 when the CSL swapped out its legacy gaming systems and retailer terminals with more modern and efficient systems and terminals. Implementation of this new technology resulted in administrative savings of around $30 million per year. Since 2002, even better gaming system technologies have emerged that address some of the issues we still face such as consolidating fragmented system components, reducing communications complexities and stabilizing applications. The CSL must take advantage of these new technologies if it wants to be able to adapt to a rapidly changing marketplace. Increased Scratchers sales over the last several years have caused us to outgrow our distribution warehouses. These warehouses are no longer optimally sized to keep up with the demand for inventory space. We must also improve the automated systems that we now use to distribute the millions of packs of Scratchers tickets we sell each year. Our goal is to improve our ability to get this product to retail in the most expedient and cost effective manner possible. In order to make good business decisions, management must have immediate access to accurate and timely information and data. The CSL will focus on modernizing management information systems that have limited reporting capabilities. For example, the CSL will develop and implement a dashboard information system that allows managers to navigate to, and extract, desired sales and retailer data in real time. Some of the other systems that we will modernize include accounting systems and business processes that are still based on essentially the same model that we used in the 1980s. These systems and processes will be improved to offer us more flexibility and efficiency. Modernizing operations will also encompass our efforts to establish a succession plan for our aging workforce, including our peace officers and long-time senior managers, and upgrading employee skill sets with improved training programs. Finally, modernizing operations will include looking at ways that we can provide better services to our customers by improving their ability to access information about the Lottery and its products and services. 74

86 Key Strategic Initiatives