China online lottery clampdown to cause short-term pain for longer-term gain

China’s clampdown on online lottery sales is likely to have a significant impact on the country’s booming lottery market in the short term, but shouldn’t be read as a signal that Beijing is seeking to permanently shut down remote lottery distribution, experts say.
E-commerce giant Alibaba on Tuesday said it was suspending sales of online lottery tickets in China, following in the footsteps of New York Stock Exchange-listed online lottery company 500.com, Tencent and others.
Although estimates vary on how much of the RMB 382.4 billion ($61 billion) in 2014 sales were actually generated online, the amount is thought to have been “substantial.” However, industry insiders say the existing system was badly flawed and the suspension may pave the way for a much needed overhaul.
Both legal lotteries in China, the Welfare Lottery and the Sports Lottery have a national brand and national regulation, but the day-to-day operations are organized at the provincial level. The province is also responsible for generating sales.
Both lotteries have one provincial administrative center per province and these centers approve individuals, usually mom and pop stores, to sell tickets. They are usually paid a sales commission of around 5-6 percent which varies according to volume.
In recent years, the administration centers have augmented their store network by signing retailer agreements with companies selling online. Those companies are able to sell a ticket to a client anywhere in the country, breaking the link between player location and processing province.
Since the marginal cost to the admin centers of internet sales in this model is lower than in the store environment, typically the commissions are set very high, often at more than 10 percent. The system has led to higher costs and duplication.
“In which other industry has the advent of the internet raised the cost of distribution versus brick & mortar?,” an industry insider said. “There is a functioning internet channel in the China lottery market but each and every transaction is attracting 2x normal commission levels. That money could be going to prizes or taxes – it need not to go to third-party websites to create needless competition between provinces for identical products.”
The system has also been hit by a series of high-profile scandals, including suspiciously anonymous winners of large prizes, delays in draws and reports of misappropriation of tax funds.
The government began an independent audit of 18 of the provinces late last year, which concluded in January. One of the outcomes of this audit was that in mid-January all the provinces were instructed to examine their past practices and report on their behavior to the national level by 1st March, which in turn lead to the current suspensions.
A formal report on the outcome of the audit is expected to be published in the near future and that may give official confirmation on what was wrong with the prior model and how the industry will move forward.
“The Ministry of Finance has already stated (2013) that they want this channel to exist. And other stakeholders do too: the provinces want more tax, the national lotteries want to preside over growing sales volumes, the lottery players want a convenient way to play the lottery,” the expert said, adding that the problem is the current system doesn’t work.
Due to technological challenges, it’s most likely that once the audit is completed, the first concrete steps to a new remote lottery distribution model will be via provincial smart-phone lottery trials for new mobile-only games, as opposed to a national internet model for existing (in-store) games.
The technological challenge of this model is more modest than developing a national internet platform. Trialing such systems in provinces is also more palatable for the national authorities because it is less visible and lower risk, as if one system does not work the damage is limited and it can be discarded .
There are plans in place to allow some provinces to trial their own approved for-mobile-only lottery games on mobile smartphone lottery systems. Only players from the province in question will be able to register for, download and play the app. However, no trial has yet been approved and none will be launched without relevant approvals, including the Ministry of Finance.
As far as the internet is concerned, both the national Welfare and national Sports lottery see the web as a national channel and intend to build a national platform that would oblige potential players to create a unique customer account.
Players would use this account to purchase tickets from licensed third-party online retailers who would process the tickets through the new national platform and receive a commission from the national platform – in this model the provincial admin centers will not be involved other than to receive their share of the tax revenue as determined by the identity (and registered address) of the player.
Both the Welfare and Sports lotteries are working to deploy such a technology platform. The timing of when this will be ready is uncertain, however.