Hide, Fight, Run

Why some companies can skirt regulation while others crash and burn

Startups are known for moving fast and breaking things. Sometimes, the things broken are rules, and sometimes, it works. Uber, DraftKings, and Airbnb famously stretched and skirted laws, ultimately reaching a size where they were able to lobby and push for legitimization. Other companies - Napster, Cerebral, Juul - got big, only to collapse underneath the laws they broke.

Why are some gray-area companies able to reach escape velocity while others crash and burn? I've been mulling this over as I've seen the rapid rise of online sweepstakes-based sports betting sites. I met a sports-book founder in February who was going through the insanely arduous process of getting licensed state-by-state. A few months later, they pivoted and were suddenly able to launch a quasi-legal sports-book in 40+ states, including California, Florida, New York, and Texas. They are not alone. A dozen startups have launched or pivoted, taking advantage of what they see as a goldmine of legislative loopholes. What's going to happen to these companies? Are there generalizable rules to when pushing the regulatory envelope can work?

First, a brief overview of what "sweepstakes" betting is. Remember the McDonald's Monopoly game? You buy something that is not a lottery ticket (food) and they give you a lottery ticket where you can win free fries or some money. Sweepstakes gambling is that taken to the extreme. You buy virtual currency (which has no value and cannot be exchanged) and, alongside, get a different form of virtual currency that can be exchanged back for cash. Birches Health, a gambling addiction treatment company (and Healthie customer!), has an in-depth (albeit opinionated) explanation here. Licensed New York sports-books like FanDuel and MGM pay 51% tax on gross revenue; these sweepstakes betting companies pay 0%. That's clearly not sustainable.

Are these companies going to make it, or are they going to get crushed? I call the determining criteria Hide-Fight-Run 

1. What is the risk of newsworthy direct harm done by the gray-area product? (Hide)

2. What is the size and fragmentation of the gray-area product's competitors? Can the fish eat the whale? (Fight)

3. How differentiated is the gray-area offering from legal alternatives? (Run)

In short, if a company can hide from serious negative public opinion, have a path to fighting back directly against incumbents, and keep distance from its competitors and then shirking regulations can potentially work. Otherwise, it ends in disaster. 

Let's apply hide-fight-run to the early stages of Airbnb.

1. Airbnb has gotten plenty of bad press for things like raising housing prices, creepy hosts, and nuisance party houses, but ultimately Airbnb is insulated. It is too easy to muddy the waters around the discussion on housing prices, and Airbnb can point to their terms of use and safety programs for any sort of host or guest misconduct.

2. There are very large hotel groups like Hilton and Marriott, but ultimately there are a bunch of them. There are also franchisees, independent operators, boutiques, etc. Airbnb had the opportunity to be as large as or larger than any one of them.

3. Airbnb (at least in the early days) was very different from booking a hotel. It added lots of new types of housing options and locations, could be much cheaper, and promised a more local and authentic experience.

Hide-Fight-Run shows that Airbnb was loved by consumers, initially looked over by competitors, had enough potential to be backed by deep pockets, and avoided stories that could have overwhelmingly stoked public opinion against them.

Now, let's look at Napster.

1. Napster's bad press was more centered around the damage to musicians and music, but ultimately limited.

2. In 2000, the music industry was concentrated across the big five record labels, which were large and dominant and had a strong lobbying arm in the Recording Industry Association of America. Napster never made any real money and did not have a clear path to doing so.

3. Napster was great for consumers (it was free), and a very different experience from having to go to a record store to buy CDs.

Or Juul:

1. So much bad press (due to instigating an entire teenage vaping epidemic) led to regulatory crackdowns.

2. The tobacco industry is highly concentrated into a big five but was an industry in decline that needed new innovation. Vaping offered the potential of a "healthier" alternative that could leapfrog existing tobacco products.

3. New, differentiated product. Better user experience than traditional cigarettes.

In these cases, despite beloved products, the companies were either too small to take on entrenched giants or too problematic to survive regulatory scrutiny.

So what about "sweepstakes" sportsbooks?

1. Gambling (especially online) already gets a lot of bad press, including vivid articles about individuals who ruined (and even ended) their lives. Sweepstakes sites have less regulation, less money laundering controls, contribute less to gambling addiction prevention, and do not provide meaningful revenue to the government (which is the largest argument in favor of legalized gambling). They are sitting ducks for damaging articles.

2. The top six U.S. sportsbooks dominate the market (having close to 90% market share). Many have ties to massive multinational casino chains (like Caesars, MGM, or Hard Rock).

3. The products look and function just like legal sportsbooks. The odds offered (effectively the cost to consumers) are very similar to legal sportsbooks. There is currently a large benefit to consumers in states like California, which have no legal online options and otherwise would have to use sketchy overseas sportsbooks or illegal local bookies. Consumers do not get any protections from gaming control boards (as these sweepstakes sites are not regulated by gaming control).

That is a grim combination. Without large product differentiation, it is hard to imagine the sweepstakes sites getting bigger than incumbents like FanDuel or DraftKings. These sites have a large target on their back from both governments (which want tax revenue) and legal sports-books (which hate having to pay taxes). They do not provide any social good or meaningful consumer benefit (besides skirting the laws). They will very visibly do harm. They fail the test of where pushing the envelope can work.

The sweepstakes wave is cresting and will crash down. We'll see states move to close loopholes, with some legalizing online sports betting and taxing it heavily. These sweepstakes companies will either ultimately fail, sell for their tech and people, or struggle to go back to a state-by-state framework and compete with dominant incumbents. On a personal level, this is somewhat of a shame as more competition leads to better prices and better products. These upstart companies are doing intelligent and innovative work, and no one should have sympathy for large casino corporations and sportsbooks. For better or worse, it won't matter. When it comes to regulating gambling, if you walk and talk like a duck, you'll get hunted like one.

n.b: You know what’s a lot more fun than stressing about the legalities of your startup? Working at a fast-growing HITRUST-certified health tech company that cares a ton about security and compliance. We’re hiring at Healthie!