Impact of Information Technology on the

US Gaming Industry

Prepared by Peter Klugsberger, 2005

pklugs@yahoo.com

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1. Introduction

2. The North-American Gaming Industry

3. Geographical distribution

4. Industry Life-Cycle

5. How do Casinos compete?

6. Harrahs – The Company

7. Problem Definition

8. A new business model

9. How does IT work?

10. Financial impact

11. Sustainability through ITC

12. Response from Harrahs

TABLE OF CONTENT

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1. Introduction

This presentation sets out to analyze the impact of Information Technology and Electronic Commerce (ITC) on the US gaming industry and how these changes contributed to one company outperforming the rest of the North American gaming market.

According to state regulatory agencies, U.S. casinos generated over $27 billion in gross gaming revenues in 2003. This volume of revenues was generated by 443 commercial casinos in 11 states nationwide.

From that revenue, casinos paid state and local governments $4.32 billion in direct gaming taxes. Compared to previous years, employment figures rose slightly in 2003, with the gaming industry providing jobs for 352,428 workers who earned more than $11.8 billion in salaries.

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2. The North-American Gaming Industry

Over the last two decades, the gaming industry in the US was dominated by four major gambling empires. These groups were:

MGM MIRAGE – (www.mgmmirage.com) Included 12 wholly owned casino resorts such as Bellagio, MGM Grand, Treasure Island, The Mirage, New York New York and Monte Carlo Resort.

MANDALAY* – (www.mandalayresortgroup.com)Included 12 wholly owned casino resorts such as Mandalay Bay, Luxor, Excalibur, Circus Circus, Monte Carlo (50% owned) and Slots-A-Fun.

CAESARS* (Park Place) – (www.caesars.com) Included 18 wholly owned casino resorts such as Caesars, Bally's, Paris, Flamingo, Grand, Hilton and Conrad brands.

HARRAHS – (www.harrahs.com)Included 28 wholly owned casino resorts such as Harrah's, Rio, Showboat, Horseshoe and Harvey's brand names.

*At the time of this analysis, the Caesars group was being acquired by Harrahs Entertainment and the Mandalay group by MGM Mirage.

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3. Geographical Distribution

Source: Harrahs Entertainment case, Harvard Business School

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4. Industry Life-Cycle Stage – “Maturity”

According to a market analysis of UBS Investment Research, the US gaming industry in 2004 was deemed to be in a mature life-cycle stage, whereby gaming revenue trends indicated a leveling-off in growth over the last years.

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5. How Casinos Compete?

The primary revenue generators of a casino, the table games and slot machines, are in essence commodities that can be easily replicated by any new entrant or competitor. For a casino operator, one of the few areas of potential differentiation is by attempting to create a unique customer experience in form of either building a ‘must-see’ property or through increased providing exceptional customer service levels (i.e. customer intimacy).

Many companies such as ‘The Mirage’ or ‘Bellagio’ have chosen the path of the ‘must-see’ property, thereby providing customers with a choice of an hourly erupting volcano or the perfectly choreographed fountains of Lake Bellagio. Contrary to those aforementioned casinos, Harrahs decided that the huge capital costs of developing one of these properties did not prove viable in achieving long-term growth, they therefore focused their efforts into developing a core competence in customer service.

Resulting strategies adopted by the main players:

‘Must-see’ Properties strategy – MGM, Caesars, Mandalay Customer Intimacy - Harrahs

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5.1 Examples ‘Must-See’ Properties

‘THE MIRAGE’ ‘BELLAGIO’

Date opened: 22nd Nov, 1989 Date opened: 15th Oct, 1998

Rooms: 3,049 Rooms: 3,005

Cost p/room: U$ 206.000 Cost p/room: U$ 532.000

Development cost: $ 630 million Development cost: $1.6 billion

Attractions: White Tiger Habitat Attractions: Art Gallery incl. Monet

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6. Harrahs – The company

Founded in May 1937 in Nevada by William Fisk Harrah, a 26-year-old entrepreneur. By 2000, Harrahs Entertainment grew to be a major player in the gaming industry consisting of 21 casinos in 17 different cities.

Early StrategyPhil Satre, who became CEO in 1984, focused his initial strategy around people. Under his reign, Harrahs developed a rewards program based on tracking cards (akin to a frequent flyer program) at each of their properties. However, this program was run independently and consequently was applied very different at each of their properties.

Customer Loyalty as a core competenceBy the mid 1990s, Harrahs felt the competitive pressures of the ‘must-see’ properties and had to choose if it wanted to imitate this approach or find new ways of competing. In an attempt to avoid the huge development costs, Harrahs decided against imitating its competitors strategy and focused rather on becoming market leader in building customer loyalty.

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7. Problem definition

Phil Satre, Harrahs CEO, hired the Harvard professor Gary Loveman as COO to convert Harrahs into a more market-driven organization.

After an initial analysis they faced several strategic issues:

Customer service levels were deemed good but not distinguished. 26% of players provided 82% of revenues – but the company did not know

what kind of customers produced these results. Harrahs only captured around 36% of their customers gambling budget

and therefore ‘lost’ an estimated $ 100 million of annual revenues to their competitors.

Player tracking systems were isolated to individual properties, making the implementation of a corporate strategy impossible.

No measurements were in place to evaluate the effectiveness of their marketing efforts (e.g. no follow-up on marketing campaigns or measurement of response rates).

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8. A new business model

“You give us your money. We learn everything about you. And then you thank us and beg for more.”

(Source: Business 2.0, April 2002)

Gary Loveman realized that the gaming industry was marred by extraordinary disloyalty. He saw an opportunity to create the same kind of loyalty that people felt towards brands such as Coca-Cola, Nike, Procter & Gamble and Tommy Hilfiger.

One of the major challenges was the integration of company-wide information including data about lodging, events, casino management systems and the customer databases. This milestone was achieved by February 1997, when the Winner's Information Network (WINet), which connected and consolidated customer information from all of the company's transactional, slot machine, hotel management and reservation systems went live.

WINet consists of a national database of operational customer data and a data warehouse (a central repository including both customer data and data on hourly slot machine usage). The marketing department uses the data warehouse to analyze the customer information for patterns and insights. It then creates individualized marketing programs for customers based on their projected worth.

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9. How does IT work? The Inception of ‘Total Rewards’

How did Harrahs use ITC to secure customer loyalty?

9.1 Acquire a rich repository of customer information

9.2 Slice and dice data finely to develop marketing strategies

9.3 Identify core customers by predicting their lifetime value

9.4 Gather increasingly specific information about customers’ preferences – then appeal to those interests.

9.5 Reward employees for prioritizing customer service

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9.1 Acquire customer information

Launched in 1997, Harrahs first attempt on a loyalty program was called ‘Total Gold’. This player card program was modeled after the airline industry’s and rewarded regular customers with free hotel rooms, dinners, show tickets and gift certificates. However, there were three major problems with this program:

No differentiation with competitive initiatives (customer used Harrahs offer and then played somewhere else)

Customers earned different rewards at different properties – there was no uniformity in the program

Customers were not given any further incentive to consolidate their gaming and stay loyal to Harrahs

While this first attempts on a fidelity program were not successful in keeping customers loyal, it provided Harrahs management with a vast amount of data on customer preferences – more than 300 gigabytes of raw data.

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9.2 Slice and dice data

Harrahs Total Gold customers told them that they were spending only 36% of their annual gaming budget at their properties and used the rest with competitors. In Loveman’s view, this presented a significant opportunity.

The goal was to increase the amount spent by customers at Harrahs and at the same time communicate more effectively with them. To do so, Harrahs needed to dig deep into the database to be able to devise an effective marketing program.

The information that was found in their database indicated that a loyalty strategy based on same-store sales growth would work. The key for this to work was to increase the customers visits just as they might do with their hairdresser or grocery store. To do so, Harrahs needed to figure out how to develop a friendly relationship with its customers that induced that kind of behavior, namely increase frequency of visits.

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9.3 Identify core customers

A study by Deloitte Consulting showed that companies who understood customer value were 60% more profitable than those that don’t. Thus, understanding and correctly applying the lifetime value concept (LTV) is an important driver in increasing a company’s bottom line.

At the heart of the idea was to shy away from a mere transactional approach – i.e. seeing each encounter with the customer as an isolated event – to a more holistic approach. The other important issue Harrahs had to address was the fact that typically around 20-40% of a company’s customers are not or only marginally profitable.

Harrahs identifies profitable from unprofitable segments by allocating an exact $-value to each customer. This is done by using a quantitative model that accurately predicts a customer’s worth to the casino – known as the ‘Theoretical win formula’. The formula computes as:

Theoretical win = average bet*time played*house advantage

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9.4 Gather specific information about customer preferences

Most companies continue to insist on treating all customers the same – despite the knowledge that some are more valuable to the company than others.

Harrahs made a point of givingdifferent attention levels basedon their value to the company.

Understanding this concept,Harrahs split its customers intothree tiers:

Gold Platinum Diamond

Platinum and Diamond card holders receive greater levels of service, whichadds an aspirational element to the program. Source: McKinsey Quarterly

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9.4 Gather specific information about customer preferences (cont.)

WINet is also the backbone for Total Rewards, the company's new tiered loyalty card program (that replaced ‘Total Gold’). When a player inserts a card into the slot machines or on video poker, the amount of time he/she plays and the respective wins and losses are recorded in the customer database. Based on how much time a customer spends gambling, they earn points, which in turn can be exchanged for comps (free dinners, hotel rooms, tickets to shows and cash).

The player cards work at all 21 Harrah's properties, making Harrah's the only national casino chain with a multiproperty player card.

When a customer calls Harrah's to make a reservation, the computer screen of the agent taking the call is instantly populated with the customer's name and tier, where they usually play, how much the customer won and lost, and what he/she might be worth. The agent then accesses the reservation system to check room availability.

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9.5 Reward employees for customer service

Loveman realized that to make full use of technology, he also needed to change Harrahs’ culture. Measuring peoples’ performance and tying their bonuses on achieving improved customer satisfaction scores changed employees’ mentality and attitudes. In 2002, Harrahs paid non-management workers $ 14.2 million in bonuses based on perceived customer service levels.

Increases in customer satisfactionwere directly translated into higherrevenues. ‘Happy’ customers increased their annual spendingon gambling by 24% whilstdisappointed customers decreasedtheir spending by 10%.

Source: McKinsey Quarterly

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10. Financial Impact of Successful ITC Application

Comparing Harrahs stock performance with its closest competitor, Caesars, the financial impact of using ITC to gain a competitive edge is evident.

Historical Stock Performance Harrahs vs. Caesars

$0

$10

$20

$30

$40

$50

$60

$70

1999 2000 2001 2002 2003 2004

Caesars HarrahsSource: Yahoo Finance

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10. Financial Impact of Successful ITC Application (continued)

Source: McKinsey Quarterly

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11. Sustainability of competitive advantage through ITC

During 2004, casino companies announced mergers & acquisitions worth $ 23 billion. If regulators approve the proposed mergers, two Casino groups – Harrah’s and MGM Mirage - will dominate the North American market.

Both companies compete for very different customer segments. Harrahs followed a ‘grind action’ strategy that aimed at attracting a large number of customers with low to medium gambling budgets. Conversely, MGM Mirage focused on so-called high rollers with sometimes considerable gambling budgets. They were mainly attracted by their ‘must-see' properties with celebrity restaurants and shows. It remains to be seen which strategy Harrah’s will pursue with the Caesar’s brand, which appears at odds with Harrah’s current strategy of looking for stable revenue streams.

Harrah’s achieved its market leading position through its rigorous customer intimacy strategy, supported by a high level of operational excellence in marketing. Obviously, a very close integration of its IT technology for customer data warehousing and its sophisticated, proprietary marketing tools was key to Harrah’s success. I believe that Harrah’s follows a holistic approach of designing a highly integrated core competency for marketing to attract the low and medium budget mass market, thereby resembling to a large degree companies such as Dell Computers or Wal-Mart. Due to the mix of sophisticated technology and process integration, Harrah’s competitive advantage can be considered sustainable and would be very difficult to imitate.

I also believe that Harrahs’ grind action strategy and its strong marketing expertise positions the company well for a future rise of the internet gambling business. By extending its marketing core competency from the current brick & mortar business to internet gambling, Harrah’s has a good chance to leverage economies of scale (network externalities) in the cyber casino business.