The lifeblood of the U.S. lottery industry is its brick and mortar retailers. Out of the $73 billion earned this year, 99% of those dollars came through the doors of a retail partner. But whether they are a mom and pop shop, a company that owns 250+ stores, or a franchiser, there are some undeniable concerns for the lotteries’ retail partners on the horizon. By understanding what their retailers are currently going through, lotteries can better position themselves to help their partners while also continuing to grow.

Tax Cuts

In December of 2017, Congress passed a $1.5 trillion tax cut. Tax experts are still analyzing the impact of these changes, but it appears that the lotteries themselves aren’t directly affected. However, consumers should see a boost in their paychecks, which bodes well for lotteries.

Hypothetically, this means more money in people’s pockets. The National Association of Convenience Stores (NACS) believes the tax cuts are good for convenience stores and lotteries. “Getting back to the basics, if people are feeling good and they have a reason to spend it, they will. We generally know that people don’t pay down their loans when they get more money or they don’t save more; they tend to spend more. That’s an opportunity for lottery,” Jeff Lenard, VP, Strategic Industry Initiatives, NACS said.

“Discretionary goods are income elastic [a big jump in income produces a relatively big increase in how much someone buys of something, inelastic would be the opposite]. Something like lottery, which is an entertainment category, you would think that it would be income elastic,” echoed Frank Badillo, Director of Research, MacroSavvy.

“I think if people are going to have more expendable cash in their pocket in any way shape or form, a portion of that is going to go to entertainment and we squarely fit into that category,” Chris Rogers, Director, Products & Marketing, Arizona Lottery said.

Unlike the Bush tax cuts of 2001/2003, there could be a lot less discretionary income for most Americans. While the average household hypothetically should get roughly a $1,610 tax cut in 2018, outliers appear to have a large effect on that number. For instance, for a household earning $50,000-$75,000, the average tax would be about $870.

“The returns are small [for consumers] and in the end there is no clear windfall. We aren’t sure how that is going to balance out. People might get a little bit more take-home pay but is it going to cost them more in terms of a mortgage or interest deduction?” Badillo asked.

Furthermore, the costs for older Americans could be far greater than the tax return. The tax plan repealed the provision of the Affordable Care Act that requires most Americans to have health insurance. Younger, healthier Americans may choose to not have health insurance. An AARP Public Policy Institute analysis found that 50 to 64 year olds would face an average premium increase in the individual market of up to $1,500 in 2019.

The Tax Cuts and Jobs Act of 2017’s primary focus was to give tax relief to corporations. By reducing the corporate tax rate from 39% to 21%, the administration and legislators are hoping to make America more appealing for corporations to invest here. The theory is that over the long run the additional revenue will trickle down to employees.

That remains to be seen, and the impact varies by sector. The reason could be related to the fact that while the corporate tax rate is 39%, the average effective tax rate is 22% (the rate companies are actually taxed at through subsidies and loopholes). In fact, many industries are already being taxed well below the new tax rate, like coal. Retail, however, was being taxed at around 35%. Grocery stores and convenience stores, which make up 72% of total U.S. lottery retailers in the U.S. (La Fleur’s 2017 World Lottery Almanac), are taxed at 33% according to Aswath Damodaran, a finance professor at New York’s University’s Stern business school.

The National Retail Federation (NRF) and NACS are understandably excited. “Passage of tax reform is a major victory for retailers who currently pay the highest tax rate of any business sector, and for the millions of consumers they serve every single day. Our priorities were clear: reform must jumpstart the economy, encourage companies to invest here in the United States, increase wages and expand opportunities for employees, and protect our small business community, of which the vast majority are retailers. That’s exactly what this legislation will achieve,” Matthew Shay, President and CEO, NRF, stated.

“Convenience stores are more likely to succeed by reinventing yourself and investing in the business. Most likely any windfall from taxes would go back into the business and that may be an opportunity to help tell a story where it fits into any sort of capital reinvestment or otherwise,” Lenard said.

“One of the things that I would anticipate from this is if lottery retailers were able to have more reserves and more money, they would be able to make more investments into their operation, whether that means updating existing stores or expanding to new locations . . . I see either one as a win for the lottery from that perspective,” Rogers said.

$15 Minimum Wage

So the tax cuts are expected to be a positive for brick-and-mortar lottery retailers. But how will it play out with the trend toward increasing the minimum wage in many cities, counties and states? New York and California have passed $15 minimum wage laws for various workers, which could have an impact on lottery retailers. One study from the University of Washington reports that the minimum wage increase is reducing employees’ earnings on average by $125 a month. Another study that looked at Seattle and other cities found the opposite. Another study on restaurants in California by a team of economists saw the bump up to $10.50 by 2017 raised earnings in those restaurants by another 20%, but reduced employment by another 10%. The conclusion of this final study was only one sentence but seemed to effectively sum up the current understanding of the effects of a $15 minimum wage—“There is more work to be done.”

Retailer associations have unequivocally denounced wage hikes. In 2015, the NRF called Senate legislation aimed at increasing the federal minimum wage by 40% an “anti-job tax” that would lead to higher labor costs for employers and fewer opportunities for young and entry-level workers.

Lenard also expressed concern: “A $15 minimum wage is more related to a living wage than a minimum wage. How does an industry that depends upon first jobs fill out jobs with $15 minimum people? How do you look to adjust labor schedules? How do people get first jobs if people aren’t offering first jobs?”

If increased wages reduce the amount of store clerks working in brick-and-mortar stores, it could have an indirect effect on lotteries.

Internet Pressure

No summation of the retailer landscape would be complete without mentioning Amazon, which has caused a colossal shift in consumer expectations. Convenience no longer means being able to walk to a small store a few blocks away. Consumers expect that products can be purchased with a click of a button.

“Amazon can have everything delivered right to your house so the challenge retailers face is that they have labor, a physical facility, property taxes,” Kansas Lottery Executive Director Terry Presta said.

“Most retail channels are seeing a decline. The only growth we’re seeing in terms of units are the very large retailers and the very small retailers,” Lenard said. “I think small retail is surviving because they can fit in downtown areas and fit in non-traditional areas in mixed-use locations.”

Another reason may be because of a shift in products offered. Many brick and mortar locations stay away from products which internet companies claim a competitive advantage, like durable goods.

“A lot of grocery stores and convenience stores are moving to gourmet food. For instance, a gourmet deli has a better margin and will bring customers into the store. You really can’t offer that on the internet,” Presta said. “Just like the convenience store was a better model than a guy just selling gasoline and changing tires, this is now the continuation of the retail evolution.”

But it is hard to seek refuge from Amazon. The company has purchased the grocery store chain Whole Foods for $14 billion in June 2017, asserting their position in brick and mortar and gourmet goods.

In January 2018, the first Amazon Go, an automated store, opened in Seattle; it replaces cashiers with cameras. While there has not been an announcement if Amazon will open more locations, the success of artificial intelligence with a physical store could create a monumental shift in the retail ecosystem.

Retailers & Lotteries

Brick and mortar retailers do have one big advantage over the likes of Amazon. They are lottery retailers and therefore they provide a unique product that has mass appeal for the general population. Retailers want to maintain that competitive advantage.

While it is a symbiotic relationship, retailers frequently demand more compensation for selling lottery products. Lotteries cannot oblige easily. Many of the commission rates are set in stone via legislation. And even a 1% increase in retailer commission rates would result in millions of dollars being taken away from players’ pockets via prizes or the good causes lotteries support.

Lotteries often point that a ~5% commission is fair compensation. After all, selling lottery has few up-front costs for retailers. Retailers must sign up and purchase product, but aside from that, there is little additional accounting cost to become a lottery retailer.

However, retailer demands should not be dismissed out of hand as there are unseen costs. For instance, it takes retailers a longer time to deal with a lottery purchaser than a normal customer. In the highly competitive world of convenience stores, each additional second it takes for a transaction to go through is expensive. If one customer is taking longer to purchase multiple instant tickets, that can dissuade other customers from attempting to purchase other things or even coming back to the store.

“They are trying to redesign their stores to be bigger, better and faster because now everyone is in a hurry,” Presta said. “If we got into that realm of speeding up our transactions and helping them satisfy the customer, we’re going to be way more successful.”

There are also costs with security. Retailers surveyed by the NRF reported an average shrinkage of 1.38% for all products, which includes both employee and customer theft. A convenience store’s margin for profit on lottery sales is low relative to other products, but it’s made up by the large quantity that is sold. Unfortunately, when a low profit item is stolen, it requires a lot more product to be sold to make up for the loss in sales.

“Most retailers will tell you that lottery is vulnerable to shrinkage because of how the inventory is done,” Presta said. “From the operational standpoint, the dual terminal system is a problem inventory-wise and labor wise. Those two things create true shrink so if a 5% item is stolen now you have to sell 20 to get back to zero.”

“Inventorying those tickets every shift and …having multiple [store clerks] pulling out of the same dispenser… that causes problems as well because you don’t balance the tickets with your accounting system so you’re doing it by hand,” Presta continued.

There is validity to retailers’ arguments. But the solution needs to address lowering costs for the retailers rather than increasing the commission rate.
Presta pointed out how gasoline used to be similar: “Gasoline had a separate system outside the POS, you had a totalizer and you had to write down every fuel purchase to read a totalizer and then come back and total it up with what the pump said and see how it compared to what you rang up see if you were long or short. It was just a nightmare.”

He continued: “When we got all that information into the POS end of the register for the first time, we retailers felt like we had control of that category. And then the best retailers became those that used their new control to figure out how to sell more.”

“Retailers are fighting all those battles [shrinkage/labor] instead of trying to figure out how they can sell more lottery,” Presta said. “If they can feel like they can have control, they can reach new goals and make more money for both of us.”