by Andrew MacDonald and William R. Eadington
“Knowledge Should Defeat Fear” – Understanding the high stakes game of Baccarat - Part II.
by Andrew MacDonald and William R. Eadington
How often do we hear that results for a casino—or casino company—were impacted (positively or negatively) by high-end play associated with the game of Baccarat? Casino managers, often expected to perform to quarterly revenue or growth targets set by financial analysts, clearly do not appreciate volatility in their gaming win, and in some cases “play the man – and not the ball” as a consequence, or shy away from the high end baccarat business altogether.
Harrah’s, for example, took the route of exiting the high-end table game business altogether a short time after they acquired the Rio in 1999. This came after a failed experiment on their part to introduce commission based programs through the use of dead chips. (Dead chips are also known by a number of other names. They are also called non-negotiable chips, rolling chips or mud chips.) Harrah’s had been, at the time of the Rio purchase, a very well respected operator of casinos throughout the US that had predominantly focussed on mid-level, avid, experienced slot machine gamers. With the Rio purchase, Harrah’s inherited some very high quality suites suited for premium players, along with a handful of such customers. This led to a period where the company dabbled for a period of time with high-end table game play.
Harrah’s was a company that was used to being number one or number two in its particular markets, and was, to a large extent, focussed on slot play. The stock market had seen Harrah’s rise over the years, producing high quality earnings with good growth and little variation in results from quarter to quarter. What the Rio experiment unleashed was a period of earnings instability. No longer could Wall Street “expertly” forecast earnings per share within a penny or two and neither did they fully understand the business that Harrah’s had now found themselves in. Furthermore, the new Harrah’s management at the Rio was pre-occupied with getting the high end play right, and spent considerable time analysing this particular segment of their business, probably at the expense of the rest of their operation.
The volatility in earnings associated with being involved in high-end table game play brought about a rethink in sentiment toward the stock that was reflected in its share price. Furthermore, the Rio was not performing to the level that senior management at corporate expected. Following several quarters of trying to work through the issues at the Rio, Harrah’s leadership came to the conclusion that high-end play was not for them; the high end baccarat business was abandoned, and the management team at the Rio was replaced by one far more compatible with Harrah’s core strategy. And over the subsequent quarters, the Rio became an important contributor to Harrah’s earnings.
Gary Loveman—Harrah’s President and CEO at the time—is without doubt one of the smartest operators in gaming today. So what did Loveman see that others perhaps had not? First, he recognised that there was not enough volume of high-end Baccarat play being generated at the Rio for the company to be comfortable that it would achieve anything near the statistical house advantage from the game on a quarterly basis. This meant that results for the Rio and the company were inherently going to be volatile. Furthermore he recognised that not only was the Rio experiencing win rate volatility but also volume volatility. There was no adequate predictor of how much and when play would be generated. Several big players may come in and play during one quarter and then might not be seen for quite a period of time. Furthermore, some or all of them might win on their short visits because of the volatility inherent in the short run.
Loveman found that an inordinate amount of time was being spent by management on the issues around one or two high rollers, or on “fixing” the baccarat problem at the Rio. Rio’s management was distressed and obsessed, and the focus of the company was being distracted by the performance of this one property. He found it unusual and frustrating that he would get calls about a particular player winning or losing millions. One customer—from Harrah’s customer base of around 17 million at the time—getting his, and other senior management’s inordinate attention just did not make sense.
Loveman also understood that the decision science tools associated with his Total Rewards program did not provide him any competitive advantage in this particular market. Furthermore, he recognized that Wall Street tended to punish bad luck on the tables to a greater extent than it rewarded good luck, so the company’s stock price would drop more dramatically on a poor quarterly result than it would benefit from a quarter impacted by good luck and strong hold percentages on table games. Even analysts who followed the primary “premium play” casino companies had trouble understanding this; for those used to Harrah’s consistent performance, the challenges of communication were even worse.
Finally, Loveman had come to the realization that the high-end table business was low margin that suited a “winner-take-all” outcome. With such powerhouses as MGM, The Mirage (and then MGM and Mirage together, after their merger) and Caesars dominating the Las Vegas Strip, Harrah’s was not going to be number one or number two in this market. Without the facilities—palatial rooms and exclusive golf courses—hardware (i.e. private jets, fleets of limousines), and hosting infrastructure that his competitors enjoyed, and with the headaches that Harrah’s had accumulated, Loveman concluded that Harrah’s—at least for the time being—should not try to be a player in the high end Baccarat market.
That left the market to be fought out between MGM Mirage and Caesars, with the Venetian playing a small but increasingly significant role. MGM Mirage was ultimately able to dominate and capture the lion’s share of the high-end Baccarat market in Las Vegas at the time due largely to economies of scale. Interestingly, prior to the takeover of Mirage Resorts by MGM in 2000, it had been much more common to hear, especially from Wall Street analysts, of results from Baccarat impacting casino companies’ performance. Consolidation then brought together two of the major players in the high-end VIP Baccarat market and as a consequence their volume increased to the point for MGM Mirage that quarterly volatility relative to expected win was significantly reduced. With Harrah’s exit at the Rio, the demise of the Desert Inn, and little other competition at the time, MGM Mirage was able to attain over 70% of the high-end Baccarat market by 2002.
What is it that makes high-end Baccarat such a feared game? Is there something magical about this game compared to others that makes it so much more volatile? Are the players more clever or lucky, or does their inscrutable behaviour work against the house? The simple answer to each of these questions is “No.” To the contrary, the game of Baccarat offers no opportunity for skilled play, and is a nearly even chance game—much like flipping a coin—with a small house advantage and a low variance. Most slot machines are designed to be far more volatile—per unit wagered—than Baccarat.
As a measure of volatility, statisticians use the “yardstick” measure of standard deviation. (The formal definition of standard deviation is the “square root of the average squared distance of the actual outcome from the expected win of the game.”) A single wager of one unit on an even money game such as baccarat has a standard deviation of one unit. With blackjack, because of 3 to 2 payouts on “naturals,” doubling down, and splitting, the standard deviation is slightly larger at 1.1 units. For a single number wager at Roulette, the standard deviation is about 5.7 units. For the lottery-s
Date Posted: 31-May-2007