Bonus Baccarat
By Andrew MacDonald and William R. Eadington - 2008

A Revolution in Baccarat

Game Pricing – by applying an in-game price modification.

Macau has quickly become the largest gaming venue in the world, based on gross gaming revenues. Macau's gross gaming revenues - which were US$10.3 billion in 2007 - have already overtaken those of the Las Vegas Strip and will likely surpass the entire State of Nevada this year. It is possible that 2008 revenues might exceed the combined gaming win of America's two largest gaming states: Nevada and New Jersey.

The breakdown of gaming revenues by source is arguably even more interesting, especially for analysts used to Western patterns. In most North American casino jurisdictions, about 70% to 80% of all gaming revenues come from slot machines, with the balance coming from table games. In Macau in 2007, table games accounted for 95.7% of gross gaming revenue. Furthermore, Baccarat (in all its variants) represented 91.3% of the total of all table game revenues. In Nevada, Baccarat makes up only about 25% of table game revenues and 8% of total gaming revenues.

The most significant revenue source for Baccarat in Macau is that portion called "VIP Baccarat," which presently accounts for approximately 70% of all gaming revenues in Macau. "VIP Baccarat" consists of those Baccarat tables located in particular gaming rooms that pay an annual premium fee of MOP300,000 (Macau Patacas) per table - approximately US$37,500 - to the government as compared to mass-market (or main gaming floor) Baccarat where the annual premium is MOP150,000. There is a degree of overlap among play and players as high-end mass market players can easily migrate to the lower-end VIP Baccarat tables and vice-versa, making the delineation of VIP and mass gaming problematic by any criterion besides the annual premium fee.

One of the driving factors behind the rapid growth and dominant importance of VIP Baccarat has been the role of so-called "dead chips" as an integral part of the game's structure. (Dead chips are also known by a number of other names. They are also called non-negotiable chips, rolling chips, or mud chips.) This system is based on the principle of the casino selling nonnegotiable chips at a discounted value to intermediaries - VIP room contractors or junket operators - who then sell the chips at face value to players who they have recruited and brought to the casino.

The dead chip system effectively allocates the theoretical win from the game (which derives from the game's inherent House Advantage - about 1.35% of all money wagered, the socalled "handle") between the casino and the intermediaries. Traditionally, the dead chip discount provided about 40% of the win for the intermediaries, with the balance going to the casino company. The casino company was responsible for the tax liability, which has ranged between 30% and 40% in Macau since the 1980s, and is now about 40%. The discounts received by the intermediaries funded their marketing efforts, lending costs, and other expenses related to their responsibilities in VIP room operations.

This informal partnership between the casino operators and the intermediaries was first developed with the monopoly operator STDM beginning in the 1980s and has remained relatively stable for some time. However, the system has been significantly affected by the rapid growth and changing competitive conditions that have evolved in Macau since 2004. Since then, the major competitors SJM (the successor company of STDM), Galaxy, Las Vegas Sands, Wynn Macau, PBL Melco and MGM, have all adopted some variation of the "dead chip system."

The mechanics of dead chip play are typically as follows. The VIP room contractor purchases dead chips from the casino concessionaire and resells them to VIP player representatives. The contractor receives a percentage commission - up to around 1.2% - on the volume of dead chips purchased. The representatives then sell the dead chips to their players who use them in actual play. When players win a wager with dead chips, they are paid off in live (negotiable) chips, which can be redeemed at the casino cage for cash. However, they are typically bought back by VIP room player representatives for dead chips; this process is called chip rolling. In order to add to their profits, VIP player representatives - working under VIP room contractors - continually purchase live (negotiable) chips from players when the players win hands. In this manner, players only make wagers with dead chips, and the VIP player representatives are continually using the acquired live chips to purchase additional dead chips.

The dead chips also provide a simple accounting system that allows the measurement of a proxy for actual handle. Indeed, for even money (or near-even money) wagers such as Player and Banker at Baccarat, the expected survival in play of a dead chip is just under 2.0 rounds, so for the game of Baccarat, for which there is about a 1.35% theoretical House Advantage, the expected win for the casino should be about 2.7% of rolling chip sales. If the commission rate to the contractor is 1.2%, for example, this would capture about 44% (1.2%/2.7%) of theoretical win. Some of this amount may be paid back to the player as incentives from the contractor or his agents, and some proportion will be paid to other intermediaries (junket operators, sub-agents, etc.) employed by the contractor. (Note that the tax comes out of the casino concessionaire's share, so at that commission rate, the concessionaire would receive about 16% of theoretical win.)

Recently, the Macau market has seen the advent of consolidators: strategic partnerships among VIP room contractors who can then negotiate more favourable terms with casino concessionaires in exchange for better commission terms. One such company is AMA International, a junket aggregation business owned by the publicly traded Hong Kong company A-MAX Holdings Ltd. For the month of February 2008, Crown Macau, which had entered into an exclusive arrangement for VIP room play with AMA International, reportedly captured an 18.1% market share of Macau's gross gaming revenues (and a 24.8% market share of VIP play) and generated rolling chip sales of US$5.3 billion. This was in contrast to their reported gaming revenue market share in November 2007, which was only 5.7%. According to analyst reports, AMA International was able to negotiate commissions of up to 1.35% on rolling chip sales, which would amount to about 50% of theoretical win. AMA International then reportedly pays the VIP room contractors up to 1.21% of rolling chip sales. This pool is further divided down the chain of junket operators, agents, and sub-agents, until the individual players also receive some form of "incentive" payment. If these figures are correct, then the after-tax theoretical win for the concessionaire would be 10% of the total theoretical win. (Rolling chip sales of UN$5.3 billion suggests a total theoretical win of US$140 million; 10% of that is still US$14 million. However, this is gross revenue prior to consideration of any fixed operating expenses, capital costs, and other overheads.)

This kind of deep discounting might be justifiable given the volumes of dead chips wagered and is much like bulk discounting to wholesalers in other industries. One of the issues with the use of dead chips, however, is the fact that the commissions paid on rolling chip sales are treated for tax purposes as an after-tax expense and are not deductible from gross casino revenues before the calculation of gaming tax. That means that in Macau - where taxes and levies are 40% of gaming revenues - the resultant margin after tax and commission are pushed to super-thin levels that only substantial volumes can overcome. As an alternative, if a way could be found so that the gaming tax could legitimately be calculated after payments are made to intermediaries, then margins could improve to more attractive levels.

To this end, one concept worthy of consideration in Macau and other comparable jurisdictions are the game variants Bonus Baccarat™ and Super Bonus Baccarat™. These patent pending concepts offer a differential pricing concept while retaining the base attributes of conventional Baccarat. By lowering the price of the game rather than giving a portion of the "after-transaction" revenue to intermediaries, the tax burden for any given level of handle will be reduced, though the tax burden on any volume of losses would be the same. What is interesting is whether this approach might create greater leverage on the part of the casino concessionaire to extract a larger margin without undermining the demand for the product. In conventional Baccarat the casino pays even money on all winning Player bets and 19-20 on all winning Bank bets (i.e. by extracting a 5% commission from all winnings on Bank bets) while Tie bets are paid at odds of 8-1. Deductive probability analysis or simulations will determine several distinct win rates for the game of Baccarat based on resolved decisions only and an eight-deck game. The win rates are:

"Banker:" 1.17%
"Player:" 1.36%, and
"Tie:" 14.36%.

These are known as the relative win rates or House Advantage, and are effectively the inherent price of the game to the player per unit of currency wagered. The process described earlier that rewards intermediaries with commissions of up to 1.35% of dead chip sales provides a price reduction of up to 0.675% against these win rates - for the primary Player and Banker bets - and is accomplished by way of generating an expense item on the casino books as a commission paid to the intermediaries, or to the players directly.

The games of Bonus Baccarat™ and Super Bonus Baccarat™ retain all the material aspects of conventional Baccarat with the exception that the game's payout structure is modified. As the objective of the game of Baccarat is to achieve a point count closest to 9, the variants offer bonus payments on how that total is achieved. For Bonus Baccarat™ a bonus payment is paid on a winning Natural 9 which is when the total of 9 is achieved in the first two cards drawn by either the Player or Banker hand. (There is no payout or bonus when both Player and Banker are dealt Natural 9s.) When a winning Natural 9 occurs, the normal payments of even money on winning Player hands or 19-20 on winning Bank hands are augmented with a one-unit bonus that raises the payout rate to 21-20 on Player hands (a 5% bonus) and to even money on Bank hands (elimination of the 5% commission). For an eight-deck game the probability that either the Player or Bank wins with a total of a Natural 9 is 9.497%. This bonus then results in a price reduction on the House Advantage of 0.47% for both hands (to 0.77% for Banker and 0.96% for Player.) This is a significant reduction in price, but one which is relatively consistent with commission payments already being paid to the various intermediaries or to the players directly.

The second variant Super Bonus Baccarat™ extends the concept one step further with all winning totals of 9 paid a bonus. The bonus is again a payment of 21-20 on winning Player hands with a total of 9 and a payment of even money for winning Bank hands with a winning total of 9. The probability of these events is respectively 13.55% for the Player and 12.98% for the Bank. As these probabilities are relatively balanced, and the bonus payments consistent for each, then the resultant discounted House Advantages are 0.65% on Bank wagers and 0.68% on Player wagers.

Note that with Bonus Baccarat™ and Super Bonus Baccarat™, the conventional game rules for Baccarat are retained. The rules and procedures of play, including the terms by which the hands are played and whether or not cards are drawn by Player or Banker, remain identical. This ensures that casino customers will not be faced with trying to interpret any game rule changes or have to consider changing the method or strategy of their play. This is particularly relevant for high-stakes players who are relatively experienced and who have certain habits when playing Baccarat. The rituals associated with playing Baccarat in Macau are complex and time-honored. They include the players squeezing the cards to expose the pips, turning the cards as they do so, rubbing the cards and calling for luck, and generally mangling the cards to "squeeze out" a winning hand. The rituals might make little sense to western observers, but to the Asian customer this is part of the skill of playing Baccarat. To change the game materially would be tantamount to heresy, and while there have been attempts to do so, most of these variants have fared poorly in competitive environments.

The impact of the changes to payout structures is also relatively inconsequential in terms of game efficiency. Paying even money is a simple process and all dealers are used to calculating amounts of 5% (usually as a deduction on the Bank bets, but now as an addition to the Player winning bet). Therefore, game speed should not be affected.

By significantly lowering the House Advantage, Bonus Baccarat™ and Super Bonus Baccarat™ reduce the theoretical loss for the Player for any given volume of handle. If this were all there was to the story, it would just be a very good deal for players, but of questionable value for everyone else. However, in light of the unusual realities of the VIP structure in Macau, these games could alter the relative bargaining strength among players, intermediaries and casino concessionaires, and could also create a number of other tangible opportunities. The lower prices might create additional benefits that - depending on price elasticities of demand for Baccarat play - might be beneficial for a number of the major actors in the VIP scene. The actual distribution of benefits among the important parties would depend on how players react to lower prices in terms of their propensities to wager, and how the relationships among players, intermediaries and casino concessionaires might otherwise change.

One obvious advantage of creating this pricing differential relative to mainstream baccarat would be the ability to offer these games to specific favored customers. In effect, the casino could incentivize key players to bypass the intermediaries and deal directly with the casino in exchange for the lower House Advantage in play. The criteria on which to decide for whom these games could be offered could depend on past game play, front money deposits, or other criteria that might suggest valuable players who would be willing to play without the services of an intermediary. In effect, the casino could use these games as part of a disintermediation strategy whereby they eliminate intermediaries' access to this form of Baccarat. A premium product for discriminating premium players - if you like.

The advantage of such a strategy is that the discount that currently shows as an expense for payments to intermediaries would basically be built into the game. The gaming tax would be computed on house win, which would shift the discount from post-tax to pre-tax status for the portion of play that takes place on Bonus Baccarat™ and Super Bonus Baccarat™. This would have a highly material impact in high tax jurisdictions such as Macau and would effectively improve operating margins for casino operators by up to 20% for any business that migrated to this option.

Such a change, however, may raise concerns for the Macau authorities responsible for tax collections, even if the tax accounting rationale for this approach is sound. The concern from the government's perspective is that price reductions might lead to reductions in gross gaming revenues for the casinos, and therefore reductions in tax receipts, even if the handle were to increase significantly. The important issue here, of course, is price elasticity of demand. Given considerably better pricing, are players going to increase their levels of action sufficiently to keep casino winnings at the same levels that would have prevailed at higher prices? This is really a behavioral question; we would not know the answer for sure until the circumstances were allowed to develop. On the other hand, there is nothing in Macau law that would argue against improving the terms of play for baccarat players. This would not be unlike going from a double-zero roulette game (with a house advantage of 5.26%) to a single zero roulette game (with a house advantage of 2.70%).

Pushback might also be anticipated from intermediaries, who might view this strategy as one which rewards the players and casinos at their expense. One way to find a middle ground with intermediaries would be to use the bonus payments in a manner where bonus chips would parallel the structure of the current dead chip system as a simple accounting tool and proxy for handle. For example, consider Bonus Baccarat™ where bonuses are paid with special non-negotiable chips. Commissions to intermediaries could be determined based on the number of non-negotiable bonus chips won by their players over any given time period. That win rate should be once every 1/p decisions, where p is the probability of the bonus being awarded. For Bonus Baccarat™ that ratio would be around 10.5 to 1. It would be possible to construct commission payments on the accrual of bonus chips. While such payments would still be an expense item on the casino's books, they create the opportunity of a hybrid that might be well received, especially if a large portion of high value players decide to bypass the intermediaries altogether. Further game discounting could be achieved by this simple mechanism when advantageous to the casino to do so, and payments to intermediaries could be made in varying increments as appropriate. Furthermore, players and casino would be better able to determine whether the services provided by intermediaries were indeed worth the cost. Competition among intermediaries to provide "value for money" would undoubtedly increase.

Thus, with introduction of these variant baccarat game offerings, casinos could begin developing a strong product differentiation strategy in Macau. The premium product offered with Bonus Baccarat™ and Super Bonus Baccarat™ could be maintained as an exclusive offering to a limited number of high-value players playing in casino controlled VIP rooms, or to such players with intermediaries where the terms offered were adequate to benefit all relevant parties. This kind of innovation might just create a win-win-win situation. If gross gaming revenues were to increase as a result of such innovation, then it would certainly be a win for players, a win for casino operators and a win for the tax coffers of Macau as well.
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