In my earlier post on the CVC/Richard Koch bid for Betfair, I commented that they may be buying into the current strategy to take on the bookmaking industry at its traditional game, or alternatively might be playing Fantasy Betfair. This blog, which is part 2 of my thoughts on a potential private equity bid, is designed to explain what I meant.

Nowadays, when you land on Betfair for the first time, you see a sportsbook, not an exchange. The need to simplify the product in a way which takes it to a broader audience has seen it focus on fixed odds to the extent that as a new Betfair customer, if you don’t know the exchange exists, you aren’t likely to find it. It’s just a small button in the top-left hand corner.

The reasons for this perfectly valid strategy are fairly obvious. The company has had a lot of problems, and the lustre has rubbed off. Last week I had to explain to someone with only five years’ experience in the gambling industry why Betfair should be of any interest to anyone: he asked why some people make a fuss about a company which, to his eyes, was just a mid-tier betting business with nothing particularly exciting about it. As I said in my last post, even some from the company’s very early days believe that it could never re-create the magic even if it wanted to – and in any case, current management doesn’t. So that’s that.

But you can indulge me, just for a little, as the exchange evangelist that I am; as someone who remembers that somewhere lost in the midsts of time, we changed the world. It was a small corner of our own little world, perhaps, but who cares? We changed it, and it has never changed back. So much of what you see as standard in the gambling industry today first appeared, for one reason or another, as a result of Betfair: football shirt sponsorships by betting companies, in-play betting, the level of transparency, the sharing of information, the tracking of funds… None of it existed when we arrived to tell people – laughable as it now sounds – that we were ‘bringing financial markets best-practice to the sports betting market’. The betting industry today is a different place because of Betfair – and specifically because of the exchange.

The exchange was not perfect, by any means: it raised questions, it brought challenges, and – most of all – it was too complicated. But in the context of the CVC bid, and bearing in mind Richard Koch’s book The Star Principle which I touched on in my last post, I think it is interesting to challenge the idea that it is the exchange at heart that is where the company has gone off the boil: is conventional wisdom right when it says that the difficulty of getting the exchange into markets, of explaining the exchange to a wider audience, of getting the exchange simply to deliver a single price to the uninitiated, meant that the business would never be as scalable as it first looked?

Away from the mechanics of the product, what made Betfair work was that every important stakeholder group thought it was the greatest thing since sliced bread: its staff were all its best salesmen, down to Rita the cleaner; its customers felt so much part of it that they called themselves Betfairians; the media thought the business could do no wrong; the City was desperate for a piece of it; and the Government saw it bringing ideas and solutions to what had been regarded as an opaque and difficult world. That is not to say that it didn’t have its detractors – of course it did – or even that everyone bought all the points just made, because they didn’t. But the people that mattered, sold it. ‘Join the revolution’ was one of our adverts: if you weren’t on it, your friends were asking you why.

One by one those key stakeholder groups fell away, to the extent that only one remains. The staff became unhappy; the customers got up in arms; the analysts and the media went from thinking that the company could do no wrong to thinking it could do no right. Only the Government, basing its view largely on initiatives taken a decade ago, continues to see the business as industry-leading in the areas that matter to it (like problem gambling, for example). The viral nature of Betfair, where its marketing spend was reinforced – not to say subsidised – by its huge army of advocates, ceased to exist. The cost of acquisition no longer benefitted from a network effect, and the company got into a cycle where its marketing spend grew, every year, in parallel with the growth of its top line.

That costs accelerated as money and people were thrown at problems is, I think, widely recognised: that’s why there have been the mass redundancies that have recently occurred. What (I think) is not so well understood is this falling away of the stakeholder groups, and the impact it has had on the business. For me, getting those stakeholder groups back is the key piece to returning the company to where it was – the lead player in a fast-growing niche – and in my opinion, that should not be an insurmountable task. After all, it is possible to identify, in each case, mistakes which drove them away.

Take the premium charge, for example. Someone mailed to ask me about it yesterday, and pointed out that I was quoted, when we introduced it, as saying that it was needed, because without it the cost of acquisition was not matched by the lifetime value of a customer: too much of the money taken from a customer who would then churn away went directly into the pocket of a small number of other clients. I said then that any business that got to where we were would have to introduce the same thing, because otherwise the revenue gained didn’t match the cost of acquiring the customer – and that was an obvious road to the poorhouse.

All that was true. But what my comments, and our strategy, probably didn’t take fully into account was why the cost of acquisition (which was so much lower than other gambling businesses) was rising (or why the network effects were diminishing); or the fact that a consequent drop in the number of advocates meant in turn that the cost of acquisition would go up at the same time as liquidity went down – creating a spiral which was going the wrong way. Replacing lost revenue means increasing tax on the people who are making the money, which in turn means more of them fall away, and the cycle continues. Observers of the broader economy will recognise the pattern.

Before long, the talk became that Betfair had saturated its audience of possible exchange customers, which explained the slowing growth. But I think that view needs challenging, even if just on the basis of anecdotal evidence. I know scores, if not hundreds, of decent-sized, sophisticated punters who don’t use Betfair, which suggests to me that far from saturating its audience, it has barely scratched the surface (and that’s just in the UK). I went to the Open Championship last year with six big gamblers who didn’t have a Betfair account between them.

And I suspect that neither, now, will they ever get one, because there’s no viral effect that will persuade them to join. Betfair is not the company that it was – not in the “those were the days” sense, but in the Star Principle sense: it is not a market leader in a fast-growth area, with advocates everywhere you look. Most think that it was always inevitable that it could not be one for ever, and the fact that it no longer is can never be changed back. But in my opinion two things are true: first, it could so easily still be one, had we made a few decisions differently. And second, pace the person I dined with on Thursday, it would not be impossible to get back to what it had and where it was.

All of which brings me to my point, in the context of mooted private equity bids for the business, which is this: there’s a path that says “the exchange could never break through to the mass market: make the most of what it created, but aggressively build a largely new business on the back of its most successful parts”; and there’s another one that says, “the stellar nature of this business has never been quite fulfilled for various reasons, but the fact is that the exchange still makes the business what it is, even if some past mistakes make it appear otherwise”. That latter case does not mean that there is no place for fixed odds: there certainly is. It just has a different focus on what is the primary product.

Plenty will think the second view a fantasy, and because of the difficulty, and risk, and short-term effect on numbers that pursuing it would have (vastly reducing – or perhaps even abolishing – the premium charge, for example), it certainly is in a public-market environment. But I happen to subscribe to it in principle; and as a private company, I think it would be entirely possible in practice.

Betfair might go private with the same strategy that it has recently chosen, or it might stay public and continue down that path, to great success. As I have said before, I think the shares are a buy at this level even with a strategy which, for the purists, makes it not Betfair in anything but name. With costs stripped out, it’s a very decent cash cow of a business even as a me-too, and good luck to it. But boy, would it be exciting and a lot of fun to see it return to being a star.