Helpful Casino Articles: Understand the Math

Cash Back vs Cash Rewards

2) Loss Discounts

3) Andrew MacDonald’s work paper on Loss Discounts

Cash Back vs Cash Rewards: What are the real costs?

Understanding the math is important

-By Steve Karoul

Customer loyalty?  Does it really exist in the casino industry today or are we just buying loyalty?  The casino industry has changed dramatically over recent years as competition increased.  As an independent casino marketing consultant I now find myself viewing the same situations that I previously reviewed as a casino marketing executive but now I look at them from a different perspective.  Casino executives tend to view many programs with an eye towards developing customer loyalty and consultants tend to look at programs from the view point of loyalty versus profitability and how do you balance both.  In the real world this is called “optimizing” the process for maximum profitability and maximum customer loyalty.  Most of these loyalty programs now target Slot players due to the fact that it is easier for the casino to more accurately track the slot customers play via their Player’s Club card in conjunction with the software used with their slot player tracking program.

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However, this is not a simple, clear cut analysis and casino management needs to very carefully evaluate many different variable factors.  In other words, you need to understand the math.  Slot marketing programs are actually quite interesting because there are so many different motivators available to choose from.  Never-the-less, they are all predicated upon rebating a pre-specified percentage of the slot handle or coin in back to the slot customer in one form of incentive or another.  In some cases, the slot customer plays for casino comps such as free room, free food or free shows.  In other cases, the player earns points based upon coin into the slot machine.  The points can then be redeemed or used at the casino for purchasing services such as rooms, food, beverage, entertainment, spa and

salon or in some instances even for retail purchases.  These points (1 point normally equals $1.00) normally cannot be used for gaming.  A second version of the program allows the points to be converted back into cash called “cash back” which is returned to the patron in the form of currency or cash.  And a third version allows the points to be converted into cash in the form of “cash rewards” but with the restriction that the given amount must be played through the machine at least once before it can be cashed out for currency.  Therefore, Cash Back does differ from Cash Rewards.

There are a number of other variables that also come into consideration such as the type of machine being played such as video poker versus video slots, the average slot hold percentage and the slot tax for that jurisdiction.  There is also one additional common denominator that is very subtly masked under all of this and that factor is called customer loyalty.  Why do casinos offer incentives?  They offer them because they work and they do help to bring players back to their casino.  These are not much different than the airline frequent flyer programs that also develop customer loyalty.  Therefore, one must assume that more incentives will translate into more customers which will also translate into more profits for the casino. Casinos constantly try to massage all of the variables in an attempt to tweak the formula for success and develop the perfect balance or optimization for maximum customer loyalty and maximum profitability.

Unfortunately, there is one major risk or flaw in this thought process.  If the formula used to initially calculate the incentive is incorrect, then it is possible for the incentive to very quickly turn from a player incentive into a casino liability because the more players that accept the flawed incentive would equal increased losses for the casino instead of increased profits.  I have seen many strange slot marketing programs that just do not make good business sense to me.  The only thought that occurred to me was that the casino must be using their slot loyalty program as a “loss leader” similar to what food chains or restaurants sometimes do to drive traffic to their location in order to help steal market share from a competitor similar to the casino $3.95 Prime Rib dinner special.  However, when you see the program continue over long periods of time you really have to ask yourself if management ever really analyzed the actual true costs of their promotion or incentives.  I would bet that they had not.  Once again, understanding the math is important.

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Unfortunately, there is one major risk or flaw in this thought process.  If the formula used to initially calculate the incentive is incorrect, then it is possible for the incentive to very quickly turn from a player incentive into a casino liability because the more players that accept the flawed incentive would equal increased losses for the casino instead of increased profits.  I have seen many strange slot marketing programs that just do not make good business sense to me.  The only thought that occurred to me was that the casino must be using their slot loyalty program as a “loss leader” similar to what food chains or restaurants sometimes do to drive traffic to their location in order to help steal market share from a competitor similar to the casino $3.95 Prime Rib dinner special.  However, when you see the program continue over long periods of time you really have to ask yourself if management ever really analyzed the actual true costs of their promotion or incentives.  I would bet that they had not.  Once again, understanding the math is important.

It is actually very important to understand the math and the cost of Cash Back as a percentage of theoretical win.  As part of my research for this article I found some excellent analysis by Andrew MacDonald from Sky City Casino in New Zealand.  Andrew also developed and maintains the gaming industry’s leading educational portal www.urbino.net which contains a number of helpful analyzers.  I also found some similar top quality research by Samson Tse who is a very talented gaming analyst with the MGM Grand.  I also further verified their analysis with Eli Abramovich who is a highly regarded gaming analyst and statistician in Israel.  Their analysis is fairly technical and involves a second order polynomial with a quadratic equation that considers the following variables:

C = cash reward percentage of drop

T = tax rate for that jurisdiction

H = hold percentage (slot win / drop)

R = 1/h (turn ratio to exhaust funds)

X = percentage of slot theoretical win

Cash Back Formula: T% x C%/{H% x (1-C%R)}

By using this formula  Samson was able to solve for C (Cash Reward as a percentage of handle) and Andrew was able to solve for potential growth in turnover and win as a function of introducing Cash Back.  If no reinvestment occurs and players cash out their Cash Back incentive rather than use it for additional play then the growth factor will equal zero percent (0%).  However, if re-investment occurs and players play until exhaustion of cash back funds, then growth =

C% = cash back percent of turnover

P% = return to player level

1 / (1-P%) = R turn ratio to exhaust funds

T% = tax rate

1-P% = H% hold percentage

Potential growth in turnover and win as a function of introducing Cash Back, Formula:

{C% x (1/(1-C%R))} / (1-P%) or {C% x (1/(1-C%R))} / H%

By inputting the correct numbers into the formula depending upon the jurisdictional tax rates will reveal some very interesting information.  For example, Andrew’s analysis was based upon information from Australia and he determined:

Cost of cash back as a percent of theoretical win:

Range from: 1.96% (play until exhaustion)

Range to: 4.67% (no play)

Growth in results due to cash back:

Range from: 0% (no play)

Range to: 4.90% (all recipients play until exhaustion)

These numbers are important for budget purposes.  For example, by knowing what percentage of the slot play comes from Slot Club members, we are able to more accurately calculate the dollar amount that needs to be budgeted to cover the cash back expense.  If approximately 40% of turnover is derived from Slot Club members, this would equate to 1.87% (40% x 4.67%) of total Slot revenue that must be budgeted as the cost of the Cash Back program using the examples cited above.

The point is that giving cash back to players may generate growth in the first year over previous year’s results and needs to be considered when analyzing results.  The cost of providing cash back may be simple to calculate when no incremental play occurs from those funds.  However, the real cost to the company may be as little as the gaming tax if the cash is played as incremental revenue and the player plays until ruin.  In jurisdictions where the gaming tax is relatively low, the real cost of the cash back will also be low if no incremental re-investment occurs.  Andrew further states, “In reality, the real cost of cash back will lie somewhere between these extremes and this factor should be considered in the design phase of any Slot Club rewards program.  Improving cash back rewards over your competitors by recognizing this fact may provide a casino with a competitive advantage.  Or, in some cases, it may result in a switch from a gift redemption to cash back when the opportunity exists to gain a lower “real” cost structure”.

However, as a further example of why you have to understand the numbers, I asked Samson to use his analysis to compare Cash Back versus Cash Rewards in two completely different gaming jurisdictions where one Slot tax rate was 8% and the other Slot tax rate was 25%.  For this analysis we used the following criteria:

Player Hold %(H) = 10%

Tax Rate % (T) = 8%

Percentage of Hold to return to the Player % (X) = 2%

Cash Rewards to offer Player % = ???

Now let’s plug the variables into the equation:

C5 = 10% x 2%/(8% 2%)

C% = 2%

This means that we should be willing to offer the players 2% of the drop/turnover if we are willing to reinvest 2% of the Hold back to the player.  Therefore, a player with a drop of $1,000, the hold should be $100 ($1,000 x 10%).   Samson then suggests that if the casino is willing to reinvest 2% of the Hold or $2 ($100 x 2%) back to the player assuming that they will play to exhaustion then the casino can reasonably budget and offer the Slot customer 2% of the drop or $20 for that reward ($1,000 x 2%).

I know that this may seem confusing to some people but this will hopefully shed some additional light on why is so critical that you understand the math.  We now use the exact same formula but we now change the tax rate from 8% to 25% which is quite common with many Native American casinos as well as international casinos.  We now see that the only variable that changes in the formula is the tax rate.  The Formula is now, C% = 10% x 2% / (25% =2%).  Therefore, the maximum amount of Cash Reward that this casino should offer to the slot patron in this situation would be $7.40.

As you can see a $20 Cash Reward has much more appeal than a $7.40 Cash Reward.  The next big question for the casino operator is what is the real cost of customer loyalty?

I covered a lot quickly.  If any reader would like to receive free copies of both Andrew’s and Samson’s work papers and analysis along with their respective analyzers please E-mail me your name, position, contact information, etc. and I will E-mail copies to you.  Good luck.

Steve Karoul is one of the top casino marketing consultants in the world today with almost 30 years of experience with the best casinos both within the U.S. and internationally. Steve has lived in numerous countries and has conducted casino marketing activities in over 80 countries around the world.   He is a contributing writer to several different major casino publications often injecting his own hands on experiences. Steve can be reached at Tel. (1-860) 536-1828       or by E-mail: [email protected]

You can understand the math too if you try.  Good luck.

– My Loss Discounts Article  Download Article

– Andrew MacDonald’s work paper on Loss Discounts  Download Article