Oregon Lottery Director Dale Penn, seeking to capture millions of additional dollars for schools and other state programs, on Tuesday proposed a nearly 50 percent rate cut for retailers offering the lottery's new electronic slot machines.
The rate cut, the biggest proposed by a lottery director since the state first ventured into electronic gambling 13 years ago, was cheered by school advocates who complain that bars, taverns and restaurants have been making excess profits off the lottery.
But the Oregon Restaurant Association, which represents many of the 2,000 video lottery retailers, immediately denounced the proposal and said few, if any, establishments would be interested in carrying the new games with such a low commission rate.
Retailers now receive slightly less than 29 percent of the roughly $531 million spent last year on the machines. Penn recommended that retailers get 15 percent of the cut for the new slot games, but he said they should be able to keep the current rate for video poker. Eventually, however, lottery officials expect the slot games to dwarf video poker in sales.
The five-member lottery commission will make the final decision sometime after the first part of April.
Penn, a former Marion County district attorney named to the lottery job last fall, is now largely coming down on the side of several economic studies done over the years that have argued that commission rates could be much lower and still provide a reasonable rate of return to retailers.
Until now, retailers have successfully fought off large rate cuts through a vigorous lobbying effort. They argue that they play a key role in making electronic gambling such a big success. The lottery is now the second-largest source of money -- after the income tax -- for the state's general fund.
Penn chose his words carefully Tuesday as he declined to criticize the current commission structure. Instead, he said he wanted to create a "financial bridge for the retailer network" by keeping the old rates on video poker games while the state introduces the new games.
Penn said he was able to propose a greatly lower rate for the new games only after recently learning that the lottery's computer network can track whether a customer is using a video terminal to play a slot game or video poker.
Eventually, the slot games are expected to be the favorite choice of gamblers. In the state's tribal casinos, more than 90 percent of the terminals are set up to play slots. Unlike the video poker machines -- which feature largely static graphics of playing cards -- the slots feature colorful animation, story-like action and simple rules.
Gov. Ted Kulongoski called for the lottery to move into the slot games, saying he needed additional money in his budget, primarily to help the Oregon State Police. Penn said he's confident the new games will raise at least the additional $60 million a year the governor wants.
Penn said he would not try to force existing retailers to offer the new games, but he said the lottery would work hard to convince them "that this is the game that customers want."
Lottery Commission Chairman Kerry Tymchuk said the commission may eventually agree on a different rate. But he added, "If (retailers) want to participate in the game they have asked for many years, they have to accept that the rates are going to be substantially reduced."
Michael McCallum, president of the Oregon Restaurant Association, said most retailers would choose not to offer the slot games if they face big rate reductions.
"I'm stunned by it," McCallum said of the proposal. "I believe retailers will be angered by it. . . . There are significant numbers who will not make money at a rate like that and will not" participate in the new games.
But others said they think the retailers will be prodded into offering the new games by the marketplace. If a nearby competitor offers slot games, they could be forced to go along to avoid losing sales.
And Penn said new video lottery retailers coming on board in the future would be required to offer both video poker and slot games.
"The competition will be such that if you don't have it, it will hurt you," said state Treasurer Randall Edwards, who called the Penn proposal "a step in the right direction" toward providing more money for schools.
Andi Jordan, vice president of legislation for the Oregon PTA, said she wished Penn had gone further.
"Good for Director Penn for having the guts to do 15 percent for line games," she said, using the technical term for the electronic slots. "But if 15 percent is good enough for line games, why isn't it good enough for video poker?"
Ed Edwards of the Oregon School Employees Association said his organization would continue with its lawsuit charging that the lottery is failing to maximize revenues to the state as required by law. He said the lottery should use the popularity of the new slot machines to "play hardball" with the retailers and also require the 15 percent rate for video poker.
However, John Marshall of the Oregon School Boards Association said his organization continues to be concerned that lowering retailers' incentives to market the lottery could jeopardize the flow of money to the state. Last year, the video games produced $292 million in profits for state programs.
"Anytime you're affecting the income of your salesmen, you worry about whether they will move your product," Marshall said. "Hopefully, they have considered that."
Steve Novick, a longtime critic of lottery commissions who works with the Portland-based Citizens for Oregon's Future, argued that video lottery sales are primarily due to location and that retailers spend little to promote the games. The machines are owned and maintained by the lottery.
Letter from Dale Penn, Director, Oregon State Lottery
In a December 16, 2004 letter to the Lottery Commission, Governor Kulongoski stated that with the addition of line games, he expected the Commission to also examine the current commission rate structure. During the past six weeks I have received several thousand emails, phone calls, letters and personal visits from representatives on all sides of the issue of retailer commission rates for Video Lottery. Two positions have emerged with very different methods of maximizing revenue for Oregon, while providing a reasonable rate of return for our Video Lottery retail network.
I. Retailer Network
Just six months ago, Video Lottery retailer commissions were reduced by 10%, the largest reduction in the history of Video Lottery. This reduction has caused financial difficulty for many retailers, although the number of retailers has remained at 2,000.
Most Video Lottery retailers (1,200) throughout Oregon receive less than $35,000 per year in Video Lottery commissions. Retailers in smaller towns are particularly financially vulnerable to additional reductions in commission rates. It is important to maintain a diversified statewide Oregon lottery system rather than forcing rural Oregonians to travel to three or four cities along the I-5 corridor to access lottery games much like traveling required to visit casinos.
Video Lottery has been very successful, producing $600 million for State services in 2003-2005. In addition, the retailer network produces substantial income for Oregon with traditional lottery sales, independent of Video Lottery sales.
Public education is the primary beneficiary of Lottery transfers to the State, receiving $445 million during 2003-2005, and over $2.1 billion since 1995.
It is important to insure the continued strength of Video Lottery to produce over $600 million of base funding for State services while attempting to introduce the new product of line games.
II. State Services
Many vital State services are facing program reductions including the State Police and Education. This has placed extraordinary stress on the State's budget process and has resulted in a careful review of the Lottery's goal to maximize revenue for Oregon.
Governor Kulongoski requested the Lottery Commission to authorize line games only because of the need to provide an adequate and stable revenue source to fund the Oregon State Police Patrol program for important public safety and economic stability.
Governor Kulongoski has personally told me several times that consistent with the statutory guidelines of maximizing resources to the state while providing the retailers with a reasonable rate of return, he would also like the Lottery to produce additional revenue for State services, including Education.
III. Lottery Commission
The Lottery Commission has carefully reviewed studies which place rates from 15% to 35%. Rates began at 35% and have been reduced over the years to the present rate of 28%.
Lotteries are complex businesses and past experience has shown that simplistic, yet dramatic, changes can result in diminished sales and diminished State revenues:
Texas reduced prize payout percentages in 1997. Sales and revenue dropped dramatically. Sales still have not surpassed 1997 levels even after corrective action in 2000.
Wisconsin cut advertising in 1993. Subsequent lost sales greatly exceeded the saved advertising costs. It was determined that every advertising dollar produced a $25 gain in sales.
The Lottery Commission has implemented and reaffirmed the finding in the 1997 KPMG Study which stated: "The study team believes that changes to compensation should be implemented in a cautious manner over a period of time." (KPMG, at p. 54)
IV. Director's Proposal
No one questions the need to maintain the base level of State funding provided by the Oregon Lottery. No one questions the need for additional services in Public Safety and Education. Lottery staff has worked exceedingly hard to develop a proposal which can produce both desired outcomes.
We have re-examined the base assumptions of my January 5, 2005 proposal. One difficult problem was that our gaming central system currently does not separate commission rates by game. This meant that we could not pay different commission rates for poker games and line games. By shifting priorities and resources, we can expedite changes to the central system allowing us to separate commissions by game. This will enable the Lottery to pay video poker commissions consistent with our contract for poker games, which was signed less than one year ago. The Lottery Commission determined this was a reasonable rate of return to Lottery retailers for the sale of video poker games and this will maximize State revenue by protecting the $600 million base revenue from these games.
Line games are a new product which will reside on almost all of the same Video Lottery terminals (VLTs) already in place throughout Oregon. The Lottery will purchase new software and computer chips to place in these VLTs which will allow them to offer line games as well as video poker games. Because line games will not significantly increase costs to retailers, and will add incremental sales, I propose a new flat commission rate for line games of 15%.
V. Process
This proposal is simply the beginning of rule-making to formally adopt a rule through an open, public process. There will be a public hearing at the Oregon State Fairgrounds on March 25, 2005 at 9:00 a.m.
I anticipate that in April, perhaps at a special meeting, the Lottery Commission will adopt a formal rule setting the commission rate for line games. After the public hearing process the Commission may adopt a rate different than my proposal today.
This is almost like cutting the hand that feeds them.