Facing the Challenges of Vertical Integration in the Gambling Industry

by Ivan Stefanović, Deloitte

One of the biggest challenges facing operators in the gambling industry is the degree of vertical integration. Every operator has to decide where to set the boundaries of its operations or, in other words, in which vertical stages of the gambling value chain will it compete.

One portion of the operators is exclusively involved in providing gambling, betting, virtual and number games (or some subset of these products) through on-line and land-based channels, while everything outside of this scope is being outsourced. Other operators decide to integrate backwards along the value chain in order to internalize the development and maintenance of a proprietary technology platform, which is essential for the operations, as well as for the products and services provided to the customers. In this way, operators are mitigating the risks inherent to the supplier-byer relations in the open market, but stepping into other business risks associated to the development and running a platform, platform maintenance, etc. (not to mention the accompanying capital costs and time needed for this endeavor).

What factors influence the decision on where will the boundary be set in terms of the scope of operator’s operations?

In essence, this challenge comes to decision on where the line will be drawn. So, what factors influence the decision on where will the boundary be set in terms of the scope of operator’s operations? How does the management decide which part of the business to outsource and which part should remain inside its scope of operations? In general, any outsourcing decision should be primarily based upon transaction costs analysis and resource/capability review.

Transaction costs are the costs of making an exchange of a product or service. This exchange can be external or internal. An external exchange occurs between two or more companies, generating the costs of sourcing the supplier, negotiating the terms of transaction, creating and monitoring agreement, etc. These costs largely depend on the level of market imperfection. More market imperfection leads to higher transaction costs. On the other hand, if a company decides to make the product or provide the service within its boundaries, that is called internal exchange, and it includes costs such as planning, developing, organizing, staffing, coordinating, controlling, etc. Internal transaction costs are directly related to the level of organizational complexity. More complex organizations have taller hierarchies, more organizational units and, therefore, more dispersed authority. In order to be controllable, more complex organizations require stronger integrating mechanisms, which are more expensive. To sum up, higher external transaction costs lead to internalization, while higher internal transaction costs result in outsourcing.

When it comes to resources and capabilities, it is of the utmost importance to make a clear conceptual distinction between these two terms.  Resources are seen as tangible and intangible assets which are tied semi-permanently to the organization (Wernefelt, 1984), while capabilities are focused on the combination and linking of resources, i.e., they represent a distinctive and superior way of allocating resources (Schreyögg & Kliesch-Eberl, 2007). One of the most sustainable competitive advantages stems from the possession of the unique and valuable resources, and the specific manner in which a company combines and uses them (Prahalad & Hamel, 1990). Therefore, if resources and capabilities comprise the strategic advantage of a company, they will remain internalized. Otherwise, the decision on outsourcing should be considered.

After reviewing the most influential factors of the outsourcing decision, it is important to take a look at the challenges facing those operators that decide to take the harder strategic choice, at least in the short-run – those opting for internalizing the development and maintenance of a proprietary platform. These challenges are structured according to the Galbraith’s Star Model (Kates & Galbraith, 2007) that encompasses capabilities, structures, integrating mechanisms/processes, performance and reward systems, and people practices.

Capabilities

Having a proprietary platform development within a gambling operator company means having two completely different organizations in one company. These two organizations require different capabilities that will ensure each of them is viable and running: IT organization must possess capabilities related to the IT operations, software development, quality assurance, etc., while gambling operator organization must focus on acquiring and understanding events and markets, bookmaking, risk management, etc. Besides these core capabilities inherent to the existing of both organizations, a more strategic capability is needed – successful integration of an IT organization and gambling operator into one company requires the ability to balance between protecting innovative and agile ventures in the IT organization from the core business of the gambling operator, and finding the right linkages to leverage the overall business by creating synergistic effect.

Structure

Having an IT organization and a gambling operator under the same roof will result in the development of a dual structure that will allow differentiating efforts to focus on either exploratory and innovative side of the IT organization or exploitative side of the gambling operations. This kind of structural differentiation protects ongoing operations in the gambling part of the company from interfering with processes and competencies being developed in the IT part of the company (cf. Jansen et al., 2009). It allows very different frames to coexist in the company, while not requiring different cognitive frames to coexist within individuals. The only frame integration that does occur within individuals is at the corporate level, where they need to engage different frames without the risk of creating operating inconsistencies (Gilbert, 2006). In other words, these differentiated autonomous parts of the company ought to be strategically integrated through a senior executive’s vision, while having limited tactical integration between themselves (Tushman & O’Reilly, 1997).

Integrating mechanisms/processes

Aforementioned structural differentiation in time leads to the creation of a deep and wide chasm between the IT organization and gambling operator. Since these two organizations are indispensable parts of a larger company and must cooperate tightly, the chasm must be bridged using strong integrating solutions. More specifically, the two organizations need to establish a supplier-client relationship, where an IT organization will be a designated supplier of the platform and other IT services to the gambling operator. Therefore, integration should be established through behavioral and social solutions, as well as carefully selected set of systems and processes that collectively define employees’ behavioral context. From the simple and less expensive to more complex and expensive integrating mechanisms, these solutions include: informal networks, teams, integrative roles, and matrix structures.

Performance and reward system

Performance and reward system should be designed in a manner that will support the alignment of individual and group behaviors and performance with the company’s goals. It needs to be designed in a way that will motivate all employees to take initiative and become active contributors to the company’s success. Even though an IT organization and a gambling operator represent two very different organizations, they are inextricably intertwined, which is why there should be some sort of a common-fate performance and reward system in place. This system needs to be one of the main tools in shaping the desired organizational culture that will pervade both IT organization and gambling operator, and unite them in their quest toward the achievement of the company’s goals.

People practices

People practices involve various policies related to selection, staffing, training, and development of employees that are established to help form the competencies and mind-sets necessary to carry out the company’s strategy. Like in other industries, it is of the utmost importance to recruit and select the most suitable candidates for each position in the company, no matter whether it is located in the gambling operations, IT organization, or some of the support processes. Of course, the special attention should be paid to the customer-facing positions, such as operator in the retail outlets and customer support specialist working on the digital channels. Comprehensive skills training for these two positions is a must. Also, people practices need to foster a high-level of mutual understanding and respect between employees working in an IT organization and a gambling operator.

Building a gambling company comprised of an IT organization and a gambling operator is a hard task to master. In order to become viable, these gambling companies must learn how to overcome the challenges of vertical integration by achieving superior performance both in more explorative and innovative activities within an IT organization, as well as in exploitative, on-going, day-to-day operations within a gambling operator part of the company.


References

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