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Lottery efficiency study:
State of the state lotteries

By Patricia A. McQueen

The results of this study are documented in tables that are available as PDF files that use the Adobe Acrobat Reader in order to be  viewed. To download Adobe Acrobat Reader, click on the graphic below.

Table 1: Lottery revenue/expense analysis

Table 1A: Video lottery operations

Table 2: Ranked by fiscal 2000 sales as a percentage of state personal income

Table 3: Ranked by fiscal 2000 government revenue as a percentage of sales

Table 4: Ranked by fiscal 2000 government revenue as a percentage of gross revenue (sales - prizes)

Table 5: Ranked by cents spent to generate one sales dollar in fiscal 2000

In the world of gaming, lotteries are unique in that their entire purpose is to generate revenue for good causes. At least in the state-run environment in which U.S. lotteries operate, there are no gaming taxes, no private industry profits siphoned off the bottom line. There are simply sales, operating expenses and net profits to state-funded causes such as education, the environment, economic development.

In our annual review of lottery operations, we examine the ability of lotteries to generate those revenues. As with any performance rankings, there appear to be winners and losers. Yet individual differences between markets are often due to public policy decisions that affect performance, as politicians wrestle with the idea of what they want their lotteries to be.

Lottery effectiveness
Although some analysts rely on per capita sales figures, we believe that measure yields too narrow a view of a lottery's success in its marketplace. A more balanced measure of effectiveness, or the ability of a lottery to penetrate the marketplace, is the percentage of personal income extracted by sales. This takes into account variations in wealth among states.

By this measure, as indicated in Table 2, the Massachusetts Lottery continued its stranglehold on the top spot, comfortably in front of Georgia, which jumped past the District of Columbia to gain the second spot. These three lotteries lead the pack by a wide margin.

The biggest mover was New Mexico, which led all states in percentage increase in sales. Its 24 percent jump moved it from 34th to 26th. Fiscal 2000 also saw a newcomer in the Top 10, as New Jersey's 11 percent growth sent it from 12th to eighth.

We remind readers that a high level of lottery sales does not guarantee a high effectiveness ranking. Numerous factors influence how well a lottery penetrates its market, including population demographics, the range of product offerings, the competitive environment, and promotion and distribution methods. Many of these things are out of a lottery's control or mandated by state policy makers, so direct comparisons between lotteries are not possible.

Lottery efficiency
Because changes in lottery effectiveness are often functions of sales changes, another useful measure of performance is efficiency: how lotteries conduct business operations regardless of sales. There are several measures of lottery efficiency, including government revenue as a percent of sales (Table 3) and as a percent of gross revenues (Table 4); and the cents spent (operating expenses, including retailer commissions) to generate $1 in sales (Table 5).

Effectiveness and efficiency are often conflicting goals, and as a result, lotteries that perform well by both measures are rare. For example, sales are often driven by a high prize payout percentage, which reduces government revenues as a percent of sales. Still, two states - Massachusetts and Connecticut - managed to be in the Top 10 in prize payout and in most other measures as well. Other stellar performers include Florida, Maryland, Michigan, New Jersey and Pennsylvania. 

On the efficiency rankings using government revenues, seemingly inconsistent performance by a few lotteries in recent years was not caused by fundamental changes in operating efficiency, but rather by the reporting of nonoperating items such as investment income and changes in the net value of investments.

None of these lotteries' operating performances should be criticized simply because market forces drove down nonoperating revenues. And given the volatility of the market, these changes are likely to continue affecting lotteries' net proceeds.

We include such nonoperating items in the calculation of government revenue because lottery money is ultimately the source of those items and lotteries' management of their investments can be an indication of their efficiency. However, because of the impact on government revenues from year to year, we are including in Table 1 a column listing operating income. While there is no table specifically ranking lotteries by this category, it is available for reference.

VLTs
The preceding analysis reflects lotteries' traditional online and instant ticket sales only. Five U.S. lotteries also offer video lottery terminals (VLTs): Delaware, Oregon, Rhode Island, South Dakota and West Virginia: the results for these activities are shown in Table 1A.

It is important to note that legislation enacted in each of the VLT states is the most important factor affecting VLT performance measures, because commissions to operators and/or vendors are the largest expense and are typically set by statute. In addition, the three states with machines at racetracks (Delaware, Rhode Island and West Virginia) have as an expense the amount set aside for purse supplements. Of those three, Delaware and West Virginia set aside the most for purses, so their net government revenue as a percentage of net machine income is considerably lower than in other states.

Definitions
Gross revenues are total sales minus total prizes paid.

Operating expenses consist of a lottery's current-year expenses, including retailer commissions but excluding identified nonoperating items.

Operating income is the net revenue generated by each lottery from current-year operations, before nonoperating items such as interest and changes in investment values.

Government revenue represents the amount available for a lottery to turn over to the government based on current-year operations and nonoperating items. The revenue may not equal the actual amounts turned over to designated state funds. Some lotteries hold back a small portion for reserves; alternatively, some draw down on retained earnings and contribute more to state funds during the current year than was actually earned. 

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