Will Indiana, Pennsylvania Follow in Illinois’ Footsteps on Lottery Privatization in 2012?

One of the more interesting developments last year in the world of privatization was Illinois’ first-of-its-kind privatization of the operation of its lottery, covered in detail in Reason Foundation’s Annual Privatization Report 2011 (lottery article link here; full report here). Illinois officials crafted the privatization initiative such that the private operator committed to increasing net lottery revenues to the state by an expected $1 billion over what the state had estimated under in-house operation over the next five years, with the new revenues dedicated to education and infrastructure.

The Annual Privatization Report 2011 article noted that Illinois’ lottery deal caught the attention of policymakers in several other states in the second half of last year, and in just the last two months, two additional states have begun taking formal steps to evaluate the potential for similar transactions.

Last Wednesday, the Indiana State Lottery Commission announced a solicitation seeking firms interested in assuming operation of the Hoosier Lottery. As Leslie Weidenbener wrote last week in The Courier-Journal:

The state will take steps to hire a private company to help run the Hoosier Lottery in an effort to make more money from the games — a step already taken by Illinois and under consideration in Pennsylvania, New Jersey and other states as well.

The Indiana State Lottery Commission voted 3-0 Wednesday to seek information from companies that would be willing to “perform a broad scope of services” for the lottery. Then in September, the state plans to accept actual bids.

“Gov. Mitch Daniels has consistently challenged all of us to identify and implement changes that promote more effective and more efficient state government,” said Hoosier Lottery Executive Director Karl Browning in a statement the agency issued Wednesday afternoon. “The goal is to become more strategic in our business approach in an effort to increase revenue for the State of Indiana,” he said.

[…] The Hoosier Lottery released what it called a “Request for Expression of Interest” on Wednesday, which lists areas of potential growth opportunities:

• Reconfiguring the current retail and distribution network, potentially increasing its scope and reach;
• Optimizing commission structure for retailers and other distributors;
• Optimizing the gaming experience within the legal parameters of the United States and the State of Indiana;
• Enhancing marketing activities;
• Marketing the Lottery to new, infrequent and lapsed players to increase the breadth of its customer base
• Implementing new technology platforms to enable more effective and efficient operations; and
• Making improvements to the supply-chain.

Similarly, last month Pennsylvania Gov. Tom Corbett announced that his administration had launched a similar process, testing the market for interest in a private management contract for that state’s lottery. According to the Governor’s press release:

Governor Tom Corbett today announced his administration is taking an innovative step that could increase future funding for a wide range of vital programs for older adults supported by the Pennsylvania Lottery.

The commonwealth has issued a Request for Qualifications to pursue a private management agreement for the Pennsylvania Lottery. Should the state decide to move forward with accepting bids, qualified private sector firms will compete to offer new ideas to maximize the Lottery’s performance and increase revenues that support programs serving older Pennsylvanians.

“The Pennsylvania Lottery is the nation’s one and only lottery that benefits older adults and that will not change,” Corbett said. “This initiative is simply part of my administration’s efforts to tap private sector innovation to make state government work more efficiently and effectively, which is precisely what taxpayers expect.

“Our state’s fast-growing population of older adults means time is not on our side, and we need to maximize funding for senior programs and services in a way that does not ask taxpayers to dig any deeper into their pockets,” Corbett added.

A private management organization may be better able to quickly adapt new technologies, develop new games and optimize retail outlet performance. It would be required to cover any initial shortfall to financial returns assured by any private management agreement.

In accordance with federal guidelines, the commonwealth would continue to own the Lottery — it would not be sold. A private management firm would be responsible for the Lottery’s operations, but the commonwealth would still conduct the Lottery and retain full rights to control, inspect and audit the Lottery.

[…] [State revenue secretary Dan] Meuser noted that over the last five years, Lottery net profits have grown an average of just 0.3 percent per year. In addition, the Lottery’s net revenue is projected to grow about 1 percent, on average, per year through fiscal year 2014- 15, which is not likely to keep pace with cost increases and demand for current programs.

These are encouraging developments in both states, as operating a lottery enterprise is not a core function of government in any semblance of the imagination. However, full privatization is not an option; any divestiture or long-term lease of lottery revenues would be prohibited under federal law according to the U.S. Department of Justice. So Illinois pioneered the next best thing: turning over lottery operations to a private consortium with deep operational expertise as a means to maximize marketing and retail performance, and thus maximize net revenues to the state. Why would anyone reasonably expect government agencies to manage such business functions better than…well, a real business?

And it’s no free-for-all for the private sector, as the contract in Illinois (and presumably the next states to follow their lead) requires the operator to receive state approval of its business plan annually and submit to other public controls. As I wrote in APR2011:

Illinois Gov. Pat Quinn announced the winning bidder for a contract to take over the management of the state lottery in September 2010. Officials expect the move to generate $4.8 billion for the state over the next five years, a $1.1 billion increase over the revenues projected under state management. Under the terms of the 10-year contract, the winning bidder—Northstar Lottery Group, a partnership between GTECH, Scientific Games and Energy BBDO—will take over responsibility for lottery operations, management and marketing functions in exchange for a portion of revenues. The state will continue to exercise control and oversight over all significant business decisions, including the state approval of annual business plans and ability to access all vendor information regarding lottery operations.

The deal also ties the operator’s compensation to its performance at enhancing lottery revenues. Through a combination of an annual $15 million management fee and incentives for extra profits, Northstar stands to earn over $330 million over five years if it reaches state-determined revenue targets. However, the contract includes a 5% total net income cap on the potential profits for the contractor, as well as penalties paid to the state if the company fails to hit revenue targets. The contractor will retain all current lottery employees and has announced its intention to hire an additional 100 private sector employees.

Read the whole thing here, and see here for more fascinating tales from the voluminous Annual Privatization Report 2011.