You Lose Again!

Once upon a time, the Texas lottery was the most successful in the world. Then the politicians got hold of it. The rest—and the lottery’s rosy future—is history.

March 1998By Comments

“YOU LOSE!” SO READ the headline of the cover story of TEXAS MONTHLY in June 1993, the first anniversary of the Texas lottery. Author Robert Draper told of the huge odds against winning the lottery and lamented how Texas had forsaken its petro-past. “Now that the state can no longer stake its fortune on the labors of a few independent-minded winners,” he wrote, “it seeks to profit from the 11 million Texans whom the state has converted into losers.”

Draper’s article notwithstanding, the Texas lottery went on to break all records as the most successful start-up in the history of the industry since the states took over the numbers racket from the Mob. But—You Lose Again!—those days are over. The already-formidable odds against winning have been made even more formidable, so that the state can gobble up some of the prize money previously paid to winners. Lottery sales have gone into a death spiral; they are millions of dollars below last year’s, and hundreds of millions of dollars short of the rosy projections made by the Legislature to balance its budget. The amount of revenue received by the state is down accordingly. The only thing worse than a successful lottery, it seems, is an unsuccessful lottery.

There will be those who say, “I told you so”—that Texas is getting what it deserves for basing its future upon the continuing gullibility of its citizens. But the sudden downturn in the fortunes of the Texas lottery is not simply a case of the public coming belatedly to its senses. The lottery is a victim of the greed and indifference of its own stewards—the Texas Legislature and the state lottery commission. They violated the first rule of government: If it ain’t broke, don’t fix it.

My own feelings about the lottery, like those of many Texans, are ambivalent. It brings in a lot of money, but it also brings in a lot of baggage. Politics, government contracts, and gambling are an explosive mix. There is too much money at stake, too many temptations, and too much opportunity to expand the lottery one day into casino gambling in the form of electronic slot machines like video poker. But the promise of easy revenue is irresistible, and so is the political appeal of a so-called voluntary tax. I volunteer only when the Lotto jackpot climbs above $20 million. When it reached $50 million just before my wife’s birthday last October, and I got a fortune at a Chinese restaurant that read “Invest wisely. Big things are coming,” I bought her $100 worth of tickets instead of blowing the same amount on a celebratory dinner. It was great fun—until our pile of slips produced one $3 winner and regret for a lost crème brûlée.

Still, you don’t have to love the lottery to want it to prosper, which it has been doing—until last year. Its annual sales for 1996 were $3.4 billion, a full billion dollars higher than any other state lottery had chalked up in its fifth year of operation. Its annual profit—that is, the state’s share of the ticket purchases—was more than $1 billion. But the figures for the last four months of 1997 tell an entirely different story. The Legislature projected a $599 million increase in the state’s share of lottery revenue during the next two-year budget cycle. Instead, the current pace of ticket sales will produce a decrease of $282 million. The difference between the budget and reality is $881 million. Since the history in other states where the lottery has slumped is for sales to get worse before they level off, the likelihood is that the final gap will reach $1 billion.

If these were hard economic times, a billion-dollar shortfall would force the state to pass a tax bill or make deep spending cuts. Fortunately, times are good, tax revenues are up, and Texas is expecting a budget surplus large enough to cover the lottery’s shortfall. But don’t think that an extra billion dollars couldn’t make a difference. It could do wonders for Governor George Bush’s proposal to have all children reading by the third grade. It’s enough money to give every school teacher in the state a $4,000 raise. It’s enough money to build forty prison units. It’s enough money to reduce school property taxes by the same amount that the Legislature, at Bush’s urging, lowered them in 1997. Whatever your preference might be, the opportunity is gone.

THE LOTTERY IS DIFFERENT FROM anything else that the State of Texas does. It is a business, and it cannot be successful unless it is run like a business, with a constant emphasis on the bottom line. A lottery ticket is a discretionary purchase; in contrast to collecting taxes, the state must actively campaign to separate people from their money. Without marketing, a lottery will wither away. Without winners, a lottery will wither away. These are the simple imperatives of the lottery business. Once the lottery got caught up in politics, however, its business side became secondary to its political side, for both the Legislature and the lottery commission. The lottery became subject to all the uncertainties of politics: greed, moralism, ambition, partisanship, and an aversion to bad press, to name a few. Decisions were made for political reasons, without regard to their business consequences, by people who never really understood how the lottery worked.

The secret to a successful lottery is never to let the public think of its participation as gambling. Opponents of the lottery criticize the state for luring the poor to buy tickets with the promise of instant wealth, but the odds are so long—16 million to one against winning the six-number Lotto jackpot—that most players know that they are probably going to lose. If all a lottery had to sell was the dream of getting rich quick, many players would soon get disillusioned and quit.

When disillusionment sets in, a lottery is said to be “mature.” It is down to its core clientele. This is why the typical pattern of a lottery’s sales is to rocket upward for several years, then reach a plateau as new customers (from population growth and coming of age) are offset by what is known in the industry as lapsed players. The longer it takes to reach the plateau, the higher the plateau will be, and the more income the state will receive, year after year. Florida and Texas had almost identical sales for the first and second years. Then Florida leveled off at $2 billion a year while Texas kept climbing to almost $4 billion. The goal of every lottery is to make its initial thrust last as long as possible.

The way to achieve this is to promote the lottery as entertainment, not gambling. Even if people lose more than they win (and almost everyone will), they will feel that they got their buck’s worth if they tune in to the drawing of the winning numbers or play with a calculator to figure how to spend their winnings or form office pools with co-workers to win a big pot. They also have to win now and then. As long as the lottery is fun, people buy tickets. When it stops being fun, they quit.

From its inception in May 1992, when the first scratch-off ticket was sold, the Texas lottery had exceeded all expectations. The take from its first day of sales was the best of any lottery anywhere. To keep up the pace, marketing by the lottery and its advertising firm, GSD&M of Austin, had to be intense. New scratch-off games had to be introduced regularly, before players tired of (losing) the old ones, and each one was sold to the public by wrapping the lottery in Texas mythology, just as GSD&M had earlier come up with “Don’t Mess With Texas” for its anti-litter campaign. There was Lone Star Millions and the Texas Two-Step, Cactus Cash and Fiesta. Eventually, GSD&M came up with “Scratchman,” a character who became the lottery’s symbol. All this effort by the state to pick the pockets of its citizens is hardly ennobling, but once its budget has become dependent upon a lottery, there is no other choice—even when things go wrong.

THE DOWNFALL OF THE TEXAS LOTTERY began in New Jersey. In October 1996 J. David Smith, the national sales manager of Rhode Island—based GTECH Holdings, was convicted in New Jersey on federal charges of fraud, bribery, conspiracy, and money laundering. GTECH operates the Texas lottery and has 70 percent of the world market for online games. At Smith’s urging, GTECH had hired a well-connected political-consulting firm to advocate expanding the New Jersey lottery to include video keno; the firm then kicked back $169,500 to Smith from its $30,000-per-month retainer. The headline on the story about the verdict in the Dallas Morning News read “GTECH Cases Not Expected to Affect Company’s Management of Texas Games.” Hah!

The genie that the Smith trial let out of the bottle was GTECH’s business practices, which could not stand the inspection they were about to get. Week after week, and sometimes day after day, Texas newspapers prominently featured negative stories about the state’s lottery contractor. By the time the revelations had run their course in the spring of 1997, the three-member lottery commission had voted to fire Nora Linares, the agency’s highly regarded executive director, and the commission had started the process of rebidding GTECH’s contract to run the games. The first revelation was among the most damaging: Smith had a contract with GTECH’s chief Texas lobbyist that at first glance seemed similar to his kickback arrangement in New Jersey. The lobbyist was none other than a former lieutenant governor of Texas, Ben Barnes, whose controversial career has made him a lightning rod for media scrutiny.

Barnes, now 59, had been Speaker of the House at 26, lieutenant governor at 30. Lyndon Johnson had predicted that he would become president of the United States. His career was torpedoed by the 1971 Sharpstown Scandal, which revolved around banking legislation sought by a Houston developer and gifts of bank stock to politicians, including the governor and Speaker of the House. No evidence ever linked Barnes to the scandal, and it is close to a certainty that he was not involved, but when he ran for governor the next year, he didn’t even make the Democratic runoff. Branded for life in politics, he became a professional wheeler-dealer, his most ambitious fling being his real estate partnership with John Connally, which ended in bankruptcy. After that fiasco, he landed the lobbying contracts for two megadeals, first a Texas bullet train, then the lottery, which he helped pass in 1991. Barnes’s emergence as a lobbyist was rather amazing, since he was long out of politics and wouldn’t have recognized most legislators if he had shared an elevator with them. But he understood a fundamental truth about lobbying: It doesn’t matter how well you lobby the Legislature; it only matters how well you lobby your client. Plus, he understood big deals, and the lottery was a big deal for Ben Barnes. So big, in fact, that his involvement alone was enough to turn a New Jersey story into a Texas story.

In the summer of 1992, after Smith began talking about going out on his own, GTECH had taken the unusual step of suspending its conflict of interest rules to allow Smith to make side deals. The next day, Smith and Barnes signed a contract. Out of every $3 Barnes received from GTECH as a lobbyist, he would pay Smith $1. In return, Smith would try to get new business deals for Barnes. To federal prosecutors in New Jersey, this seemed like another kickback scheme. But there were crucial differences. Barnes didn’t work under Smith, nor did he owe his GTECH employment to him. Barnes had a personal friendship with GTECH CEO Guy Snowden, who had found Barnes through their mutual contacts with the Bass interests in Fort Worth. (The Basses had loaned Snowden and his co-founders $200,000 to start GTECH in the early eighties; that investment earned them $40 million.) Nor was there any reason to believe that the arrangement between Smith and Barnes, however peculiar, wasn’t legitimate. Smith knew the gambling business in every state; a referral from him could lead to the big play Barnes is always on the lookout for. (The judge in Smith’s trial recently forced prosecutors to apologize to Barnes for disclosing grand jury information about him in Smith’s presentencing report.)

The next revelation was the size of Barnes’s lobbying contract, which was divided with an associate: $25,000 a month, plus four cents out of every dollar earned by GTECH in Texas after expenses, as much as $3.2 million in a single year. No one was more dumbfounded than Barnes’s cohorts in the lobby. “It’s as if everyone is driving Model T automobiles,” one told the Dallas Morning News, “and a spaceship lands from Mars. It’s a standard beyond what people even dream about.”

Even before the Barnes stories, GTECH had been no stranger to controversy in Texas. While it was still in a bidding war for the state’s lottery contract in the early nineties, consultants for its opponent (now known as Automated Wagering International, or AWI), assembled a book of unfavorable news clippings from other states about GTECH. Today, GTECH, its contract in Texas in jeopardy, does the same to AWI. It is hard for the public to tell what is just smoke, like the Barnes-Smith contract, and what is a smoking gun. During GTECH’s run of bad press in Texas, story after story detailed how many influential lobbyists GTECH had hired; what they didn’t say was that any company that is fighting for a nine-digit contract and doesn’t hire lobbyists is bringing a knife to a gunfight. Nor did anyone other than GTECH point out that none of the stories impugned GTECH’s handling of the operation of the lottery itself, which was, by all accounts, close to flawless.

The Barnes contract was made more controversial just because it involved Barnes. Republicans in particular were outraged. They had always been suspicious that the lottery was a Democratic playpen. Governor Ann Richards had endorsed it; Comptroller John Sharp had overseen it; Sharp had picked Linares, his own employee, to regulate it; and the lottery’s lucrative advertising contract had gone to GSD&M, whose “S,” Roy Spence, had handled the advertising for Walter Mondale’s 1984 presidential race. Now here was Barnes, a generous giver to national Democratic campaigns, getting $3.2 million in one year. “I think we have a gigantic problem, and it needs to be fixed,” said House GOP leader Tom Craddick of Midland. “We have got to see what kind of vendors we have got out there that allow a lobbyist to make $3.2 million a year.” By the end of 1996, as more stories about GTECH’s operations made the papers and the 1997 legislative session loomed just ahead, it was clear that the lottery wasn’t just entertainment anymore. It was politics.

WHAT WAS IN STORE FOR THE LOTTERY at the Capitol became evident at the first Senate hearing on the lottery commission’s budget in January 1997. The absence of any of the three appointed lottery commissioners had senators in a foul mood. Finance Committee chairman Bill Ratliff (R-Mount Pleasant), an uncompromising foe of the lottery, criticized a TV spot that showed an overjoyed winner jumping on a bed in glee. “[W]e are encouraging people to believe that you too can be a millionaire through the lottery,” Ratliff said. That, of course, is what a lottery does; the only way not to encourage it is not to have a lottery. Interim director Zoann Attwood, who had replaced Linares, could only reply, “I’m not sure exactly how you can promote a lottery without advertising it.”

The assault continued in the House. Rob Junell (D-San Angelo), the chairman of the Appropriations Committee, compared Scratchman to Joe Camel, an attempt to get kids hooked. Another House member said that there was no need to increase the advertising budget because the lottery had been around for five years and everybody knew about it by now. Very smart. Tell that to Coca-Cola. When the lottery’s marketing director warned the committee that sales would surely drop, she was berated for lecturing them and wagging her finger. In the end, the Legislature cut the two-year advertising allowance by $12 million, or 13 percent. The lottery commission decided to retire Scratchman rather than risk Junell’s wrath.

The effect of these decisions was devastating. Texas is an expensive state in which to run a statewide advertising campaign. It has twenty “designated marketing areas,” more than any other state. Dallas and Houston are extremely expensive buys. Now there would be fewer dollars to go around. Scratchman was a money-saver; Scratchman spots were cheap to produce and, because he was such a recognizable icon, had to run fewer times to get the message across. Still worse, GSD&M’s upcoming campaigns were based on Scratchman. Now the firm had to start from scratch, as it were, to create new spots and a new strategy, a process that takes months to develop, during which the lottery would be without marketing. Indeed, no lottery ad appeared on television between mid-May and November.

But the Legislature wasn’t through messing with Texas’ lottery. It needed additional revenue to offset the school property tax cuts promised by Governor Bush. At one point a committee voted to slap a sales tax on lottery tickets. Instead, budget writers decided to lower the percentage of each dollar that went for prizes, from 57 percent to 53 percent, raising the state’s share from 31 percent to 35 percent. (The remaining 12 percent goes to run the lottery and to retail ticket outlets.) The payout for new scratch-off games will go as low as 50 percent. You Lose Again!

The Legislature did all this despite ample evidence of the consequences: California’s lottery hit the skids when its legislature got greedy for more revenue, and it has never recovered. GTECH lobbyists warned that sales would plummet. Players, especially frequent players, know when they are getting ripped off. In the early years of the lottery, GTECH ran a test in which two games, Cactus Cash and Grand Slam, were marketed identically. The only difference between them was that the payout for Cactus Cash was 65 percent compared to 55 percent for Grand Slam. In ten weeks, according to GTECH, Cactus Cash chalked up $63 million in sales, while Grand Slam had $33 million. If you want more revenue, GTECH told lawmakers, don’t cut the payout; increase it. But nobody was listening to GTECH anymore.

GTECH WASN’T GETTING A GOOD reception at the Texas Lottery Commission, either. In the spring of 1996, well before Ben Barnes’s contracts became public knowledge, the commission had to decide what to do about GTECH’s five-year contract, which was due to expire in August 1997. The company wanted to negotiate a five-year extension without going through the lengthy process of competitive bidding—something that is not unusual in the industry—but its old rival for the Texas contract, AWI, was back in town, telling the commission that GTECH’s share of the lottery proceeds was too high. (This was the same figure, 3.944 cents out of every dollar-ticket sold, that had been 30 percent lower than AWI’s bid.) AWI told the commission that it would be worth $60 million to $360 million to the state over five years to rebid the contract. Executive director Linares and the commission staff favored renegotiating—why switch horses in the middle of a revenue stream?—but AWI’s message appeared to be getting through to commission chair Harriet Miers. Only when AWI admitted that it wouldn’t be ready to bid for at least another year did Miers agree to the renegotiation. Ever since, she has been GTECH’s worst nightmare.

A striking woman with below shoulder-length light brown hair and ever-assessing blue eyes, Miers has a knockout resume: former president of the State Bar of Texas; president (formerly known as managing partner) of the blue-chip Dallas law firm of Locke, Purnell, Rain, and Harrell; attorney for Microsoft, Disney, and a fellow named George W. Bush, both personally and as general counsel of his transition team. Her politics have been confined to serving on the nonpartisan Dallas City Council, running for bar president, and helping judicial candidates. She has built her career on integrity and public service—about as far removed from the world of GTECH as you can get. In early encounters, GTECH officials felt that she had exhibited no interest in what they call “growing the lottery.” The term they sometimes used for her was “supercop,” and that signaled trouble ahead, because the lottery commission is like no other regulatory agency: It is a business partner of the company that it is regulating. No business can function effectively if its partners must have a totally arms-length relationship. The tension between public ethics and private business is part of the baggage that comes with having a lottery. Pay too much attention to one side of the equation and the other will suffer.

That dilemma confronted Miers not long after GTECH’s contract was renegotiated. In November 1996, shortly after GTECH included a warning in its annual report to stockholders that “[t]he company is aware of federal grand jury investigations in New Jersey, Georgia, and Texas,” the news broke that executive director Linares’ boyfriend, Mike Moeller, had gotten a five-month, $30,000 consulting contract from GTECH in 1992 through J. David Smith. (At the time, Moeller had been under indictment for misusing taxpayer funds at the Texas Department of Agriculture; he is currently serving a sentence in federal prison.) The contract called for Moeller to find hunting leases for GTECH in New Mexico. Linares maintains that she knew nothing of the contract, and that their relationship, while friendly, was not romantic at the time. These protestations would stretch credulity, except for two things: the contract required Moeller to keep his employment confidential, and lottery directors who fall into disfavor with GTECH have a history of losing their jobs. It happened in Colorado, in Arizona, in Kentucky, and says Linares in a suit she has filed against the company, to her. (“In an effort to have some potential, future leverage over Ms. Linares, Mr. Smith instructed Mr. Moeller to keep his consulting agreement secret from all others, including Ms. Linares,” her petition alleges.)

But Linares’ situation was untenable, and the commission fired her in January 1997. Miers felt that there was a potential cloud over the lottery. “From the beginning,” she told a Dallas Morning News reporter, “Ms. Linares has been consistently an advocate of GTECH and its performance. I would hope it has been based on objective criteria and performances, but that is obviously an issue that this commission has to look at.” The biggest project that Linares (along with three other commission staffers) had overseen was GTECH’s contract extension. It had cut GTECH’s share of lottery proceeds to an average of 3.54 cents (from 3.944) over the life of the new contract. It also called for GTECH to install six thousand new online terminals that would bring in a projected $1.03 billion to the state. Sure, GTECH’s share of the proceeds could have been smaller, but then GTECH would have provided fewer terminals—and new terminals, which generate increased sales, are worth more to the state than fractions of pennies per ticket. In any case, both the first contract and the second contract were great deals for the state as well as for GTECH.

But that baby was destined to go out with the bathwater. In February 1997 Miers said that “the time has come” to rebid GTECH’s contract. AWI and a company called Scientific Games submitted proposals. GTECH, contending that the process had been biased against the company and that it had a legally binding contract (despite a clause giving the commission the right to terminate the contract “for any reason whatsoever” with no less than thirty days notice), chose not to send in a proposal and filed suit against the commission. The Texas lottery had ceased to be fun, and when a lottery stops being fun, the public stops buying tickets.

THE DECISION TO REBID THE CONTRACT squarely raises the issue of whether a supercop commission can run the lottery. To focus on ethics to the detriment of revenue is as much a failure of the lottery commission’s duty as to focus on revenue to the exclusion of ethics. Miers’ critics second-guess many of her decisions—should she personally have fought harder to stop the threat to revenue?—but the larger question is not the past but the future. One concern is that since Linares left, revenue has not been a high enough priority with the commission. At its December meeting, commissioner John Hill, a former chief justice of the Texas Supreme Court, said, “If the lottery is less successful in dollars, it doesn’t mean it’s less successful, just less remunerative.” Sorry, less remunerative is less successful.

The question, then, is whether GTECH can be replaced as the operator of the Texas lottery without harm—additional harm, that is—to the revenue stream. If lottery operators were interchangeable, like, say, lead pencils, it would not matter with whom the state did business. But they are not. GTECH operates 29 of the 38 state lotteries and 49 more in foreign countries. Sad to say, they are the best at what they do. So why does the commission seem determined to get rid of them? “It’s not in the best interests of the state to get into a discussion of fault,” Miers told me, “when the contract gives the commission the right to terminate for any reason.”

And what of GTECH’s competitors? Scientific Games’ experience is in instant tickets, not running online games. As for AWI, it is proof that operating a lottery is no cinch. In Arizona its contract was canceled after its computers weren’t programmed to handle Leap Year, and then, a few days later, almost every ticket terminal in the state failed. In Minnesota its machines couldn’t read the bar code for instant tickets; they would say “no winner” when the ticket was a winner, or “$25 winner” when the correct amount was $5. In Maryland AWI posted incorrect winning numbers at retail outlets, so that many players thought they had won when in fact they had lost, and vice versa. Missouri rejected a bid from AWI because of doubts that the company could do the job. In Kentucky AWI won the contract in 1996 but withdrew after the state treasurer raised questions about AWI’s financial health. Even when nothing goes wrong, AWI doesn’t produce big sales numbers. Florida, AWI’s biggest prize, has had flat sales for years. Nothing in AWI’s history indicates that it is capable of running the Texas lottery as well as GTECH, if at all. For now, GTECH has a contract, but if GTECH goes away, so will the bad headlines, and the politicians will say that no one can speculate whether sales would have been better if GTECH had stayed on. Ethics or money: This is the kind of choice that gambling creates, and either way, You Lose Again!

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