Evaluating the Applications to Run the National Lottery

NATIONAL AUDIT OFFICE

REPORT BY THE COMPTROLLER AND

AUDITOR GENERAL

Evaluating the Applications to Run the National Lottery

ORDERED BY THE HOUSE OF COMMONS TO BE PRINTED 3 JULY 1995

LONDON: HMSO HC 569 Session 1994-95 Published 7 July 1995 f8.95 NET

EVALUATING THE APPLICATIONS TO RUN THE NATIONAL LOTTERY

This report has been prepared under Section 6 of the National Audit Act, 1983 for presentation to the House of Commons in accordance with Section 9 of the Act.

John Bourn Comptroller and Auditor General

National Audit Office 23 June 1995

The Comptroller and Auditor General is the head of the National Audit Office employing some 750 staff. He, and the NAO, are totally independent of Government. He certifies the accounts of all Government departments and a wide range of other public sector bodies; and he has statutory authority to report to Parliament on the economy, efficiency and effectiveness with which departments and other bodies have used their resources.

EVALLJATLW THE APPLICATIONS TO RUN THE NATIONAL LOTTERY

Contents

Summary and conclusions 1

Part 1: Introduction 3

The National Lottery etc. Act 1993 3 Award of the licence to run the National Lottery 4 Study scope 5 Acknowledgement 7 Publication of application details 8

Part 2: The evaluation process 9

The objectives 9 The Invitation to Apply 9 Specifying the evaluation process 11 Controlling the evaluation process 16 Use of specialist advisers 18 The evaluation process in retrospect 19

Part 3: The Diitrihution Fund contribution 20

General 20 Ranking Distribution Fund contribution at applicants’ forecast revenues 21 Ranking Distribution Fund contribution at common revenues 23 Assessment of revenue potential 25

Part 4: The decision 32

The inputs to the decision 32 Selection 35 Review 36

Part 5: The launch 38

The launch commitments 38 The on line game launch 38 The instant game launch 39 Sales 40

1. Applicants’ perspectives on the evaluation process 43

2. Evaluation of applicants’ marketing proposals 52


Summary and conclusions

1 Eight applications for a licence to run the National Lottery, to be issued under Section 5 of the National Lottery etc. Act 1993 (“the Act”), were submitted to the Director General of the National Lottery by the closing date of 14 February 1994. Following their receipt the Director General, with the assistance of expert advisers, evaluated the applications and, on 25 May 1994, announced that Camelot Group plc was the successful applicant. The relevant licence was issued on 29 July 1994, effective until 30 September 2001.

2 The National Audit Office brst reviewed the process by which the Director General reached his decision and then focused on two questions they considered central to the process:

l did the Director General select the application appearing most likely to provide the maximum return to the National Lottery Distribution Fund (the “Distribution Fund”) - and if not were the reasons for choosing a lower yielding application sound?

l had the successful applicant fuhllled the key commitments made in its apphcation - and if not could and should the Director General have foreseen this during the evaluation process?

3 The National Audit Office’s main conclusions were that the evaluation process was comprehensive, consistent, logical and properly controlled; that throughout the process the Director General acted in accordance with the statutory duties placed upon him; that following the competition the licence was awarded to the applicant who was shown by the Director Generals evaluation to offer the highest return to the Distribution Fund; and that the key commitments offered in the successful application were incorporated in the Section 5 licence issued.

4 The National Audit Office’s other main findings were that:

. the Invitation to Apply for a licence to run the National Lottery was widely publicised and generated significant public interest;

l the way in which applicants were required to structure their applications effectively guaranteed that, as sales increased, an increasing proportion of the revenue generated accrued to the Distribution Fund, thus ensuring the Fund benefited from any unexpected success in the lottery;

l the evaluation process was carefully thought through and codified in a manual drafted before the applications were received. This manual was logically sound, was applied rigorously, and proved robust in practice;

EVALUATINGTHEAPPLKATIONSTORUNTHENATIONALLOTTERY

l the security arrangements designed to protect the confidentiality of the applications and of the evaluation process were rigorous and appear to have achieved their objective;

. the calculation of the present value of applicants’ proposed contributions to the Distribution Fund was a huge task, involving not only thousands of arithmetical calculations hut also the exercise of judgement in certain key areas. The National Audit Office are satisfied that the arithmetical calculations made were correct in all material respects and that the judgements made were exercised properly in the context of the statutory objectives set out in the Act;

. the contest for the licence was a remarkably closely fought one, suggesting that, within the framework set by the relevant legislation, it produced the best possible result for the Distribution Fund;

. the licensee launched the on line game on time, met the licence commitments relating to outlet numbers and (to a large extent) their geographical distribution, and achieved sales to 31 March 1995 that were some 40 percent ahead of forecast INB. The extent to which key licence commitments have been met In practice will be considered ln more depth in a separate National Audit Office study of the monitoring and regulation of the lottery); and

l the launch of the first instant scratch card type game on 21 March 1995 was initially affected by computing problems which resulted in the suspension of instant ticket services to the lottery’s retailers for most of the first day The launch of the second instant game on 2 May 1995 was accomplished without any such problems.

5 At a detailed level, this report identifies some stages in the evaluation process at which, in the National Audit Office’s view, the available information was capable of different interpretations. Indeed, given the complexity and sophistication of the evaluation it would be surprising if that were not the case. But the reservations are minor technical ones and:

0 fall well within the normal range of variation in professional opinion and, more important:

. are not sufiiciently material to affect the outcome of the process.

6 The National Audit Office invited alI the applicants to comment on the evaluation process. Some of the comments received (see Appendix 11 raised issues relating to the way in which the selection process was carried out, others addressed perceived deficiencies in the legislation and were therefore outside the National Audit Office remit, while the remainder focused on specific aspects of the evaluation. Where appropriate, the points raised were taken into account in the relevant parts of the National Audit Office examination and in the bindings and conclusions, as summarised above.

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Part 1: Introduction

The National Lottery etc. Act 1993

1.1 The National Lottery etc. Act 1993 (“the Act”) provides the statutory framework for a United Kingdom National Lottery to be operated by private sector organisations, with the objective of generating funds for distribution to bodies specified in the Act (the “Good Causes”). The Act envisages a Lottery comprising a series of games, entry to which is to be widely available to all persons aged 16 and over. Winners are to be selected by processes involving chance rather than skill, and to receive prizes funded from the revenues earned from ticket sales.

1.2 The Act further envisages that distribution of the proceeds of the lottery to the Good Causes will be conducted through the National Lottery Distribution Fund (the “Distribution Fund”). Those proceeds will be allocated to the arts, sport, the national heritage, charities and projects to mark the beginning of the third millennium.

1.3 The Act does not seek to prescribe the basic design of the National Lottery; it is for those who wish to run the lottery or promote games within it to develop and submit their own proposals for game design and portfolio, target prize totals etc. Rather, the Act spe&es the control framework within which the National Lottery is to be managed. The Act is therefore sufficiently fleldble to accommodate a wide range of ideas from those who wish to contribute to and share in its success.

1.4 The substance of this report focuses primarily on the arrangements brought into being by Part 1 of the Act, which deals with the authorisation and regulation of the National Lottery. Part 1 recognises four key parties involved in operating the Lottery.

i. The Secretary of State for National Heritage (the “Secretary of State”) - who may, among other things, issue Directions and Regulations establishing the policy framework for the lottery.

ii. The Director General of the National Lottery (the “Director General”) - who is appointed by the Secretary of State and is charged like him with a duty to exercise his functions under the Act in the manner he considers most likely to ensure that the lottery is run with all due propriety, that the interests of every participant in the lottery are protected and, subject to the foregoing, to maximise the net proceeds from the lottery, paid into the Distribution Fund for the benefit of the Good Causes. The key function prescribed for the Director General under the Act is to issue licences for the operation of the lottery, ie:

. under Section 5 of the Act to licence a body corporate to run the National Lottery - the “Section 5 Licensee”; and

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EVALUATINGTHEAPPLKATIONSTORUNTHENATlONALLOTTERY

l under Section 6 of the Act to licence a body (or bodies) corporate to promote lotteries as part of the National Lottery - the “Section 6 licenseeW.

In addition the Director Generals statutory powers, including those relating to the grant and revocation of licences, imply a duty to monitor and regulate the National Lottery in accordance with the objectives set out in the Act.

ill. The Section 5 Licensee - which provides the technical, retailing and marketing infrastructure within which bodies holding licences under Section 6 of the Act can operate, and which also sets detailed standards for customer service, security etc. The Section 5 licensee is also responsible for ensuring that all commitments to prize winners and the Distribution Fund, both those arising out of its own Secuon 5 licence and those of all Section 6 licensees, are met.

iv. The Section 6 Licensee(s) - which promote(s) Individual games to be played within the overall framework of the National Lottery, as provided by the Section 5 licensee.

1.5 The Act envisages that the operation of the lottery itself will be entirely in the hands of private sector companies. Further, the Act allows for the possible involvement of more than one such private sector body. It creates a two tier licensing system but makes no presupposition that the Section 5 and Section 6 licensees will be either the same or different, or how many Section 6 licensees will be involved in the lottery at any one time. It is, however, relevant to note that Section 1(3)(b) of the Act provides that any prospective Section 6 licensee can only promote a game within the National Lottery in pursuance of an agreement with the Section 5 licensee. The Act does not empower the Director General to impose a Section 6 licensee on an unwilling Section 5 licence holder.

Award of the licence to run the National Lottery

1.6 Eight applications for the licence to run the National Lottery, issued under Section 5 of the Act, were submitted by the closing date of 14 February 1994 - see Figure 1 opposite. Following their receipt the Director General, with the assistance of expert advisers, evaluated the applications submitted and, on 25 May 1994, announced that Camelot Group plc (“Camelot”) was to be awarded the Section 5 licence, effective until 30 September 2001, to run the National Lottery. The relevant licence was issued on 29 July 1994.

1.7 A Section 6 licence to promote the initial on line game within the National Lottery was issued by the Director General to Camelot on 8 November 1994, for the period 14 November 1994 to 31 December 1997. He has subsequently issued a number of other Section 6 licences to promote instant “scratch card” type games (‘Tnstant games”), all to Camelot. It is envisaged that, subject to the Director Generals approval, further such licences will he issued to Camelot or other applicants as required to facilitate the lottery’s game development strategy.

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Eight applicationsforthe licence to run the National Lotterywere received an 14 February1994 The applicants were, in alphabetical order...

Company name Code name

Camelot Group plc Games far Good Causes plc GBLC plc LotCo plc Rainbow UK Ltd The Enterprise Lottery Company Ltd The Lottery (RT) Ltd UK Lotteries Ltd

Istanbul Madrid Prague Nairobi Seattle Cairo Copenhagen Oslo

Note : For s.ecuriVreasons, on receipt, each application was a//o&d the code name shown and this name was then used throughout the evaluation process. The same convention has been followed in this repoti except when referring to Camelot Group p/c, which is identified by its proper name.

1.8 A summary of key dates in the development of the National Lottery is set out in Figure 2 over-leaf.

Study scope

1.9 The National Audit Office study focused primariIy on the evaluation process leading to the award of the Section 5 licence to run the National Lottery, ie the work that took place between the closing date for Section 5 licence applications (14 February 1994) and the announcement of the successful applicant on 25 May 1994.

1.10 The objectives of the study were:

l to review whether the Director General had established a proper and appropriate evaluation procedure for the examination of applications for the licence to run the National Lottery under Section 5 of the Act, in accordance with the statutory objectives set out therein and in a way which ensured a consistent and fair treatment of all applications;

l to establish that the Enal choice of the preferred applicant was arrived at in a rational and proper way, by reference to the established evaluation procedure and any properly documented modifications to it, whilst allowing the Director General to exercise his judgement properly in the context of the statutory objectives set out in the Act; and

l to establish whether the Section 5 licence granted by the Director General reflected the relevant commitments in the successful application.

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EVALUATlNGTHEAPP!.KATIONSTORUNTHENATIONALLOTTERY

Within just over a year of the Act receiving Royal Assent, the lottery was up and running...

6 March 1992 White Paper “A National Lottery Raising Money for Good Causes” published.

17 December1992 National Lottery etc. Bill published.

21 October1993 National Lottery etc. Act 1993 received Royal Assent.

25 October 1993 Director General of the National Lottery appointed.

11 November1993 Draft invitation to Apply for a licence to run the lottery under Section 5 of the National Lottery etc. Act 1993 issued for consultation.

30 November 1993 Closing date for comments on draft Invitation to Apply.

21 December1993 Final Invitation to Apply issued.

14 February 1994 Closing date for applications for the Section 5 licence.

25 May 1994 Announcement made that Camelot Group plcwas to be awarded the Section 5 licence.

29 July 1994 Section 5 Licence issued to Camelot authorising it to run the National Lottery until 30 September 2001.

8 November 1994 Section 6 Licence issued to Camelot authorising itto promote an on line game as partofthe National Lottery, effective from 14 November 1994 to 31 December 1997.

14Novemberl994 National Lottery on line game launched.

19 November1994

First National Lottery draw forthe on line game.

17 March 1995 Section 6 Licence issued to Camelot authorising itto promote an instant game as part of the National Lottery, effective from 20 March 1995 to 20 March 1996

21 March 1995 Launch of first instant game.

24 April 1995 Another Section 6 Licence issued to Camelot authorising it to promote a second instant game as par-l of the National lottery, effective from 25 April 1995 to 24 April 1996.

2 May 1995 Launch of second instant game. (Several more Section 6 licences have since been issued. It is envisaged that, subject to the Director General’s approval, further such licences will be issued as necessalyto facilitate the lottery’s game development strategy.)

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EVALUATINGTHEAPPLICATIONSTORUNTHENATIONALLO'I-TERY

1.11 In approaching this task, the National Audit Office paid particular regard to the statutory requirement for the Director General to maximise the net proceeds paid to the Distribution Fund, and to the fact that information is now available on the successful applicant’s performance since the launch of the lottery. They therefore addressed two further questions:

. did the Director General select the application appearing most likely to provide the maximmn return to the Distribution Fund - and if not were the reasons for choosing a lower yielding application sound; and

. had the successful applicant fulfilled the key commitments made in its apphcation - and if not could and should the Director General have foreseen this during the evaluation process?

The tit of these questions is considered in Parts 3 and 4 of this report, the second in Part 5. The evaluation process itselfis discussed in Part 2. The Director Generals monitoring and regulation of the lottery and the distribution of monies generated by it will be the subject of future National Audit Office reports.

1.12 As far as possible, throughout this report fact and interpretation have been segregated. The main text consists of descriptions of specific aspects of the evaluation process, while National Audit Office comments are printed in italics and contained in separate boxed paragraphs.

Acknowledgement

1.13 The National Audit Office received specialist advice on marketing issues arising from the evaluation process from Professor Patrick Barwise, Director of the Centre for Marketing at the London Business School. Advice was also received from Dr Philip Stem of the Warwick Business School. The National Audit Office also had discussions with officers and auditors of selected lotteries currently operating in Europe and North America. The lotteries concerned were, in alphabetical order:

An Post Lottery Company, Republic of Ireland

British Columbia Lottery Corporation, Canada

New York Lottery, USA

Texas Lottery Commission, USA

1.14 In addition, all the applicants for the Section 5 licence were invited to comment on the evaluation process. Of the eight applicants, six provided written or oral comments and two stated they did not wish to do so. Where appropriate the comments received have been taken into account in this report. In addition, the points raised by applicants are considered specifically in Appendix 1.


1.15 The National Audit Office wishes to thank all the foregoing parties for their contribution to the study.

Publication of application details

1.16 At the time of publication of the Invitation to Apply for a Section 5 Licence, the Director General gave a formal undertaking that he would not divulge information from applications to third parties without the applicant’s consent. The National Audit OiI?ce have the power under the relevant legislation to examine and report on such documents as part of their work. In the light of representations from the Director General concerning his undertaking, the National Audit Office considered carefully the need to publish such details in this report. They concluded that the need to provide Parliament with information to support an assurance on how such a significant contract was awarded, outweighed the concerns expressed by the Director General. They notified all the applicants of the decision to publish such details and the reasons for so doing.

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Part 2: The evaluation process

The objectives

2.1 As stated at paragraph 1.4, the Act requires the Director General to ensure:

. that the lottery is run with all due propriety;

l that the interests of every participant in the lottery are protected; and

l subject to the above, to maximise the net proceeds from the lottery, paid into the Distribution Fund for distribution to the Good Causes.

The Invitation to Apply

2.2 The purpose of the Invitation to Apply for a licence to be issued under Section 5 of the Act was to seek applications from bodies corporate to run the National Lottery. The applications would then provide the information needed to assess applicants against the above criteria. Applicants were required to ensure their submissions provided comprehensive responses to all information requested, and to demonstrate this was done by cross referencing their responses to the relevant section numbers in the Invitation to Apply. The ten main headings under which information was required are outlined in Figure 3 overleaf.

2.3 The draft Invitation to Apply was made available for public consultation on 11 November 1993. The final version issued on 21 December 1993 generated over 450 requests for copies and, as already noted, eight applications were submitted to the Director General by the closing date of 14 February 1994. The Director General received two other submissions but decided these did not constitute valid applications under the terms of the Invitation to Apply.

National Audit Office comment 1

The Invitation to Apply for a licence to run the National Lottery was widely publicised and generated significant public interest. All those wanting to submit an application had the opportunity to do so, and the high calibre of the applications received is no doubt attributable, at least in part, to the quality of the Invitation to Apply.

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EVALUATING THE APPLICATIONS TO RUN THE NATIONAL LOlTERY

The Invitation to Apply gave applicants very detailed guidance on the information required...

1. General Information General Information eg. regarding company directors, key employees and major shareholders. Organisation Structure. Management Approach ie. commitment to good corporate governance. Lottery Personnel eg. steps taken to ensure their integrity, preventfraud etc. Relevant Experience of the Applicant.

2. Licence Commitments Proportion of revenue to be paid to the NLDF. Proportion of revenue to be paid in prizes. Target Launch date and proposed number of retail outlets. Retail Build-Upthroughout licence period. Minimum Marketing Expenditure from 1 April 1999. Proposed Commercial Ancillary Activities. Systems Development Plan.

3. Business Plan Summary Business Plan and Accounting Statements for each year of the licence. Staffing and Remuneration proposals. Pm-operational and Development Expenditure proposed. Business Plan for proposed Commercial Ancillary Activities.

4. Game Plan Proposals for Game Design and Portfolio. Proportion of prize money in “2” above to be paid out in different games. Plans for Section 6 Licence(s).

5. Retail Distribution Plan The number, mix and distribution of proposed outlets at the peak of proposed Retail Coverage. Retail Build-up ie. the number, mixand distribution of retail outlets throughout the licence period. Financial Arrangements with Retailers ie, proposed commission. Commitments already received from Retailers to sell lottery tickets. Details of Non-Independent Retail Outlets ie. those wholly/partly owned by applicant Any proposals for Attended Vending Machines. Any proposals for Payments and Receipts by Customers other than at Retail Outlets, e.g. subscriptions. Proposals for selection, support and control of retailers. Proposals for sales force to manage the retail network.

6. Marketing Plan Proposed Total Marketing Expenditure analysed by type of expenditure and game involved over the licence period. Advertising and Promotion plan. Proposed strategy for Public Relations overthe licence period.

7. Customer Services and Customer Relations

Proposed Information Strategy and Complaints procedures.

Systems for Prize distribution and communication with winners. Code of Practice on Customer Relations. Performance Standards eg. for speed of prize payment

8. Security of Prize Money and Banking Proposals for Securii for Prize Monies. Banking arrangements.

9. Game Playing Processes and Controls Proposed Player and Ticket Services, including design specification of equipment to be used. Retailer Support Services eg. repairing faults, System for recording tickets. System for validating prize claims. Method of validating and delivering prize pay-outs. Equipment and systems used to draw resub.

10. The Lotte~Systems Systems and Service Design and Installation. Securii and Resilience of proposed systems. Process Assurance eg. audit logs etc. Arrangements for Internal Audit. Cash management ie ticket reconciliation. transaction matching etc.

Source: National Audit Gffice preck based on the Invitation to Apply for a Section 5 Licence.

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EVALUATING THE APPLICATIONS TO RUN THE NATIONAL LOlTEFiY

Specifying the evaluation process

2.4 To ensure the fair and consistent treatment of all applicants, the evaluation of the eight applications received was carried out in accordance with procedures speciiied in a manual drafted by the Director General prior to the receipt of the applications. The definitive version of this manual was produced on 11 February 1994. ‘I+.wo revised versions produced on 18 April 1994 and 11 May 1994 did not signihcantly change the procedures envisaged in the original version.

2.5 The manual sub divided the evaluation into 18 discrete tasks, which can be summarised as follows:

l Task A. This task involved sifting the applications to eliminate from further consideration those that did not fulfil the requirements of the application procedure and/or the Act. It also required the completion of a set of pro formas summarising the key features of each application, designed to give every member of the evaluation team an overall appreciation of each application, in particular any unusual features.

l Task B to Task I (excluding Gl. Each of these seven tasks involved detailed examinations of one aspect of each of the applicants’ proposals, eg the systems proposed, the market development plans, the business plans etc.

. Task G. To discharge his statutory responsibility to ensure that all those associated with the lottery were “fit and proper”, as part of Task G the Director General obtained 239 corporate and 1302 personal declarations from the bodies corporate seeking the Section 5 licence, their shareholders, directors and key employees. These declarations were then verified with the relevant agencies such as financial regulators, Police, Stock Exchange etc, in the United Kingdom or their overseas equivalents, as required.

. Task K. This task involved the production of one report on each application, summarising the outputs of tasks B to I, (excluding Gl without at this stage any reference to, or comparison with, any other application.

. Task J. This task afforded all applicants the opportunity to make a presentation to the Director General emphasising any aspects of their application they wished. It also enabled the Director General to put questions to the senior management team of each applicant.

. Task L. This task allowed the Director General to decide whether at this stage to suspend any applicant from further consideration because a fundamental flaw had been exposed in its application such that there was no reasonable prospect that it could be awarded the Section 5 licence.

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l Task M. The primary objective of Task M was to identify sign&ant differences between the applications which, although they would not have a directly quantifiable impact on the application’s revenue potential, might have an indirect impact. These included, for example, one applicant’s intention to remit its profits to charity, one applicant’s intention to seek stock exchange flotation, potential conflict between some applicants’ lottery and other business interests etc.

. Task N to Task Q. In these tasks the Director General ranked applications in ways which helped specifically to determine which applicant was most likely to meet the statutory objective of maximising the contribution to the Distribution Fund.

l Task R and Task S. These tasks involved the final selection of the successful applicant, and the review of that decision. In undertaking these tasks the output of all other evaluation tasks was drawn upon as required.

Figure 4 opposite illustrates diagrammatically how the 18 evaluation tasks were linked and records who (ie the Director General or one of his consultants) was responsible for each.

2.6 The manual was both detailed and prescriptive specifying for each of the 18 evaluation tasks the:

l Owner - the party responsible for that particular task, in practice the Director General himself or one of his (named) consultants.

. Inputs - the specific section(s) of the completed applications the task owners were required to evaluate, and/or any of the other 18 tasks, the output of which they were required to consider.

l Aim - a statement of the fundamental objectives of the task in hand (see Figure 5 overleaf for a complete list of tasks and their objectives).

l Process - how the task owners were to set about their work, the steps they were required to complete in the course of their evaluation and, where necessary, background explaining the rationale behind the required approach.

l Outputs - the end product required when the task was complete - typically the content of any report required and if appropriate its format, and/or specific questions that the task owners must answer.

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The evaluation process was broken down into 18 discrete tasks and clear responsibility allocated for each...

~ pr~p~iEI~~+ Rejection

/ Task H

Security of Prize

Money

Task I Task G

Customer Protection and Retail Support

Applicants “Fit and Proper”

I I I I Task K2 Consistency and preparation of reports ’

Task M

Significant Differentiating

Factors

Task N

Ranking of contribution at applicants’

forecast le”en”es

Assessment of

Motes. Task Owner I The Director General 2 PA Consulting Group 3 Men%6 Management Consulting 4 National and Economic Research Associates

Notes: Task Owner 5 Hill Samuel Bank Lfd 6 Lawrence Graham 7 A// ,xttfes

Source: National Audit Office adaptaffon of the Evaluation Process Manuaf

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EVALUATM3 THE APPLICATIONS TO RUN THE NATIONAL LOTTERY

Task Al - initial Assessment and Sift

To sift out applications which are incapable of providing the basis for a licence. ie to reject applications which:

- are not from a corporate body

- do not provide the material information required in the Invitation ta Apply

Consider for rejection at this stage applications which:

a are part of multiple applications

Task AZ. Preparallon 01 Summaries

For+& e~luator responsible far each of tasks S ta I to summarise his preliminary understanding of the applications so that the evaluation team may gain an overall understanding of each application and its approach before stating detailed evaluation.

Task S . Lottery Systems

To establish whether the applicanYs systems and processes cover the full scope of the proposed Lottery operations and are likely to suppolt the volumes of business transactions and data storage required to meet the business plans for the central case and the assadated sensitivities.

To establish whether the applicanIs systems are secure and resilient enough to provide customer protection and due propriety.

To establish whether the proposed systems development and implementation plans are feasible and integrated with the applicanrs target launch date, retail rotI-out plan, game plan, business plan and, if appropriate its marketing plan. and that the proposed standards and methods of specifyfng and proving functionally are adequate and consistent with the development plans.

To protide inpti in support of tasks 0 and E by establishing whether the systems cost elements of the pre-operational development expendture are consistent with the s&terns development and implementation plans.

To summarise the applic8.W depth of experience in setting up and operating Lotteries or any other directly relevant or comparable business and to prepare questions to be put to referees by the Office of the National Lottery (OFLOT) (see task G).

Task C - Market Dwelopment

To evaluate whether:.

a the applicant’s game, retail and marketing plans are likely to support the revenue in the business plan. and are robust under alternative scenarios

. the applicant demonstrates management and marketing competence in its plans, specificatb that it has a clear view of Me market for the Lottery and its plans address the market effectivet$

Task D _ Business Plan and Contribution to the National Lottery DiStribution Fund (NLDFI

a To analyse the applic.m?s business plan forecast.

a To analyse applicant’s bid generosity, ie the proportion of revenue to be paid to the NLDF.

a To assess the applicant’s ability ta adapt and to modify its plans in the face of an uncertain market environment so as to protect revenues and the contribution to NLOF.

a To assist in assessing revenue potential of marketing plans.

a To check for consistency and understand the commitments given concerning

- Percentages Offered to the National Lottery Distribution Fund

- Target Prize Totals

- Adjustments fOr Changes in Lottery Duty

Target Launch Date and Coverage

- Retail Build-up

- Minimum Marketing Expenditure from 1 April 1999

- Lottery Ancillary Activities

- Time Plan

Task E. Financial Soundness of the Applicant

To establish whether the applicant:

a is Snancialiy capable of funding the Lottery start-up on schedule

a can fund the business and its commitment to the NLOF, hating regard to a range of business scenarios as envisaged by certain of the sensitivity tests requested.

Task F. Management Approach

To assess:

* the overall abiliv of the management to run Sx National Lottery

. the appropriateness of the overall organisational structure and approach

. the strength of the management structure and approach - how robust the structure is if things were to go wrong

a the structure of the applicant in terms of the extent of Cqntl~Cting/SUbCqntl~i”g envisaged and the impact of any such arrangements on compliance wit3 the Licence

a the legal relationships that are intended to apply between the Licensee and participants and the impact of these on participants’ protection.

. apptlca”Is powers of dtsenfranchlsement of shareholders

e compliance with tix Code of Best Practice as set out in the Cadbury Committee report

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EVALUATING THE APPLICATIONS TO RUN THE NATIONAL LO’ITERY

Task G . Ftt and Proper Applicant

a To establish positively that the applicant and all persons benefiting from or managing all or part of the business of running the Lottery are fit and proper to do so. NG, their competence at management and their competence at lottery operations are assessed elsewhere.

. To co-ordinate the seeking of references from other Lottery regulators. and to pass the responses back to the appropriate task.

Task H. Security al Prize Money and Banking

To assess:

a that the arrangements proposed by the applicant provide adequate secuiky fOr prize winners

a that the applicant3 banlcing arrangements are secure and apprOpriate.

Task f - Custmner Protection and Retailer Support

l To determine whether the applicanrs procedures and outline Codes of Practice on customer relations, advertising and sales and its proposed PerfOrmanCe standards are likely to ensure that the Lottery is conducted with due propriety, and that the interests of Lottery palticipants are adequately protected.

. To assess whether the resources that the applicant plans to devote to customer support, retailer support and system development are adequate to achieve the target standards of service embodied in codes of practice and performance standards.

a To determine whether the application contains anyuling which, if implemented, would contravene the National Lottery Regulations 1994.

Task J. Presentations

a To allow the Director General to hear each applicanYs view of its own application.

a To allow Vie Director General to ask questions directly of the applicant.

Task K-Consistency

To provide assurance:

a thatthe application is self consistent

a that the evaluation process and standards have been consistently executed across all applications.

Task L - Suspension

To allow the etiuators oft&s S to I to make recommendationstothe Director Generalthat he suspends from further consideration any applications which were so assessed in any of Tasks G to I.

Task M -Significant differentiating Factors

To assess anyditinct or differentiating factors which are considered to be impollant in the selection of an application otberthan those covered intasks G to I and 0.

Task N - Ranktng of Contribution at Applicants’ Forecast Revenues

a To rankthe remaining applications in order of the total contribution the applicant Offers to the NLDF in ks application using the applicanIs own lOreCaStS for Lottery revenue. Rankings will take place at three levels:

- each applicant’s revenue sensitivity if games produce only 50% of forecast revenue.

- each applicant’s central business case

- each applicant’s revenue sensitivity if games produce 200% of forecast revenue.

. To contribute to the understanding of the difference between the applications.

Thistask contrasts with task P which compares the contribution based on averages of revenue forecasts taken from all remaining applications.

Task P -Ranking of Contribution at Common Revenues

To rankthe applications in order of generosity. This is measured bythetotal contribution theapplicant offento the NLDF at forecaSt revenues based on aI remainins applications. Rankings wilt be made at a number of revenue Iw?k:

i an average profile based on the average of the revenues in the applicants’ principal business cases

ii. Iwo optimistic profiles lying one and two standard deviations above the aver&w profile of(i) above

iii.two pessimistic profiles lying one and two standard deviations below the average profile of(i) above

iv.three revenue profiles, based on the average profile of(i) above, adjusted to reflect different views of the time taken for revenue to reach maturity, and the rate of change in revenue after maturity

v. each applicant’s own principal revenue forecast, to reflect the total range of all applicanrs views about the development of me lottery (excluding any applicant suspended at Task L).

Task (1 -Assessment of Revenue Potential

To assess the potential for revenue generation in each applican8 business plan on the basis of infonntion on the rwsnue ddversand OtherfactolS in their plan.

Task R . Salection

For the Director General to selectthe application that is the most likely to maximise proceeds to NLDF subject to the over-riding requirements of CUStOmsr PrOteCtiOn and propriety.

Task S. Review

To review the Mliti@ of the decision taken in Task R.

15

EVALUATING THE APPLICATlONS TO RUN THE NATIONAL LOTTERY

2.7 To illustrate how task specifications were constructed in practice, the specification of Task P has been extracted from the manual and reproduced as Figure 6 opposite. This task ranked applicants’ proposed contributions to the Distribution Fund at common revenues. It was therefore an important step in identifying the applicant most likely to maximise the contribution to the Distribution Fund and is considered in more detail in Part 3 of this report.


The evaluation process was carefully thought through and codified in a manual drafted before the applications were received. This manual was logically sound, was applied rigorously, and proved robust in practice.

Controlling the evaluation process

2.8 One of the key considerations driving the evaluation process was a concern to protect the security and confidentiality of the applications received. The Director General has explained that specific controls implemented to ensure this security included those set out below.

l Of the 21 sets of applications received, 17 were held in the Director General’s own offices. When not in use they were kept in cabinets secured by combination locks, with the added protection of 24 hour security guard coverage. One set of applications was stored at the Department of National Heritage as a precaution against fire at the Director General’s offices. For operational reasons the Treasury Solicitor’s Department, Messrs Lawrence Graham and Hill Samuel Bank Ltd were also given copies, on condition that the same strict security procedures were observed.

l With the exceptions noted above, at no time was any part of any application allowed to leave the Director General’s offices.

. Only accredited members of the evaluation team were allowed access to the applications.

l All working papers were colour coded either white or pink. White papers contained information unique to one application, pink was used for all working papers containing comparative information drawn from more than one application. Team members were allowed to retain white papers to work outside the Director General’s offices, but not pink.

. On receipt all applications were given a code name, as shown in Figure 1 on page 5. These names were used throughout the evaluation process in all discussions, working papers etc. This convention has also been followed in this report, with the exception of the references to Camelot, ultimately the successful applicant.

16

EV4LUATINGTHEAPPLICATIONSTORUNTHENATIONALLOTTERY

The specification for each task, incorporated in the Evaluation Process Manual, followed the same format. For example in Task R..

Owner: National Economic Research Associates (NERA)

Inputs: For the applications which were not suspended in task L:

in Summaries produced in task A2

ii. Outputs of tasks B to I, as modified by task K.

Aims: To rank the applications in order of generosity This is measured by the total contribution the applicant offers to the NLDF at forecast revenues based on all remaining applications. Rankings will be made at a number of revenue levels:

i. an average profile based on the average of the revenues in the applicants principal business cases

ii. two optimistic profiles lying one and two standard deviations above the average profile of(i) above .,. rkr. two pessimistic profiles lying one and two standard deviations below the average profile of(i) above

iv. three revenue profiles, based on the average profile of(i) above, adjusted to reflect different views of the time taken for revenue to reach maturity and the rate of change in revenue after maturity

“. each applicant’s own principal revenue forecast, to reflect the total range of all applicants views about the development of the lottery (excluding any applicant suspended at Task L).

At this stage, the revenue of the National Lottery is unknown and even with the best forecasts and research there is still a wide range of possible outcomes. An applicant that makes optimistic assumptions about such factors could be able to claim larger revenues and thus seem to offer a larger total contribution to the NLDE In orderto provide a common basis for comparison, this task calculates the NLDFcontribution on a number of common revenue scenarios.

Process: For each of the revenue levels defined above in “Aims”, calculate the Lottery revenue in each year of the licence for all remaining applications.

For each applicant calculatethe contribution to the NDLF for each revenue level. Each years contrtbtion will be subjectto a real discount rate of 6% pato produce a present value (PV) for the applicants total contribution to the NLDF over the life of the Licence at each revenue level. The contrtbotton from each applicant is then ranked. Contribution is expressed as an actual value; it is not expressed as a percentage of revenue. NEBAwill produce this ranking.

Some of the revenue levels could lie outside the range of an applicant’s own business case. For this reason it may be necessary to establish the credibility of an applicants’ proposal at those level(s). The credibility tests provide OFLOT with confidence that the application is viable at a given level of business. Credibility tests consist of:

i. does the application have the financial soundness to sustain that level of business

ii. does the application have systems that can sustain that level of business

iii. does the applicant have marketing and game plans which can generate that level of business.

At this stage, credibility tests would be conducted only on the applications which lead the rankings and where the revenues are outside the applicants business cases (which were subjected to credibility tests in task D). However, there is nothing to prevent credibility tests being done on other applications which come close to the leaders, or for credibility tests to be done during later evaluation tasks.

output: The PV of each applicants contribution to the NLDF ranked in order for each of the levels of revenue specified above in “Aims”,

A statement of the credibility, or otherwise, of the applicants’ business cases at these revenue levels. This will not be necessary where credibility at these revenue levels has already been established as part ofTask D.

Source : Evaluation Process Manua/

EVALUATINGTHEAPPLICATIONSTORUNTHENATIONALLOTTERY

The effectiveness of these arrangements is evidenced by the minimal press coverage of the evaluation process that appeared before the announcement of the result.

2.9 The evaluation process was overseen by a project manager seconded from PA Consulting to the Director General’s staff for that purpose. He was initially responsible for ensuring that the 18 evaluation tasks were conducted on time and in accordance with the evaluation manual. At a later stage in the process, however, the project manager was given additional responsibilities and became a key contributor to the evaluation itself.


. The security arrangements designed to protect the confidentiality of the applications and of the evaluation process were rigorous and appear to have achieved their objective.

l The project manager was recruited initially to oversee the evaluation process. He became involved in the later stages in the substance of the process itselt: but there was no evidence that this combination of hm distinct roles impacted adversely on the decision making process.

Use of specialist advisers

2.10 Throughout the process, use was made of advisers to provide the specialist support considered necessary for specific tasks. In all, three diierent teams of advisers were used, ie

l The Operational Consultants. Headed by National Economic Research Associates (economic advisers), this team also included, as sub contractors, consultants from Mercer Management Consulting (marketing, game and retail advisers) and from PA Consulting Group (IT and security advisers).

l Hill Samuel Bank Ltd which provided financial and general business advice.

l Treasury Solicitors. The Treasury Solicitor advised principally on public law matters, such as the legality and fairness of the process. Their agents, Lawrence Graham, provided advice on commercial and intellectual property law issues.

18

EV4LUATINGTHEAPPLICATIONSTORUNTHENATIONALLOlTERY

The evaluation process in retrospect

2.11 It is now a matter of historical record that the launch of the on line game was very successful. The licensee met its agreed launch date and provided the retail network promised in its application, whiie broadly its systems coped satisfactorily with the demands placed upon them during the launch and immediate post launch period. Although the launch of the first instant game was affected by computing problems these were resolved quickly and did not recur at the launch of the second instant game on 2 May 1995.

2.12 It is now apparent therefore that many of the key questions that exercised the Director General during the evaluation have been demonstrated in retrospect to have been satisfactorily dealt with by the success of the lottery launch and subsequent operations.

2.13 For this reason, the remainder of this report focuses primarily on the work done in quantifying the probable contribution to the Distribution Fund implicit in each applicant’s proposal and concludes with a summary of the achievements of the lottery in its early days.

?

19

E"ALUATINGTHEAPPLlCATIONSTOR"NTHENATlONALLO',TERY

Part 3: The Distribution Fund contribution

General

3.1 It has already been noted that, subject to his overriding responsibility to ensure propriety and that the interests of participants are protected, section 4(Z) of the Act requires the Director General to exercise his functions in a way that maximises the net proceeds of the lottery.

3.2 Arguably, the simplest way of achieving this objective would have been to hold a competition and award the lottery licence to the applicant offering the highest cash bid, subject only to obtaining the necessary assurances on qualitative issues. This is a familiar approach, similar to that used when letting commercial television licences for example.

3.3 The Director General considered that this was not a feasible approach to adopt when letting the licence for the National Lottery, however, and in his view would not have maximised the return to the Distribution Fund. At the time of the competition, there were no relevant United Kingdom data available to underpin a confident prediction of the British public’s propensity to purchase lottery tickets. Such evidence as was available rested on experience drawn from other countries, and on market research in the United Kingdom. Thus it was difficult, if not impossible, to forecast the revenue generating potential of the lottery. Under such circumstances there was a danger that if the lottery operator was required to pay a futed sum for the licence and ticket sales were less than anticipated, then the operator could be forced out of business. Conversely, if ticket sales exceeded expectations then “excessive” profits could accrue to a private operator from an undertaking which is ultimately intended to operate primarily for the benefit of the Good Causes.

3.4 The Director General therefore adopted an approach which involved “risk sharing”. He considered it more appropriate for the Invitation to Apply to require applicants to specify in their applications what proportion of total ticket sales income, net of lottery duty, they proposed to pay out in prize money, what proportion would be paid to the Distribution Fund and, by deduction, what proportion would be retained by the operator to meet costs and ultimately to provide profit. Applicants were required to specify the proportions of ticket sales income which would be committed to prize money and the Distribution Fund for a range of revenue scenarios up to and significantly beyond the applicant’s principal business forecast, in the expectation that economies of scale would enable applicants to offer higher percentages to the Distribution Fund as the overall size of the lottery increased.

20

EVALUATINGTHEAPPLICATIONSTORUNTHENATlONALLOTTERY

3.5 While the Director Generals commitment to maximise payments to the Distribution Fund underpins the whole appraisal process, it is brought into particularly sharp focus in Tasks N, P and Q. In practice only seven of the eight applications were subjected to this part of the process, one application, that of Seattle, having been suspended from the competition prior to this stage because, in the Director Generals view, the application focused principally on the provision of instant games and did not give him full confidence that the applicant “understood and would undertake the full range of responsibilities of a Section 5 licensee”.


The way in which applicants were required to structure their applications effectively guaranteed the Distribution Fund a share in and benefitfrom any unexpected success in the lottery in that, as sales increased, an increasing proportion of the revenue generated accrued to the Distribution Fund. Given the d@culties inherent in forecasting sales accurately, this was a sound approach. One consequence, howeven was that the comparative evaluation of competing applications had to be sufficiently sophisticated to cope with the fact that all the applications offered different percentages to the Distribution Fund based in turn on differing assumptions about total sales revenue. Task N provided one element in this process.

Task N - Ranking Distribution Fund contributions at applicants’ forecast revenues

3.6 Task N ranked the present value of each application’s ticket sales payment to the Distribution Fund at its own principal revenue forecast (ie the forecast on which the applicant’s business plan had been based), and also at scenarios prescribed in the Invitation to Apply in which actual sales were assumed to be half and double respectively those envisaged in the principal forecast - see Figure 7 overleaf. The objective of these additional scenarios was to enable the Director General to assess each applicant’s ability to withstand actual results significantly different from its forecast. The purpose of this task was not to put the applications on a comparable revenue basis with each other (this was done in Task P) but simply to put forward, in order of contribution, what each applicant had set out in its principal forecast.

3.7 Figure 7 overleaf reflects clearly the uncertainly referred to above over the ticket sales revenue likely to be generated by the lottery over the period of the licence, ie applicants’ principal business plans contained widely differing revenue forecasts ranging between present values of El7 billion and almost E.30 billion.

3.8 In every case but one the ranking of the applicants’ contributions to the Distribution Fund was identical to the ranking of the magnitude of their revenue forecasts. The exception was Nairobi which ranked seventh in its revenue forecast but fifth in its Distribution Fund contribution.

21


The key factor determining each applicant’s apparent contribution ta the Distribution Fund was not the applicant’s generosity, but the assumptions it made about revenue...

Oslo Camelot Copenhagen Cairo Madrid Prague Nairobi

Revenue Distribution Forecast Fund Contribution

fBn fBfl % 29.75 8.06 27.10 25.46 7.04 27.66 25.34 6.90 27.33 23.74 6.26 26.37 20.77 4.46 21.46 18.05 4.31 23.87 17.07 4.51 26.39

Source: National Audit Office analysis of the Task N working papers. A// data subsequently confirmed direct to original applications by National Audit Office.

3.9 The more conservative forecasts for total sales were closely based on the findings of United Kingdom market research into the propensity to purchase lottery products, or on econometric analysis of a wide range of overseas lotteries. The more optimistic principal forecasts were characterised by major upward adjustments to the estimates derived from market research or other quantitative analysis, reflecting factors such as the introduction of a second weekly draw, the introduction of new types of games or the effects of some specific features of the proposed games.


l The calculation of the present values of applicants’ contributions to the Distribution Fund at their principal revenue forecasts, and at sales levels assumed to be half and double those in the principal forecasts. was a major task. In all it required some 2,000 separate calculations. The National Audit OjJice developed. independently of the Director General and his advisers, a set of spreadsheets to re-perform these calculations. The results of this work agreed with those calculated originally by the Director General and used in the evaluation process.

l The most significant result of the Task N comparisons was to show that a simple evaluation based on the applicant’s own forecast of the sum to be paid to the Distribution Fund wouldfavour the applicant making the most optimistic assumption about revenue ie, the key factor determining the apparent contribution to the Distribution Fund was not the generosity or otherwise of the applicant, but rather the revenue assumption incorporated in the applicant’s business plan. Clearly, therefore, an improved insight into the potential implications for the fund implicit in the applications received could be achieved by assessing them against common revenues, as prescribed in the evaluation manual. This was done in Task r!

22


Task P - Ranking Distribution Fund contributions at common revenues

3.10 In Task P the Director General compared applications over a standard set of revenue assumptions. Given the absence of relevant United Kingdom data, the sales revenues contained in the principal forecast of each of the seven remaining applications were averaged and that average was used as the fundamental basis for comparison - the “average revenue case”.

3.11 Four alternative scenarios were constructed by assuming optimistic and pessimistic sales levels at one and two standard deviations either side of this mean, which worked out at plus and minus 19 and 38 percent of the average revenue case.

3.12 A further three scenarios were constructed, again based on the average revenue case, but this time assuming different rates of growth and decline to and beyond maturity, ie one assuming slower than predicted growth, one assuming earlier market saturation (no growth in revenue beyond 1996/97) and the third assuming premature decline (revenues declining at five percent per annum after 1996197).

3.13 A final set of seven comparisons was undertaken, based on each of the principal revenue forecasts of the remaining applicants.

3.14 In total, therefore, the Director General compared the present value over the whole licence period of contributions to the Distribution Fund implicit in all applications over 15 different revenue forecasts ranging from E14.1 billion to Z31.6 billion, including the average revenue case of E22.9 billion. This analysis revealed remarkably tight grouping in the applications received. On the average revenue case, the present value of the contributions to the Distribution Fund proposed by the applicants ranged from E5.7 billion to 6.3 billion, with the exception of one application which offered rather less than E5 billion. Broadly, the output of this task was as follows:

. Nairobi was the most generous across the whole set of forecasts, although at the average revenue case it offered only E75 million (1.2 percent) more than Camelot;

. the leading group, Nairobi, Camelot and Copenhagen (at average and optimistic scenarios), were within three percent of each other;

. there were two middle ranking applications, Oslo and Cairo - their applications were about five percent less generous to the Distribution Fund than the most generous one; and

. there were two less generous applications, Prague and Madrid - some 9 and 21 percent respectively below the most generous application.

The results are set out graphically in Figure 8 overleaf.

EVALUATlNGTHEAPPLICATlONSTORUNTHENATlONALLOTTERY

The leading group, Nairobi, Camelot and Copenhagen, were remarkably close, with Nairobi olfering only f75 million more than Camelot at the average revenue ease...

l(

9

8

z ‘Z = 2 7

z E 12 E ‘S 6 = g %

5

4

3

2 1

;

OS10

Camelot

1 Copenhagen

Cairo

Nairobi

Madrid

Prague

I, I I /

4 15 16 17 18 19 20 21 22 23 24 215

26 ;7 ;8 ;9 ;O

31

Sales revenue

All figures at present value, fbillion

Source: National Audit Office analysis of the Task P working papers. All data subsequently confirmed direct to or;ginalapplications by Nafional Audit Office.

24

EVALUATlNGTHEAPPLlCATIONSTORUNTHENATIONALLOTTERY

‘National Audit Office &o&&t 6 :,, :, :I

. The comparison of the present values of applicants’ contributions to the Distribution fund over the 15 revenue forecasts defined in Task P was an essential step. It was also a huge task. It involved some 10,000 calculations in addition to those already performed as part of Task N. Again, all these calculations were checked and agreed independently by the National Audit Office.

. The most important output of Task P was to identih a leading group of three applicants, closely followed by a middle ranking group of a further two, with the remaining applications some way behind. In undertaking this analysis the Director General consciously avoided making any specific, quantified adjustment for particular factors inherent in the individual applications which could impact on the turnover of the lottery This was the objective of Task Q.

Task Q - Assessment of revenue potential - general

3.15 Task P sought to compare the contributions to the Distribution Fund implicit in each application on common revenue bases. Differences between applications meant, however, that some might have greater revenue generating potential than others. The pm-pose of Task Q was to examine each application in an attempt to assess the “revenue drivers” in it and then to quantify the revenue generating potential of each applicant’s approach, and to estimate the degree of caution or otherwise exercised by the applicant when forecasting its central business case. The aspects of applications which were considered in Task Q included an assessment of the financial impact of different launch dates, the value of additional payments to the Distribution Fund and the impact of differences in retail density, prize payouts, game structure and marketing expenditure. Task Q should be contrasted with Task M in which the signihcant differentiating factors of each application, which were recognised to be qualitative rather than quantifiable, were identified and examined.

3.16 While, in the view of the Director General, some of the relevant factors were capable of being quantified with confidence (ie those discussed in i, ii and iii below), others were more problematic (ie those discussed in iv below). The Director General saw his analysis of this last group of factors as providing a broad indication of the directional impact of the factors concerned on the revenue generating potential of the application as a whole, rather than as a precise quantification.

25


(i) Task Q - Financial impact of different launch dates

All applicants proposed different launch dales, and allowance had lo he made for this...

Applicant

Nairobi Camelot Copenhagen OS10 Cairo Prague Madrid

Launch dale adjustment

2, No Change

(117) (30) 30

Source : Task Q working papers. A// data subsequently confmed direct to original applications by National Audit Ofh

3.17 Applicants assumed different launch dates in their business plans, and also assumed different dates on which the Director General would announce his decision on the successful applicant. It was therefore necessary for the Director General to calculate the effect of these differences on the contributions to the Distribution Fund. This was not a straightforward calculation because the applicants had not been required to break down their revenue streams into sofliciently short periods (ie months or weeks) so a revenue stream was estimated by interpolation. For this reason the results, set out in Figure 9, can only be regarded as approximations.


The planned launch date in the successful applicants bid was 5 November 1994, based on cm assumed notification by 31 May that year In fact the Director General announced his decision on 25May but the lottery was not launched until 14 November The Director General has explained that the decision to defer the launch of the lottery was agreed by him in July 1994, after consultation with the Department of National Heritage, to avoid any clash between the first draw, which would otherwise have taken place on Saturday 12 Novembel; and the Remembrance Day commemorations. The launch date adjustment made by the Director General did not reflect the decision to postpone the launch, but the Director General has pointed out that his evaluation could only be based on the applications submitted, and that the decision to defer the launch was taken after the evaluation and was in no way related to any failure on the part of the successful applicant.

26

EVAL"ATINGTHEAPPLICATIONSTORUNTHENATIONALLOT-lERY

(ii) Task Q - Value of additional sums accruing to Distribution Fund

3.18 Three applicants offered additional payments to the Distribution Fund, over and above the contribution in their applications. Cairo and Copenhagen offered contributions which were related to the profits they earned, while Camelot offered to maintain in an Escrow Account a balance equal to 2.5 percent of the value of the previous years’ ticket sales, less E40 million. Upon termination of the licence for whatever reason, including the effluxion of time, the Escrow balance would revert to the Distribution Fund. At the average revenue case Cairo and Copenhagen’s profit sharing schemes were calculated by the Director General to have, over the life of the licence, present values of El18 million and Z61 million respectively to the Distribution Fund, while Camelot’s Escrow arrangement was calculated to have a present value of f55 million.

3.19 While giving full weight to these factors the Director General noted that the additional contribution from Camelot was a firm commitment, since it was calculated as a futed percentage of lottery revenue, but that the sums from Cairo and Copenhagen were based on profits and so “subject to the vagaries of accounting practice and other business decisions of the applicants”. Although reasonably certain, the present value of the payment from Camelot would of course vary according to the revenue scenario assumed.

3.20 One applicant also offered to remit all its profits to charity. The Director General has pointed out that the Act requires him, inter alia, to seek to maximise the sums paid into the Distribution Fund, but that applicants’ intentions regarding the use to which their profits would be put is not, as such, a relevant consideration under the Act. The Director General has explained that, after taking legal advice, he decided he could not make any specific adjustments to reflect this offer, although the wider question of the impact such a commitment might have on the public’s perception of the lottery, and hence its impact on total sales and therefore the probable Distribution Fund contribution, was considered as part of Task M (see also Appendix 1, Comment 15).

National Audit Offke comment 8

The Director General’s calculations of the value of additional payments to the Distribution Fund proposed in the applications made by Cairo, Copenhagen and Camelot were re-performed by the National Audit Office. This confirmed the values for Copenhagen and Camelot, but indicated that on the National Audit Ofice’s preferred basis of calculation the value of Cairo’s proposed additional payment was overstated by E4 million. However this discrepancy did not have any material impact on the results of the evaluation process.

EVALUATlNGTHEAPPLlCATlONSTORUNTHENATIONALLOlTERY

(iii) Task Q - The proportion of sales income retained by the applicant

3.21 In general, in the applications received, higher Distribution Fund conlx-ibutions tended to be matched by lower prize payouts. The Director General was conscious that in practice it was possible that there could be a “trade off between the two. Given that higher prize payout ratios should increase ticket sales then, although it might appear paradoxical, reducing the Distribution Fund percentage contribution and making more money available for prizes could lead in the longer term to an increase in gross revenue and thus in the total amount paid to the Distribution Fund. The difficulty facing him was to evaluate these differences in bid strategy.

3.22 The Director General sought to address this issue by calculating the present value of the net revenues retained by the applicants after payment of all licence commitments, reasoning that the lower the value of retained revenue the greater the total resources available for increasing revenue to the Distribution Fund - see Figure 10 opposite. For this purpose, retention was de6ned as the sum left after payments to the Distribution Fund, prizes and lottery duty.

3.23 This exercise established that:

l Camelot’s application provided the lowest revenue retention across a wide range of revenue scenarios, beaten only by Copenhagen at relatively optimistic revenue cases and by Madrid at relatively pessimistic ones. At the average revenue case the present value of Camelot’s retention over the life of the licence was 52.5 billion or 10.87 percent of revenue, E72 million less than the next bid, Copenhagen;

l the relative ranking of the retention of some other bids varied substantially on differing revenue scenarios; Nairobi and Madrid were attractive at pessimistic revenues while Copenhagen was attractive at optimistic ones; and

l Cairo, Oslo and Prague were consistently less am-active than the other applicants on the average revenue case. The first two were some 8 to 9 percent worse than the best while in Prague’s case the difference was some 15 percent. In cash terms, at the average revenue case, these differences were worth between 2211 million and SE382 million at present value.


The Director General’s calculations showed Camelot retaining the least revenue for its own purposes at most revenue scenarios...

4

3.5

E ‘- g 3

E

g

E 0”

2.5

2

1.5

OS10

Camelot

I Copenhagen

Cairo

Nairobi

Madrid

Prague

///’ I__ ,,,_11’ ___j’

,~~/ /A / ,/1’

14 15 16 17 16 19 20 21 22 23 24 25 26 27 26 29 30 31

Sales revenue All figures at present value, fbillion

Source: National Audit Office analysis of Task Q working papers. A// data subsequently confirmed direct to original applications by National Audit Office

29

EVALUATINGTHEAPPLlCATIONSTORUNTHENATlONALLOTTERY


l The calculation of the operatorS retention undertaken as part of Task Q involved a further 2600 calculations. Again these calculations were re-performed independently by the National Audit Ofice and the results confirmed those identified by the Director General.

. Three applicants offered additional payments to the Distribution Fund. Camelot proposed an additional payment to the Fund to be made at the end of the Section 5 licence period, while Copenhagen and Cairo offered profit sharing payments to the Distribution Fund to be made during the life of the licence. The National Audit OfJice note that the Director General did not include the present value of these additional payments in his calculation of applicants’ payments to the Distribution Fund (Tasks N and P) or his calculation of applicants’ retention (part of Task QI, but dealt with them separately. Since such additional payments come out of operators’ retentions, the effect of this treatment was to make those three applicants appear to contribute less and retain more for themselves than was in fact the case. The key point, howevel: is that had these additional payments been included in the calculation the result would have been to emphasise the superiority of the leading group already identified by the Director General, namely Nairobi, Camelot and Copenhagen.

(iv) Task Q - Market sensitivities

3.24 Four further factors were identified as likely to have a direct impact on the revenue potential of applications. These were:

l number/density of retail outlets:

. prize pay out ratios for on line and instant games;

l the on line game’s base jackpot size and rollover frequency; and

. marketing/advertising spend.

3.25 The Director General made an estimate of the range of impact of these factors on the revenue potential of each application, and of the confidence which could be placed in those estimates, using data available from overseas lotteries and independent econometric and other studies commissioned by the applicants - see Figure 11 opposite.

30


Some applications contained features thought likely to help them generate more (or less) revenue than others. The Director General sought to allow for this...

Feature Percentage Adjustment

Retail density Prize payout Lotto game structure Marketing spend

Nairobi 4

(5) (1) (1)

Camelot Copenhagen OS10 Cairo Prague Madrid 12 (zztoll) 3 1 (3) (3)

(8) (8) 1 (4) 17

c:, 2to26 1 to 8

(8) 2 (8) (i, (8) (5) 11 11

Total (3) 9 (26) to 9 (12to4) (6) (4) 20

Source: Note:

Tots/ Task Q working papers These percentages were intended as an indication of the relative importance of different factors in the applicants’ plans in generating revenue, rather than as a precise quantification of revenue potential.

3.26 In making the estimates incorporated in Figure 11 the Director General noted, however, that “although it is possible in most cases to estimate a quantified potential impact from these factors, assumptions and estimates have to be made for this purpose and the answers can only be treated asindications of the general directional impact of the factor concerned rather than being the calculation of a precise and meaningful number”. This issue is discussed further in Part 4 of this report.


Professor Patrick Barwise, Director of the Centre for Marketing at the London Business School, was employed to advise the National Audit Office on, inter alia, the assumptions made and methodology followed by the Director General in Task Q. The summary of his report is reproduced in Appendix 2. The key conclusion is that although there is scope for alternative interpretation in the detail of some of the adjustments made in part of Task Q, these differences fall well within the normal range of variation in professional judgement and, more important, would not influence the outcome of the process, ie the choice of the successful applicant.

31


Part 4: The decision

The inputs to the decision (Task R)

4.1 F’rior to the start to Task R, the Director General had completed a comprehensive body of analysis, the results of which were available to facilitate his choice of the successful applicant. The first element in the iinal decision making process required the Director General to review the output of this work, ie:

l Task G, the information obtained as part of the investigation into whether the applicants and all persons benefiting from, or managing all or part of, the lottery were fit and proper to do so.

l Task J, the notes of the presentations made by applicants

l Task K, the summaries of applications based on the outputs of Tasks A to I (excluding G).

l Task M, which identified significant but unquantifiable factors that differentiated the applications.

l Task N, which ranked each applicant’s contsibution to the Distribution Fund based on its own revenue forecast.

l Task P which ranked each applicant’s contribution to the Distribution Fund on the basis of 15 different revenue scenarios.

l Task Q which assessed the impact of a number of revenue drivers identified by the Director General, the quantification of some of which he regarded as reliable, while others he saw as giving only a broad indication of the directional impact of the factor concerned.

4.2 The National Audit Office examined all the relevant data carefully but in the context of this report it is not possible to give a comprehensive summary of the information available to the Director General at that lime. In order to give a broad flavour of the data available concerning the contribution to the Distribution Fund, however, the National Audit Office has constructed Figure 12 opposite. This table has been compiled by applying the Director Generals tentative quanC6cation of the revenue drivers identified as part of Task Q (which has been reproduced in Figure 11 on the previous page) to the Distribution Fund contribution at the average revenue case.

32

EVALUATINGTHEAPPLICATIONSTORUNTHENATIONALLOTTERY

The initial ranking of raw Distribution Fund contributions showed Nairobi narrowly in the lead: after adjustment, however, Camelot was the most attractive application, by a significant margin

Raw Contribution (Task P)

Nairobi Camelot Copenhagen Oslo

6,305 6,229 6,132 5,997

Adjustments

TYPO A Profit Share Escrow Launch Date (38)

Type 6 Retail Density 252 Prize Payout (315) Lotto Game Structure (63) Marketing Spend (63)

Total Adjustments (227)

Adjusted Contribution 6,076

All figures at present value, f million

55

747 436

(125) (498)

615

6,644

61 118

(117) (30)

(1349 to 675) 180

(491) (480) 123to1594 60 to 480

123 (460)

(1650) to 495 (330 to 750)

4,462 to 6,627 5,247 to 5,667

Cairo Prague Madrid

5,979 5,714 4,959

30 34

60 (171) 60 (229)

(457) (476) 628

(210) (195)

5,769 5,519

Source : National Audit Office analysis of Task P and Task Q working papers, The Director General considered vpe A adjustments to be reasonably firm, vpe Badjostmen$ much less so.

50

(149) 843

(248) 545

1041

6,000

4.3 It must be emphasised that the calculation in Figure 12 was produced by the National Audit Office for the purposes of thii report and was not undertaken by the Director General. It is, in a number of important respects, a simplification, ie:

. it is based on the average revenue case only - the Director General took into consideration 15 different revenue scenarios: and

. it mixes the results of certain and probabilistic analysis indiscriminately - the Director General had to allow for the fact that some of this analysis produced only a range of probabilities rather than absolute values.

. it is constructed by applying the percentages in Figure 11 on page 31 to the raw Distribution Fund contribution. The adjustments are, therefore, calculated on the basis that changes in contribution vary directly with changes in revenue. In reality increases/decreases in revenue do not generate exactly proportional changes in Distribution Fond contribution since the percentage contribution increases or decreases faster than revenue.

It cannot therefore be regarded as a definitive comparative summary of the applications received.

33

E"AL"ATlNGTHEAPPLKAT,ONSTOR"NTHENATIONALLO'lTRRY


Despite the limitations noted above, Figure I.2 does highlight certain key messages.

l By far the most importantjinancialfactor in all the applications was the level of contribution to the Distribution Fund at common revenues. This swamped in its significance all other factors such as those for which adjustments were made in Task Q.

l The basic levels of Distribution Fund contributions in the leading applications were grouped remarkably tightly, suggesting that the competition had been a close one and presumably therefore, within the framework set by the relevant legislation, that it had produced the best possible result for the Good Causes.

l Notwithstanding the closeness of the competition, the basic contribution implicit in the bids from Prague and Madrid meant they were clearly lagging behind the leading group, while Nairobi, Camelot and Copenhagen were the mostfinancially attractive applications, with Nairobi apparently having a slight edge.

l Although the basic level of contribution was by far the most significant financial factor: because the leading applications were grouped so tightly it was not a particularly powerful discriminator: The factors identified in Task Q were therefore more significant than they would otherwise have been.

The NationalAudit Ofice’s calculation of the adjusted contribution (see Figure 12) showed Camelot clearly injirst place, with Nairobi and Madrid some way behind. There luas a great deal of uncertainty over the ad&ted contribution from Copenhagen however because of the &&6culties inherent in quanh~ing the impact of certain novelfeatures in its application - although even on the mostfavourable interpretation. Copenhagen stillfell behind Camelot.

4.4 As already noted, the Director General had fti confidence in the adjustments to the Distribution Fund contribution required to allow for differences in applicants’ launch date, escrow and profit sharing proposals (Figure 12 “Type A” adjustments), and took their full value into account when making his decision. He considered a number of options for including the effect on total revenue of the other revenue drivers (the “Type B” adjustments) to produce an overall ranking of contributions. On every approach taken, however, Camelot was comfortably the leader with Copenhagen, Nairobi, and Oslo figuring consistently in the leading group, although the order of those three changed with the approach taken. One approach placed Oslo and Nairobi close together in second and thiid places, whereas other approaches produced ditrerent rankings. The Director General concluded that the revenue impact of the adjustments could only be expressed as a general directional indication since any single numerical approach would be based on subjective judgements about marketing sensitivities and economic elasticities.

34

EVALUATINGTHEAPPLICATIONSTORUNTHENATIONALLOT,-ERY

Selection - Task R

4.5 Following his review of all the available information, tbe Director General identified three of the remaining seven applications he considered significantly less likely than the other four to meet the objectives set out in the Act. These three, Madrid, Prague and Cairo, were omitted from the selection process at this stage, and the Director General prepared a brief report giving the reasons for his decision. These included:

. relatively low or moderate contributions to the Distribution Fund across the whole range of revenue scenarios examined;

. relatively high proportions of revenue retained by these three applicants over most revenue scenarios, eg as much as 12.54 percent at the average revenue case against Camelot’s 10.87 percent;

l various technical matters arising from some of these applications including, for example, concerns such as

- one applicant’s perceived lack of lottery experience

- the state of readiness of the retail networks of two of the applicants

- the state of readiness of the communications network of one applicant

- the ability of one applicant’s systems to support its forecast sales volumes.

4.6 The next stage in Task R then required the Director Generals four senior advisers, working independently, to make pairwise comparisons between each of the remaining four applicants, a total of six comparisons per adviser, and to use these to rank the applicants in preferred order. Brief reports were required from each senior adviser justifying their assessments. This process produced substantial, though not unanimous, agreement between the advisers. Three of the advisers preferred the application from Camelot, one preferred Nairobi. Copenhagen and Oslo came third and fourth.

4.7 In the third stage of this task the Director General himself finalised his own pairwise comparison between Camelot and each of the other applications in the final four, drawing on all the output from previous tasks and the results of bis advisers’ pairwise comparisons.

4.8 The main issues highlighted by the Director General in his summary of the reasons for the choice of the preferred applicant were:

i. Camelot was the second most generous contributor (unadjusted) to the Distribution Fund across the common range of revenue scenarios. The difference between it and Nairobi, which was ahead of Camelot in this respect, was minimal - 575 million present value at the average revenue case. The lead of Nairobi was more than eliminated when other factors

EVALUATING THE APP!XATIONS TO RUN THE NATIONAL LOTTERY

affecting revenue potential were taken into account. The Director General attached particular importance to the size of the proposed on line retail network - Camelot planned 27,000 outlets to Nairobi’s 19,000, and the fact that Camelot had the lowest operator retention (as defined by the Director General) of any applicant, across most revenue scenarios.

ii. Camelot’s application was “one of all round strength and dependability”. In particular the Director General noted Camelot’s:

l strong shareholder base;

. impressive management team with specific experience in lottery systems and game support, and in United Kingdom retail marketing;

l high level of preparedness - particularly of its retail network and its systems, which were in use in a large number of lotteries around the world and were therefore capable of demonstrating their reliability in practice;

l sound retail, marketing and game plans; and

l proposed arrangements for the security of the players prize money, provided by the use of a trust account.

4.9 As a result, the Director General selected Camelot to run the National Lottery.

National Audit Offke comment 12

Appendix 2 of this report, together with the National Audit OfJice comments in the main text, includes reference to some areas where alternative interpretations of the available data are possible. However; none of these is of suficient importance to have a significant impact on the decision making process.

Review - Task S

4.10 The purpose of Task S was to give the Director General an opportunity to reflect on the whole evaluation process and to review, and if appropriate con&m, the decision taken at the end of Task R.

4.11 The process also required the Director General’s four senior advisers to review the pairwise comparisons made between the successful applicant, Camelot, and the other three applicants remaining in consideration at the final stage, as well as to undertake four more pairwise comparisons between Camelot and all the other applicants suspended or eliminated earlier in the decision making process.

4.12 The results of this review confirmed the Director General in his original choice made in Task R, and he announced his decision on 25 May 1994. The licence was issued on 29 July 1994.

EVALUATINGTHEAPPLICATlONSTORUNTHENATIONALLOTI-ERY

National Audit Office coniment 13

. Key commitments offered in Camelot’s original application, specifically those relating to the launch, the Distribution Fund contribution and prize money, have been checkedfrom the application to the Section 5 licence as issued. The National Audit Office are therefore satisfied that the licence does reflect accurately those commitments. The extent to which some of the licence commitments in turn have been adhered to in practice is discussed briefly in Part 5 of this report.

. During the process of checking the licence the National Audit Oflice identified an inconsistency in it arisingfrom the way in which any increases in lottery duty were to be met. The Director General has since implemented a variation in the licence to remove this anomaly and the National Audit Ofice are satisfied that the revised version is consistent with the operators original licence application.

37


Part 5: The launch

The launch commitments

5.1 Although, for the reasons outlined in Part 1 of this report, the National Audit Office study focused primarily on the financial case, the Director General had to consider many less clear cut issues reflecting on the credibility of the applications received. A timely, successful launch, however, would go a long way to demonstrate that the successful applicant could indeed finance the launch, develop the promised retail network in the time available, install the necessary terminals and communication network on time, establish its central computing capacity etc, and hence that the Director Generals judgements on these issues had been borne out in practice. The National Audit Office therefore examined relevant developments relating to the launch and the period to date.

The on line game launch

5.2 The three licence conditions relating specifically to the on line game launch are set out below.

i. A launch date of 14 November 1994.

ii. At least one terminal to be available in each relevant local authority area.

iii. A minimum of 9,000 outlets to have on line facilities available, with the licensee using “all reasonable endeavours” to achieve 10,000.

5.3 Performance against these commitments was as follows:

i. Launch date

It has already been noted that the planned on line game launch date proposed in Camelot’s bid was 5 November 1994. In fact the Director General agreed to defer the target date for the launch of the lottery to 14 November to avoid any clash between the launch and the Remembrance Day commemorations. The lottery was indeed launched on Monday 14 November and the first draw took place on Saturday 19 November.

ii. Terminal availability - geographical coverage

There are 485 relevant local authority areas in the United Kingdom. “Relevant” in this context means, in England and Wales, a district council, London borough, the City of London and the Isles of Scilly; in Scotland a district or an island area; in Northern Ireland a local government district within the meaning of the Local Government Act (Northern Ireland) 1972. At the date of the on line

38

EVALUATINGTHEAPPLICATIONSTORUNTHENATlONALLO'ITERY

launch Camelot reported that terminals were available in 472 of these areas. By the time of the first draw five days later, this figure had increased to 483. Of the two areas without terminals, Kincarclme and Deeside had its first terminal available on 22 November; Tweedale on 15 December 1994.

iii. Terminal availability - numbers of outlets

Camelot reported that on the day of the launch 10,106 outlets were in operation. This increased to 10,507 by the time of the first draw. By the end of the first (part) year ie 31 March 1995, 15,200 on line terminals were reported to be in operation - see Figure 13. This achievement comfortably exceeded that required ln the licence.

The operator has met comfortably its licence commitments regarding on line outlet numbers...

Week Ending larger - Actual

Source: Data supplied to the NationalAudit Office by the Director General

The instant game launch

5.4 The Section 5 licence contains no commitments relating speciiically to the launch of instant games. It does however require that by 31 December 1995 there should be at least 28,170 lottery outlets, of which up to 10,800 may be equipped to sell instant games only. A Section 6 licence to promote an instant game was issued to Camelot on 17 March 1995, effective for the period 20 March 1995 to 20 March 1996.

EVALUATINGTHEAPPLlCATlONSTOR"NTHENATIONALLOll'ERY

5.5 The first instant game was launched on 21 March 1995, but was initially a&ted by computing problems which resulted in a loss of instant ticket services to retailers from approximately 8.30 am to 7.00 pm that day. To explain the reason for that failure it is necessary to outline some of the background to the system:

l on receipt the retailer must acknowledge all deliveries of instant game tickets via its terminal, this acts as coniirmation that the retailer has accepted responsibility for the tickets concerned;

l prior to sale, the retailer must use its terminal to “activate” the pack to be sold. Activation fulfils several purposes, amongst other things it triggers the invoicing system to charge the retailer for the tickets concerned.

l prior to paying out any prize, the retailer must “validate” the relevant ticket. The validation process reqoires the retailer to scan a bar code on the ticket and then to feed in through its terminal a unique validation number appearing on the ticket. The central computer is then able to confirm that this validation number does indeed belong to a prize winning ticket, and the value of the prize concerned. This process serves to make it much more diEcult to forge prizewinning tickets. And by allowing payment only against properly activated tickets it reduces signi6cantly the risk of prizes being paid against stolen tickets.

5.6 The Director General has explained that all instant game cards were delivered either late on Monday 20 March or early on Tuesday 21 March 1995. Thus early that day some 20,000 retailers were all trying, more or less simultaneously, to use their terminals to acknowledge receipt of their deliveries, to activate the tickets they wished to sell and to validate any prize winning tickets already sold. The system could not cope with the demands made upon it and, to protect the integrity of its data base, it was decided to close it down. By 8.30 am the instant ticket system was shut down completely.

5.7 The Director General has further explained that the problem was resolved by making changes to the software which simplified, and so speeded up, the relevant processes. As a result the system began to function normally again at about 6.30 to 7.00 pm that evening, although the official re-launch was deferred until 12.30 pm the following day. The Director General has told the National Audit Office he is now satisfied this problem should not recur, and it is relevant to note that the launch of the second instant game on 2 May 1995 was accomplished smoothly.

Sales

5.8 The principal revenue forecast incorporated in Camelot’s application was based on sales of E850 million in the period from launch to 31 March 1995. In the event, the popularity of the lottery significantly exceeded expectations, with Camelot reportjng actual sales of El.191 million in that period, ie some 40.1 percent higher than forecast. As a result, the actual contribution to the Distribution Fund in respect of ticket sales in the first (part) year ofits operation ending on 31 March 1995 totalled E311 millton, some 40.7 percent higher than forecast.

40



l The operator launched the on line game on time and, on the basis of the information supplied, appears to have met the licence commitments relating to outlet numbers and (to a large extent) their geographical distribution. In addition sales to 31 March 1995 were reported to be some 40 percent ahead offorecast. Thus the Director Generals judgement that Camelot would engineer a punctual and successful launch of the on line game appears to have been borne out in practice.

. The launch of the first instant game on 21 March 1995 did not go according to plan, howeven resulting in the loss of instant ticket services to the lottery’s retailers for approximately 11 hours. The Director General has explained that this failure ums caused by overloading the system, that appropriate steps have been taken to ensure this problem should not recur and that the launch of the second instant game on 2 May 1995 mas accomplished smoothly.

. The extent to which key Section 5 licence commitments have been met in practice will be considered in more depth in a separate National

,Audit Office study of the monitoring and regulation of the lottery.

41

EVALUATING THE APPLICATIONS TO RUN THE NATIONAL LO’ITERY

Appendix 1 Applicants’ perspectives on the evaluation process

1 As part of its examination of the process leading to the award of a licence to run the National Lottery issued under Section 5 of the National Lottery etc. Act 1993, the National Audit Office contacted aII the applicants Involved to obtain their views on that process. Six of the eight applicants provided written and/or oral comments. The remainder of this appendix details the comments received from applicants, together with the National Audit Office’s observations on the points made.

2 In some cases different applicants made the same or similar comments. In such cases applicants’ contributions were merged so that the relevant wording below is a “composite” comment. In other cases applicants’ comments have been redrafted for presentational purposes. Throughout this process great care has, of course, been taken not to distort the sense of applicants’ original comments and the applicants have coniirmed that this has not been done inadvertently.

3 Taken In isolation, the comments could paint a negative and critical picture. Such a picture would be misleading. In fact, while making critical comments at the detailed level, a number of applicants commented favourably on the process as a whole, remarking on the “rigour”, ” professionalism” and “fairness” with which it was conducted.

Comment 1

Applicant’s comment

Eight groups declared their Intention to bid for the Section 5 licence. Each of these groups had to satisfy a very complex application requirement in full. This necessitated thousands of pages in tens of volumes, costing each bidder upwards of El million and many months of work. A more efficient process would have been to pare the eight bidders down to two or three through a more informal, less costly, screening procedure, before entry to a more demanding final stage. Such a procedure has been adopted by some United States state lotteries.

Observation

Clearly this argument appears logically sound. In any competitive situation where there can be only one winner, inevitably all the other competitors lose money on abortive expenditure incurred in preparing their unsuccessful bids. In this particular instance there are perhaps two points that should be made:

43

EVALUATINGTHEAPPLICATIONSTORUNTHENATIONALLOlTERY

l The cost of preparation of applications was not a factor the Director General was empowered to take into consideration in discharging his responsibilities under the Act. He was required, inter alia, to maximise the net proceeds of the lottery. Insofar as a two stage competition might have taken longer than a single stage one, and so delayed the launch of the lottery, it would have been incompatible with this statutory requirement.

l In practice, although clearly this is only apparent with hindsight, the applications received were of a high quality. It is not obvious that any of them could have been filtered out at an initial stage. All of them required careful consideration before the successful application could be identified.

Comment 2


An approach which selected an operator but left the selection of suppliers to a subsequent process, conducted perhaps by the operator and the Director General together, might have created greater competition and a higher return to the Distribution Fund in the longer term. The process chosen had its risks. Had, for example, each of the terminal suppliers adopted the G Tech approach (G Tech is a major American based supplier of lottery terminals and holds 22 percent of Camelot’s share capital) and worked with a single consortium only, then the number of credible bidders would have been severely constrained, perhaps to two or three.

Observation

Again, this argument is also logically sound. The Director General did not seek to dictate or constrain the composition of the bodies eligible to apply for the Section 5 licence. However:

l had the Director General adopted the “two stage” process suggested it could have delayed the launch of the lottery with a consequent effect on the proceeds available for the Good Causes.

. In practice the situation envisaged did not arise, ie. the competition for the licence was very fierce.

l The Director General has told the National Audit Office that there were at least four potential terminal suppliers and has argued that, in the unlikely event that they all restricted their participation to one single application there would still have been, in his view, more than adequate competition.

44

E"ALUATINGTHEAPPLlCATIONSTORUNTHENATIONALLOlTERY

Comment 3


From the earliest stages of the Application process, we believed the Office of the National Lottery intended that all Applications be made public, thereby following a similar approach to that used previously in the Channel 3 Licence Applications. It is our view that such transparency would have aided public understanding of the grounds on which the decision to award the licence was made and would have facilitated subsequent consideration of the Lottery’s performance.

Observation

The minutes produced at the time record that the proposed confidentiality regime was discussed with prospective applicants during the consultation on the draft Invitation to Apply. In addition the covering letter distributed with the final Invitation to Apply and dated 21 December 1993 stated “Following the submission of applications on 14 February 1994, I shall publish the names and addresses of applicants. Neither I, nor my advisers, will publish generally or to any third party any further details of applications”.

One of the objectives of this report is that it should increase the “transparency” and “aid public understanding” etc. of the choice of licensee.

Comment 4


The National Lottery etc. Act 1993 envisages two types of licence, ie a Section 5 licence to run the National Lottery and a Section 6 licence to promote a game within it (see paragraphs 1.4 to 1.7 of this report). This framework created an uncertainty for Section 5 Applicants which the Office of the National Lottery could not resolve. The requirement for prospective Section 6 applicants to agree satisfactory arrangements with the Section 5 licensee could potentially give rise to problems should the Section 5 licensee not feel that a separate Section 6 licensee would enhance the National Lottery’s performance. In such a circumstance, the frustrated Section 6 applicant might seek redress through the relevant competition authorities in the United Kingdom and the European Union, giving rise to further uncertainty and accompanying expense.

Observation

This issue arises from the legislative environment in which the lottery operates rather than from the evaluation process itself. As such it is an issue that must be considered, if necessary, by the courts. It would not be appropriate in a report such as this to attempt to provide a definitive interpretation of the law.

45


Comment 5


The Section 5 licensee has the sole responsibility for recommending to the Director General the award of Section 6 licences. The current Section 5 licence holder has however refused out of band to consider Section 6 proposals from other bodies. Such behaviour is anti-competitive and does not reflect Parliament’s intention. Separate and competitive management and promotion of instant and on line games is the only way to maximise proceeds and player satisfaction.

Observation

In general the relationship between the Section 5 and Section 6 licencees, and the Director Generals powers and duties with regard to that relationship, is another issue that arises out of the legislative environment in which the lottery operates.

In response to this specific comment Camelot has told the National Audit Office that it has had only one short informal discussion with one other applicant regarding a Section 6 licence. The proposal tabled closely mirrored Camelot’s own plans and would not therefore in their view have generated additional income to the Distribution Fund. As a result no further dialogue took place. Camelot further stated that its policy is to evaluate ail submissions it receives to assess any potential gain for the Distribution Fund. To date no formal proposals have been received, however.

In addition the Director General has also told the National Audit Oftice that one unsuccessful applicant declared its intention to seek a Section 6 licence for instant games, and sought his support. The Director General referred that applicant to Camelot. The Director General added that the applicant provided no evidence, either at its meeting with him or in its Section 5 application, which would lead him to believe that its approach would maximis e the proceeds of the National Lottery or improve upon that adopted by Camelot. The Director General also added that any prospective Section 6 licensee who believes Camelot is acting against the interests of the National Lottery is bee to make representations to him, but that he had received no such representations.

Comment 6


Instant games should always be the pioneer product for a new lottery, gaining wide distribution and making participation available to the broadest possible franchise. If they are not launched first international experience shows they will never gain sufficient foothold and will not achieve their full potential. The invitation to tender however was biased in favour of the on line game and away from instant scratch card type games.

46


Observation

The Invitation to Apply had a clear bias towards an initial on line launch but did not preclude a launch based on an instant game. In the event the majority of applicants proposed an initial on line launch, although one suggested a simultaneous launch of both an instant and an on line game, while another favoured the instant game.

Applicants gave various reasons in support of their chosen strategies but recurring themes were the need to launch the United Kingdom lottery with a “bang”, which could best be achieved through the introduction of an entirely novel on line lottery game with its associated technology, and the perceived “downmarket” image scratch cards had acquired in this country through being used as, for example, a sales promotion device etc.

On the question of whether instant games can and will “gain sufEcient foothold etc.” in the United Kingdom market, the Director General has pointed out

that the sales of Lottery products are currently some 40 percent ahead of forecast and that instant games are making a major contribution to this success in that they currently account for approximately 40 percent of total sales.

Comment 7


The evaluation process may not have given proper weight to the applicant’s proposed game strategy and game marketing proposals, given that the best games, game strategy and marketing plan will help to maximise revenues to the Distribution Fund.

Observation

As can be seen from Figure 5 on page 14, Task C included an evaluation of applicants’ game and marketing plans. As such they fed into Task R (the selection of the successful applicant) both directly and through the summaries of applications produced as part of Task K, and through Task Q - see Figure 11 on page 31. These plans were therefore one of the (many) factors the Director General took into consideration when discharging his responsibility under Section 4 of the Act to exercise his functions in the manner he considered most likely, inter alla, to maximise the revenues to the Distribution Fund.

Comment 8


Questions of the tastefulness of lottery games may not have been adequately taken into account. The concept of the National Lottery should be based on fun rather than greed. It is not in the interest of the public that one individual should be able to win tens of millions of pounds. Were the more fun-orientated,

EVALUATINGTHEAPPLKATIONSTORUNTHENATIONALLO?TERY

interesting and less greed-ridden games given the due credit they deserved in the evaluation process?

Observation

See Comment 7.

Comment 9


The lottery field matrix chosen by the successful applicant was 6149 (ie required the player to select six numbers from a field of 491 with odds of 1:14 million and is too small a field matrix for a lottery to be played by the United Kingdom population. The state of Florida (with a population of 13 million) uses a 6/49 field matrix. Further, this 6/49 field matrix was inevitably going to make the successful applicant’s business plan appear more robust than if they had chosen a more appropriate field matrix (eg. 7/49).

Observation

The arguments presented under Comment 7 are equally applicable here.

In addition it should be recognised that the main effect of using a 7/49 matrix instead of the existing 6149 one would be to increase the odds against winning a jackpot from 1:14 million to 1~86 million. This would result in more frequent rollovers and jackpots shared between fewer winners.

The majority of applicants proposed a 6/49 matrii and while it is impossible to know how the United Kingdom market would have responded to a 7/49 matrix, there can be no doubt that the 6/49 matrix is very popular, as is evidenced by the higher than expected sales.

Comment 10


The evaluation process did not give proper weight to applicants’ proposed launch dates. An almost inevitable consequence of attaching too much significance to the launch date was that the applicant who spent most money in preparing his bid would be the one to succeed.

Observation

Applicants’ states of preparation was one of the (many1 factors contributing to the Director Generals decision. The way in which applicants’ launch date proposals were taken into consideration in the evaluation process is outlined in the discussion of Task Q - see in particular 3.17 and Figure 9 on page 26 of this report.

48

EVALUATlNGTHEAF'PLKATtONSTORUNTHENATlONALLOTTERY

Comment 11


The evaluation process did not give proper weight to central system and terminal performance, in particular processing speed and system versatility, ie the central system technology used by the current Section 5 licence holder is not the most modem or versatile system available.

Observation

As can be seen from Figure 5 on page 14, Task B included an evaluation of applicants’ proposed systems, the result of which fed into Task R (the selection of the successful applicant) both directly and via the Task K summaries of applications received.

The Director General has told the National Audit Office that while he accepts the comment on the systems chosen, he attached considerable weight to reliability and proven practical experience In a major lottery, particularly since the United Kingdom launch was likely to involve twice as many terminals as any other launch in the global lottery industry. In his view the chosen applicant was well able to demonstrate such experience and reliability.

Comment 12


The evaluation process did not give proper weight to an applicant’s commitment to return “windfall” profits to the Diin-ibution Fund ifturnover exceeded expectation.

Observation

The way in which applicants’ profit sharing commitments were taken into consideration in the evaluation process is outlined in the discussion of Task Q in Part 3 (ii) on page 27 of this report.

Comment 13


The sensitivity tests applicants were asked to conduct were geared more to the prospect of failure than success, which is unrealistic in the context of other national lottery performance models. In particular, the pessimistic sensitivity test which applicants were asked to cnndnct contemplated a wholly mrealistic.

disastrous scenario given the monopoly position of the Section 5 Licensee and the experience of lotteries elsewhere.

49

EVALUATINGTHEAPPLICATlONSTORUNTHENATIONALLOTTERY

Observation

As is explained in the discussion of Task N on page 21 of this report, applicants were required to submit business plans based on their own revenue forecasts, and also on scenarios in which actual sales were assumed to be half and double respectively of those envisaged in the principal forecast. The object of this was to test how robust applicants’ proposals were in the face of unexpected circumstances eg. if sales were higher than expected, could their systems cope with the extra volume? On the other hand, if the lottery took longer than expected to capture the public’s support, did the applicant have suiEcient financial backing to survive in the meantime?

It was a matter for the judgement of the Director General to decide how much importance to attach to these alternative possibilities, but prudence demanded they should at least be considered.

Comment 14


The evaluation process did not give proper weight to the alleged activities of G Tech as documented in BBCZ’s “The Money Programme” in October 1993.

Observation

The references to Task G in Part 2 of this report outline the steps taken by the Director General to satisfy himself that all those involved in seeking the Section 5 licence, were “fit and proper” for their proposed role in the National Lottery.

Comment 15


The evaluation process did not give proper weight to the market research which established that more players would spend more money on the National Lottery knowing that all profits would go to good causes.

Observation

Paragraph 3.20 in the main text explains why the Director General considered he could not adjust one applicant’s commitments to the Distribution Fund to reflect proposed payments to charities of the applicant’s choosing.

The Director General noted that most applicants (including the applicant who proposed to give profits to charity) believed that the chance of winning provides the primary motivation for playing, and that the contribution to good causes provides permission to play. However, he acknowledged that one applicant’s assertion that “more players would spend more money if they knew that all profits would go to charity” might provide it with an arguable case that it would

50

EV4LUATINGTHEAPPLICATIONSTORUNTHENATIONALLOlTERY

generate higher lottery sales than other applicants. As part of his evaluation, therefore, the Director General asked the applicant concerned to submit full details of the market research it had undertaken to support its assertion. This was normal practice: the Director General also asked other applicants to submit detailed market research results to support their (different) marketing assertions.

Following examination by his marketing consultants, the Director General concluded that the applicant’s market research was constructed in such a way that, while it identified general support for the idea of donating profits to charity, it did not allow either the applicant or the Director General to make any estimate of the amount by which total revenue would be increased as a result. The Director General concluded that the research did not provide the basis for applying any quantitative adjustment to lottery revenue.

51


Appendix 2 Evaluation of applicants’ marketing proposals

1 The National Audit Office received specialist advice on marketing issues arising i?om the evaluation process from Professor Patrick Barwise, Director of the Centre for Marketing at the London Business School. The following is the summary taken from his detailed report,

Introduction

2 I have been asked to advise the National Audit Office on whether the assumptions made and methodology followed by the Director General in his evaluation of applications to run the National Lottery (specifIcally, the evaluation of applicants’ marketing proposals) conform with accepted professional practice. The short answer is yes.

Overall assessment

3 The launch of the National Lottery has been a clear marketing success. I believe this has not been a matter of mere good luck, but instead reflects the high quality of marketing analysis and plating in the successful application.

4 Overall, I believe the information available underlines the high quality of the work done in:

. developing an Invitation To Apply which generated several very good applications;

l evaluating the applications received; and

. leaving a clear and well-structured paper trail justifying the final decision.

5 These achievements were based on detailed prior plating, leading to a well structured Invitation To Apply and to a comprehensive Evaluation Process Manual which proved robust and needed only minimal changes in practice.

EVALUATINGTHEAPPLKATIONSTORUNTHENATIONALLOTTERY

6 This is not to say that I am able to endorse every element in the Director Generals evaluation of the applicants’ marketing proposals. My view of several of the marketing variables, and of the best way of factoring them into the evaluation process, differs in some specific areas Tom that taken by the Director General. However, these differences:

. fall well within the normal range of variation in professional judgement and, more important;

. would not have changed the outcome, ie the choice of Camelot Group plc to run the National Lottery.

Documents

Evaluating the Applications to Run the National Lottery