June 12, 2011

Economics of a Small Poker Room

This spring, Iowa poker players have been abuzz about the larger than usual bad beat jackpots at the Prairie Meadows Racetrack, Casino, and Den of Iniquity. In mid-May, the main jackpot went off at a little north of $215,000. The reserve jackpot of roughly $95,000 was then rolled out, and has since grown to nearly $110,000. With shares of 50% to the losing hand, 25% to the winning hand, and the remaining 25% divided equally among the other players at the table, the bad beat jackpot is certainly a nice pay day for catching the wrong end of a cosmically rare lucky cooler hand.

After a little reflection on the bad beat jackpot (BBJ), it occurred to me that the nature of the BBJ structure and the timing of the recent jackpot win permit some intriguing insights into the economics in play at the Prairie Meadows poker room. In particular, the BBJ information provides a method for making a meaningful estimate of the number of raked cash game hands dealt, total cash game rake taken by the house, average rake per hand, and even dealer and cocktail server tips.

Looking first at the structure of the BBJ, the sizes of the the main and reserve BBJs in May suggested that the jackpot drop was distributed to the two BBJ funds in a 2:1 or 3:2 ratio. A poker room manager confirmed to me that the jackpot drop was distributed with 60% going to the primary BBJ and 40% to the backup BBJ. Even more important is that the room's other uses of jackpot promotion funds—$200 flat payments to straight flushes—are not funded with a dedicated reserve, but instead bonuses for straight flushes are deducted first from each day's jackpot drop, with the remaining funds then credited to the two BBJs. [FN1] Thus, unlike many poker rooms which use their jackpot drop to fund a variety of promotions, it is fairly easy to determine the actual total jackpot drop taken at Prairie Meadows.

To calculate the jackpot drop taken at Prairie Meadows, we first take the amount of the reserve BBJ, which we know was wholly funded since the last BBJ was won. Dividing the reserve BBJ ($95,000) by 40% gives the amount contributed to the main BBJ ($142,500 of the $215,000), for total BBJ funding of $237,500 since the last BBJ was won. Next, we need to add an estimated payout for straight flush bonuses from the jackpot drop. Talking with the poker room manager, roughly two to four straight flush bonuses are paid out each day. Assuming an average of 20 straight flush bonuses per week adds roughly $208,000 per year to the jackpot drop taken (20 x $200 x 52 weeks).

Next we need a way to convert the BBJ funds to an annual basis. This is where the timing of the recent BBJ win comes into play. The recent jackpot was won roughly six months after the last win in late December. So, to get an estimated annual jackpot drop, we can simply double the jackpot drop since the last BBJ win ($237,500 x 2 = $475,000) and add the annual straight flush payments ($208,000) for a total annual jackpot drop of $683,000. [FN2]

Now the interesting point to keep in mind is that the amount dropped for the jackpot fund  is correlated to the amount dropped by the house in rake.  The dollar dropped each hand for the jackpot fund is taken at the same time as the first dollar of rake (at $10 in the pot). So, if a hand is not raked, no jackpot dollar is dropped. Thus, the amount dropped for the jackpot fund is the minimum amount taken by the house for rake (the "base rake"). To estimate the total amount taken in rake, one must simply estimate the percentage of raked hands that also reach the second, third, and fourth dollars of rake (taken at the $20, $30, and $40 marks).   This depends to a great degree on the game mixture in each room. A room spreading $2/$4 LHE will take less rake than a room with $3/$6 or $4/$8 as the smallest LHE game. Similarly, a room with $1/$2 NLHE will hit those rake marks less frequently than a room with $1/$3 or $2/$5 NLHE as its smallest game (though some rooms offer more graduated rake structures for their bigger games). Rooms that allow or require kills, half-kills, and/or straddles will also take more in rake.

Turning back to Prairie Meadows, the estimated annual jackpot drop of $683,000 translates into a base rake for the house of $683,00. Taking into account that the jackpot drop calculation might be subject to some variation based on season, economic conditions, the effect of promotions, and the live horse-racing season, the jackpot drop and base rake might vary up to 20%, giving us a range of jackpot drop and base rake of roughly $550,000 to $825,000, though the actual number is most likely much closer to the original estimate, probably around $650,000. Converting the base rake to an estimated total rake merely requires estimating the frequency of each raked hand also being raked at the second, third, and fourth dollar levels. A room with mostly small stakes limit games and "social" style no-limit games will generate a less aggressive rake profile than a room with predominately action-oriented no-limit games. The following table for a room with base rake similar to Prairie Meadows illustrates the range of total rake that might be taken depending on the nature of the room's game mix and action level [FN3]:

Table 1—The "additional rake distribution" columns reflect the
percentage of raked hands which reach each additional dollar of rake 
($1 in rake taken at $20 / $30 / $40 in the pot). Figures are on
an estimated annual basis. (Click on table for larger view.)

The left hand column for total rake is probably a closer fit for a poker room with mostly $2/$4 LHE and some $1/$2 NLHE, while the right column for total rake is a better fit for a room with mostly action-oriented $1/$2 or $2/$5 NLHE and some $3/$6 or higher LHE. Prairie Meadows generally spreads mostly $1/$2 NLHE and $3/$6 LHE (with a full kill), along with fairly regular $2/$5 NLHE and a weekly $6/$12 Omaha8 game. Using a base rake of ~$650,000 per year, and the more aggressive rake assumptions, the estimated total annual rake for Prairie Meadows is roughly $2.25 million.

Looking at the Iowa Racing and Gaming Commission official financial reports, Prairie Meadows reported total poker rake of $2.3 million in 2010. Assuming $75,000-$100,000 of the reported rake is from poker tournament entry fees [FN4], the estimate of $2.25 million in cash game rake, as well as the underlying assumptions regarding the size of the annual jackpot drop and the aggressive rake structure are validated as being reasonably accurate.

As an interesting side note, the Caesars Entertainment family of casinos has imposed a $5 maximum rake at most of their poker rooms (and a $5.50 maximum rake at their Horseshoe Casino in Council Bluffs, Iowa). The amount generated by this extra rake can be estimated by adding the amounts in the following table to the rake calculated previously for a $4 maximum rake (the table below shows the percentage of hands that reach the maximum rake threshold of $50):

Table 2—Effect of a $5 maximum rake, related to percentage
of raked hands that reach the maximum rake ($50+ in pot). Figures
are on an estimated annual basis. (Click on table for larger view.)

Based on the table above, if Prairie Meadows increased its maximum rake to $5, it could generate an additional $250,000 to $300,000 in annual revenue. Although there would be some resistance from players to any rake increase, Prairie Meadows really has little direct competition due to geographical constraints. The closest competitive poker rooms in terms of size and action are in Council Bluffs (across the river from Omaha) and Kansas City, each two or more hours drive from the Des Moines area (not to mention these rooms already have at least a $5 maximum rake). Some players might go to rooms at Meskwaki or Riverside (near Iowa City), but these rooms generally have less action and less satisfactory room set-ups in addition to being an extra one to two hour drive for most players. In any event, it's easy to see why Caesars increased its maximum rake.

Now, why bother deriving the jackpot and rake drops indirectly if the rake drop can be determined simply by looking at financial reports? First, as noted previously, we can verify the general validity of our assumptions about the rake structure, which will help derive financial data for all Iowa casinos (the subject of an upcoming post). Second, knowing the jackpot drop can help us draw some other interesting conclusions about the economics of the poker room, specifically the amounts spent by poker players on tips to dealers and cocktail servers.

Our analysis of dealer tips begins with the observation that the jackpot drop is essentially a proxy for the number of hands that are raked. Each dollar in the jackpot drop represents one hand that was large enough to generate rake (i.e, had at least $10 in the pot). Generally speaking, if a pot is large enough to be raked, a dealer is usually tipped at least $1. Some players will tip on smaller pots, while some players are stingier with tips. In a room like Prairie Meadows with a high number of regular players and mostly long-term dealers, tips tend to run above the $1 per hand benchmark, with a fair number of players tipping more than $1 on larger pots. A matrix of raked hands dealt ("tipped hands") and average tip size gives us a reasonable range of total dealer tips per year:

Table 3—Range of total amounts paid for dealer tips. Figures are
on an estimated annual basis. (Click on table for larger view.)

Using a range of 550,000 to 650,000 tipped hands per year, and assuming $1.25 to $1.50 per tip, a reasonable estimate of total dealer tips would be roughly $800,000 per year. Assuming 20-25 dealers on the regular rotation, this works out to $32,000-$40,000 per dealer per year, which seems a reasonable income (some regular dealers with more seniority, prime shifts, and better people skills likely pull down well above this amount, while the part-time dealers earn substantially less).

Turning to cocktail server tips, the connection between raked pots and server tips is not as closely correlated as was the case with dealer tips. However, servers generally come by each table two to three times each hour, and typically bring three to five drinks each trip. Most players tip $1 per drink, so a server should earn $6-$15 per table per hour. So, if we assume that the typical table gets in approximately 25 raked hands  (30 total hands) per hour, then we can estimate the reasonable range of cocktail server tips:

Table 4—Range of total amounts paid for cocktail server tips. Figures
are on an estimated annual basis. (Click on table for larger view.)

Using the range of 600,000 to 650,000 raked hands, and assuming $10-$15 per table per hour (Prairie Meadows players and servers being regulars, tips run on the generous side), an estimate of $300,000 in server tips per year seems reasonable.

Taking each of these economic factors into account, the total financial costs of poker at Prairie Meadows can be calculated:

Rake:                 $2,300,000
Jackpot Drop:      $650,000
Dealer Tips:         $800,000
Server Tips:         $300,000 

Total:               $4,050,000

This figure is only an estimate, but the rake figure is definite (based on financial records), and the jackpot drop is likely not overestimated by more than $50,000 or so. Even if the dealer and server tips are overestimated by as much as 25% ($275,000 too high), the most conservative estimate for the total costs of poker at Prairie Meadows is still $3.7 million. Of course, the dealer and server tips may be underestimated as well. 

Prairie Meadows is just one of 16 casinos in Iowa that offer poker, albeit being the second-largest room in terms of both casino and poker revenues (after the Horseshoe). Prairie Meadows is a typical small-to-mid-sized (11 table) poker room with a mostly local / regional player base. Non-local players find their way to the poker room because Des Moines is the state capital and state's largest city, which helps attract a certain number of business and convention travelers. Also, Drake University is located in Des Moines while Iowa State University is in Ames, an easy 30 minute drive north of the casino. Des Moines is located in the center of the state, at the intersection of I-80 and I-35, generating additional players from long-distance travelers, primarily truck drivers (it certainly doesn't hurt that the casino is located right off an I-80 exit near the east I-80/I-35 mixmaster, an exit shared with the Adventureland amusement park). Certainly, the room certainly has a different player base and business model than similarly sized rooms in Las Vegas.

In any event, it is indisputable that poker players pay roughly $4 million per year in actual costs for the privilege and convenience of playing poker at Prairie Meadows, money which is completely removed from the poker community. Obviously a certain percentage of the Prairie Meadows players are winners. So, the Prairie Meadows poker community as a whole has to generate non-poker income sufficient to cover the $4 million in overhead costs, as well as pay the winning players their profits. This money can only come from one source—players' outside income, whether from wages, business or investment revenue, savings, government assistance, or other sources. With Iowa having a population of only 3.04 million, median household income of $48,000, and median individual income of $31,400 (women) to $42,600 (men), generating $4 million to cover the poker overhead at Prairie Meadows is no mean feat. It certainly gives one pause to reflect on the long-term sustainability of poker, at least in the live casino setting on the current scale.

Stay tuned! Later this week crAAKKer takes a broader look at the economics of the live poker scene in the state of Iowa as a whole.

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[FN1]  In the rare instance that the straight flush payouts exceed the daily jackpot drop, the amount needed to cover the excess straight flush payouts is deducted from the reserve BBJ fund. The poker room manager indicated this situation has occurred "at most three or four times".

[FN2]  This annual estimate might be a little on the high side given that the Prairie Meadows poker room generally sees somewhat higher action during winter months (monthly poker room rake ranges from $165,000 to $220,000 according to Iowa Racing and Gaming Commission reports). Also, the BBJ mania likely generated somewhat higher than normal numbers of players, though much of this extra business probably generated lower than normal rake rates as many of the extra players sat in $3/$6 LHE games and folded hands with little or no BBJ potential, while checking down or light-betting hands with BBJ potential.

[FN3]  The spreadsheet from which all the tables were derived can be viewed on Google Docs.

[FN4]  Prairie Meadows has three weekly tournaments with buy-ins of $60 or less, each of which has 30-100 entries. Assuming 150-200 entries per week at $10 each, the poker room will earn a total of ~$75,000-$100,000 per year from poker tournaments. Although many poker rooms offer more tournaments with higher entry fees, clearly poker rooms rely on cash games to generate the bulk of their revenues.

6 comments:

  1. I thought the old adage was that whenever a lawyer picked up a calculator, it was immediate grounds for malpractice :-P

    Interesting post!

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  2. I have issues with some of your assumptions, but your larger point (that rake eats a much larger portion of money than most people realize) is quite valid. I spoke with a poker room manager who told me that most tables generated between $100 and $120 in rake per hour. LHE tables generated about 10% to 20% more than NLHE tables (less time in the tank = faster hands) and that lower limits (3/6 and 4/8) yielded FAR better tips than higher limits. The best dealers can shoot 30 hands in an hour (2/minute). Most are around 22-25, which is why good, fast dealers who can move the action are really worth it to the casino. On average, there is only 1 unraked pot per hour at the lower limits. Based on these numbers, you simply multiply by the number of tables and you have your drop and your total rake. Even assuming max rake per hand, I think its far less than the numbers you put out, but it's a lot.

    I thought about this again 3 days ago, because I hit a nice room share on a $75,000 BBJ in a casino that had just 5 tables - only three of which are ever in action outside of a tournament.

    -DrC

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  3. @ CK-BWoP: Agreed! But my current gig is far too often requiring me to dust off my long-neglected basic accounting skills.

    @ Dr. Chako: My rake figure is dead-on balls accurate, since it is verified by the official state reported figures. I agree that LHE tables may be faster, but NLHE tables are far more likely to hit max rake per hand (especially in Vegas, where LHE may be predominately $2/$4). Still, I think many people underestimate the frequency of hands hitting max rake, regardless of game.

    As for tips, I agree with you completely that the lowest level games spread in a room tend to have the highest tip/hand rate. What that tip rate might be can only be estimated, unless a poker dealer wants to speak up. Knowing several poker dealers who have expressed that getting $1/hand is a good down, I'm using that as sort of a baseline. If I'm off here, I suspect I might be off on the low end.

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  4. Dude maths iz hard....going to go to bed and re-challenge you at words with friends.,,,words easier...mathz hard - burke 3265

    ReplyDelete
  5. Reader Tarpie posted the following comment at 12:14 pm CST, but it is not appearing here. I am reposting the comment based on the email notice I received from Blogger. -- Grange95

    $2.3M is available to pay floors, cashiers, dealer base, and alcohol (assuming free alcohol flows in IA, if not this applies to LV and AC casinos). It doesn't seem like there is a lot, if any, profit to be made by running a poker room. I guess they really are loss leaders in destination markets. Husband plays poker while wife funds the casino with slot play, or so the theory goes.

    I'm not sure jackpot drop is actually being removed from the poker economy. If nothing else, poker players win it, so there's a good chance it gets put back into play at some point.

    Same for dealer tips. Many dealers play the game, so tip money tends to get put back on the table. The off-duty GN dealers at Bill's Thursday night were definitely dumping money into the poker economy :)

    Still a lot of money coming off the table.

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  6. In response to Tarpie's comments:

    * In Iowa, alcoholic drinks are not free.

    * In Iowa, poker dealers cannot play poker or other table games, only slots. So dealer tips are removed from the poker economy.

    * Jackpot payouts for straight flushes may make it back in play, but the main jackpot drop funds go to the BBJ. Winners are rarely from the area, and the large amounts of the BBJs usually end up being spent away from the poker room.

    * I think there is more profit in poker for the house than commonly believed. At the least, I don't think poker is any less profitable than most table games. Check back later this week for my breakdown of the larger Iowa poker and gambling scene.

    ReplyDelete