BuSiNeSS PlAN - California Lottery

CommissionersJOHN MASS, of Los Angeles, was first appointed to the State LotteryCommission by Governor Schwarzenegger on December 13, 2004 andwas reappointed by the Governor on December 28, 2006 and has servedas Commission Chair since December 13, 2004.Chairman Mass is Executive Vice President and head of CorporateDevelopment and New Ventures for the William Morris Agency, LLC,where he oversees strategic planning, acquisitions and investments.Chairman Mass is also a member of the company’s Board of Directors.Prior to joining William Morris, Chairman Mass was an Associate inthe Investment Banking Division at Bear, Stearns & Co., Inc.RACHEL MONTES, of El Monte, was appointed to the California StateLottery Commission by Governor Schwarzenegger on March 30, 2004.Commissioner Montes has been a businesswoman for over 38 yearsin sales and consulting. Commissioner Montes served as CommunityLiaison for the Mountain View School District for 10 years. She waselected as City Clerk of El Monte and later was elected as the firstLatina Mayor of El Monte in 1999.Currently, Commissioner Montes serves as Cultural Commissioner forthe City of El Monte. Additionally, she has been recently asked to jointhe Board of Directors of L.E.O. Affiliates and “Enough,” both nonprofitorganizations which benefit her community.MANUEL ORTEGA, of Yorba Linda, was appointed to the CaliforniaState Lottery Commission by Governor Schwarzenegger onMarch 29, 2005.Commissioner Ortega served as Chief of Police in three differentcommunities. Most recently, he retired from the City of Bell Gardensin December 2005, after serving five years as its Chief of Police.In addition, Commissioner Ortega was appointed to the Commissionof Peace Officer Standards and Training (P.O.S.T), served as Chairmanof the P.O.S.T. Commission for one year in 1996-97, and served on theBoard of Prison Terms from 1997 to 2000.California Lottery 2007–2010 Business Plan

Table of ContentsIntroduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2Business Overview1.1 Creation and Purpose of the Lottery . . . . . . . . . . . . . . . . . . . . 51.2 Beneficiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51.3 Distribution of Funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71.4 Business Model. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91.5 The CSL Game Portfolio . . . . . . . . . . . . . . . . . . . . . . . . . 131.6 Organizational Structure . . . . . . . . . . . . . . . . . . . . . . . . . 171.7 Key Events in California State Lottery History . . . . . . . . . . . . . . 20Integrity, Security, Honesty, and Fairness2.1 A Winning Experience . . . . . . . . . . . . . . . . . . . . . . . . . . 232.2 Security and Law Enforcement. . . . . . . . . . . . . . . . . . . . . . 232.3 Audits and Compliance. . . . . . . . . . . . . . . . . . . . . . . . . . 242.4 Social Responsibility . . . . . . . . . . . . . . . . . . . . . . . . . . . 252.5 Problem Gambling . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28Market Analysis3.1 Customer Demographics and Playership Trends . . . . . . . . . . . . 313.2 Consumer Product Sales Comparisons . . . . . . . . . . . . . . . . . 363.3 Consumer, Retail and Technology Trends . . . . . . . . . . . . . . . . 373.4 Lottery Industry Trends and Best Practices . . . . . . . . . . . . . . . 38Performance Assessment4.1 Overall Sales Evaluation . . . . . . . . . . . . . . . . . . . . . . . . . 414.2 Benchmarking the California Lottery. . . . . . . . . . . . . . . . . . . 444.3 Draw Game Performance . . . . . . . . . . . . . . . . . . . . . . . . 474.4 Scratchers Game Performance . . . . . . . . . . . . . . . . . . . . . 524.5 Retailer Network Assessment . . . . . . . . . . . . . . . . . . . . . . 564.6 Efforts to Improve the Business Model . . . . . . . . . . . . . . . . . 574.7 Retailer Recruitment and Optimization. . . . . . . . . . . . . . . . . . 584.8 Administrative Operations Assessment . . . . . . . . . . . . . . . . . 594.9 Marketing and Communications Assessment . . . . . . . . . . . . . . 624.10 Barriers to Success. . . . . . . . . . . . . . . . . . . . . . . . . . . . 67Strategic Vision5.1 Focus on Long Term Planning . . . . . . . . . . . . . . . . . . . . . . 715.2 Improve Our Brand Image . . . . . . . . . . . . . . . . . . . . . . . . 715.3 Shift the Jackpot Paradigm . . . . . . . . . . . . . . . . . . . . . . . 725.4 Modernize Operations . . . . . . . . . . . . . . . . . . . . . . . . . . 73Key Strategic Initiatives . . . . . . . . . . . . . . . . . . . . . . . . 75California Lottery 2007–2010 Business Plan

Introduction

MissionTo implement the public’s mandateto maximize supplemental fundingfor public education through theresponsible sale of lottery products.VisionTo be a responsible and respectedorganization that has a broad baseof community support and thatmaximizes supplemental fundingfor public education.California Lottery 2007–2010 Business Plan – –

IntroductionIn order to fulfill the California State Lottery’s (CSL’s) mission and vision,this plan lays the foundation for consistent, long-term growth. It establishesa structure from which we can optimize sales from our game portfolioand more successfully introduce new products and gain new customers.Past StrategyThe CSL has achieved significant success since it began in 1985. In 21years, the CSL has managed to double sales from $1.7 billion in fiscalyear 1985-86 to $3.6 billion in fiscal year 2005-06.CSL’s growth over the lastdecade was largely dueto a singular strategy.The CSL reducedadministrative expenses,increased efficiencies,and invested morefunding into Scratchersgame prizes. As a result,the CSL has been ableto return greater andgreater amounts to publiceducation over the years.The CSL accomplished this growth despite what many in the lotteryindustry believe to be the most onerous restrictions in the nation. TheCSL’s growth over the last decade was largely due to a singular strategy.The CSL reduced administrative expenses, increased efficiencies, andinvested more funding into Scratchers game prizes. As a result, the CSLhas been able to return greater and greater amounts to public educationover the years. However, the CSL’s growth is significantly less than thosestates with the flexibility to maximize revenue through even higher payoutswhich in turn fueled their tremendous Scratchers sales growth.Unfortunately, the CSL’s strategy has reached its peak. There are no furthersignificant sources of funding that can be redirected toward higherScratchers prizes. In the 2007-08 fiscal year, the CSL is forced to reduceScratchers prizes from 57.5% of sales to 56.5% of sales.Draw game sales have been relatively flat over the last few years. TheCSL and the lottery industry have been using new games and largerlotto jackpots to maintain sales, as opposed to growing sales. This iswhy nearly all states have joined a multi-state lotto game such as MEGAMillions or Powerball. Reliance on large, jackpot-driven lotto games isrisky because year-to-year sales can fluctuate significantly dependingon jackpot amounts. The CSL must determine if there is a more consistentsource of sales that would minimize reliance on jackpots.– –California Lottery 2007–2010 Business Plan

Future StrategyThe CSL has undertaken a year-long process of gathering data, commissioningresearch studies, consulting lottery industry leaders and experts,evaluating CSL history, and conducting internal planning sessions. In thelast year, the CSL began selling lottery products in over 90 Sears storesthroughout California, piloted an industry first alternative business modelwith CVS Pharmacies, introduced innovative ticket packaging neverbefore used in the lottery industry to appeal to mass merchandise andsuper stores, and introduced the Million Dollar Raffle game. Given ourextensive research and assessment of the current environment, the CSLis confident that the best opportunity for growth lies in four key strategies:Long Term PlanningThe CSL’s history of short term planning is keeping it from achievingits full potential. The organization needs significant change if it is goingto thrive in today’s marketplace. Much of this change will need multi-yearimplementation strategies before return on investment is achieved.The CSL has undertakena year-long process ofgathering data, commissioningresearch studies,consulting lottery industryexperts and leaders,evaluating CSL history,and conducting internalplanning sessions.Improving the CSL’s Brand ImageAs the CSL has been focused on administrative savings and higher prizepayouts, it has neglected to develop its brand image. Research showsthat, in the absence of CSL communications, players and the publicdo not know how ticket revenues are used, have not heard about lotterywinners, and express a poor opinion of the CSL. A key component ofthe most successful companies is positive brand image and brand imageawareness. A positive brand image will allow us to more successfullyintroduce new products and attract new customers. The success ofthis campaign hinges on the CSL’s ability to send a consistent messagethrough all channels and commit to the campaign for the long term.Changing the Jackpot ParadigmGiven the volatile nature of lotto games and their dependency on largejackpots, the CSL must focus its marketing and game developmentefforts on games that encourage regular play and provide more winningexperiences at lower prize levels. This effort requires less marketingCalifornia Lottery 2007–2010 Business Plan – –

focus on huge jackpots and more focus on entertaining games thatcreate more winners. More regular play will help the CSL provide morepredictable and consistent revenue for education and will be a key tofuture growth.Modernizing OperationsWhile the CSL has focused on increasing Scratchers prizes, many partsof the CSL have gone neglected. The CSL must invest in systems andprocesses from its gaming systems to its distribution warehouses if it isto maximize revenue. These investments will create additional efficienciesand provide the foundation for a flexible and nimble business enterprisethat can quickly take advantage of opportunities as they arise.These strategies are fully achievable,but require dedication, commitment,and a concerted effort by all employees.We believe the CSL’s employeesare up to the challenge andcan make significant strides in reinforcingthe CSL as a well-regardedcontributor to public education.In 2002, the CSL rolled out new Alturaterminals at 19,000 retailers statewide.The Altura terminals were a significantequipment upgrade which provided ourretailers enhanced management functionality,better sales tools, customer servicecapabilities, and enhanced security.– –California Lottery 2007–2010 Business Plan

1.1 Creation andPurpose of the LotteryIn 1984, voters passed Proposition 37 and created the California StateLottery. The purpose of the CSL is to provide supplemental funding forthe benefit of public education without the imposition of increased taxes.The Lottery Act (California Government Code Section 8880 et seq.)provides that net revenues of the CSL shall not be used as substitutefunds, but rather shall supplement the total amount of money allocatedfor public education in California.The Lottery Act provides that the CSL shall be initiated and operatedso as to produce the maximum amount of net revenues to supplementthe total amount of money allocated for public education in California.The Lottery Act also provides that the CSL shall be operated to promoteand ensure integrity, security, honesty, and fairness.CSL revenues are distributed as follows: as nearly as practical 50% mustbe returned to the public as prizes; at least 34% must be distributed to publiceducation; and no more than 16% may be used for administrative expenses.The Lottery Act providesthat funds shall be usedexclusively for the educationof pupils and studentsand that no funds shall bespent of the acquisition ofreal property, constructionof facilities, financing ofresearch, or any othernon-instructional purpose.The Lottery Act provides that none of its provisions may be changedexcept to further its purpose by a two-thirds vote of the membershipof both houses of the Legislature and approved by the Governor.The Lottery Act specifies that the CSL is overseen by a five-memberCommission appointed by the Governor and confirmed by the Senate.A Director, who is also appointed by the Governor and confirmed bythe Senate, serves as the chief administrator of the CSL.1.2 BeneficiariesThe CSL’s mandate is to provide supplementalfunds to public education on all levels from kindergartenthrough higher education plus severalspecialized schools.The educational institutions which receive lotteryfunds and the approximate percentage of overalllottery funds they receive are shown in Figure 1.1California schools put lottery funds to a varietyof uses including funding field trips, specialeducation, classroom technology, staffdevelopment, and the purchase of specializedequipment for disabled students.California Lottery 2007–2010 Business Plan – –

Figure 1.2 – 2004–05 K-12 Percent of Lottery FundExpenditures by Category*Salaries and Benefits 64.9%Books and Supplies 19.2%Services and Operations 13.1%Capital Outlay and Other* 2.8%* As reported by the California Department of Education1.3 Distribution of FundsFor every dollar the CSL receives in sales, it returns approximately 88%to schools and players. The Lottery Act only requires the CSL to return84%. Figure 1.3 details how lottery dollars are spent.Figure 1.3 – Allocation of CA Lottery Revenues FY 05/0654%34%12%The CSL uses just 12% ofthe allowed 16% of ticketsales to cover its operatingexpenses, with mostof these costs dedicatedto retailer compensation.Prizes Education Operating ExpensesThe CSL is allowed to use 16% of ticket sales to cover its operatingexpenses; however, through efficiency efforts, the CSL has reduced itsexpenses and only uses about 12% of the money made from ticket salesto cover administrative expenses. It should also be noted that the largestsubcategory of administrative expenses is retailer compensation. 4% ofadministration expenses are allocated to prizes. Figure 1.4 shows howthis 12% was spent in the 2005-06 fiscal year.California Lottery 2007–2010 Business Plan – –

Figure 1.4 – Detailed Breakdown of the AdministrativeBudget FY 05/062%6.7%1%1.2%1.1%Gaming ContractorsPersonnel ExpensesRetailer CompensationAdvertising and CommunicationsGeneral Operating Expenses6.7% Retailer CompensationRetailer compensation includes all money paid by the CSL to retailers assales commissions and cashing bonuses. In the 2005-06 fiscal year, thetypical CSL retailer had ticket sales of approximately $14,500 per month,and received associated compensation in excess of $1,000 per month.2.0% Gaming Contractors CostsGaming contractors costs include payments for the operation of thegaming system and Scratchers ticket development and printing. Alsoincluded within this category are costs for distributing Scratchers ticketsto retailers.1.0% Advertising and Communications CostsAdvertising/communications costs include television and radio advertising,retailer point of sale materials, internet, billboards, and retailer andconsumer promotions.1.2% Personnel CostsPersonnel costs for employee salaries and benefits.– –California Lottery 2007–2010 Business Plan

1.1% General Operating ExpensesGeneral operating expenses include a collection of miscellaneous operatingexpenses such as general operating costs, contracted services, assetdepreciation, State Controller’s Office support expenses and facilitiesmaintenance costs.1.4 Business ModelThe CSL has been operating under the same basic business model for20 years. This business model is based on partnering with retailers forthe sale of lottery products. This business model is still used, with onlyminor variations, by every state lottery in the United States. The basicsof the CSL’s business model are as follows.• With few exceptions, players must purchase lottery tickets fromauthorized CSL retailers.The CSL has been operatingunder the same basic businessmodel for 20 years.• Retailers earn sales commissions, cashing bonuses, andmiscellaneous incentives for performing a range of activitiesassociated with selling and cashing tickets.• There are two basic categories of lottery tickets: draw gametickets and Scratchers tickets also known as instant games.• Draw game tickets can only be sold through either retailerclerk-operated terminals or player-operated self-service terminals,and all purchase transactions must be recorded in a centralcomputer system to be valid.• Scratchers tickets are sold directly by retailers and throughself-service vending machines, and no computerized recordingis required for these sales transactions.• All cashing activities must be authenticated through the centralcomputer system.• Retailers can pay prizes up to $599 – larger prizes must be paiddirectly by the CSL.• Scratchers tickets are printed by a handful of specialized vendorswho follow prescribed industry standards.• Draw game contractors typically provide and maintain all gamingsystem software, data center operations, gaming terminals,retailer hotline support, and telecommunications services.California Lottery 2007–2010 Business Plan – –

Retailer CompensationAs previously noted, retailer compensation represents the largest shareof the Lottery’s administrative budget. The following provides a high levelsummary of this compensation.Compensation TypeAmountSales Commissions6% of the retail sales price of the tickets soldCashing BonusesBetween 2% and 3% of the value of the prizes cashedIncentive Bonuses0.5% of prizes of $1 million or more soldat the retailer’s locationIn addition, retailers receive sales commissions for tickets that are soldfrom Lottery self-service vending machines in their stores as well ashandling fees for issuing free ticket prizes.Retailer NetworkThe backbone of the CSL is our extensive retailer network. With over19,000 retailers across California, lottery products are available throughoutthe state. The CSL’s retailers can be segmented as follows.Convenience Stores With or Without GasThe backbone of the CSLis our extensive retailernetwork. With over 19,000retailers across California,lottery products are availablethroughout the state.This is the CSL’s most prevalent trade style with over 7,500 retailer locations.Circle K and 7-Eleven are the dominant chain accounts, although mostretailers in this category are independent “mom and pop” shops. Overallthis category of retailers outsells every other major trade style that currentlysells lottery products.Liquor StoresLiquor stores also make up a large percentage of the retailers in the CSL’sretailer network. Sales performance of liquor stores is similar to that ofconvenience stores. There are approximately 4,200 retailers in this category.– 10 –California Lottery 2007–2010 Business Plan

SupermarketsAlthough supermarkets have high foot traffic, theirlottery sales are below average. Most retailers inthis category are part of a major chain, and thevast majority of these retailers utilize self-servicevending machines. It should also be noted that themajority of the CSL’s 1,400 draw game self-serviceterminals are installed in chain supermarkets. Likemost multi-lane retailer accounts, supermarketstend to be concerned with the perceived highlabor costs associated with selling lottery tickets,especially those costs associated with handlingScratchers ticket inventory. There are about 1,900retailers in this category.Grocery StoresThese stores are smaller than supermarkets and defined as havingfewer than five cash registers per store. As a trade style, grocerystores are declining in numbers as competition from supermarketsand mass merchandise retailers such as Costco and Sam’s Clubhave been increasing their market share for decades. Grocery storestend to be among the weakest CSL retailers. There are fewer than2,000 retailers in this category.James Scott, (right) Santa Fe Springs DistrictSales Supervisor, helps celebrate as a luckyplayer shows off his winning ticket.Bars, Restaurants, and Other Sit-Down LocationsThese are sit-down locations where customers tend to stay for 30 minutesor longer. The most popular lottery game in these locations is Hot SPOT.Most of these retailers have special television monitors that show HotSPOT draw results every 4 minutes. The CSL has approximately 1,700retailers in this category.Other Retailer Trade StylesThe CSL’s remaining retailers fall into dozens of different retailer tradestyles, with 430 drug stores representing the single biggest trade style.Other retailer trade styles include bowling alleys, tea houses, gift shops,donut shops, gift stores, and hardware stores.It is clear that the CSL has done an outstanding job in recruiting conveniencestores and liquor stores. However, given consumer and retailtrends, the CSL must translate this success into the recruitment of othertrade styles as well. Figure 2.5 displays the number of retailers in Californiaby trade style and the number that sell Lottery products.California Lottery 2007–2010 Business Plan – 11 –

Figure 1.5 – Lottery Retailer Coverage by Trade StyleTrade StyleTotal StoresLotteryRetailers 2006PercentCoverageC-store/Gas 9,239 7,542 81.63%Liquor 5,129 4,149 80.89%Grocery/Supermarket 15,680 3,883 24.76%Drug Stores 4,731 433 9.15%Bars 3,926 846 21.55%Warehouse,Superstores,Mass Merchants,Department Stores6,803 359 5.28%TOTAL 45,508 17,212*Source: GTECH Corporation*This figure does not represent the sum total of all Lottery retailers, which number over 19,000 retailers. This figure only accounts for the totalnumber of retailers as listed by major trade style in the chart.Major Business PartnersThe CSL has critical business partners in three different areas: (1) gamingand telecommunications systems, (2) Scratchers game development andticket printing, and (3) product advertising and promotion.The CSL has critical businesspartners in three differentareas: (1) gaming and telecommunicationssystems,(2) Scratchers game developmentand ticket printing,and (3) product advertisingand promotion.The most predominant of these business partners is GTECH, with a multiyearcontract in the order of $50 million per year. GTECH is a lotteryindustry leader in gaming systems management. They provide and maintainall CSL gaming equipment and software, a variety of retailer support andhotline services, two geographically remote data centers and all retailertelecommunications services. GTECH also provides a variety of researchand game development services. Because about 90% of all GTECHcontract income is paid in the form of a sales commission, GTECHmanagement is financially motivated to help the CSL increase sales.There are several different companies that develop Scratchers gamesand print tickets for the CSL. The CSL’s primary printer is ScientificGames and secondary vendors such as Pollard Banknote and CreativeGames are used if they offer unique products or if Scientific Gamescannot meet the volume of tickets the CSL needs. Like GTECH, ScientificGames is paid based on a percentage of sales and is financially motivatedto help the CSL increase sales.The CSL contracts with two main advertising agencies. BBDO West handlesall general market (English language) advertising, while Casanova Pendrill– 12 –California Lottery 2007–2010 Business Plan

handles all Spanish language advertising. Advertising services includethe development of different messaging strategies for different games,oversight over media production services, and the actual media placementof advertising messages. The CSL also has smaller contracts for pointof sale advertising and African American and Asian advertising.1.5 The CSL Game PortfolioThe CSL offers a diverse portfolio of games that cater to the entertainmentneeds of a broad consumer base. Our product portfolio consists of twoprimary types of games: draw games and Scratchers games.Draw GamesDraw games involve players purchasing paper tickets which containcertain numbers (or symbols) according to the game’s play style. Thetickets are issued by store clerks or by stand-alone self-service terminals.In all cases, the terminal transmits the player’s numbers to a centralsystem computer, which logs the wager.The CSL offers a diverseportfolio of games that caterto the entertainment needsof a broad consumer base.At the time tickets are issued, they have no prize value. However, atsome point after the purchase, the CSL conducts what is called a “draw”where winning numbers are selected randomly. Players win prizes bymatching the numbers on their tickets to the winning numbers drawnby the CSL.Draw games include SuperLOTTO Plus, MEGA Millions, Fantasy 5,Daily 3, Daily Derby, and Hot SPOT.Scratchers GamesScratchers tickets, also known within the lottery industry as “instanttickets” are issued in a variety of distinct games which have unique playstyles and themes. The CSL typically orders between 20 million and 30million tickets for each game. Games are packaged in groups of 80 or250 tickets which are sold to retailers for sale to the public.Scratchers games have a latex-covered play area that is removed byscratching to reveal various numbers and symbols. Players typicallydetermine if they won by achieving some specified winning outcomelike uncovering three identical dollar amounts or by matching somemaster set of numbers or symbols.Elaborate security measures are used to ensure that no one, includingCSL employees, contractors, or retailers can determine where any ofthe winning tickets are located before they are sold.California Lottery 2007–2010 Business Plan – 13 –

Game ProfilesSuperLOTTO PlusValue Proposition: Offers the opportunity to win a lifealtering prize.FY 06/07 Sales: $630,786,207 (estimated)How it’s played: Pick five numbers from 1 to 47 and one MEGAnumber from 1 to 27 for each play. Cost is $1 per play. Draw timesare Wednesday and Saturday at 7:57 PM.SuperLOTTO Plus Facts• SuperLOTTO Plus jackpots typically range from $7 million to$100 million with an average jackpot of $27 million.• Sales for this game currently range from $10 million per weekto over $20 million per week once the jackpot exceeds the$80 million level.• The game originally started as a pick 6 of 49 and has evolvedover the years.MEGA MillionsValue Proposition: Offers the opportunity to win a lifealtering prize.FY 06/07 Sales: $393,431,768 (estimated)How it’s played: Pick five numbers from 1 to 56 and one MEGAnumber from 1 to 46 for each play. Cost is $1 per play. Draw timesare Tuesday and Friday at 8:00 PM.MEGA Millions Facts• MEGA Millions is a multi-state lotto game in which 12 statescurrently participate.• California became a MEGA Millions state in June 2005.• In March of 2007, MEGA Millions hit a record jackpotof $390 million.• Jackpots typically range from $12 million to $300 million withan average of $66 million.• CSL sales range from $5 million per week when jackpots arebetween $12 million and $30 million to over $20 million per weekonce the jackpot breaks $200 million.– 14 –California Lottery 2007–2010 Business Plan

Fantasy 5Value Proposition: The better odds daily lotto gameFY 06/07 Sales: $146,977,719 (estimated)How it’s played: Pick 5 numbers from a field of 39 per play.Cost is $1 per play. Drawings are held daily at 6:59 PM.Fantasy 5 Facts• Typical top prize ranges from $50,000 to $500,000.• The game offers better odds at the 2nd and 3rd prize levelsthan any other lotto type game the CSL currently offers.• Fantasy 5 features a second chance draw option. Whenplayers purchase 5 plays of Fantasy 5 on a single ticket, theyautomatically receive a coupon that can be mailed in for anopportunity to appear on the Big Spin Show and play the DreamMachine for up to $150,000.Daily 3Value Proposition: The best odds at winning a $500 prizeevery day, twice a day.FY 06/07 Sales: $152,351,791 (estimated)How it’s played: Players pick three numbers from 0 to 9, withrepeat numbers allowed. Players can choose one of three play options.The first play option is “straight”, meaning if the player selects 529 astheir number and 529 is drawn in exact order, the player wins. Thesecond play option is “box” meaning the player can match 3 numbersin any order. The third play option is to play both “straight” and “box”options. Cost is $1 per play.Daily DerbyValue Proposition: A daily game with a horse race themeFY 06/07 Sales: $11,046,311 (estimated)How it’s played: Players choose three horses from a group of horsesrepresented by the numbers 1 through 12, with each individual horsedesignated to take first, second, and third place in the race. Then playerschoose a finish time which can range from 1:40:00 to 1:49:99. Cost is $2per play and the drawings are held daily at 6:59 p.m.California Lottery 2007–2010 Business Plan – 15 –

Hot SPOTValue Proposition: Flexible play style and draws every4 minutesFY 06/07 Sales: $143,424,765 (estimated)How it’s played: Players select from two to five or eight numbersfrom a field of 80 numbers. The Lottery draws 20 numbers from thesame field. Depending on the numbers matched, players win differentprizes typically ranging from $1 to $10,000. Players can choose howmuch they want to wager per draw and prizes are multiplied by theamount wagered. Each play costs a minimum of $1 and drawingsare held every four minutes. Winning numbers are displayed on TVmonitors that the CSL installs in retail locations throughout the state.Scratchers TicketsValue Proposition: Huge variety and instant winning opportunitiesFY 06/07 Sales: $1,827,049,782 (estimated)How it’s played: Players select from as many as 40 differentgames with unique themes (e.g., money, wealth symbols, gaming,licensed properties, etc.) and play styles (e.g., match 3, key numbermatch, bingo, crossword, etc.). By scratching off the play area, playerscan determine instantly if they have won a prize. Prizes range froma free ticket to $3 million. One of the key benefits of these games isthe ability to offer immediate gratification to players. One of the oldestgames is “The Big Spin” Scratchers. This game, first introduced in1986, gives players the opportunity to appear on the CSL’s Big SpinTV Show. Scratchers tickets cost between $1 and $5 each.– 16 –California Lottery 2007–2010 Business Plan

1.6 Organizational Structureof the LotteryThe CSL is organized into the following six divisions which report to theDirector: Executive, Finance and Administration, Corporate Communications,Security and Law Enforcement, Information Technology Services, andSales & Marketing (see Figure 2.6).The CSL is currently staffed with 620 permanent budgeted positions,and includes a headquarters facility, nine district offices and the Southernand Northern Ticket Distribution Centers. Approximately 380 employeeswork at headquarters and 240 employees work in the field locations.Figure 1.6 – California Lottery Organizational ChartCALIFORNIA STATE LOTTERYCOMMISSIONExecutive DivisionDirectorChief Deputy DirectorSpecial ProjectsLegal /ContractServices OfficeInternal AuditsOfficeBusiness PlanningOfficeLeg/EducationOfficeProduct Dev.OfficeFinance & AdministrationDivisionDeputy Director’s OfficeCorporate CommunicationsDivisionDeputy Director’s OfficeSecurity & Law EnforcementDivisionDeputy Director’s OfficeInformation TechnologyServices DivisionDeputy Director’s OfficeSales & Marketing DivisionDeputy Director’s OfficeFinanceDepartmentCorporateProductions &Customer ServiceField OperationsDepartmentPlanning OfficeSales DepartmentHuman ResourcesDepartmentPublic RelationsOfficeHeadquarter’sOperationsDepartmentProgramManagementOfficeMarketingDepartmentBusiness/FacilitiesServicesDepartmentAdministativeServices OfficeClaims & PlayerServicesDepartmentGaming ApplicationManagementOfficeApplicationServicesDepartmentInfrastructureDepartmentClient ServiceDepartmentCalifornia Lottery 2007–2010 Business Plan – 17 –

Description of Lottery CommissionThe Lottery Commission, whose members are appointed by the Governor,is charged with the authority and responsibility to oversee the Lottery and toensure its integrity, security, and fairness. The Commission meets at leastonce a quarter and the meetings are open to the public.Description of Organizational DivisionsExecutive DivisionThe Executive Division is responsible for directing, managing and administeringthe CSL under the provisions of the Lottery Act. The Executive Division iscomprised of seven offices which have different organizational responsibilitiesincluding special projects, legislation, outreach legal services, auditing, businessplanning, and product development.Finance and Administration DivisionThe Finance and Administration Division is responsible for conducting thefinancial, accounting, budgetary, personnel, training, and facilities managementactivities of the CSL. The Finance and Administration Division is comprised offour departments: Finance, Human Resources, Business and Facilities Services,and Claims and Player Services.Corporate Communications DivisionThe Corporate Communications Division manages external communicationsactivities on behalf of the Director and the Lottery Commission. This Divisionprovides the media, education community, and general public with accurateinformation on the CSL and its activities. This Division also provides varioustypes of information in response to routine requests from the public.Security and Law Enforcement DivisionThe Lottery Act requires that a Director for Security and Law Enforcement beappointed by the Governor and charged with the responsibility for assuring theintegrity, honesty and fairness of the operation and administration of the CSL. TheSecurity and Law Enforcement Division is comprised of two departments, FieldOperations and Headquarters Operations. Staff is located both at Sacramentoheadquarters and at the nine district offices throughout California.Information Technology Services DivisionThe Information Technology Services Division (ITSD) provides all informationtechnology services for the CSL. This includes servicing and maintaining computerapplications, desktop and laptop computers, printers, telephones, and otherrelated technology tools. ITSD works closely with all CSL divisions to identifyopportunities to use technology to improve operations.– 18 –California Lottery 2007–2010 Business Plan

ITSD consists of four offices and three departments: Information TechnologyPlanning Office, Program Management Office, Information Technology AdministrativeServices Office, Gaming Applications Management Office, ApplicationServices Department, Infrastructure Department and Client Services Department.Sales & Marketing DivisionThe Sales Department’s activities are focused on creating, supporting, andmaintaining a viable retailer network. The Department coordinates retailernetwork development, manages Scratchers ticket distribution, and maintainsthe key account program for large chain retailers. A key Department responsibilityis to manage a sales force responsible for servicing all retail accounts and“selling-in” new lottery products.The Sales Department is comprised of four distinct, but closely related, sections:Key Accounts, Southern Field Operations, Northern Field Operations, and RetailerNetwork Management.The Marketing Department’s activities are focused on assessing long-term marketpotential; creating marketing plans and budgets; implementing marketing plans;coordinating marketing activities with all CSL departments and multiple contractedagencies; and conducting ongoing advertising research and analysis. The MarketingDepartment is comprised of the Consumer Marketing and Advertising Sections.Lottery Offices and FacilitiesThe CSL has nine district offices, a central headquarters facility in Sacramento,and distribution warehouses in Northern and Southern California.Fig. 1.7 District OfficesThe nine district offices service the regions shown in Figure 1.7.Figure 1.7 – District OfficesSacramento DistrictSan FranciscoDistrictEast Bay DistrictCentral Valley DistrictVan Nuys DistrictInland EmpireDistrictSanta Fe Springs DistrictSanta Ana DistrictSan Diego DistrictInland EmpireDistrictCalifornia Lottery 2007–2010 Business Plan – 19 –

1.7 Key Events in California State Lottery HistoryOctober 14, 1986Lotto 6/49 is introducedas first draw gameFebruary 1, 1992Fantasy 5 IntroducedApril 2, 1992Daily 3 IntroducedJuly 10, 1994Fantasy 5 drawingschanged to 5 days a weekNovember 16, 1992Keno introducedNovember 6, 1984California voters approveconstitutional amendment tocreate California State LotteryJune 21, 1990Lotto 6/49 changed to Lotto 6/53March 5, 1990Decco 6/52 Lotto game introduced1984 1986 1988 1990 1992 1994October 3, 1985California Lottery initiated andfirst Scratchers ticket goes on saleApril 10, 1991Little Lotto 6/39 introducedOctober 1993First Scratchers priced higherthan $1 introduced1993Multiple Scratcherstrategy introducedSeptember 30, 1987Lotto 6/49 begins two draws per weekDecember 15, 1991Lotto 6/59 Changed toSuperLOTTO (6/51 matrix)– 20 –California Lottery 2007–2010 Business Plan

Integrity,Security,Honesty,and Fairness

2.1 A Winning ExperienceWe are proud to be a part of California and the exciting experiences thatcome with living in or visiting this great state. To us a winning experienceisn’t just about prizes, it’s about our customers feeling confident that weare ensuring the integrity of our games and knowing that they are helpingto contribute supplemental funding to our schools.In the lottery business, maintaining the public trust is the foundation ofa successful lottery. Maintenance of the public trust ensures players thatgames are operated fairly and winning tickets will be honored. Withoutthe public trust, there can be no lottery.The CSL was founded on the principles of integrity, security, honesty,and fairness. In every product we sell and every communication we have,we challenge ourselves to reinforce the public trust.The CSL was founded onthe principles of integrity,security, honesty, and fairness.In every product we sell andevery communication wehave, we challenge ourselvesto reinforce the public trust.The CSL is operated by nearly 600 dedicated employees throughout thestate. Our employees are a part of their communities and are proud oftheir contributions to public education and responsibility to maintain theCSL’s integrity.While the general public knows that the CSL sells lottery tickets, most areunaware of our efforts to ensure our integrity, security, honesty, and fairness.2.2 Security and Law EnforcementThe Lottery Act provides for the appointment of a Deputy Directorfor Security with law enforcement experience.The CSL’s Security and Law Enforcement Division is one of the mostwell-regarded security divisions in North America. In fact, the CSL’sSecurity and Law Enforcement Division has been consulted on a numberof occasions by other lotteries throughout the United States and Canadaon security and investigation best practices.Over the years, these sworn peace officers have ensured the CSL’sintegrity. However, their day-to-day activities, while paramount to theorganization, often go unnoticed. For example, every prospective andcurrent employee, retailer, vendor, and supplier must go through arigorous background investigation performed by the Security and LawEnforcement Division. This involves obtaining fingerprints and checkingcriminal histories with the California Attorney General’s Office and theFederal Bureau of Investigations. This is critical to ensuring that our productsare not compromised at any point from initial design to ultimate purchase.The CSL’s Security andLaw Enforcement Divisionis one of the most wellregardedsecurity divisionsin North America.California Lottery 2007–2010 Business Plan – 23 –

The CSL not only employsinternal auditing staff, butcontracts with the StateController’s Office andindependent auditing firmsto further ensure theintegrity of all operationsand transactionsAdditionally, the Security and Law Enforcement Division works to ensureour players have a total winning experience. In a recent case, Bob Sehestedof Camarillo took his winning ticket to a retail clerk who cashed the ticketfor $4. The clerk subsequently tried to claim Mr. Sehested’s winnings ashis own. CSL law enforcement personnel routinely investigate large claimsto ensure the rightful owner is paid. When questioned in this case, theclerk could not identify when or where the ticket was purchased or whetherhe had used his own numbers or used the “quick pick” feature to pickrandom numbers. Lottery Security and Law Enforcement personnel actedquickly, and with the help of the retailer and the local media, they wereable to provide security camera footage of the actual winner to the publicin an effort to track down the true winner. Luckily, Mr. Sehested heardabout this on the news and went to the CSL’s website wondering if a friendor relative was the winner. Mr. Sehested identified himself as the personin the video on the CSL’s website and subsequently claimed his $530,858prize with great appreciation to those who had worked so hard to locatehim. With the help of the Ventura County Sheriff’s Department, the VenturaCounty District Attorney’s Office and the CSL’s Security and LawEnforcement Division, the clerk is now serving a 5 year prison sentence.In addition, the CSL’s Security and Law Enforcement Division conductsinternal and external criminal, civil, and administrative investigations,establishes the security systems and procedures for our games, andtrains retailers in loss prevention. The CSL believes it is important for thepublic to know that behind every ticket we sell there is a team of dedicatedpeace officers and civilian staff who ensure its security and integrity.2.3 Audits and ComplianceThe CSL maintains a meticulous and comprehensive audit program. TheCSL not only employs internal auditing staff, but contracts with the StateController’s Office and independent auditing firms to further ensure theintegrity of all operations and transactions.The CSL’s independent auditing firm performs annual financial audits ofour financial statements and works with the Finance and AdministrationDivision to complete quarterly reviews of various accounts. The CSL isproud to have had 21 years of unqualified opinions. In addition, an auditingfirm witnesses and reviews every lottery draw to ensure accurate completionof the draw procedures, including the verification of technology systems,draw machinery and draw items such as lotto balls.Every two years, the CSL utilizes an independent auditing firm to conducta comprehensive study and evaluation of all aspects of security in theoperation of the CSL. This security study addresses CSL personnel,– 24 –California Lottery 2007–2010 Business Plan

Day-to-day decision making within the CSL is a foundation of our socialresponsibility. We have an obligation as internal stakeholders to act withintegrity at all times. All employees are ambassadors of the organizationto those outside of the CSL and must provide positive examples for thosethey interact with. Every action must be considered in the context of thewhole organization.To that end, the CSL will continue to require ethics and sexual harassmenttraining of all staff. The CSL will continue our efforts to increasecommunication between management and staff and will work to createa mechanism for any employee to voice concerns or ideas confidentially.Employee recognition efforts will be expanded to acknowledge employeeswho go above and beyond to promote the integrity of our products.IntegrityFundamental to our success is our relationship with our customers. Wecontinually strive to offer fun and entertaining products within a fair andsecure framework. We recently introduced “Check-A-Ticket” devicesthat allow customers to scan their own tickets to determine not only ifthe ticket is a winner, but also the amount won. We are also developinga consumer protection website to help players and retailers find theresources they need to ensure a safe and enjoyable gaming experience.We strive to market our products responsibly in a manner that targetsthose over the age of 18. Recently, we began a program to ensure thatour retailers are not selling lottery products to minors. We will expandthis program statewide during the coming fiscal year.Good Community PartnersWhile customers and retail partners are our most obviousstakeholders, we feel a responsibility to reach out andcreate dynamic relationships with local communities,philanthropic organizations, elected officials andcommunity leaders. Given the reach of the CSL andits objective of providing an entertaining way to createsupplemental revenue for public education, we workdaily to expand the knowledge of the CSL, its people,and its products in every community we touch.– 26 –This lucky office pool won a $72 million jackpot10 years after starting their player group. The groupleader bought the winning ticket at Sacramento’slucky retailer Lichine’s Liquor and Deli.We hope to instill a sense of ownership in our missionwith our staff, vendors, retailers, and neighbors. Wehave a sense of pride in our state and work to balancebusiness and community.California Lottery 2007–2010 Business Plan

Since its inception, the CSL has worked to be a good community partnerwhether through sponsorships or staff volunteering their time. Lotteryproducts are available in nearly every community in the state, but ourrelationship with the community must extend beyond the next excitinggame. Our staff and retailers live and work in these communities and havea vested interest in the community as a whole. Lottery staff volunteer theirtime as individuals and as an organization. We mentor, we walk, we buildand we raise funds for the causes that are important to our communities.Last year, CSL staff alone raised over $15,000 for the State’s United Waycampaign. In the coming year, we will challenge ourselves again as weparticipate in the California State Employees Charitable Campaign andCalifornia State Employees Food Drive. Additionally, we hope to createa mechanism for CSL employees to log their volunteer hours in orderto better acknowledge the staff who give their time in the community.The CSL also helps ensure that winners meet their financial obligations.The CSL participates in a program that checks Franchise Tax Board andState Controller’s Office databases to confirm that winners of $600 ormore have no unpaid child support, alimony, taxes, or state or local fees.A Partner in ConservationWe recently introduced“Check-A-Ticket” devicesthat allow customers toscan their own tickets todetermine not only if theticket is a winner, but alsothe amount won.The CSL is a partner in the environmental efforts of the state. While muchof our infrastructure and day-to-day activities are performed electronically,we constantly assess avenues where we can improve. Recently, the CSLhas identified areas where paper forms are being used for functions that canbe effectively performed electronically. The CSL is moving toward streamliningmany of its functions in order to be a more responsible environmental partner.Much of the environmental effects of the CSL’s business occurs at bothends of the supply chain with our retail partners and our customers.Legislative restrictions regarding the delivery of our games effectively requirethat we use paper tickets. We will continue to seek opportunities to createalternative forms of responsible gaming. While gaming generates waste inthe forms of play slips, promotional or information materials, Scratcherstickets, and terminal receipts, the CSL makes every effort to print theseusing recyclable materials and encourages our end users to recycle.Additionally, our field offices and headquarters facility participate in a recyclingprogram. We believe there are additional ways the CSL can be a partner inimproving the environment and will continue to work with our partner stateagencies, retailers, and vendors to minimize waste in the state.We look forward to growing our social responsibility program in the comingyears and continuing to maintain an open dialogue about our ongoingefforts and future plans.California Lottery 2007–2010 Business Plan – 27 –

2.5 Problem GamblingAlthough not required by the Lottery Act, the CSL has been a leader inproblem gambling awareness. In 1998, the CSL created a problem gamblingawareness program that included funding a helpline. This was the firsthelpline of its kind in California. The CSL’s program has grown over time andcontinues to ensure that education and awareness of problem gamblingresources are included in its communications with the public. Since 1998,the CSL has spent over $1 million to address the issue of problem gambling.In 1998, the CSL createda problem gamblingawareness program thatincluded funding a helpline.This was the first helplineof its kind in California.In 2003, the California Legislature created an Office of Problem Gambling(OPG) at the Department of Alcohol and Drug Programs within the Healthand Human Services Agency. This office was tasked with developinga statewide problem gambling prevention program including a toll-freehelpline and referral service, a public awareness campaign, empiricallydriven research programs, and best practices in prevention and treatment.The CSL has had a strong relationship with the OPG since its inceptionand looks forward to expanding that relationship. In the coming year,the CSL will transition its gambling helpline number (888-277-3115) tothe number now used statewide (800-GAMBLER). We will continue ourcommitment to printing problem gambling warnings and providing thenew phone number on our tickets, brochures and advertisements, andon our terminals throughout the state. We will also take steps to expandour current program of distributing problem gambling brochures inorder to bring the program in line with the statewide efforts, ensuringmessage continuity statewide.Since 2003, the CSL has sponsored Public Service Announcements(PSAs) on both television and radio that air during National ProblemGambling Awareness Week. In 2006, the Lottery expanded this effortand aired PSAs throughout the entire month of March. We look forwardto working with OPG to create a fresh PSAs that can be used by all gamingentities throughout the state in a year-round rotation in order to raiseawareness. We also hope to expand the distribution of the PSA and offerit in languages other than English and Spanish.As a first step in continuous employee training, a problem gamblingpresentation was given at this year’s sales conference. We look forwardto expanding the presentation to a more complete training programfor all CSL staff in the field. Additionally, we will regularly update ourretailers via our retail newsletter on current events and issues surroundingproblem gambling.– 28 –California Lottery 2007–2010 Business Plan

Last year, the California Problem Gambling Helpline received over 4,700calls related to gambling problems. Of those who called the helpline lastyear, almost 28% had played the CSL at some point and 2.2% of callersindicated that the CSL was their primary gambling preference. Thehelpline has made a difference to those with a gambling problem in thestate. We are hopeful when we see that of the callers surveyed, nearly97% claimed that their call to the helpline helped them recognize theirproblem and nearly 65% were able to quit gambling after their contactwith the helpline.The CSL will continue to assess funding opportunities at the community,county, and statewide level by sponsoring organizations which raiseawareness or provide treatment for problem gambling.The CSL has been recognizedfor pioneering problem gamblingawareness efforts in California andwill continue its efforts to educateplayers about the hazards of problemgambling and the resources availableto them. Research on this importanttopic is ongoing. Efforts are underwayto examine the creation and expansionof problem gambling treatmentprograms in California. As moreinformation becomes available, theCSL will look for ways to contributethrough staff time, funding, andcontributing other resourcesas appropriate.An Assembly Resolution was presented recognizing National Problem Gambling Awareness Week byAssemblyman Alberto Torrico to, Left to Right: Anna Carr, Deputy Director of Legislation of the CaliforniaGambling Control Board; Terri Sue Canale, Manager, Charitable & Responsible Gambling Programs,California Department of Justice, Division of Gambling Control; Alexandra Vuksich, Commissioner of theCalifornia Gambling Control Commission; Assemblyman Alberto Torrico; Joan M. Borucki, Director of theCalifornia Lottery; Steve Hedrick, Deputy Director of the Department of Alcohol and Drug Program’s Office ofProblem Gambling; Sue Ross, Legislative Coordinator of the California Horse Racing Board; Bruce Roberts,Executive Director of California Council on Problem Gambling.California Lottery 2007–2010 Business Plan – 29 –

– 30 –California Lottery 2007–2010 Business Plan

Marketanalysis

3.1 Customer Demographicsand Playership TrendsOver the years, the CSL has used various tools to capture customerdemographics including an ongoing player tracking study and variouscommissioned studies. This data helps us identify our customer segments,their purchasing habits, the effectiveness of our marketing, and overallperformance. Most importantly, ongoing demographic research helpsus identify consumer trends, tailor our product development efforts toparallel these trends, evaluate the effectiveness of our distribution channels,and respond to the needs of our customers. The demographic databelow is from a study conducted by professors from the University ofCalifornia, Los Angeles that was commissioned by the CSL. While thisdata is currently in draft form and being reviewed for accuracy, nomaterial changes are anticipated.The majority of California’sadult population is between25 and 54 years of age,while the majority of lotterysales are to players between35 and 64 years of age.AgeFigure 3.1 – Total Sales by Age Group vs.California3.1 TotalPopulationSales by Age Groupbyvs.AgeCaliforniaGroupPopulation by Age Group30%25%% of Adult Population% of Total Annual LotterySales by Age Group20%15%10%5%0%18–24 25–34 35–44 45–54AgePopulation Data Source: 2005 American Community Survey55–64 65–74 75+Figure 3.1 compares total Lottery sales by age group to California’s adultpopulation by age group. The majority of California’s adult population isbetween 25 and 54 years of age, while the majority of lottery sales areto players between 35 and 64 years of age. Our player base continuesto age and shrink every year. This creates a growing imperative to reachnew customer segments.California Lottery 2007–2010 Business Plan – 31 –

EthnicityThe following charts show how lottery sales vary by ethnic classificationand game, with the percentage of the California adult population shownon each chart. Only the four major ethnic classifications are shown.Percentage of Game Sales Attributed to CaucasiansPercentage of Game Sales Attributed to Caucasians60%California AdultCaucasian Population50%40%30%20%10%0%Scratchers SuperLOTTO MEGA Millions Daily 3 Fantasy 5 Hot SPOTPercentage of Game Sales Attributed to HispanicsPercentage of Game Sales Attributed to Hispanics35%California AdultHispanic Population30%25%20%15%10%5%0%Scratchers SuperLOTTO MEGA Millions Daily 3 Fantasy 5 Hot SPOT– 32 –California Lottery 2007–2010 Business Plan

Percentage of Game Sales Attributed to AsiansPercentage of Game Sales Attributed to Asians18%16%14%12%10%California AdultAsian Population8%6%4%2%0%Scratchers SuperLOTTO MEGA Millions Daily 3 Fantasy 5 Hot SPOTPercentage of Game Sales Attributed to African AmericansPercentage of Game Sales Attributed to African americans14%12%10%8%6%4%California AdultAfrican AmericanPopulation2%0%Scratchers SuperLOTTO MEGA Millions Daily 3 Fantasy 5 Hot SPOTSome notable observations from these charts include:• Caucasians, relative to their population tend to be light players, with the onlyexception being SuperLOTTO Plus where sales match the relative population.• Hispanics, relative to their population tend to play slightly more and havea preference for Scratchers and Daily 3.• Asians, relative to their population tend to play slightly more and havea preference for Hot SPOT.• African Americans, relative to their population tend to play slightly moreand have a strong preference for Daily 3.California Lottery 2007–2010 Business Plan – 33 –

GenderThe household incomeof past month lotteryplayers is similar to thehousehold income ofthe general Californiaadult population.Although California’s population is almost evenly divided betweenmales and females, males tend to be more prone to make lottery ticketpurchases. This is shown in Figure 3.6 which depicts the relativepercentages of past month lottery players by gender. The followingseries of charts come from the CSL tracking study.Figure 3.6 – CurrentFig. 3.6Players:Current Players:GenderGenderMale 55%Female 45%Source: Continuous Tracking Study 3rd Quarter, March 2007Household IncomeThe household income of past month lottery players is similar to thehousehold income of the general California adult population as shownin Figure 3.7.Figure 3.7 – Household Income of Lottery PlayersIncome Level CA Adults PlayersUnder $ 20,000 24% 21%$20,000 to $ 35,000 21% 22%$35,000 to $ 50,000 15% 16%$50,000 to $ 75,000 14% 15%Over $ 75,000 26% 26%Source: Continuous Tracking Study 3rd Quarter, March 2007– 34 –California Lottery 2007–2010 Business Plan

EducationThe education level of past month lottery players also tends to mirrorthe statewide population as shown in Figure 3.8.Figure 3.8 – Education Level of Lottery PlayersEducation Level CA Adults PlayersSome high school or less 15% 13%High school graduate 25% 28%Some college 23% 26%College graduate or more 37% 33%Source: Continuous Tracking Study 3rd Quarter, March 2007Playership TrendsPast year play has been declining in recent years as shown in Figure 3.9.Fig. 4.9 Playership TrendsFigure 3.9 – Playership trends70%60%50%61%58%53%52%}9%Past year play has beendeclining in recent years.40%30%20%10%0%FY 02–03 FY 03–04 FY 04–05 FY 05–06Source: Continuous Tracking StudyCalifornia Lottery 2007–2010 Business Plan – 35 –

3.2 Consumer ProductSales ComparisonsFigure 3.10 shows the United States lottery industry’s annual sales incomparison to some other common products. It is interesting to notethat the movie and music industries pale in comparison to the lotteryindustry, with combined total sales of $21.5 billion in comparison tolottery industry sales of $47 billion.Figure 3.10 – United Fig. 4.10 States US Consumer Consumer Product Comparison Product Comparison$45$40MoviesMusic$43.0$45.0$47.0Total Sales in Billions$35$30$25$20Salty SnacksSoft DrinksWine & SpiritsU.S. Lottery$32.5$15$10$9.4$12.1$5$0Sources: 2004 Estimated Total Annual U.S. Sales (MarketResearch.Com), 2004 Estimated Total Annual U.S. Sales (US Census),Calendar Year Sales 2005According to a report issued by the California Research Bureau in May2006: “Over a ten-year period, from 1994 to 2004, the gross gamblingrevenue earned by the legal gambling industry doubled in the UnitedStates. In 2004, consumer spending increased by seven percent fromthe previous year to $78.6 billion. This was more than consumers spenton movie tickets, recorded music, theme parks, spectator sports, andvideo games combined.”– 36 –California Lottery 2007–2010 Business Plan

3.3 Consumer, Retailand Technology TrendsThe following are significant trends in consumer behavior, the retailindustry, and technology.Consumer Shopping Habits Continue to ChangeConsumer shopping habits are constantly changing. The directionof these changes indicates that consumers are increasingly:• Time starved• Value oriented• Moving toward new shopping venues• Developing new shopping habitsFigure 3.11 compares the percentages of households that visited differenttrade styles for 1999 and for 2005. Dollar stores, warehouse stores,super centers, and online shopping are gaining significant market shares.4.11 Consumer Shopping TrendsFigure 3.11 – Consumer Shopping TrendsHousehold Penetration by TradestyleHousehold Penetration by Tradestyle100%70%70%19992005Percent of Households70%60%50%40%30%20%10%0%Grocery Convenience Drug Dollar Warehouse Supercenters OnlineShoppingSource: GTECH CorporationMost of the CSL’s existing retailers are not well positioned to addresschanging consumer needs. Recruitment efforts must be directed atretailers that provide the shopping experience that consumers prefer.California Lottery 2007–2010 Business Plan – 37 –

Technology TrendsAll of these technologytrends point to a societythat is moving towardeasily accessible andcustomizable content,consumer conveniences,and digital interactions.Major technological developments are occurring in wireless communicationsand mobile computing. High-speed wireless networks are being establishedin numerous locations to allow everyone access to this service. This willexpand society’s ability to communicate in different ways than in the past.Mobile phones are becoming increasingly sophisticated with additionalfunctionality being introduced regularly. Text messaging continues to growand is increasingly used to provide personalized marketing. Mobile phonesand personal digital assistants can now be used to play MP3 music files,watch television and videos, support network gaming, and make purchases.Information is readily available and often customizable to meet user’sneeds. Technologies like Rich Site Summary (RSS) allow for syndicatingnews and the content of news-like sites to be personally deliveredto consumers. More services are being made available that allow peopleto subscribe to services and receive information and updates on specifictopics at their convenience.All of these technology trends point to a society that is moving towardeasily accessible and customizable content, consumer conveniences,and digital interactions.3.4 Lottery Industry Trendsand Best PracticesIn the United States, lotteries operate in 42 states and the District ofColumbia. The following is a brief overview of some significant industrytrends and best practices over the past 10 years.Higher Payout ScratchersBolstered by the success of state lotteries like Massachusetts and Texas inthe 1990s, virtually all state lotteries have been increasing their Scratchers prizepayouts and enjoying significant sales and profits gains. The CSL has alsofollowed this trend and enjoyed major sales gains, although to a lesser extent.Higher Price Point TicketsIn the 1980s, all lottery Scratchers tickets sold for $1 throughout the country.In the early 1990s several states experimented with $2 tickets, and theirsuccess led to the introduction of $3 tickets and $5 tickets. In most cases,the more expensive tickets were also large in size and they featured higher– 38 –California Lottery 2007–2010 Business Plan

prize payouts. The trend toward higher priced, higher payout ticketscontinues today. In fact most lotteries now offer Scratchers tickets at $20price points, with Texas recently introducing $50 tickets.Because consumers expect higher cost tickets to provide more prize value,more prize money is needed to fund higher cost tickets. Unfortunately, theCSL does not have this prize money available due to statutory restrictions,so our highest priced Scratchers games are $5, and even these gamescan only be released occasionally when prize funds are available.Multiple ScratchersWhen the CSL first started selling Scratchers tickets in 1985, the industrynorm was to issue a single $1 game at a time. When this single game soldout or sales dropped to unacceptable levels, a replacement game wouldbe introduced. In the late 1980s, a few state lotteries started experimentingby simultaneously selling two or three Scratchers games at the same time,and the results were positive. Before long, the multiple Scratchers marketingstrategy became the industry norm, and the trend moved to increasingthe frequency of game introductions. The CSL now issues about 40 gameseach year. In recent years, this trend seems to have peaked with statelotteries averaging about 50 Scratchers game introductions each year.Multi-state Lotto Games and Bigger JackpotsRecognizing that higher lotto jackpots trigger higher sales, a numberof state lotteries decided to organize into consortiums in the 1990s soprize money could be pooled to fuel larger jackpots. Two consortiumsemerged: Powerball with 29 current member states and MEGA Millionswith 12 current member states, including the CSL. With multiple stateparticipation, jackpots soared with the industry record being a $390million MEGA Millions jackpot in March 2007.The industry continues to focus on increasing jackpot sizes with ongoingdiscussions revolving around changing game designs to worsen theodds of winning, increasing annuity periods to advertise higher jackpots,and establishing national and international lottery games.With multiple stateparticipation, jackpotssoared with the industryrecord being a $390million MEGA Millionsjackpot in March 2007.Jackpot FatigueIt has long been known within the lottery industry that large lotto jackpotsstimulate incremental sales, and very large jackpots create a conditioncalled “lottomania” or “lotto fever” where millions of players willinglystand in line to buy tickets for a chance to win huge jackpots. Lotteriesnow depend on these occasional players, who only play when jackpotsCalifornia Lottery 2007–2010 Business Plan – 39 –

are large, to maintain sales in lotto games. However, as lotteries havestrategically sought to maximize jackpot amounts over time, the playingpublic has continually modified its definition of a large jackpot. As a result,occasional lotto players wait longer and longer before participating.Jackpots of $30 millionor more were enoughto trigger the lottofever phenomenon inthe 1980’s. In 2007,the lotto fever thresholdis about $200 million.For the CSL, jackpots of $30 million or more in the 1980s were enoughto trigger the lotto fever phenomenon. In the 1990s, the lotto feverthreshold increased to jackpots of $100 million or more. In 2007, thelotto fever threshold is about $200 million, with the recent $390 millionjackpot raising the lotto fever bar yet again. Because it is difficult to fundlarger and larger jackpots, player interest in lotto-style games is waningacross the lottery industry. Consequently, an argument can be made thatstate lotteries have maximized large jackpot games, and that futuresales declines for these games are almost inevitable. It is interestingto note the Ohio State Lottery recently began a campaign to encourageplay at lower levels to address jackpot fatigue.Player Loyalty ProgramsVarious lotteries offer lottery clubs that allow players to sign up andreceive benefits such as e-mails on winning numbers and jackpots,chances to win free merchandise, promotion notices, birthday coupons,and text message notices. Some lotteries provide videos of daily drawsand lottery commercials, web-based interactive games for fun, andsubscriptions through the Internet.Draw Game StagnationThe last significant draw games to be introduced in the lottery industrywere fast draw keno and cash lotto games (e.g., Fantasy 5) in the early1990s. Since that time, the industry has struggled to find entertainingnew draw games. A number of state lotteries experimented with noveldraw game concepts, but the results have been consistently disappointing.The CSL’s only attempt to introduce a novel draw game occurred in 1998with the launch of Daily Derby, a $2 draw game with a horse racing theme.This game also proved to be disappointing, as it never exceeded 1% ofthe CSL’s total sales and it now languishes at about three-tenths of 1% oftotal sales. In recent years, draw game sales have been declining acrossthe lottery industry and state lotteries are still looking for a major newdraw game success story.Recently, lotteries in about 20 states have found success with raffle styledraw games. However, by their nature, raffle style draw games can only beoffered for limited time periods and they do not provide the type of revenuea permanent and ongoing draw game can provide. Nonetheless, rafflegames have provided some excitement and novelty in the lottery industry.– 40 –California Lottery 2007–2010 Business Plan

Performanceassessment

IntroductionIn FY 05/06, the CSL reported the highest sales in its history at $3.58billion and transferred $1.28 billion to education. This marked the sixthconsecutive year the CSL contributed more than $1 billion to education.In fiscal year 2006-2007 the CSL is poised to finish the year with $3.3billion in sales. While the CSL is proud to record its seventh consecutiveyear with over $1 billion contributed to education, sales have declinedfrom the previous year.Although the CSL, as is true of any business, has historically experiencedgrowth and decline from year to year, it is important to undertake a thoroughanalysis to determine the causes of the recent decline and predict futureperformance. This entails careful examination of the CSL’s historical effortsto build sales, the current state of its business, and an assessment of theindustry and marketplace.4.1 Overall Sales EvaluationGiven the continueddownward trend of drawgames in California andacross the nation, it isnecessary to determinehow this trend can bereversed or to developnew strategies for longterm growth.While the CSL has managed to increase sales and contributions toeducation over a 10-year period from 1997 to 2006, virtually all of thisgrowth was fueled by higher Scratchers game payouts which increasedfrom 51.52% in 1996-97 to 58.32% in 2005-06.The CSL is dependent on using administrative funds from draw game salesto supplement higher payouts on Scratchers. As is evident from the currentfiscal year, poor draw game performance has limited our ability to fundScratchers payouts and consequently affected overall sales significantly.In fiscal year 2006-07, the CSL suffered a series of low jackpots dueto jackpots being hit at lower levels than statistically expected in bothSuperLOTTO Plus and MEGA Millions. In addition to poor rollover luck,there are a number of other factors contributing to the 2006-07 salesdeclines. Jackpot fatigue is also a factor behind the recent SuperLOTTOPlus sales declines.Given the continued downward trend of draw games in California andacross the nation, it is necessary to determine how this trend can bereversed and to develop new strategies for long term growth. This ismore imperative in California, where the CSL’s ability to fund Scratchersprizes has peaked and is likely to decline as draw game sales decline.California Lottery 2007–2010 Business Plan – 41 –

Historical CSL SalesHistorically, CSL sales have increased and decreased from year to year,but overall sales levels have grown significantly since the inception ofthe CSL. As shown in Figure 4.1, since 1986 CSL sales have grown from$1.7 billion to $3.5 billion a year.Fig. 5.1 Historical Lottery Sales by Fiscal YearFigure 4.1 – Historical lottery sales by fiscal yearSince 1986 CSL saleshave grown from$1.7 billion to$3.5 billion a year.$3,500$3,000$2,500$2,000$1,500$1,000$500$019861988199019921994Sales in Millions199619982000200220042006Public education has used Lotterymoney for new equipment includingestablishing computer labs in schools.– 42 –California Lottery 2007–2010 Business Plan

Figure 4.2 is a list of some of the key events which have impacted CSLsales since 1986:Figure 4.2 – KEY SALES EVENTS OVER TIME1985–86 Scratchers sales begin on October 3, 1985; salesare more than $ 10 million per day, but quickly dropas expected based on the experiences of other newlotteries. Fiscal year sales end up at over $ 1.7 billion.1986–87 Scratchers sales drop as expected, but theintroduction of Lotto offsets much of the sales decline.1987–88 to 1988–90 Lotto sales grow, aided by the introduction of twiceweekly draws. Scratchers sales gradually decline.1990–91 to 1991–92 Scratchers sales decline over this time period forunknown reasons, while Lotto sales soften. Lotto ismodified to a 6/53 matrix (players pick 6 numbersfrom a field of 53 numbers instead of 6 numbers froma field of 49 numbers) which appears to accelerate thegame’s sales decline.1992–93 to 1994–95 Lotto is re-launched with a 6/51 matrix and salesrebound. Three successful draw games, Fantasy 5,Daily 3, and Keno are introduced. All three gameshelp fuel sales increases. The Lottery implementsa multiple Scratchers strategy and installs vendingmachines. Scratchers sales almost double in the nextfour years.1995–96 Keno is terminated on June 24, 1996 as a result of aCalifornia Supreme Court ruling. In addition, vendingmachines are removed from retailer locations basedon an Attorney General’s opinion.1996–97 to 1999–00 Keno is replaced with Hot SPOT; the Legislatureapproves the reinstallation of vending machines; andLotto is again modified with positive results. The Lotteryimplements a policy of redirecting funds into additionalScratchers prizes. Sales increase significantly.2000-01 to 2002-03 A State Controller’s Office recommendation resultsin unclaimed Lotto jackpot annuity prize moneyreverting to education as a lump sum, rather thanover the term of the annuity. This results in a onetime revenue windfall of approximately $36 millionin fiscal year 2000-01.2003-04 to 2004-05 New gaming contract saves the Lottery about $ 40million per year. These funds are invested in Scratchersprizes and sales again increase significantly.2005-06 Sales reach a record level at just under $ 3.6 billion.California Lottery 2007–2010 Business Plan – 43 –

4.2 Benchmarking theCalifornia LotteryIndividual state lottery performance can be benchmarked against theperformance of other state lotteries. Presented below is a comparisonof the CSL’s performance as gauged against other state lotteries in termsof the most common performance benchmarks in the lottery industry.Figure 4.3 – Sales and Net Transfers to BeneficiariesPer Capita, 4.3 Sales FY and 05–06 Net Transfers to Beneficiaries per Capita, FY 05–06$400$350$300Sales per CapitaNet Transfers toBeneficiaries per Capita$250$200$150$100$500NY NJ GA PA MI FL OH IL TX CASource: La Fleur’s 2007 World Lottery AlmanacCalifornia has the lowest per capita sales and per capita net transfersto beneficiaries amongst the ten most populous lottery states.– 44 –California Lottery 2007–2010 Business Plan

Figure 4.4 – Overall PRIZE PAYOUTS and Scratchers GamePrize PayoutS as a Percentage of SalesFiscal Year 2005–06 4.4 Prize Comparison Payout as a of Percentage Ten Most of Populous Sales, FY States 05–0675%70%Scratchers GamesOverall Prize Payout65%60%55%50%45%40%GA PA NY OH TX MI NJ IL FL CASource: LaFleur’s 2007 World Lottery Almanac, TLF Publications, Inc.Fiscal Year ends June 30 except New York (March 31), Texas (August 31), and Michigan (September 30)Data represents only revenue from traditional lottery games (e.g. VLT sales are not included)Prize payouts do not include VLT prizes paidAs shown in Figure 4.4 California has the lowest prize payout percentageamongst the ten most populous states, in terms of both total prize payoutsand Scratchers prize payouts.California Lottery 2007–2010 Business Plan – 45 –

Figure 4.5 – U.S. Lottery Sales and Prize Payoutsby Per Capita RankFiscal Year 2005–06Source: LaFleur’s 2007 World Lottery Almanac, TLF Publications, Inc.Fiscal Year ends June 30 except New York (March 31), Texas(August 31), and District of Columbia and Michigan (September 30)Data represents only revenue from traditional lottery games(e.g. VLT sales are not included)Prize payouts do not include VLT prizes paid***No information availableRankLotterySalesPer CapitaOverall PrizePayoutInstant GamePayout1. Massachusetts $699.26 71.9% 76%2. District of Columbia $458.08 55.1% 68%4. New York $336.01 59.4% 68%4. Georgia $315.61 61.4% 69%5. Maryland $277.95 57.9% 69%6. Connecticut $276.86 60.5% 68%7. New Jersey $275.83 57.4% 65%8. South Carolina $264.88 61.4% 70%9. Pennsylvania $246.79 58.8% 69%10. Rhode Island $244.57 59.3% 66%11. Michigan $219.14 57.3% 65%12. Florida $217.19 59.6% 64%13. New Hampshire $199.82 58.0% 65%14. Ohio $193.49 59.0% 67%15. Virginia $178.64 56.7% 66%16. Kentucky $176.49 59.9% 68%17. Maine $173.81 61.9% 65%18. Vermont $168.05 63.4% 67%19. Texas $160.57 61.2% 66%20. Missouri $156.35 62.7% 68%21. Tennessee $153.60 58.0% ***22. Illinois $153.08 59.0% 65%23. Delaware $145.99 52.1% 65%24. Indiana $129.30 60.4% 67%25. West Virginia $119.92 60.5% 68%26. Iowa $113.85 56.0% 61%27. Colorado $98.62 60.1% 65%28. California $98.33 53.9% 58%29. Oregon $98.11 66.0% 65%30. Wisconsin $91.62 57.7% 64%31. Idaho $89.54 58.4% 66%32. Minnesota $87.03 59.5% 67%33. Kansas $85.40 55.5% 59%34. New Mexico $79.10 54.7% 57%35. Louisiana $77.46 50.7% 59%36. Arizona $76.01 55.3% 60%37. Washington $74.72 61.1% 67%38. Nebraska $63.96 56.3% 65%39. Oklahoma $57.23 53.5% 56%40. South Dakota $50.44 56.7% 65%41. Montana $42.26 51.9% 62%42. North Dakota $35.12 49.4% ***43. North Carolina $25.92 51.8% ***– 46 –California Lottery 2007–2010 Business Plan

Figure 4.5 shows that in terms of payout percentage, California ranksnear the very bottom of all states. In fiscal year 2005-06, Californiaranked 28th amongst state lotteries in terms of per capita sales.Figure Fig. 5.6 State 4.6 – Lottery State per Lottery Capita Sales Per by Capita Rank Sales by RankWAORNVCAIDAZUTMTWYCONMNDSDNEKSOKTXMNWIIAILMOARMSLAMIPAOHINWVVAKYNCTNSCALGANHVTNYMEMARICTNJDEMDDCEast Coast states performbetter than states westof the Mississippi. Culturaldifferences between thetwo coasts may accountfor these differences.Rank 1–14Rank 15–28Rank 29–42No LotteryFLIn Figure 4.6, state lotteries are color coded according to their per capitasales ranking from Figure 4.5. Looking at regional performance amonglottery states, it is interesting to note that East Coast states perform betterthan states west of the Mississippi. Cultural differences between thetwo coasts may account for these differences. The East Coast has hada much longer history with lotteries and numbers games. Lotteries wereused as early as the 1600s to raise funds to build schools and roadsin the Colonies. Lotteries became widespread in the 1800s only to bebanned by state constitutions in the late 1800s due to abuses by privatelyoperated lotteries. In 1964, New Hampshire was the first to establisha “modern” state operated lottery.4.3 Draw Game PerformanceThe CSL is constantly looking for ways to increase draw game sales. Itdoes this by monitoring the lottery industry to see what is working in otherstates; designing and testing new game and promotion concepts usingboth quantitative and qualitative research, and partnering with its gamingsystem and marketing vendors to identify the most promising new products.California Lottery 2007–2010 Business Plan – 47 –

The first lotto gameoffered by the CSL wasLotto 6/49. This gamewas introduced in October1986. Since the introductionof Lotto 6/49, the CSLhas taken numeroussteps to improve lottogame sales with varyingdegrees of success.With the exception of raffle games, the CSL’s draw games fall into twobasic categories: lotto games and daily games.Lotto games are draw games that offer long odds of winning a very large,life-altering jackpot prize. Lotto games currently have only two prizedrawings per week each. The CSL currently offers two lotto games:MEGA Millions and SuperLOTTO Plus.Daily games are draw games that offer good odds of winning a smallertop prize. Daily games have a prize drawing every day of the week. TheCSL currently offers four daily games: Fantasy 5, Daily 3, Daily Derby,and Hot SPOT.Improving Lotto Game SalesThe first lotto game offered by the CSL was Lotto 6/49. This game wasintroduced in October 1986. Since the introduction of Lotto 6/49, theCSL has taken numerous steps to improve lotto game sales with varyingdegrees of success. These steps include complete game redesigns andthe addition of new game features.In addition to game redesigns and new game features, the CSL routinelyruns special promotions aimed at increasing lotto game sales. Over thecourse of the last 15 years, the CSL has run about 28 such promotions.Some examples include the “Match 3 Numbers for a Million” promotionwherein a specified number of players who match 3 out of 6 numbers arerandomly selected to win $1 million instead of the normal $5 prize andthe “Buy 10 SuperLOTTO tickets and Get 1 Free” promotion that providesa purchase incentive by offering a free play with every $10 purchase.Improving Daily Game SalesThe first daily game offered by the CSL was a card themed game calledDecco. This game was introduced in March 1990. As with lotto games,the CSL has taken numerous steps to increase sales of daily games byredesigning the games, adding game features and supporting the gameswith promotions.Over the course of the last 15 years, the CSL has run about 19 promotionsto increase daily game sales. Most of these promotions were aimed at theHot SPOT game. Daily game promotions have also included cross promotingFantasy 5 with SuperLOTTO Plus by offering a free SuperLOTTO Plus playwith every Fantasy 5 purchase of $5 or more.– 48 –California Lottery 2007–2010 Business Plan

Raffle GamesRaffle-style games are the newest draw games in the lottery industry.These games are designed to increase draw game sales by attractingnew customers who normally do not play the lottery by appealing topeople’s familiarity with raffles. Raffle games offer a limited quantityof tickets for a limited time period. Prizes are normally awarded in one“grand prize” drawing that is tied to a holiday like New Year’s Eve.The CSL launched its first Raffle game, Million Dollar Raffle, in February2007. This game was tied to the St. Patrick’s Day holiday. While the gamedid not sell out, it raised over $5 million in mostly incremental revenue forpublic education. The game was well received by the public, and lotteryretailers are requesting a return of the game. The CSL plans to run moreRaffle games in the future.Draw Game AssessmentAside from legal restrictions, the CSL faces the same challenge that allother lotteries in the nation are facing when it comes to improving drawgame sales. As shown in Figure 4.7, draw game sales have been stagnantthroughout the industry for the last several years despite numerous effortsin various states to improve sales.Figure 4.7 – Industry Fig. 5.7 Industry Draw Draw Game Game Sales: 1998-2006 1998–2006$20$20$19.63 $19.71 $19.22 $19.18$20.11$20.44$21.75$21.11$22.71Draw game sales havebeen stagnant throughoutTotal Sales in Billions$15$10the industry for the lastseveral years despitenumerous efforts in variousstates to improve sales.$5$01998 1999 2000 2001 2002 2003 2004 2005 2006Source: La Fleur’s 2007 World Lottery AlmanacCalifornia Lottery 2007–2010 Business Plan – 49 –

Figure 4.8 – California Fig. 5.8 California Draw Game Sales: 1998-2006 1998–2006$1.6$1.62$1.53$1.71 $1.71$1.57$1.60$1.56$1.62$1.4$1.40$1.2Total Sales in Billions$1.0$0.8$0.6$0.4$0.2$01998 1999 2000 2001 2002 2003 2004 2005 2006Figures 4.7 and 4.8 show that draw game sales across the lotteryand California industry have been relatively flat over the last 10 years.Reliance on Lotto GamesOf the ten most populousstates, California is significantlymore reliant onlotto game sales. This hascertain disadvantagesbecause lotto game salesare subject to jackpot fluctuationand jackpot fatigue.Figure 4.9 shows that, of the ten most populous states, California is significantlymore reliant on lotto game sales. This has certain disadvantages becauselotto game sales are subject to jackpot fluctuation and jackpot fatigue.FigureFig.4.95.9 Performance– Performanceof Lotto Gamesof Lottoand Multi-StateGames andGamesMulti-State as Games a Percentage as a of Percentage Overall Sales of Overall SalesFiscal Fiscal year Year 2005–06 Comparison of of Ten Ten Most Most Populous Populous States States35%30%25%20%15%10%5%0%CA FL* IL PA NJ OH TX NY MI GA* Florida does not participate in Mega Millions or PowerballSource: La Fleur’s 2007 World Lottery Almanac– 50 –California Lottery 2007–2010 Business Plan

Pursuant to section 8880.64 of the Lottery Act, the CSL has supplementedScratchers prizes because it has proven to return $2 to our beneficiaryfor every $1 invested. On a marginal cost basis, both SuperLOTTO Plusand MEGA Millions can operate on 8% of their sales, leaving an identical8% of sales within the CSL’s 16% administrative spending allowance.Consequently, each game leaves about 8% of sales which can beallocated for Scratchers prizes. So if SuperLOTTO Plus and MEGAMillions fail to perform as expected, the CSL suffers a double hit: (1) welose the sales from the lotto sales shortfall, and (2) we lose the 8% ofsales that is used for Scratchers prizes.Accordingly, a 10% drop in lotto game sales causes a disproportionatelylarger drop in sales and contributions to education. With the uncertaintyassociated with projecting lotto game sales, the negative impacts areeffectively compounded, subjecting the CSL to unpredictable swingsin revenue.Daily Numbers Games AssessmentWhile lotto games comprise the large majority of the CSL’s draw gamesales, its daily games are relatively weak when compared to the industryas shown in Figure 4.10.Figure 4.10 – Performance of 3-Digit and 4-Digit NumbersGames Fig. as 5.10 a Performance Percentage of 3-digit of Overall and 4-digit Sales Numbers Gamesas a Percentage of Overall SalesFiscal Year 2005–06 Comparison of Ten Most Populous StatesFiscal Year 2005–06 Comparison of Ten Most Populous States35%30%25%20%15%10%5%0%MI NJ OH GA IL NY PA FL TX* CA** State has no 4-digit numbers gameSource: La Fleur’s 2007 World Lottery AlmanacCalifornia’s daily numbers game, Daily 3, accounts for a very smallpercentage of overall sales, at 4% of total sales. In sharp contrast,7 of the 10 state lotteries shown in Figure 5.10 have numbers gamessales which exceed 20% of total lottery sales.California Lottery 2007–2010 Business Plan – 51 –

4.4 Scratchers Game PerformanceIndustry Growth ComparisonsThe United States lottery industry has enjoyed tremendous Scratchersgame growth over the last decade as shown in Figure 5.11.Figure 4.11 – Industry Scratchers Game GrowthFig. 5.11 from Industry 1998–2006 Scratchers Game Growth from 1998-2006$30$28.384$25$24.893$22.060$20$19.524In Billions$15$14.392$15.371$17.055$12.337$10$9.937$5$01998 1999 2000 2001 2002 2003 2004 2005 2006Source: La Fleur’s 2007 World Lottery AlmanacFigure 5.11 shows that lottery industry Scratchers sales have almosttripled over the past eight years. This has been due to increasedScratchers prize payouts and higher priced tickets, although otherfactors such as increased game variety and improved distributiontechnology have helped fuel these increases too.The CSL has also enjoyed similar increases in Scratchers sales. Asshown in Figure 5.12, the sales trend has been positive although saleshave flattened in the last year.– 52 –California Lottery 2007–2010 Business Plan

Fig. 5.12 CSL Scratchers Game Growth from 2001-2007Figure 4.12 – CSL Scratchers Game Growth from 2001–2007$2.0$1.737$1.930$1.827In Billions$1.5$1.189 $1.184$1.212$1.339$1.0$0.5$0FY01 FY02 FY03 FY04 FY05 FY06 FY07How the CSL Maximizes Scratchers SalesThe CSL’s business practice since 1996 has been to channel availableadministrative moneys back into supplemental Scratchers prizes. TheCSL does this because money added to Scratchers prizes generates anincrease in sales which in turn produces additional revenues for education.The CSL’s experience is that every $1 invested in Scratchers prizes resultsin $7 of sales and $2 for education. In other words, for every $1 the CSLcan invest in Scratchers prizes, it can generate $2 for education.Largely based on this higher payout strategy, Scratchers sales haveincreased from just over $527 million in fiscal year 1996-97 to $1.93 billionin fiscal year 2005-06. During this time period, the Scratchers prize payoutwas increased from 51.52% of sales to 58.32% of sales.The CSL’s experience isthat every $1 invested inScratchers prizes resultsin $7 in sales and $2for education.It should be noted that there is a limit to this strategy, because thereis an optimal amount that should be invested in prize payouts thatwill maximize total contributions to education. As shown by other statelotteries, this optimal amount is far higher than what the CSL can reach.Most state lotteries are able to offer significantly higher prize payoutlevels due to more flexible or nonexistent legal restrictions, and theyhave seen gains in Scratchers sales far in excess of California. Unfortunately,the $164 million in supplemental Scratchers prizes in 2005-06 appearsto be the maximum amount that can be reached, with lesser amountspredicted for future years.California Lottery 2007–2010 Business Plan – 53 –

Other Strategies to Maximize Scratchers SalesThe CSL has recently adopted a more aggressive approach tothe use of callout messaging on Scratchers tickets. Callout messagesseek to capitalize on a game’s particular strength, suchas a large top prize or good overall odds of winning. Over thepast year, the CSL has added more ticket messages about topprizes, the number of prizes in a game, or the total amount ofprizes in a game. While the results have been generally positive,the CSL has a need to better understand exactly how and whycallouts drive consumers to buy a particular game. To answerthese questions, the CSL formed a joint initiative with ScientificGames to determine the optimal number and type of callouts forthe purposes of maximizing Scratchers sales. The end result ofthe research is a secure, interactive database containing detailedinformation about over 15,000 Scratchers games, over 500,000weeks of sales data, and over 7,100 ticket images. All of this datais sorted and filtered to help us determine the optimal messagingstrategies for different types of Scratchers games.In fiscal year 2005-06, the CSLsupported local businesses by payingretailers sales commissions of over$252 million.Another strategy the CSL has used to stimulate incremental Scratcherssales has been to increase ticket prices and providing a more involvedgaming experience which takes longer to play. Again, this has been anindustry best practice, but it effectively requires higher prize payouts tosupport the more expensive games where players have come to expectmore value.Figure 4.13 – Scratchers Game Price Point Distribution5.13 Scratcher’s Game Price Point Distribution Calendar Year 2006Calendar Year 200645%40%35%44.00%IndustryCalifornia30%25%20%15%13.80%19.80%25.20%20.60%24.00%15.60%19.70%10%8.60%8.00%5%0%0.00%$1 $2 $3 $5 $10 $20+0.00%Source: La Fleur’s 2007 World Lottery Almanac– 54 –California Lottery 2007–2010 Business Plan

As shown in Figure 5.13, the lottery industry is introducing much higherprice point Scratchers games than California. Most state lotteriesoffer both $10 and $20 Scratchers games and, in 2006, over 27% ofall Scratchers game sales within the lottery industry came from $10and $20 games. California has yet to introduce a $10 or $20 game, andcan only occasionally introduce $5 games due to its limited prize fund.Portfolio OptimizationOne strategy that can be applied to both draw games and Scratchersgames is the concept of portfolio optimization. Portfolio optimizationrequires aligning, positioning, and setting prize payouts for each gamewithin the portfolio to maximize revenues.For every game of chance, including lottery games, there is an optimumprize payout level that maximizes the amount of revenue generated. Forexample, casino keno and bingo games tend to pay out in the range of80% of the dollars wagered. This payout level is presumed to maximizecasino profits, because if casinos could make additional profits by loweringthese prize payouts, they clearly would. Slot machines tend to pay outat about 94% of sales and, again, this is based on business decisionsdesigned to maximize profits.The CSL only has the ability to pay out just under 54% of total salesfor prizes. However, this overall payout level can, and should, vary byindividual lottery game. And, as is the case for casinos, the CSL shouldadjust individual game payouts to optimize revenue for education. Becausethe CSL’s total prize payout capabilities are capped, the challenge is tooptimize total profits, recognizing that we can never maximize revenuefor education under current payout restrictions.For every game ofchance, including lotterygames, there is an optimumprize payout level thatmaximizes the amountof revenue generated.Historically, the CSL has introduced games on an ad hoc basis with littleregard to the positioning of games within the portfolio. An assessmentof all games within the portfolio may reveal that the CSL is not optimallydistributing prize funds across games or positioning games within itsportfolio. An example is the CSL’s lotto game portfolio. SuperLOTTOPlus is in direct competition with MEGA Millions. Both games havesimilar play styles and offer large jackpots.California Lottery 2007–2010 Business Plan – 55 –

4.5 Retailer Network AssessmentThe backbone of the CSL is the strength of its retailer network. With over19,000 retailers statewide, the CSL has an unparalleled distribution andmarketing channel with respect to gaming alternatives in California.However, compared to the lottery industry, the CSL has fewer retailersper capita than the ten most populous states.Fig. 5.14 Population per RetailerFigureFiscal4.14Year–2005–06PopulationComparisonperof TenRetailerMost Populous StatesFiscal Year 2005–06 Comparison: Ten Most Populous States2,0001,5001,0005000%CA IL* PA FL TX NJ OH GA NY MI* Previous fiscal year dataSource: La Fleur’s 2007 World Lottery AlmanacFigure 4.14 shows that California appears to have a shortage of retailersbecause the population per retailer is the highest among the mostpopulous lottery states. However, as shown by Figure 4.15, sales per retaileris a significant factor in determining the optimum number of retailers.Retailer of the Year, DonutsGalore, is recognized forits outstanding performanceby the CSL. Left to Right:Joan Borucki, Director of theCSL presents the 2006 Retailerof the Year Award to ownersLang and Chun Sor. DaughterMiranda and son John wereon hand for the celebrationwith Tricia Metzger,Lottery Sales Director.– 56 –California Lottery 2007–2010 Business Plan

Fig. 5.15 Sales per RetailerFigure 4.15 – Sales per RetailerFiscal Year 2005–06 Comparison of Ten Most Populous StatesFiscal Year 2005–06 Comparison of Ten Most Populous States$400,000$350,000$300,000$250,000$200,000$150,000$100,000$50,000$0NY NJ GA PA FL OH IL* TX MI CA* Previous fiscal year dataSource: La Fleur’s 2007 World Lottery AlmanacAlthough California has fewer retailers per thousand of population thaneach of the other large states, it also has the lowest sales per retailer.While it may appear that sales may be increased simply by increasingthe number of retailers, this would be effective only if demand for lotteryproducts was sufficient to justify additional outlets. However, the datapresented in figures 4.14 and 4.15 suggest that demand for lottery productsin California is much lower than in the other states. Accordingly, additionalretail outlets may simply cannibalize existing sales rather than increaseoverall sales. The CSL has conducted several studies to determine theimpact of higher retailer saturation levels on net sales and profits, withinconclusive results. The CSL plans to continue studying this issue andconducting further tests. However, it is clear that the CSL must activelypursue trade styles that reflect consumer shopping trends.4.6 Efforts to Improvethe Business ModelThe CSL has been locked into the same basic business model sinceits inception. A major limitation with this model is that, in the absence ofself-service equipment, selling lottery products is labor intensive, and manyretailers and retail chains question the value of carrying lottery products.One of the most taxing aspects of being a lottery retailer is the requirementto carry and market 20 or more different Scratchers games at any giventime. Currently, there are no automated systems to track and documentCalifornia Lottery 2007–2010 Business Plan – 57 –

In an effort to break intoadditional multi-lane retailertrade styles, the CSLembarked on a specialpilot test of a new businessmodel in February 2007Scratchers sales, so retailers are forced to reconcile ticket inventorychanges to ticket sales reported by the CSL. For “mom and pop” storeswith ample clerk time and centralized inventory control, these reconciliationchallenges are manageable. For multi-lane retailers, these challenges areoften considered too labor intensive and not cost effective.In an effort to break into additional multi-lane retailer trade styles, theCSL embarked on a special pilot test of a new business model in February2007. Under the new business model, the CSL rents space for self-serviceterminals and performs all machine maintenance and Scratchers inventorymanagement. Retailer activities are effectively limited to cashing winningtickets for which they receive standard handling fees and cashing bonuses.While retailer workload drops significantly under the new business model,the rental and cashing bonus income retailers receive is much less thanunder the conventional business model.The new business model is in the process of being evaluated for its financialfeasibility, with pilot test evaluation results expected in December 2007.4.7 Retailer Recruitmentand OptimizationAs noted earlier, retailers are the foundation of the CSL’s business model.While the CSL is continuing to explore alternative product distributionopportunities, it must also continue to improve the current businessmodel to be as cost-effective as possible.Retailer RecruitmentEfforts to improve retailer recruitment include identifying and recruitingnew retailers that show a high potential for sales, replacing consistentlyunderperforming retailers with new retailers, offering retailer incentives,and providing new products that appeal to specific tade styles.Retailer OptimizationThe CSL has a program to help increase sales and efficiency of its existingretailer network. The CSL identifies underperforming retailers based onseveral criteria and visits those retailers to determine the causes andworks with the retailers to improve sales. Recommendations includeplacement of terminals and equipment and better use of point of salematerials. During the past 10 years, the CSL has been providing betterand more gaming equipment and improving the quality of retailer financialstatement and billing information. For example, the CSL now provides– 58 –California Lottery 2007–2010 Business Plan

etailers with special “Check-a-Ticket” devices, which give players theability to check their own ticket to determine if it is a winner. The CSLalso created a special retailer web site which provides retailers direct accessto automated billing statement information. This web site has been verymuch appreciated by our retailers, especially those in the supermarketand drug store trade styles.4.8 Administrative OperationsAssessmentAdministrative Costs as a Percentage of RevenuesThe CSL has always made a concerted effort to find operational efficienciesand reduce administrative costs. As a result, it ranks amongst the mostefficient lotteries in the United States.Figure 5.16 4.16 Administrative – Administative Expenses Expenses as a Percentage as a of percentage Total Revenue of total revenue25%20%15%10%5%0%MassachusettsWest Virginia (Traditional)Rhode Island (Traditional)MarylandNew JerseyFloridaNew YorkSouth CarolinaGeorgiaPennsylvaniaCaliforniaMissouriConnecticutMichiganTexasOhioVirginiaIllinoisTennesseeWisconsinIndianaNew HampshireOklahomaColoradoKentuckyOregon (Traditional)WashingtonNorth CarolinaArizonaMinnesotaLouisianaMaineVermontKansasIdahoNebraskaDistrict of ColumbiaNew MexicoNorth DakotaSouth Dakota (Traditional)Delaware (Traditional)MontanaSource: La Fleur’s 2007 World Lottery AlmanacSince 1996 the CSL has, as a deliberate good business practice, reducedoperating expenses from just under 16% of sales to 11.5% of sales forthe 2005-06 fiscal year. Excluding retailer compensation, which is about7% of total sales, CSL operating expenses as a percentage of total salesare about 50% lower than just 10 years ago. Figure 4.17 shows the declinein CSL administrative expenses.California Lottery 2007–2010 Business Plan – 59 –

Figure Fig. 4.17 5.17 – General General Administrative administrative Costs as a Percentage costs of Total Revenueas a Fiscal percentage Years 1985–86 of total through revenue 2005–6Fiscal year 1985–86 thruough 2005–06Current CSL staffing isabout half of what it was in1989. In 2006–07, the CSLcut 30 positions–from650 to 620 positions.Percent of Total Revenue20%18%16%14%12%10%8%6%4%2%0%Staffing Levels85-8686-8787-8888-8989-9090-9191-9292-9393-9494-95Fiscal YearCurrent CSL staffing is about half of what it was in 1989. In 2006-07, theCSL cut 30 positions – from 650 to 620 positions.95-9696-9797-9898-9999-0000-0101-0202-0303-0404-0505-06Figure 4.18 shows the numbers of CSL authorized positions since 1986-87.Fig. 5.18 Number of Personnel per Fiscal yearFigure 4.18 – Number of personnel per fiscal year1220117011201070102097092087082077072067062057052086-8787-8888-8989-9090-9191-9292-9393-9494-9595-9696-97Fiscal Year97-9898-9999-0000-0101-0202-0303-0404-0505-0606-07– 60 –California Lottery 2007–2010 Business Plan

Gaming System ComplexityThe CSL’s gaming system is very efficient in virtually all respects, withthe exception being the computer applications environment. The CSLcurrently has four different computer domains that require separatelogons, and the interfaces among these different domains can posesome operational challenges. At the present time, about one-half of theapplications that CSL staff use have web-enabled interfaces while mostof the balance of the applications have Windows server interfaces.The implications of this somewhat fragmented environment are thatsystem programming changes take longer and are more expensive thanwould be the case in a consolidated environment, and there is a certaindegree of staffing inefficiency as staff often must move from one computerenvironment to another to perform their daily job duties.Migration to a newer,more consolidated gamingsystem environment wouldreduce programming bugs,and make new programmingmore efficient and timely.The CSL’s preference would be for all applications used by employeesto have web-enabled interfaces. Migration to a newer, more consolidatedgaming system environment would reduce programming bugs, andmake new programming more efficient and timely.Outdated Back Office Systems and Business RulesThe CSL’s back office systems include the automated financial systemsthat are in use by the Finance and Administration Division. Organizationalfunctions supported by these systems include procurements, generalaccounting, financial statement preparation, and investments management.In addition to these systems, CSL staff use some older generation systemsfor human resources activities, law enforcement investigations, andemployee/contractor background investigations.While the back office financial systems are functionally adequate for theCSL’s traditional business model, the interfaces between these systemsand GTECH’s gaming system are relatively poor, and it is not unusual forstaff to manually key gaming system data into Microsoft Excel spreadsheets for various financial applications. These manual processes increasethe chances for error and, in a number of cases, there are automationopportunities that would reduce costs and increase efficiency.In addition to in-house computer system weaknesses, the CSL has anumber of business rules which are due for reassessment. A businessrule is defined as a policy for how a certain business process or functionshould be handled and, in the vast majority of cases, these businessrules have remained unchanged for a decade or more. As we recentlyCalifornia Lottery 2007–2010 Business Plan – 61 –

learned when we implemented the pilot test of the new retail businessmodel, the CSL’s traditional retailer compensation structure is “hardcoded” and any modifications or alternative structures require extensiveprogramming or manual processes. Consequently, a thorough reassessmentof these business rules will be conducted to determine if changingcircumstances and new technology improvements have rendered the oldrules either obsolete or in need of modification.Other Administrative OpportunitiesThe CSL’s in-house administrative operations have remained largelyunchanged for the past 20 years. During the current fiscal year, theCSL will reassess the CSL’s business operations. A review of the CSL’spractices for distributing Scratchers tickets and point of sale materialswas recently completed, and further reviews are planned for all internaloperations. Additionally, the CSL has been hiring skilled analyst staffwith strong technical skills and this practice will continue.4.9 Marketing andCommunications AssessmentThe success of CSL’s marketing and communications efforts is difficultto gauge. In the past, most advertising dollars have been targeted atSuperLOTTO Plus and MEGA Millions. Despite receiving the bulk of theCSL’s advertising budget, sales for these two games combined havedropped significantly in the last two consecutive years.The CSL has devoted little money in terms of marketing support ofScratchers, daily draw games, or the Hot SPOT monitor game. Despitethis lack of advertising support, Scratchers sales have been generallygood, while sales for the remaining games have been flat or, in the caseof Daily 3, slowly increasing.The CSL has also devoted little money to develop and maintain its brandimage, with most efforts in this area limited to brochures, newsletters,and annual reports.As shown in Figure 4.19, California trails the other states in dollars spentper capita on advertising. This is largely due to the fact that the CSL mustchoose between spending additional advertising dollars or supplementingScratchers prizes. The CSL’s decision to fund more Scratchers prizesaccounts for much of the per capita spending differences shown below.– 62 –California Lottery 2007–2010 Business Plan

Fig. 5.19 Budgeted Per Capita Advertising ExpendituresFigure 4.19 – Budgeted Per Capita Advertising ExpendituresFiscal Year 2005–06 Comparison of Ten Most Populous StatesFiscal Year 2005–06 Comparison: Ten Most Populous States$4.00$3.50$3.00Dollars Per Capita$2.50$2.00$1.50$1.00$0.50$0NY PA GA MI NJ OH IL* FL TX CA* Advertising expense from lottery’s FY 05–06 Financial StatementsSource: La Fleur’s 2007 World Lottery AlmanacPositioning Research Study FindingsFrom a public relations standpoint, the CSL tends to have a relativelypoor and ill-defined public image. As will be explained, the generalpublic and education groups both have a number of misconceptionswhich work against the CSL.In September of 2003, the CSL concluded a comprehensive researcheffort designed to measure public perceptions about the CSL (PositioningResearch Study by Crestwood Associates). The research findings weredisappointing, but not unexpected.• Fifty percent of all educators believe that less than 10% of lotteryticket sales go to schools, and even 47% of our past month playersand 45% of infrequent players shared this same dismal view. Theactual percentage of ticket sales that is contributed to schools ismuch higher than 10%, at approximately 35% of sales.• Thirty nine percent of past month players believed that no more than10% of ticket sales are returned to players as prizes, and only 14%of these players correctly perceived that more than 50 cents of eachdollar wagered is returned to players as prizes.• As an overall finding, the interviewed groups think the CSL is spendingapproximately 45¢ of every dollar on operating and marketingexpenses. The actual number is about 12¢ of every dollar.California Lottery 2007–2010 Business Plan – 63 –

• When asked about their general perceptions of the CSL,31% of all educators had a negative view, while only 11% hada positive view. Even among past month players, only 38% hada positive view of the CSL, with 62% having either a neutralor negative view.• Only 8% of educators and school administrators believe the CSLis “making a difference” in the quality of education in California.Brand Image Evaluation FindingsIn today’s competitivemarketplace, consumersview a brand image asan integral part of theirpurchase decision.Companies continuallywork to differentiatethemselves and connectwith their customers inmeaningful ways that buildloyalty and understanding.A company’s brand image exists only in the minds of consumers and isdefined as what a consumer thinks and feels about the company. Brandimage is developed through the impressions made by consumers’ encounterswith our name, logo, marketing messages, and everything elsethat consumers see and hear about our business. In today’s competitivemarketplace, consumers view a brand image as an integral part of theirpurchase decision. Companies continually work to differentiate themselvesand connect with their customers in meaningful ways that buildloyalty and understanding.In January 2007, the CSL requested its marketing agency, BBDO West,to conduct a brand image audit to determine the state of our brandamongst Californians. The findings parallel the Positioning ResearchStudy by Crestwood Associates discussed above. The followingsummarizes the findings of the brand image audit.Umbrella BrandThe general public either feels nothing about the CSL, or associates it witheither a big government bureaucracy or a big, profit-driven business.In general, the public does not have a good understanding of the benefitsof the Lottery, where the money goes or what the money is being used for.There is a vague awareness of our mandate to provide funding for education;however, there is also a lot of skepticism as to whether this mandateis met sufficiently.Educators expressed negative feelings about the CSL because, eventhough they work within the education community, they do not knowwhere the money goes or what it is being used for.CSL employees are passionate about the CSL’s mission but in general,are discontent with the environment. Many employees feel that theirwork is not appreciated and their input is not considered. There is alsoa sense of apathy or lack of faith in the CSL’s vision.Retailers have a positive perception of the CSL through strong relationshipswith our sales force and the contributions of CSL’s games to their bottomline. However, they agree that there is inconsistency with CSL messaging.– 64 –California Lottery 2007–2010 Business Plan

There is an opportunity to reverse the negative image of the CSL brandand focus on demystifying the operations and purpose of the CSL.Besides specific tactics, a clearly defined positioning strategy is neededto invigorate the brand, create a rallying cry for employees and stakeholdersand create synergy across the portfolio.In terms of consumer brand awareness by game, the results aresomewhat mixed.SuperLOTTO PlusSuperLOTTO Plus is perceived as “California’s game.” It has strongbrand awareness and this is the reason why many consumers referto the CSL as “the Lotto.” Consumers enjoy the simplicity and familiarityof this game. There is an opportunity to leverage the loyalty, provenance,and affinity of this game.MEGA MillionsMEGA Millions is known as the big jackpot game amongst consumers.Unfortunately, it lacks a clear image and differentiation within the drawgame portfolio and there is a false belief that MEGA Millions revenueleaves the state, because it is a multi-state game. MEGA Millions isa relatively new game offering and does not have the brand equity orloyalty enjoyed by SuperLOTTO Plus.Fantasy 5, Daily 3, Daily Derby, and Hot SPOTFantasy 5, Daily 3, Daily Derby, and Hot SPOT continue to be nichegames with a small core following of frequent players. Fantasy 5 is seenas the game most similar to the original Lotto 6/49 game. Daily 3 andHot SPOT offer engaging play that is appealing to frequent players. Afternearly 10 years, Daily Derby is still seen as confusing and out of place.This information, when combined with the popularity of these typesof games in other states, shows there is an opportunity to expand theplayership of most of these games.ScratchersScratchers have the most compelling brand image of our product offerings.These games are seen as fun, interactive, and accessible. They providetremendous variety and instant gratification. Due to their popularity, thereis an opportunity to leverage Scratchers as a vehicle to increase playershipof games within the draw game portfolio.California Lottery 2007–2010 Business Plan – 65 –

Other Communications VehiclesBig SpinConsumers like the idea of being able to purchase a Big Spin Scratchersticket for an opportunity to win millions on The Big Spin TV show. TheBig Spin Scratchers game continues to be one of the CSL’s bestperforming Scratchers games. However, many consumers have to bereminded that there is still a TV show and their perceptions are drivenby past experiences rather than recent ones. The Big Spin Show lacksentertainment value and is seen as being reminiscent of a 1950s gameshow. The Big Spin Show enjoys wide recognition and provides a communicationvehicle that few businesses enjoy. There is an opportunityto contemporize the show and leverage it to reinforce a new brand image.Retailer NetworkThe CSL’s network of over 19,000 retailers is a powerful communicationschannel. Through their daily interactions with our customers, the CSL’sretailers are the face of the Lottery. Generally, the message conveyed toour retailers is disjointed. There is a sometimes overwhelming amount ofCSL materials sent to retailers, and some of these materials get outdatedbefore they are removed. There is also no continuity of message orconsistency of branding to connect the many point of sale materials weprovide to retailers, and each different lottery game is given a uniquepersonality that can confuse the overall brand image the CSL wouldlike to project.Fortunately, largely through the efforts of our sales representatives, theCSL enjoys a very good relationship with its retailers. This relationshipcan be leveraged to more effectively utilize our retailer network as a toolto communicate our brand image.WebsiteOur website will be keyto connecting with ourplayers and reachingnew player segmentsin the future.Our website receives 5 million visitors and 19 million page views everymonth. If the search term “lottery” is entered into the Google searchengine, the first result is the CSL website. However, the CSL’s website isgeared toward functionality, not marketing. It is functional and informative,but not engaging or interactive. Given the continuing growth of theInternet as an important tool to interact with consumers, it is imperativethat our website be redesigned as an integral part of our marketing andcommunications efforts. Our website will be a key to connecting withour players and reaching new player segments in the future.– 66 –California Lottery 2007–2010 Business Plan

Public Relations and OutreachOur fractured relationship with our beneficiary and lack of political supporthas led to sporadic and haphazard public relations and outreach efforts.California’s size and geographic and cultural diversity have also made itdifficult and costly to reach consumers and stakeholders.Future efforts must promote the fact that millions of people win everyyear (winner awareness) and let consumers know where lottery moneygoes (proceeds awareness). Consumers need to know that people regularlywin money playing the lottery. Otherwise, consumers will have fewerreasons to play. The CSL was created by the voters, and voters have theright to know where lottery money goes and how it is being used. At thesame time, the CSL has a responsibility to put the funding in context –it only accounts for less than 2% of the education budget in California.Future efforts must promotethe fact that millions of peoplewin every year (winnerawareness) and let consumersknow where lottery moneygoes (proceeds awareness).Winner awareness and proceeds awareness efforts should be focusedat the regional and local levels. Attempting to cover the entire state ofCalifornia has often proven to be inefficient and ineffective.4.10 Barriers to SuccessFractured Relationship with BeneficiaryWhen the CSL was first established by Proposition 37 in 1984, it waspitched as the solution to all of education’s needs. In reality, the LegislativeAnalyst estimated that the CSL would generate about $500 million peryear for public education. The CSL has actually contributed over a$1 billion to public education for each of the last six fiscal years.As a result of this somewhat controversial start, the CSL has never enjoyeda good relationship with its beneficiary. The CSL no longer widelycommunicates its contributions to public education. In the absence ofthese communications, the general public has no knowledge of how theCSL benefits the state and is left wondering why California has a lottery.This has been detrimental to our ability to grow our player base, introducenew products, and connect with our customers.Education interest groups have consistently opposed efforts to increaseprize payouts even though higher prize payouts would significantly increasecontributions to public education.California Lottery 2007–2010 Business Plan – 67 –

Fixed PrizesThe CSL is the only lottery in the United States that cannot pay out fixedprizes without limitation. This restriction was an outgrowth of a 1996California Supreme Court decision which stated that the CSL mustalways have a predetermined prize liability for draw games. With theseunprecedented restrictions, the CSL cannot guarantee specific prizeamounts for specific winning outcomes in any draw game. This causesplayer confusion because wide swings in prize payout amounts are quitecommon. For example, in the CSL’s Daily 3 game, payouts for pickingthree correct numbers in sequence range from a low of about $300 toa high of over $800. A particularly troublesome aspect of this restrictionis the difficulty in marketing new draw games and attracting new players,as players cannot be told how much they can win.Prohibition Against Using New TechnologyIn October of 1993, the State Legislature passed legislation which providedthat: “no changes in the types of games or methods of delivery of thesegames that incorporate technologies or mediums that did not exist, werenot widely available, or were not commercially feasible at the time ofthe enactment of this chapter in 1984 shall be made” without advancelegislative approval [Lottery Act Subsection 8880.28(b)]. This legislationeffectively keeps the CSL in the “dark ages” of technology. The CSL cannot:offer either subscription play or interactive play through the Internet,permit cell phone wagering, or take advantage of a number of other newand emerging technologies that could otherwise be leveraged to attractnew players and increase CSL sales and contributions to education. Dueto the 1993 restrictions players must continue to visit “brick and mortar”stores to make purchases despite the fact that there is a growing trendtowards online shopping.Due to the 1993 restrictionsplayers must continue tovisit “brick and mortar”stores to make purchasesdespite the fact that thereis a growing trend towardsonline shopping.Prohibition on Certain Game ThemesThe CSL’s enabling legislation contains a number of game themerestrictions which inhibit the CSL’s ability to offer attractive games tothe public. While some of these restrictions have been removed (e.g.,bingo and horse racing), theme restrictions covering “roulette, dice,baccarat, blackjack, Lucky 7s, draw poker, slot machines, or dog racing”still remain (Lottery Act Subsection 8880.28(a)(1)). Of these restrictions,the dice, blackjack, Lucky 7s, and slot machine restrictions pose themost problems, as these themes are successfully used by other statelotteries, especially for Scratchers games.California Lottery 2007–2010 Business Plan – 69 –

Ticket Dispenser RestrictionsThe restrictions are sobroad that they preventticket dispensing machinesfrom performing a functionas simple as providingcustomers with change.In August of 1997, the State Legislature passed legislation which restrictedthe types of machines that can be employed to dispense lottery ticketsto the public. These restrictions are quite technical. For example, the CSLis not allowed to show a facsimile of an actual ticket on the face of anyticket dispensing machine nor can the machine produce a “Quick Pick”ticket without querying a central system. In addition, the restrictions areso broad that they prevent ticket dispensing machines from performinga function as simple as providing customers with change. While a numberof these restrictions are difficult to interpret, the CSL is generally prohibitedfrom using any ticket dispensing machine that is not virtually identical tothe machines used by the CSL in 1997.– 70 –California Lottery 2007–2010 Business Plan

StrategicVision

IntroductionA careful analysis of our recent sales decline, an evaluation of our businessand its processes and strategies, and an assessment of our environmenthave resulted in the identification of four key strategic directives that webelieve will substantially grow sales over the next few years. These directiveswill serve as our guiding principles as we establish priorities and allocatefunding over the next three years.Implementation of this plan will establish the CSL as a valued partnerin our community, provide a significant source of more consistentrevenue, and establish an infrastructure to support future growth andnew business opportunities.5.1 Focus on Long Term PlanningSeveral factors make it difficult for the CSL to plan for the long term.Government agencies with appointed executives are subject to regular,and sometimes frequent, changes in leadership. The CSL has beenno exception. Since it began 22 years ago, the CSL has had 19 changesof Directors. The CSL is required to budget on a year-to-year basisand cannot retain funding for long term investment and planning. Takentogether, these factors encourage short term planning.As a result, the CSL has reached the point where some core businessfunctions have suffered. Our brand image is poor, our strategy for growthhas come to an end, and our systems and business processes are inneed of modernization.The key strategic initiatives presented in this Plan have all been developedwith an eye toward long term and stable growth that will set the CSL ona course to realize its full potential.5.2 Improve Our Brand ImageImplementation of thisplan will establish theCSL as a valued partnerin our community, providea significant source ofmore consistent revenue,and establish an infrastructureto supportfuture growth and newbusiness opportunities.The CSL’s brand image has suffered in the absence of efforts to developand maintain a positive brand image. Specifically, our games have beenmarketed, but our brand has not. As a result, consumers do not knowwhat to expect from our products, do not know where proceeds go, andcontinue to believe that CSL revenue will take care of all of education’sneeds. In addition, there has been a shortage of stories about winners,leading many players to become discouraged about their chances ofwinning a meaningful prize.With a generally poor brand image, the CSL needs to reintroduce itselfto consumers every time a new product or promotion is introduced. ThisCalifornia Lottery 2007–2010 Business Plan – 71 –

is not true of companies with strong brand images. For example, whenApple introduces a new product, consumers expect it to be innovative,cutting edge, user-friendly, and consistent with their lifestyle. Applecan then focus on the benefits of the product itself because consumersalready know what to expect from the company. Similarly, when Lexusintroduces a new vehicle, it does not have to spend time convincingconsumers that customer service is a key selling point. Lexus is alreadyfamous for its exemplary customer service.In contrast, when the CSL introduces a new product, as we saw withthe Million Dollar Raffle, consumers don’t know where the money goes,don’t believe that 50% of sales is returned in prizes, and haven’t heardabout anyone winning the Lottery in a long time. Accordingly, CSL salesrepresentatives and retailers have difficulty selling new products, especiallyto new customers.The key to improving ourbrand image is to establisha cohesive, comprehensive,and understandable messageabout what the CSL representsand what to expect fromlottery products.The key to improving our brand image is to establish a cohesive,comprehensive, and understandable message about what the CSLrepresents and what to expect from lottery products. The messagemust be given credibility through the products and services we offer.And, finally, the message must be conveyed effectively through the mostappropriate communications channels.Some strengths of the CSL include the brand equity of SuperLOTTOPlus, the retailer network, the Big Spin Show, and the traffic of its publicwebsite. These existing communications channels are readily availableto optimize our brand image improvement initiatives.5.3 Shift the Jackpot ParadigmReliance on large jackpots as the basis for draw game growth is a doubleedgedsword. On the one hand, large jackpots can generate tremendoussales in a very short period of time. On the other hand, jackpot-drivengames are subject to sales fluctuations caused by the luck of the drawand to sales declines caused by jackpot fatigue. These fluctuations areparticularly risky for California where draw game sales are needed tofund higher Scratchers prize payouts.In the United States, the draw game industry has been focused, almostwithout exception, on creating larger and larger jackpots. In California, wewent from Lotto 6/49 to Lotto 6/53 to SuperLOTTO to SuperLOTTO Plusand MEGA Millions to increase jackpot sizes and attract occasional players.Other state lotteries are already discussing ways to change game matrixes,increase annuity periods, create national lottery games, and even joininternational consortiums all in an effort to create larger and larger jackpots.– 72 –California Lottery 2007–2010 Business Plan

Unfortunately, increasing jackpot sizes invariably comes at the expenseof worse odds and longer periods between what are perceived to beattractive jackpots. This further feeds into the belief that no one winsanymore, so jackpot fatigue combines with poorer odds to result indeclining sales. The CSL may be the most vulnerable lottery in thecountry because, of the ten most populous states, we rely the mostheavily on sales from our large lotto games.As we have seen in recent years, MEGA Millions has cannibalizedSuperLOTTO Plus sales more than expected. These games were poorlypositioned within our portfolio because they are essentially the same gamewith the same play style. Our billboards display jackpots amounts forboth games side-by-side and invite consumers to make comparisons andchoose between the two games. SuperLOTTO Plus sales were on a slightdownward trend before the introduction of MEGA Millions, and a changeor replacement game was certainly worth consideration. However, theintroduction of MEGA Millions has dramatically hastened the decline ofSuperLOTTO Plus to the point where it has become critical to begin theresearch and development effort to change or replace SuperLOTTO Plusbefore it is overwhelmed by the much larger jackpots of MEGA Millions.We must implement a strategyto rely less and less on largejackpot games. Shifting thejackpot paradigm entails lessfocus on large jackpot gamesand providing consumerswith fun, entertaining gamesthat are conducive to moreregular play, and providemore winning experiencesat smaller but meaningfulprize levels.In assessing the sales of our daily draw games and Hot SPOT monitorgame, it is apparent that there is room for significant growth. Thesegames provide more regular play and more winning experiences than eitherSuperLOTTO Plus or MEGA Millions. There has been little to no marketingof our daily games due to their disparate personalities and relatively smallplayer bases. By aligning these products into a single portfolio and creatingsynergy between these currently disparate products, we can begin tomore effectively and efficiently market these games and build a strongerplayer base. Aligning this portfolio also allows us to cross-promote andcross-sell these games as a suite of games. This portfolio of games mustalso be analyzed to determine if prize funds are optimally distributed toenhance players’ experiences and maximize sales.We must implement a strategy to rely less and less on large jackpotgames. Shifting the jackpot paradigm entails less focus on large jackpotgames and providing consumers with fun, entertaining games that areconducive to more regular play, and provide more winning experiencesat smaller but meaningful prize levels.5.4 Modernize OperationsOur goal is to implement a modern infrastructure that minimizes our relianceon manual processes so that we are in a better position to take advantageof new business opportunities as they arise. These improvements will alsohelp the CSL keep up with changing consumer and retail trends.California Lottery 2007–2010 Business Plan – 73 –

Our goal is to implement amodern infrastructure thatminimizes our reliance onmanual processes so thatwe are in a better positionto take advantage of newbusiness opportunities asthey arise. These improvementswill also helpthe CSL keep up withchanging consumer andretail trends.The CSL has been primarily focused on investing available administrativefunds to increase Scratchers prize payouts. As a result, the CSL has notinvested the resources necessary to improve and modernize its operations.The CSL can no longer ignore investing in modernizing its operations.The last concerted effort to modernize operations occurred in 2002 whenthe CSL swapped out its legacy gaming systems and retailer terminalswith more modern and efficient systems and terminals. Implementationof this new technology resulted in administrative savings of around $30million per year. Since 2002, even better gaming system technologieshave emerged that address some of the issues we still face such asconsolidating fragmented system components, reducing communicationscomplexities and stabilizing applications. The CSL must take advantageof these new technologies if it wants to be able to adapt to a rapidlychanging marketplace.Increased Scratchers sales over the last several years have caused usto outgrow our distribution warehouses. These warehouses are no longeroptimally sized to keep up with the demand for inventory space. We mustalso improve the automated systems that we now use to distribute themillions of packs of Scratchers tickets we sell each year. Our goal is toimprove our ability to get this product to retail in the most expedient andcost effective manner possible.In order to make good business decisions, management must haveimmediate access to accurate and timely information and data. The CSLwill focus on modernizing management information systems that havelimited reporting capabilities. For example, the CSL will develop andimplement a dashboard information system that allows managers tonavigate to, and extract, desired sales and retailer data in real time.Some of the other systems that we will modernize include accountingsystems and business processes that are still based on essentially thesame model that we used in the 1980s. These systems and processeswill be improved to offer us more flexibility and efficiency.Modernizing operations will also encompass our efforts to establish asuccession plan for our aging workforce, including our peace officersand long-time senior managers, and upgrading employee skill sets withimproved training programs.Finally, modernizing operations will include looking at ways that we canprovide better services to our customers by improving their ability toaccess information about the Lottery and its products and services.– 74 –California Lottery 2007–2010 Business Plan

Key StrategicInitiatives

Strategic Initiatives DefinedUnderlying each strategic direction are a number of supporting strategicinitiatives. Each initiative is representative of a major project or programthat needs to be accomplished. The initiatives are synergistic with otherinitiatives that are found under different strategic directions. While actionplans are the detailed steps that have to be taken to implement strategicinitiatives, these action plans are beyond the scope of this document.Improve Brand ImageOur strategic focus here is to align products with brand image andmarketing campaigns and improve the CSL’s image. This goes beyondresearching and developing a new logo; it involves taking actions thatsupport the Lottery’s image as a socially responsible and welcomemember of the community. We will accomplish this by adopting acommunications and outreach approach that offers a unified message,proactive communications, localized communications, and incorporateswinner and proceeds awareness.1. Proceeds & Winner AwarenessDevelop and implement a program that regionalizes or personalizeshow Lottery proceeds work to make local communities a better place.Highlight local winners, even those who don’t win major prizes.November 2007...................Program DevelopedJanuary 2008.......................Begin Program Implementation2. Improve Problem Gambling ProgramFurther improve the Problem Gambling Program by continuing to assessfunding opportunities at the community, county and statewide level bysponsoring organizations that raise awareness or provide treatment forgambling addiction.July 2007...............................Begin printing a new helpline numberon Lottery materialsJuly 2008................................Transition helpline to statewide number3. Improve & Fully Leverage The Big Spin ShowUse the high visibility and strong brand equity of The Big Spin Showto reinforce the Lottery’s image.September 2007..................Issue RFP for new TV show creativedevelopment and productionApril 2008.............................Award contractJuly 2008...............................Begin airing new showCalifornia Lottery 2007–2010 Business Plan – 75 –

Shift the Jackpot ParadigmOur strategic focus here is to give players a reason to play on a regularbasis, not just when there is a huge jackpot. We will accomplish this bymaking changes to our current draw games portfolio, adding new drawgames, evaluating prize payouts and the positioning of our entire gameportfolio and exploring the potential of regional and special game offerings.4. Implement a New Year’s Raffle GameOffer players a second raffle-style game tied to the New Year’s holiday andmarket the game as a part of the Lottery’s 2007 holiday product offerings.July 2007...............................Finalize game designNovember 2007...................Sales beginJanuary 2008.......................Sales end and prizes awarded5. Assess Draw Game OpportunitiesConduct a qualitative and quantitative study to determine the optimumoffering and alignment of draw games. Explore the desirability of regionalgames, and the desirability of repositioning lotto games, new monitorgames and special games.November 2007...................Findings and recommendationsModernize OperationsOur strategic focus here is on improving and streamlining businessoperations through advanced technologies and best business practices.The intent is not only to improve efficiency and reduce operating costs,but also to make Lottery products and services more accessible andreadily available. We will accomplish this by optimizing our retailernetwork, improving product distribution facilities and technologies andlooking at new retail business models and non-traditional trade styles.Another important part of modernizing our operations includes maintainingthe highest possible level of security and integrity in all aspects ofLottery operations.Key Strategic Initiatives6. Improve Back Office SystemsHire a consultant to review all of the Lottery’s accounting policiesand procedures, systems and process workflows in order to makerecommendations for improvement.August 2007.........................Issue RFPSeptember 2007..................Award RFPNovember 2007...................Final report & recommendations– 76 –California Lottery 2007–2010 Business Plan

7. Improve Management Information SystemsImplement a tool that provides a single point of access to informationand data required by the Lottery’s decision makers.November 2007...................Obtain consultants & toolsMay 2008................................Install business solutionAugust 2008.........................Deployment & training completed8. Improve Investigative Case Management SystemReplace the Security & Law Enforcement Division’s outdated casemanagement system to improve its ability to perform thorough investigations.August 2007.........................Procure new systemJanuary 2008.......................Finalize customizationJune 2008..............................Deployment & training complete9. Improve Gaming SystemsRedesign gaming systems into a uniform, integrated, state-of-the-artenvironment to speed up the introduction of new games and promotions.October 2007......................Planning and analysis beginsOctober 2008......................Conversion to new systems beginsMarch 2010...........................Deployment & training completed10. Improve Product Management & DistributionImprove Scratchers game and point of sale material distribution by creatingefficiencies in the Distribution Centers, gathering and utilizing sales dataat retail locations and improved tracking of Scratchers game inventories.October 2007......................Implement a more automated ticketordering system to ensure thatretailers always have the supplyof tickets they needNovember 2007...................Implement an automated system formaintaining inventory and trackingthe distribution of all Point of Salematerials to reduce waste and thetime required to post these materialsAugust 2008.........................Replace inadequate productdistribution facilities in Northernand Southern California11. Optimize Traditional Trade Style Retailer NetworkImprove sales in high potential current retailers and recruit new retailers intraditional lottery trade styles.September 2007.....................Establish retailer performance benchmarksMarch 2008..........................Evaluate retailer performance criteriaJune 2008................................. Recruit new traditional trade style retailersCalifornia Lottery 2007–2010 Business Plan – 77 –

12. Recruit Non-traditional Retailer Trade StylesAssess opportunities for recruiting retailers in non-traditional trade stylesby focusing on growing retail markets and consumer shopping trends.January 2008.......................Assessment completed13. Improve District Office Operations and ServicesDetermine if the Lottery’s nine District Offices are the optimal numberto serve the entire state.August 2007.........................Recommendations completed14. Optimize the Sales ForceReassess all sales force job classifications and staffing levels.December 2007...................Reassessment completed15. Use On-site Marketing TeamsAssemble teams of people to be stationed in retail locations that havelottery self-service ticket dispensers to teach consumers how to usethese devices.September 2007..................Plan developedOctober 2007......................Vendor identifiedDecember 2007...................Teams available to be deployed16. Fully Leverage the Lottery’s WebsiteImplement an infrastructure that allows the Lottery to take advantage ofthis underutilized asset to improve communications and marketing efforts.September 2007..................Web usability study and redesignplan completedDecember 2007...................New infrastructure in placeMarch 2008..........................Website redesign completed17. Implement a Law Enforcement Staff Succession PlanMore adequately prepare law enforcement staff for supervisoryand management level positions in light of a large number ofanticipated retirements.July 2007 ..............................Develop planAugust 2008 ........................Develop new classificationsMarch 2008 .........................Recruit new staff and initiatenew training program– 78 –California Lottery 2007–2010 Business Plan

Contact InformationIf you have questions or comments regardingthe California State Lottery’s 2007-10 Business Plan,please contact:JOAN M. BORUCKIDirectorMAILING ADDRESS600 North 10th StreetSacramento, CA 95811Emailbusinessplan@calottery.comTelephone800-LOTTERY (800-568-8379)The following are registered trademarks of the California State Lottery: “Advance Play ® ”, “Big Spin ® ”, “The Big Spin ® ”,“Bulls-Eye ® ”, “California Lottery ® ”, “Daily Derby ® ”, “Hot Spot ® ”, “Quick Pick ® ”, “Scratchers ® ” and “SuperLOTTO Plus ® ”;“Mega Millions ® ” is a registered trademark of a California State Lottery partner. The trademarks and logos of California StateLottery and its partners represent commercial value and are the property of the California State Lottery or their respectiveowners. Use of any trademark displayed in this document without the prior written permission of the California State Lotteryor the respective owner is prohibited.

www.calottery.com600 North 10th Street, Sacramento, CA 95811