Paddy Power Betfair faces gamble on online betting exchange

Online betting exchanges are a 21st-century phenomenon. They work like this: one client fancies a horse to win at 2/1, the other offers those odds against the same beast crossing the line first, the exchange matches them and earns its money by charging whoever wins a commission.

They have two virtues. One is that they allow punters to trade, so the person who backs the horse at 2/1 can offer shorter odds, say 1/1 (even money) against it. If somebody else accepts the lower odds, the backer has a no-lose bet. The second advantage stems from this. The way exchanges work, the odds available against any horse in any race should ultimately reflect what the market believes are its real chances of winning.

Thus, a betting exchange should almost always offer more generous odds than conventional bookmakers, who build profit margins into their prices. In fact, the exchanges’ arrival in 2001 into a hidebound betting market ushered in a new era of competition that still influences the business.

Even so, it was surprising that Paddy Power Betfair chief executive Peter Jackson acknowledged yesterday that generous horse-racing offers from rivals such as Bet365 posed challenges to Betfair's betting exchange, which was actually the first when it launched 17 years ago.

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Jackson suggests that Bet365 operates at almost zero margins, not sustainable unless it simply uses racing as a way of luring punters to bet on other sports.

The question is how Paddy Power Betfair tackles this. As the clients determine the exchange’s odds, the group cannot attract more business by stepping in directly to increase potential payouts on a winner.

However, a betting exchange operates like any other market: the more liquidity it has, the more value it offers participants, who can expect better returns as a result. Boosting liquidity requires more punters. The only real option for attracting them is for Paddy Power Betfair to cut commission charges, which are generally 5 per cent.

This could mean further short-term pain, but in the long run, it should translate into more business, more commission and better returns for the group itself.