State Audit Shows Lottery Management Weak

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State Audit Shows Lottery Management Weak

Special Report - April 28, 2008
State Auditor Les Merritt released an audit of the NC Educational Lottery (NCEL) on April 10, 2008 that reveals glaring problems in the way the lottery is being managed. Four performance management weaknesses were identified: (1) no documented revenue forecasting methodology; (2) no formal strategic plan; (3) no ongoing marketing or operational research; and (4) no full-cost accounting of promotional events. In the audit letter, State Auditor Merritt noted that the audit was performed at the request of the NC Legislative Black Caucus Economic Development Committee and covers the period from inception on March 30, 2006 to September 30, 2007 (an 18 month period).

In researching the lottery revenue forecasting methodology, state auditors determined that forecasting was done loosely by consensus between the NCEL Executive Director, the Legislature, and the Governor’s Office. NCEL Executive Director, Tom Shaheen, had no formal documentation for the lottery revenue projection methodology but said the first year revenue estimates, $1.2 billion in sales and $425 million (35% of gross revenues) to the State for education, were determined by the Legislature’s Fiscal Research Division and the Governor’s Office prior to the Lottery getting started. Shaheen commented: “I tried to back into the $1.2 billion predetermined number as close as possible. In the end, the closest I felt comfortable with was $1.148 billion based on the information I obtained and that was a stretch.” Neither the Governor’s Office nor the Legislature’s Fiscal Research Division could supply documentation for the original Lottery revenue estimates, but Fiscal Research stated its forecast was based on the lottery experience of other states.

The State Auditor recommended that the NCEL “document its revenue forecasting methodology, along with the underlying assumptions, and make it available to all participants in the budget process. NCEL should also analyze variances between previous revenue projections and actual results to improve the forecast methodology.” The report noted that schools and students were promised $425 million in net revenues in fiscal year 2007 for new school construction, class size reduction, and college scholarships; however, because total sales fell short by $325 million, education funding suffered a $111 million shortfall. It also noted that no formal documentation of the underlying assumptions and methodology exists for the 2008 revenue forecast, and that even though revenue projections were reduced to $341 million, sales for the first half of the 2008 year seem to indicate another shortfall will occur for the 2008 fiscal year, resulting in nearly $32 million less for education than budgeted.

The audit report noted a second weakness in management practices of the NCEL—lack of a formal strategic plan. Although it acknowledged that NCEL did have an outline for the first three years of the lottery and a marketing plan, neither plan was comprehensive enough, lacking an environmental assessment of the NCEL’s strengths, weaknesses, opportunities, and threats; measurable goals and objectives; and performance measures to track progress. A third weakness of the NCEL performance management practices was the failure to conduct ongoing operational and market research. Market research could identify industry best practices, reduce costs, and improve operations, while market research could identify industry trends, evaluate advertising effectiveness, and determine customer satisfaction. The fourth and final management practice weakness of the NCEL was the lack of consideration of the full cost of promotional events in evaluating the rate of return.

The State Auditor found that the management compensation for NCEL was comparable to surrounding state’s Lotteries and that ethnic diversity of the management, staff and vendors was in keeping with ethnic diversity of the State as a whole. It also found that the NCEL met the state’s goal of 10% participation by minority businesses in awarding contracts.

NCFPC director of government relations John Rustin said, “This audit confirms what opponents of the lottery suspected all along, revenue projections were ‘cooked’ in order to garner support for the lottery’s passage. If lottery revenue estimates had been based in reality and on standard business practices the projections would not have looked so rosey and gambling proponents may not have been able to force the bill through the General Assembly.”