The California State Lottery (lottery) originated with the passage of Proposition 37 in November 1984. The primary purpose of the proposition was to provide additional moneys to benefit education without the imposition of additional or increased taxes. On October 14, 1986, the lottery began selling tickets for California's first on-line lottery game "Lotto." On-line games are sold from lottery computer terminals installed at retail locations throughout California. A communications network links these computer terminals to a central data system. The terminals, communications network, and central data system comprise the lottery's on-line gaming system.
Until late June 1992, one of the lottery's primary objectives was to independently manage and own its on-line gaming system. The lottery intended to achieve its independence from lottery vendors by owning its central data system computers, terminals, and software and by using its staff, with assistance from one or more lottery vendors, to operate the system. At some point between late June 1992 and midOctober 1992, lottery management decided to move away from owning its on-line gaming system. The decision meant that instead of the lottery owning its system, the lottery would seek one vendor who would provide its own system, including a central data system, software, and lottery terminals.
The lottery issued a request for proposal (RFP) on January 27, 1993, that reflected its change in direction for the on-line gaming system. In return for providing a new system, the lottery would pay the winning vendor a percentage of the sales generated from the on-line games.
The RFP required the winning vendor to replace the lottery's old online gaming system using either a preferred or an alternative implementation schedule. Under the lottery's preferred implementation schedule, the lottery required a vendor to replace the old lottery-owned on-line gaming system by October 14, 1993, that is, within 175 days, or approximately six months, from the date the lottery commission approved the contract. The RFP also stated that the lottery could assess liquidated damages of up to $250,000 per day for each day the vendor did not have the new vendor-owned on-line gaming system operational after October 13, 1993. Under the lottery's alternative implementation schedule, the final RFP required a vendor to replace the lotteryowned central data system by October 14, 1993, and replace the 12,000 lottery-owned terminals by January 30, 1994. From the date the lottery commission approved the contract, this schedule allowed a vendor 175 days to install a vendor-owned central data system and software and an additional 109 days to replace the lottery-owned terminals with vendorowned ones. The final RFP stated that the lottery could assess liquidated damages of up to $250,000 per day for each day the vendor did not have the central data system and software operational after October 13, 1993, and for each day the vendor did not have all the lottery terminals replaced after January 30, 1994. Furthermore, if the winning vendor opted to use the alternative implementation schedule, for each lottery-owned terminal that the vendor had not exchanged with a vendor-owned terminal by October 14, 1993, the lottery would pay the vendor only half of the negotiated percentage of sales generated from those terminals. The RFP required vendors to submit their proposals by February 17, 1993. Of three vendors that the lottery identified as likely bidders, only the lottery's incumbent vendor, GTECH Corporation (GTECH), submitted proposals.
Results in Brief
The purpose of this audit was to review the lottery's entire procurement process for awarding a contract for its new on-line gaming system. We found that competition for the contract was limited to a single vendor by the restrictive implementation schedules the lottery included in the RFP. This was not consistent with lottery policy that prohibits the drafting of an RFP that limits bidding to a single vendor. Because it was too short, the lottery's preferred implementation schedule was restrictive to two of the three vendors interested in the procurement. The lottery's alternative implementation schedule was restrictive to the two nonincumbent vendors because it was not viable.
Reasons why the lottery issued an RFP with restrictive implementation schedules include the lottery's failure to question the advice of its consultant, the lottery's questionable decision to not pursue negotiations to extend the contract for the old on-line gaming system with its incumbent vendor, GTECH, and the lottery staff not fully recognizing that two of the three vendors had raised serious concerns about the RFP and had indicated they might not submit proposals. Because the restrictive implementation schedules limited competition to a single vendor, the lottery could not be assured that it had received the best on-line gaming system at the best price.
Although the lottery's restrictive implementation schedules limited competition during the procurement of its on-line gaming system, other aspects of the procurement process appeared adequate. For example, we reviewed certain experience and technical requirements the lottery established during its development of the RFP to determine whether the requirements were reasonable, allowed competition, and were in the best interests of the State. Our review indicated that the requirements appeared to have been reasonable and did not limit competition. Further, we found no indication that they were not in the State's best interests.
In addition, although it received proposals from only one vendor, the lottery's procedures for evaluating these proposals appeared to be adequate. We also reviewed the procedures the lottery used to negotiate the contract price with the winning vendor to determine whether the actions the lottery took preparing for and conducting the negotiations were reasonable. Our review indicated that the procedures used by the lottery to negotiate the contract for the online gaming system appear to have been reasonable. We also found that the lottery complied with applicable contract approval requirements. Finally, to determine whether the lottery was adequately monitoring the implementation of the on-line gaming system contract, we reviewed the procedures the lottery used to track the items it wanted the contractor to deliver.
To ensure competition during future procurements and to ensure that it receives the best goods and services at the best price, the lottery needs to improve the oversight of its procurement process. Specifically, the lottery should take the following actions:
Although the lottery does not fully agree with all of the conclusions in our audit report, it does agree with our recommendation that it take additional steps to ensure maximum competition in future procurements.