Allocating spectrum to mobile operators by auction is the mechanism preferred by most regulators, and allows a scarce resource to be assigned to those who value it the most, so helping to identify the highest value use and users. However, much depends on the auction format and auction rules, which are usually designed to deliver policy objectives, but there are aspects of these formats and rules that present a high risk of adverse consequences, as they distort spectrum auctions. The common distortions are:
The public good is best served by policies that advance the following objectives:
Inefficient spectrum allocations may lead to a reduction in total industry capacity, potentially leading to greater network congestion, and an opaque allocation process could lead to slow or curtailed network deployment and reduced consumer choice. These criteria are well accepted in most countries. However, there is ample scope to disagree on what constitutes a high net return to the public. Policymakers often seem to emphasise the direct auction proceeds a government will receive, at the expense of wider social and economic benefits; as Thomas Hazlett and colleagues observe in ‘What really matters in spectrum allocation design’:
“The ratio of social gains [is of] the order of 240-to-1 in favour of services over licence revenues… Delicate adjustments that seek to juice auction receipts but which also alter competitive forces in wireless operating markets are inherently risky. A policy that has an enormous impact in increasing licence revenues need impose only tiny proportional costs in output markets to undermine its social utility.”
Higher retail prices and/or reduced network investment, whether caused by artificially high spectrum costs or by reduced competition, undermine the adoption and consumption of services, bearing negatively on digital participation and economic productivity. Moreover, once they are lost, these economic benefits cannot be recovered.
“There is ample scope to disagree on what constitutes a high net return to the public.”
SAFEGUARDS BY SET-ASIDES OR SPECTRUM CAPS
Spectrum set-asides, floors and/or spectrumacquisition caps are designed to prevent excessive spectrum concentration, and need to be determined with great care to avoid unduly distorting outcomes. The main risks include inefficient spectrum use and, in the case of spectrum reservations, potentially higher spectrum costs on aggregate, resulting in higher retail prices and/or reduced network investment. Recent examples of unfavourable outcomes caused by spectrum reservations or caps include the following:
“Artificially high reserve prices are prone to distort outcomes and harm the public interest.”
EXCESSIVE RESERVE PRICES ARE NOT IN THE PUBLIC INTEREST
Artificially high reserve prices are prone to distort auction outcomes and harm the public interest in a number of ways:
If a single licence is available, regulators tend to rely on either a Sotheby’s style rising clock auction, or a sealed-bid format. A sealed-bid auction may either use a first or a second-price rule. Under the firstprice rule, winners pay the amount of their winning bids. This can lead to a ‘winner’s curse’: paying more than would have been required to win, which threatens auction efficiency. A first-price rule also yields an uncomfortable trade-off between minimising the risk of losing, and minimising the winner’s curse.
The 1998 Brazilian auction for 2G licences provides an example of this problem: BellSouth paid $1 billion more than the next highest bidder for the São Paulo metro licence. The introduction of a second-price rule eliminates this particular problem. Under the latter, the winner pays the amount of the next highest bid. A Sotheby’s style English auction approximates the second-price rule: prices stop rising when the second-highest bidder drops out. This incentivises truthful bidding, as there is no penalty for bidding full value, because winners pay no more than the minimum required to justify their allocation. If all participants bid their true values, the auction will be efficient in identifying the highest value user of the resource.
Moreover, if the two highest valuations are relatively close, this may generate higher proceeds than a first-price auction in which participants ‘shade’, ie. reduce their bids in order to avoid the winner’s curse. Because they promote allocation efficiency, second-price formats are vastly to be preferred when awarding single licences.
The main formats used to auction multiple spectrum blocks are the combinatorial clock auction (CCA), which uses a generalised secondprice rule, and the simultaneous multiple round auction (SMRA). Sealed bid formats are sometimes adopted, such as the combinatorial second-price auction and the combinatorial first-price auction.
“No format is perfect and policymakers need to consider potential sources of distortion.”
AUCTION FORMATS IMPACTING OUTCOME
Under a given set of circumstances, each of the above formats may produce widely differing outcomes. While no format appears to be perfect, policymakers need to consider the following potential sources of distortion:
The CCA format is generally vulnerable to the first three of these forms of distortion, SMRA to the last two, and combinatorial first-price auctions to the first, second and last.
Following the UK’s multiband award in 2013, which used a CCA mechanism, the UK National Audit Office (NAO) observed that two bidders appeared to be subject to fixed budget constraints, and that this may have prevented them from achieving all their objectives. This potentially limited the efficiency of the auction.
The issue in a CCA is that participants have limited visibility over their actual price exposure, as the bids of rivals, which determine the price they pay if they win, are not disclosed. This introduces a potentially intractable strategic dilemma for bidders that are constrained by a fixed budget, rather than by their spectrum valuations. To minimise the risk of being knocked out, such bidders may choose to bid full valuations on smaller packages. However, in doing so they squeeze the extra amount they can bid for additional lots, while staying within their overall budget limit. This reduces their chances of winning the extra lots.
As a result, they can fail to secure the larger package that, given the relative valuations and constraints of each participant, they actually ought to win. The opposite strategy open to management is to bid the available war chest on a larger package and reduce the bid values for smaller packages. This would increase the chance of winning a more ambitious prize, but also the risk of walking away with nothing. Given the resulting threat to efficiency, the NAO recommended that UK regulator Ofcom “select designs for future auctions that take account of the circumstances of likely bidders, such as the likelihood that they will be subject to budget constraints”.
Since prices in a CCA are determined by the marginal bids of rivals, there is potential for pricing asymmetries. For example, Swisscom secured a larger package, yet paid a lower amount than Sunrise during the Swiss multiband auction in 2012. The limited feedback between what one bids and what one pays may also invite bid strategies designed to impose higher costs on competitors.
The SMRA format introduces different threats to efficiency. First, since participants bid on individual lots rather than on entire combinations, it is possible to win an unwanted subset of a target package. Subsequently, management’s need to manage this risk may distort bid behaviour. If the lots reflect specific frequency ranges rather than generic quantities within a given band, there is also a risk of fragmented assignment, which is technically inefficient. Neither issue arises in a CCA or in a first-price sealed-bid auction, because participants in these either win a whole package bid, or nothing at all.
Second, SMRA may be construed as a tacit negotiation between the auction participants: the quicker everyone agrees on who gets what, the less bidders will pay collectively. While demandmoderation strategies are rational, these may impact spectrum auction revenues. However, if an efficient allocation is the prime objective, policymakers should be less concerned about the impact on auction receipts – which will be, in part, self-correcting through corporate taxation. Nor does demand moderation necessarily lead to a suboptimal distribution of resources: if bidders are realistic and correctly gauge relative spectrum valuations, the outcome may be the most efficient.
CCA and SMRA both have disadvantages. However, the combinatorial first-price auction introduces even greater risks, which also share the following key drawbacks with the CCA format:
Combinatorial first-price auctions are the most distorting of the main auction approaches and should be avoided. Opinions will differ on whether CCA or SMRA is more prone to distortions overall. The relative levels of risk will also depend on circumstances as well as the detailed rules. Regulators should examine their national circumstances and reflect feedback from operators in their ultimate choice of format.
The economic cost of inefficient spectrum allocations can readily be quantified by analysing their effect on total industry capacity. Comparing the latter with potential (ie. unconstrained) demand allows us to express the inefficiency in terms of foregone consumption. This can in turn be used to gauge the impact on consumer and producer surplus (CS and PS):
Where spectrum is left unsold due to high reserves, these costs sometimes far exceed the extra auction proceeds that may reasonably be attributed to them, as was the case in India. As this highlights, the social and economic cost of inefficient allocations is often substantial, especially if spectrum is left fallow or is underutilised for prolonged periods, making it vital that governments research and choose the right auction format.
Continuing our coverage of spectrum auctions, Stefan Zehle explores further the pitfalls and implications for the public purse, drawing on key examples from the past decade.
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