How can governments ensure that spectrum is entrusted to operators who will deliver quality service to the public at a reasonable price? For decades, auctions have been the preferred method for assigning spectrum licenses. When executed well, spectrum auctions promote fairness, transparency and efficiency. In this post, we will look at the most popular spectrum auction formats.
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Risks in spectrum auctions
Yet, auctions are not without risks. Collusion and speculation can distort prices. Competition might cause winners to overpay – what we call the Winner’s Curse – forcing them to pass costs on to customers or operate at a loss. Meanwhile, participants might end up missing key bands they need to create an efficient network – a phenomenon known as Aggregation Risk. In extreme situations, this may lead to locking the best providers out of the market.
So how can regulators ensure spectrum auctions are successful? The 2020 Nobel Prize for Economics went to two professors who studied this exact question. Paul Milgrom of Stanford and Robert Wilson of Stanford examined how the rules of auctions impact results.
They found traditional auctions, where items are sold one by one, don’t work for spectrum. Operators need to acquire continuous spectrum within a category and – in the case of a multi-band auction – complementary bands to build an efficient network. In sequential auctions, an operator might acquire 90% of the spectrum they need only to lose a few critical frequency blocks at the end, reducing the overall value of their other bands. Meanwhile, competitors and speculators drive up prices if they know a particular operator needs a particular band.
To address these problems, Milgrom and Wilson invented the Simultaneous Multiple Round Auction – SMRA. In an SMRA, all blocks are auctioned simultaneously, with participants bidding on one or more blocks in each round. This allows operators to redirect their bids if their first-choice bands grow too expensive.
SMRAs also have an activity rule which means participants need to actively bid in early rounds or be locked out of future rounds – discouraging speculation and overt attempts to sabotage competitors.
Yet, while SMRAs have been adopted in countries around the world, they are not perfect for every context. Even with simultaneous bidding, participants can still find themselves locked out of specific bands they need to create an efficient network.
This led Milgrom and others to develop another format- the Combinatorial Clock Auction – CCA. CCAs are more complex, but, in theory, can produce a more efficient allocation.
Participants in CCAs do not bid on specific blocks. Instead, the auctioneer groups blocks into categories of equal value. For example, a government might group five low-frequency blocks into Category A, seven mid-frequency blocks into Category B and three high-frequency blocks into Category C.
Bidding proceeds through three distinct phases:
- The “clock phase”
- The “supplementary phase” and
- The “assignment phase”.
The clock phase is divided into rounds, just like traditional and SMRA auctions. But instead of bidding on individual blocks, participants say how many blocks they would like from each category at the current price.
Once everyone has submitted their bids for a round, the government compares total demand for each category to the supply. If demand for a Category exceeds supply, the price will go up in the next round. If not, the price will remain the same.
The bidding continues until demand for all categories is equal to or less than supply, at which point the clock phase ends.
The main advantage of CCA is that bidders will either get all the blocks in their package bid or none. If prices change in subsequent rounds, operators may submit a new package bid. Either way, there is zero risk that a company will end up with a combination of blocks they wouldn’t actually want.
To keep participants from endlessly bidding on different combinations, the designers included a mechanism to limit the number of blocks participants may include in their package bid for a given round.
Prior to the auction, operators pay a deposit for eligibility points. The larger the deposit, the more points they receive, allowing the operator to bid on more blocks per round.
These eligibility points must be used or lost, and are never increased. So, bidders who do not actively participate in early rounds will quickly become sidelined, meanwhile – the longer bidding goes on – the more participants have to focus their bids on the most desirable blocks. Eventually, this drives the auction towards a balance of supply and demand.
Having said that, the concept of eligibility points applies to both spectrum auction formats – SMRA and CCA.
At the end of the clock phase, all participants should have a clear sense of the demand for each category. Next comes the Supplementary Phase, where participants submit additional, closed-envelope bids. This could include offering to pay more for a package submitted in the clock phase or new packages with different combinations of blocks.
That said, there are rules to prevent bidders from deviating too drastically from their Clock Phase bids. Participants cannot attempt to deceive competitors by bidding one way in the public clock phase and bidding a completely different way in the secret Supplementary Phase.
Once all supplementary bids are in, the auctioneer determines the winning packages. A computer algorithm analyzes all of the bids submitted in the Clock Phase and Supplementary Phase. It also accounts for the value of any unsold blocks, based on their reserve price. The winning combination is the one with the highest sum of bid values.
After determining the winning combination of bids, the auctioneer will set the final prices utilizing the “second-price rule”. So instead of paying their own bid for a given combination, winners pay the amount of the second-highest bid.
Having determined how many blocks each participant will receive from each category, it is time for the Assignment Phase.
The government presents the winners with various allocation options and the participants bid on their preferred scenario. Whichever allocation receives the highest sum total bids will be the winning one.
So, as we noted up front, Combinatorial Clock Auctions can be quite complex.
Spectrum auction formats – and the winner is?
But does all the added complexity really produce better outcomes? The answer is “it depends”.
If participants have a strong interest in acquiring certain complementary combinations of blocks or if there is a high aggregation risk that participants are unable to win certain key blocks, then then yes, it might be worth considering the CCA format. However, if this is not the case, then other formats might offer a simpler, easier solution.
Selecting the best format for a spectrum auction is an important decision, and proper execution is critical. Fortunately, regulators and operators don’t have to navigate these challenges alone. Specure provides regulators and operators with software, consulting and hands-on support for spectrum auctions. We have helped clients implement successful auctions in many countries and are available to answer any questions you might have. For more information, visit our website at specure.com/auctions.