1. Dennis Ward Spectrum Auctions Masterclass Farnham Castle, Farnham, UK April 15 -19, 2013 Spectrum Auction Design

2. 2 Purpose: Provide a quick overview of common auction designs Discussion of SMRA and CCA designs

3. 3 There are many auction designs that promote efficient outcomes … Three main types of auctions:  English (ascending, best known)  Dutch (descending)  Sealed bid With many options:  Single or Multiple Item  Single or Multiple round  Transparent or anonymous (FCC 700MHz)  Simultaneous or Sequential  Combo/Package bidding  Common (spectrum) and private (art) values  1 st, 2 nd or uniform pricing Revenue equivalence!

4. If bidders do their part… Know values and bid them... “straight-forward” biddingKnow values and bid them... “straight-forward” bidding Know opponents (especially for 1st price and descending auctions which encourage bidder entry)Know opponents (especially for 1st price and descending auctions which encourage bidder entry) “Shade” bids just enough to win“Shade” bids just enough to win If “shade” too much, bidder with lower value winsIf “shade” too much, bidder with lower value wins inefficient outcomeinefficient outcome Auction is mechanism for price discoveryAuction is mechanism for price discovery Activity rules, withdrawal penalties, click-box and anonymous bidding all promote honest price discoveryActivity rules, withdrawal penalties, click-box and anonymous bidding all promote honest price discovery Bidder with highest value wins at one increment greater than second highest bidder in ascendingBidder with highest value wins at one increment greater than second highest bidder in ascending Equivalent to second price auctionEquivalent to second price auction Efficient outcomeEfficient outcome

5. But inconclusive with respect to which is most efficient... Not clear that there is a “best” auction format  Efficiency, not revenue, is goal but how do you prove efficiency? Agencies will always say results are efficient “There were no higher bids”  Select what works best for you and customize  If exposure is a serious problem then clock combo But theoretical expectations may not be met?  Incumbent value includes premium for blocking entry  Bidders may not know values for all licences/packages  In combo don’t enter all relevant supplementary bids?  Bid budget and not their values?

6. 6 The SMRA has been the auction of choice since 1994…  SMRA is a transparent process Bidders and bids are known Simple price discovery hones private values Activity rules to promote bidding in every round Arbitrage across substitutes although licences often differ obvious why bidders win Maximizes social welfare because bidders with highest values place highest bids and win  Reduces Winner’s Curse  Avoids legal challenges

7. 7 But outcomes have not always been optimal... 1.Exposure problem 2.Policy issues related to block sizes, geographical coverage and other rules used to achieve policy goals such as:  Entry of designated bidders (Small business, women, natives, Designated bidding credits)  Spectrum caps and set-asides to allow entry and/or limit holdings 3.Bidding behaviour, signalling, retaliatory affects outcome  Values include the market share loss to entrant so outcome may be inefficient if incumbent wins  May be budget constrained!

8. 8 1)“Exposure problem” when bidders wish to assemble “packages” of licences With SMRAA, two outcomes are possible if a bidder wants to form “package” of licences:  They bid aggressively but don’t win desired “package” and therefore pay more than licences are worth (Winner’s Curse) business plan not remunerative  They don’t think they can win the “package’ they want so they don’t bid true values for licences and efficient packages are not formed

9. 9 …Example of “exposure problem”... Y bids $12 and $17  Next valid bids $13 and $18. What should X do? 1)Bid because value (40) > 29 but may win just one  Winner’s Curse 2)Stop bidding, Y wins  Assignment “inefficient” 3)Need mechanism that allows X to win to ensure efficient assignment BidderValue AValue BValue A+B X101540 Y17 38

10. So bidders have developed strategies to deal with exposure risk (eg Canada’s PCS 2001) When faced with exposure risk, bidders may focus bidding on principal markets first  If they can’t win they can withdraw from auction without incurring financial losses  Or sell any licences post-auction at favourable prices In PCS 2001, needed licence in Southern Ontario to compete nationally  Multiple FB/OB = 32!  Bidders may have had higher values for other licences but didn’t need to bid 10 RegionFB/OB Nfld1 NS/PEI2 NB1 East Que1 S Que6 Out1 N Que0 S Ont32 N Ont1 Man2 Sask1 Alta1 BC1.4 * 10 MHz licences @ 2 GHz

11. 2.Policy Decisions have led to large variation in prices for similar licences... Spectrum agencies (eg. FCC, Industry Canada) will often offer licences  Different block sizes  Different geographic coverage  Spectrum caps and/or set-aside To promote competition and entry by smaller firms but this can affect arbitrage and perhaps the efficiency of licence assignment For example.... 11

12. Different block size and geography can affect prices as seen in the AWS - 1*… Day 3 Day 4 Day 5 Stage 2 Final 40% discount 6 REAGs 176 EAs 734 CMAs Peter Cramton * 10 MHz block

13. Limited substitution in the 700 MHz also led to wide price variation … Verizon AT&T Verizon and AT&T won 85% of spectrum Peter Cramton

14. 3.Bidders behaviour can circumvent intent of auction … Establishment of shell companies is an example  Entrepreneurs Auction where large companies competed as small companies to win The use of bidder information to identify competitors for “punishing” or “retaliatory” bids also subverts the intention of the auction although this behaviour is not outside the rules of the auction Large bidders supported the release of bidder date in the AWS – 1 if eligibility ratio was greater than 3 In auction it was >3 but 4 bidders placed no bids and 7 make one bid each…  Highly suspicious 14

15. These weaknesses have made the Combo-Clock (CCA) an attractive alternative … Used by Ofcom in 2008, Austria, Denmark, Netherlands (2010) Australia, N’lands and Switz 2012, Canada, Australia, UK 2013 Similar to SMRA, many licences at once, points, activity rules, etc Proposes  identical size lots to promote tech neutrality, arbitrage and similar prices for licences  Activity-based increments  Anonymous bidding to encourage “straight-forward” bidding Reduces bid reduction, signalling, retaliatory bidding  Package bidding Addresses exposure problem 15

16. And, while some of these attributes could be adopted by the SMRA … Identical sized blocks and activity-based increments can be implemented in the SMRA to promote uniform pricing  Policy decisions (theoretically better to have identical)  Makes arbitrage easier and promotes identical prices Can offer anonymous bidding with SMRA  Eliminate signalling/demand reduction/retaliatory bidding/jump bids that may allow market-clearing at low (implicitly collusive) prices 16

17. 17 The “clock” is unambiguously faster (No round-by-round winner determination)… RoundABCD 10B1B2B3B4 11B5B2B3B4 12B5B1B3B4 13B5B1B2B4 14B5B1B2B3 SMRAA…4 ROUNDS COMBO/CLOCK…1 ROUND RoundABCD 10 D=5 S=4  PRICE 11 D=5 S=4  PRICE

18. The combo-clock has other desirable characteristics… No exposure problem (all bids are packages) Activity rule: 100% of eligibility points  Promotes price discovery  Can only decrease activity during auction Second price rule encourages truthful bidding If D>S, prices rise until no excess demand exists Supplementary round to enter bids on other packages of interest Also assignment round for bidders to “top up” bids if they have a preferred frequency Efficient outcome (ie welfare maximizing)

19. It works very simply, like this.... 19 Round Opens – Bids Accepted Round Closes – Demand Exceeds Supply Results from previous round – New lot prices Round Closes – D < = S End of Clock Supplementary Round Assignment Round `

20. 20 But it may create the “threshold” problem... Assume small bidders have higher value than single bidder on same package of licences  Can’t coordinate bidding Result:  non-efficient assignment of licences Four single bidders for licences A, B, C, D  willing to pay $2 for each licence  currently high bidders at $1 each (total $4)  “Package” bid of $5 received  Which bidders will increase bids to win?  Free rider

21. 21 and “package bidding” may favour large bidders… Increased complexity requires high level of sophistication “Packaging” increases likelihood that small licence would be subsumed in larger package  may be more difficult to win licences But spectrum business is BIG business anyway

22. And the activity rules are complex… Bidders are encouraged to enter supplementary bids at end of “clock” to:  Improve clock bids; and  Bid on other relevant packages which they would be interested in winning But their eligibility to bid on these packages will be constrained by their past bidding behaviour Have to know best bidding strategy or have flexible activity rules that will allow them to bid on all packages of interest Bidder should generally select highest valued package at each price during “clock” phase but this could constrain ability to enter supplementary bids

23. Optimal bidding…. Bidding on most profitable package is usually best (as long as relative prices don’t change) Clock yields competitive equilibrium with efficient assignment and supporting prices If no supplementary bids needed  Final assignment = clock assignment If unsold lots then need supplementary bids

24. 24 MESSAGES …. SMRAA has served us well in the past But the CCA offers an attractive alternative Anonymous bidding should be adopted in SMRAA to stop retaliatory bidding, demand reduction and other signalling associated with transparency Serious consideration should also be given to packaging  Identical lots promote arbitrage and uniform pricing Bidding in CCA is still a complex issue and efficiency depends on getting it right Bidders may need to be taught how to bid to ensure they can fully express their values in the supplementary round.