Mallinson: Germany's spectrum auction shows how monopoly power can be exploited - and hurt operators

Keith Mallinson

Monopoly pricing of a very scarce commodity was clearly demonstrated in last week's German spectrum auction results. Around the world, cash-strapped governments, via their telecommunications regulation agencies, have proven themselves to be increasingly adept at creaming-off the economic surplus in mobile communications supply for themselves while various operators struggle to achieve adequate operating profits.

Spectrum prices high, even with fewer mobile operators
Increasing operator market concentration with the number of bidders reducing does not appear to be reducing spectrum prices at auction. In Germany, following Telefónica's acquisition of E-Plus in October 2014, which left only three mobile operators, total bids exceeding €5 billion ($5.6 billion) for a total of 270 MHz have been received by the German regulator Bundesnetzagentur in the auction which came to an end on June 19. The lower figure of €4.4 billion was raised for 369 MHz in the previous auction in 2010, of which the majority, €3.6 billion, was for spectrum in the 800 MHz bands.

In the most recent auction for mobile spectrum in the U.S., it is the top two operators AT&T Mobility and Verizon Wireless that scooped up most of the AWS-3 bands available by paying $18.2 billion and $10.4 billion, respectively, of the $41.33 billion in total net proceeds for 65 MHz of spectrum.

With strong data traffic growth, mobile operators need to hang on to as much of their existing spectrum as possible, while also adding additional new blocks. Even though there is a lot of excitement about many of the numerous features in LTE Advanced and with the possibilities in 5G use cases, the driving force in mobile operator investment is in building mobile broadband network capacity in urban areas with high traffic demand. Additional spectrum, as well as using carrier aggregation, remains the top priority for mobile operators because this tends to be faster to deploy and more cost effective than densification with heterogeneous networks in satisfying this increasing demand.

Maximising auction receipts was not supposed to be paramount in the German auction. However, commitments which require operators to invest in coverage infrastructure nationwide and can depress auction prices were clearly not onerous. The auction proceeds were high because new low-band spectrum, which is particularly attractive for coverage and existing mobile spectrum in the prime 900 MHz and 1800 MHz bands, was included. Germany is the first country in Europe to make spectrum in the 700 MHz frequency band available for mobile broadband. This was previously used for terrestrial television. Auction assignees have to commit to providing broadband coverage to at least 97 per cent of households in each federal state and at least 98 per cent of households nationwide, with a minimum transmission rate of 50 Mbps per sector and an average of 10 Mbps per household. The existing mobile spectrum was included in the German auction because usage rights for it expire at the end of 2016.

Coughing up
Governments like to maximise what they pocket in spectrum sales at the expense of mobile operators. Nevertheless, Vodafone, for example, has foundered in a public relations battle versus activists who argue the company is not paying its fair share to society in taxes. Meanwhile, the company is only achieving mediocre operating performance including only 28.2 per cent EBITDA margin in Europe in its last fiscal year.  .

Bidding discounts appear to be wasteful, with incumbent operators' shareholders rather than consumers picking up benefits. For example, Ofcom concluded in 2012 "that consumers were likely to benefit from better services at lower prices if there were at least four credible national wholesalers of 4G mobile services." In February 2013 it also stated it "took the view that there were only three operators (EE, O2 and Vodafone) with sufficient spectrum to support such services.

Therefore, in the interests of competition, spectrum was reserved in the auction for a fourth national wholesaler. That spectrum has been won by Hutchison 3G UK"

That operator acquired 2 x 5 MHz of 800 MHz band spectrum at a £50 million (€70.4 million/$78.8 million) discount (equivalent to 18 per cent) to the price paid by Telefónica UK, whose 2 x10 MHz of 800 MHz spectrum was of diminished value due to coverage obligations. In other words, the effective discount is even larger. However, by March 2015, Hutchison Whampoa agreed definitive terms to acquire O2 in the UK from Telefónica, and so the number of UK competitors will consolidate from four to three despite the discount from which Hutchison has benefitted. There are many other examples from around the world where set-asides and discounts have not delivered the touted benefits, and so these perks are on the decline.

Redistribution of wealth
However, conventional auctions are drawing too much capital out of the mobile communications sector when it would be beneficial to invest more in improving and advancing networks. Similarly, the European 3G auctions at the turn of the millennium caused a massive economic shock to mobile operators, which impaired infrastructure and service investment for many years while raising more than €100 billion for governments. Following lacklustre adoption of 3G until less than a decade ago, European operators continue to lag behind the U.S., Japan and South Korea in 4G.

The mobile industry would like to do a lot more than simply increase coverage, capacity and maximum speeds. It will be possible with 5G also to massively increase average and minimum speeds per user, while significantly reducing network latency and reliability. That will be costly in technology development and in implementation by operators.

Spectrum is too valuable to be given away. However; a more sophisticated array of operations obligations and commitments could encourage more capital to be invested in improving mobile networks and services, and making them cheaper, rather than simply siphoning off as much money as possible from operators in auction proceeds for governments to spend on other programmes outside telecommunications.

Keith Mallinson is a leading industry expert, analyst and consultant. Solving business problems in wireless and mobile communications, he founded consulting firm WiseHarbor in 2007. Find WiseHarbor on Twitter @WiseHarbor.

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