Kovacs: Designing a spectrum-auction for maximum proceeds

Anna-Maria Kovacs

Anna-Maria Kovacs

The FCC is preparing the most complex spectrum auction it has ever run, the upcoming 600 MHz auction. It will simultaneously run a reverse auction to buy back spectrum from broadcasters and a forward auction to sell that spectrum to wireless carriers.

The FCC is attempting to meet several goals. It must make as much spectrum as possible available for wireless broadband, to meet the explosive demand consumers and businesses are placing on the carriers. It must also maximize auction proceeds to pay for the spectrum it reclaims, as well as to pay for the construction of a nationwide broadband interoperable public-safety network, and for deficit reduction. 

In other words, it must both maximize the amount of spectrum that is reclaimed and maximize auction proceeds. Those two goals are, of course, complementary. Higher auction proceeds will allow the FCC to offer more funds to broadcasters, thus enticing more of them to sell back spectrum, which will make more spectrum available for broadband. With more spectrum available for resale, auction proceeds will increase. 

There have been suggestions that the FCC should complicate this auction even more, by bringing into the auction a process that it has traditionally treated separately. In past auctions, the FCC has allowed all willing and qualified bidders to participate. After the close of the auction, it has examined the results against its spectrum screen, case by case. In markets where it has found excess spectrum aggregation after the auction, it has required divestitures. 

Thus, the FCC has treated the auction itself separately from its spectrum-aggregation policy. There have been suggestions that it intertwine these two processes. Under this new regime, the FCC would establish spectrum caps and exclude carriers who might exceed those caps from the 600 MHz auction right up-front. 

This idea has resulted in a vociferous debate, with some economists claiming that auction proceeds will be maximized if all willing bidders participate and others arguing that excluding some bidders will maximize proceeds. If the debate has accomplished nothing else, it has made it clear that the only way to know the full market value of the spectrum is to let all willing bidders enter the fray.

Indeed, in response to the concern that exclusion of selected bidders might reduce auction proceeds, a recent proposal by an advocate of exclusionary auctions has suggested that the excluded carriers become pinch-hitters, to be brought in off the bench if the auction fails to raise the FCC's revenue target. They would be allowed to bid on one license at a time, until the FCC's revenue target is reached. With such a back-up plan, what could go wrong?

Even the most cursory review of the results of Auction 73, the 700 MHz auction run in 2008, shows that at least two things could go wrong. If the FCC's revenue target is below the full market value of the spectrum, the auction will raise less than the spectrum is actually worth. And no one will ever know how much money the auction left on the table.

In Auction 73, the FCC set reserve prices for each block of spectrum. Together those totaled $10 billion--the auction's revenue target. In fact, Auction 73--which was open to all bidders--raised $19 billion. The FCC not only underestimated the total value of the spectrum but miscalculated the relative values of individual blocks. The B-block, to which the FCC attributed the lowest valuation per MHz-POP (megahertz per unit of population), raised almost seven times the FCC's valuation--by far the highest valuation in the auction.

The FCC has tremendous expertise in running auctions, both internally and via external advisors.  But it has shown that it can undervalue spectrum radically. Because Auction 73 was open to all bidders, the auction proceeds were not limited to the FCC's low revenue target. The full market value of the spectrum was revealed in the auction process and obtained for the Treasury. Having built in the safe-guard of openness, the FCC had every reason to be proud of a very successful auction, and to brag in its post-auction press release that it raised $9 billion more than anticipated.

Now imagine that Auction 73 had been run as an exclusionary auction, with some bidders relegated to the bench, to be called out only if that $10 billion revenue target were not reached. The bidders on the field would have had every incentive, collectively, to reach that $10 billion target in order to keep the pinch hitters out of the game. Once they had accomplished that, they would have had no incentive to exceed the target. 

But let's imagine that they failed and the pinch-hitters did get into the game. They were allowed to bid on the A-block and their higher bid was enough to enable the FCC to reaches its revenue target for the auction. That would have closed the auction and the spectacularly-undervalued B-block would never have been opened to bidding by the pinch-hitters. In Auction 73, the sale of the B-block at its reserve price instead of its full market value would have left $7.7 billion on the table. And no one would ever have known.

Without an open auction to reveal the full value of the spectrum, there is no way to calculate the discount the included bidders receive. It is literally incalculable.

Recently, speaking of the FCC's data collection efforts, FCC Commissioner Rosenworcel said that "we cannot manage what we cannot measure." The only way the FCC can avoid providing an un-measurable transfer of wealth from the U.S. Treasury to favored bidders in the 600 MHz auction is to run an auction open to all bidders. 

Having established the value of the spectrum and assured maximum proceeds from the auction, the FCC can then move on to the next step to make its decisions about spectrum aggregation.

Anna-Maria Kovacs is a Visiting Senior Policy Scholar at Georgetown University's Center for Business and Public Policy. She has covered the communications industry for more than three decades as a financial analyst and consultant.