Spectrum Auction Recommendations for ICASA in South Africa

Spectrum Licensing & Auctions Karen Wrege, KB Enterprises, LLC iWeek 2009

Elements of Spectrum Management Definition (Service Rules) Allocation (License Definition) Assignment Enforcement

Overview of Assignment Options First In Time Lottery Beauty Contest Auction “ Hybrid” process

First In Time Attributes: Administrative award process Award based on the order in which applications are received Advantages: Quick Low litigation risk since selection criteria is simple and straight forward Inexpensive Fair and efficient in situations where demand does not exceed supply Disadvantages: Inefficient if demand exceeds supply Does not compare applications against each other to determine best assignment

Lottery Attributes: Random assignment of licenses if demand exceeds supply May includes some applicant pre-qualification criteria Advantages: Quick (depending on complexity of pre-qualification process) Low cost (depending on complexity of pre-qualification process) Fair (everyone has an equal chance of winning) Disadvantages: Does not compare applications to determine best use Possibility of windfall profits if secondary trading is allowed May encourage speculators if there is lax pre-qualification or low entry costs

Beauty Contest Attributes: Comparative selection (merit-based) Regulator publishes evaluation criteria (and fee, if any) Advantages: Regulator has high degree of discretion Can involve many different objectives (e.g. social objectives) Disadvantages: Difficult to define criteria that can be compared objectively Subject to favoritism/corruption Litigation risk Incentive for applicants to overstate their capabilities Large burden on applicants to create complete & compelling business case.

Auctions Attributes: Spectrum awarded to the highest bidder Can include other factors beyond price (e.g. minimum quality of service) Advantages: Well designed auctions lead to an efficient outcome Fair and transparent Well designed auctions (and software) can be straightforward for bidders Extracts scarcity value of spectrum Disadvantages: If poorly designed, may lead to overpayment and strategic manipulation Problems if design does not take into account potential market failure risks Prices paid can potentially slow down service roll-out

Hybrid Process Attributes: Combination of “Beauty Contest” and auction Those passing the beauty contest proceed to the auction Advantages: Gives regulator more discretion than in a pure auction Potentially avoids some risks of a pure beauty contest May reduce incentives for applicant to over-state their capabilities Extracts value of spectrum Disadvantages: Retains many of the disadvantages of beauty contests Time consuming and risk litigation by unsuccessful applicants Could produce less competitive auction and increase possibility of collusion

ICASA Bandplan Options ICASA presented 3 options

Bandplan Options ICASA found option 1 unworkable because of incumbent allocations at 2500 MHz ICASA found option 2 undesirable because it is not technology neutral This leaves option 3, a flexible bandplan – but this may not be as flexible as it first seems

Flexible(?) Bandplan Given the incumbents at 2500 - 2570, a “flexible bandplan” would require relocation to allow for FDD pairing Source: Martyn Roetter

Bandplan Issues Incumbents occupy 65 MHz so 125 MHz remains Guard bands will be necessary for TDD & FDD to coexist Band Plan will require reshuffling to accommodate FDD Allocation impacts assignment mechanism

Assignment Options Per the General Notice, ICASA is considering: A purely comparative evaluation process; or A purely competitive evaluation process; or A combination of the two. For ease of reference, the Authority shall refer to combination of the competitive and comparative evaluation processes as truncated granting methodology .

ICASA Assignment Methodology Concerns Concerns for Comparative Process Opaque and Non-transparent Requires Ranking Applications Concerns for Competitive Process Risk of Collusion Spectrum acquisition costs being passed through to consumers ICASA documents appear to favor the “truncated granting methodology” -- a hybrid approach

Choosing Auctions As Part of the Assignment Mechanism Multiple types are used for spectrum, including: First Price Sealed Bid Second Price Sealed Bid Simultaneous Multiple Round Ascending (SMR) SMR with Switching Rules Ascending Clock

Auction Types: First Price Sealed Bid Only one opportunity to provide bid – must know price information. Bidders submit their bids independently and are prohibited from sharing information. Highest bidder wins. Winner pays its bid. Losers pay nothing. But when bidding below value, you risk regret. Optimal bid strategy trades off risk of not winning & gain from winning with lower bid. Bidding your valuation guarantees you get no surplus, thus: Best strategy is to bid less than true valuation (shading). $200 $150 $300 High Bidder Pays $300

Second Price Sealed Bid Only one opportunity to provide bid – must know price information. Bidders submit their bids independently and are prohibited from sharing information. Highest bidder wins. Winner pays highest losing bid. Losers pay nothing. William Vickrey won 1996 Nobel prize for his work on this subject Encourages bidders to bid to their private valuations, protects against an enormous erroneous bid. Called “incentive compatible”. High Bidder only pays $201 $200 $150 $300

Simultaneous Multiple Round (SMR) All items are auctioned simultaneously. Bidding progresses through a series of discrete timed rounds. Standing high bids are determined at the close of each round. Prices increase on all licenses that were bid on in the previous round. The auction closes after a single round in which there are no new bids on any of the licenses. Highest bidder on each item wins it and pays the price bid.

SMR with Switching Rules Switching Rules allow bidders to move freely to substitutable licenses during the auction as prices rise. Bidders who have standing high bid on a lot may switch their bid to another lot. Facilitates aggregations.

Ascending Clock Auction Simultaneous ascending auction (like SMR). Generally used to sell multiple identical items. At the end of each bid round, prices increase if there is excess demand. Bidders choose whether to accept or reject the new announced prices. The auction closes when the number of bids equals the number of licenses (supply=demand). The winning bidders all pay the required bid amount and each of them is assigned an identical license. Clock auctions can also be combined with a subsequent phases to deal with bids for packages of complementary licenses.

Arguing Against A Beauty Contest A beauty contest component, even if paired with an auction is problematic: Difficult to be objective, non-discriminatory and transparent Litigation risk Difficult to set selection criteria and evaluate. Often favors incumbents Often a lengthy process Because it is a subjective process there is no guarantee that it will not disqualify an applicant that could build out a network effectively

Arguing for a Pure Auction Approach More flexible and responsive than selling at a fixed price Less haphazard than negotiations Simplicity in determining market-based price (price is set by the bidders competing) Minimizes transaction costs Allows mechanization of process Opens market to more participants Can speed up the time of negotiations Ideal for Internet execution Can still meet social objectives

Incorporating Social Objectives into an Auction Strict eligibility requirements Bidding credits for small businesses, disadvantaged individuals and women New entrant set-asides Spectrum caps for incumbents to promote new entrants Lease fees in lieu of full payment for spectrum licenses Strict build out requirements Use or lose spectrum policy

Desirable Properties for an Auction Wide participation Efficiency: Goods go to entity that values them the most Incentive compatible Flexible and Robust Dynamic Transparent Simple Rules to maximize social welfare

Auction Components Definition of product being sold (property rights and responsibilities) Bidding Auction Deposits (Must be enough to level the playing field and attract serious bidders) Who is allowed to bid? (Eligibility requirements) How are bids presented? (One time or Multiple rounds) How much must bids be beaten by? (Bid increments) Information Are current bids revealed? (Hiding bid identities during the auction helps to reduce strategic gaming) Are winners identified? (Transparency of process) Clearing Who gets what and at what price? (First or Second price)

Auction Rules Matter Regulators want bidders to tell the truth, but.. Bidders might do better by lying (e.g., by forming a ring or by colluding ) All auctions types are subject to some sort of manipulation by collusion among buyers, sellers, and/or auctioneer. Bidders need to be wary of “winner’s curse” (bidder who wins believes they overpaid) Encourage bidder participation – more competition, reduces ability to collude. Minimize/eliminate exposure and aggregation risks - bidders that win some but not all of their desired licenses Allow bidders flexibility to pursue back up strategies without increases exposure risks

Choosing an Auction Type Sequential vs. simultaneous auctions Simultaneous auction takes into account complementarities and substitutability of spectrum licenses. Single round vs. multiple round auctions Multiple round allow bidders to help avoid the “winners curse” and allow for price discovery during the auction. Simplicity vs. more complex auctions Depends on the number of licenses, bidder sophistication, and degrees of complementarities and substitutability of the licenses in the auction. Clock auctions vs. Simultaneous Multiple Round Auctions Clock auctions are generally simple for bidders to participate in but may require additional measures to deal with overshooting.

International Auction Practices in 2.5 and 3.5 GHz bands Most countries have used an auction to allocate spectrum in these bands Some countries have allocated spectrum nationally, while others have opted for regional allocations Most countries have auctioned 2.5 and 3.5 GHz bands separately Spectrum generally will be allocated on a “technology neutral” basis

International Experiences: In June 2002, Nigeria held a single round combinatorial auction for 3.5 GHz spectrum UK and the Netherlands plan to auction spectrum using a combinatorial clock auction with final round stages to choose high bidders and assign specific frequencies. Paired and unpaired spectrum assigned through the auction mechanism. Denmark recently issued a consultation document proposing a combinatorial clock auction using the CEPT bandplan. New Zealand in December 2007 chose a SMRA auction method with defined paired and unpaired spectrum blocks in the 2.3 and 2.5 GHz bands

International Experiences: Sweden and Norway opted for SMR auctions with switching rules where paired and unpaired spectrum was pre-defined Italy auctioned 3.5 GHz licenses using a first price sealed bid auction method in early 2008 Germany auctioned 3.5 GHz licenses using a Simultaneous Multiple Round Ascending Auction format Taiwan used a hybrid “beauty contest”/Auction process Hong Kong used an SMR format where paired and unpaired spectrum was pre-defined. Jamaica conducted a hybrid “beauty contest”/sealed bid auction in early 2009. The auction failed to meet the established reserve price.

South Africa Licenses 2.5 GHz Band Nationwide license areas 30 MHz blocks 4 licenses Technology Neutral 3.5 GHz Band Designated Geographic Catchment areas At most 28 MHz per operator 2 licenses per geographic area Technology Neutral

ICASA Policy Objectives from the Electronic Communications Act The policy objectives set forth in the Electronics Communication Act are broad and far reaching and include the following social objectives: Promote the empowerment of historically disadvantaged persons, including Black people, with particular attention to the needs of women, opportunities for youth and challenges for people with disabilities; Ensure that broadcasting services and electronic communications services, viewed collectively, are provided by persons or groups of persons from a diverse range of communities in the Republic; Provide assistance and support towards human resource development within the ICT sector; Ensure the provision of a variety of quality electronic communications services at reasonable prices; Promote the interests of consumers with regard to the price, quality and the variety of electronic communications services;

Self-Certification in Auction Applications Consider Self-certification process in the pre-auction application that could include the following: that the applicant is legally, technically, financially and otherwise qualified pursuant to the Electronic Communications Act; that the applicant has at least 30% (thirty percent) direct Black Economic Empowerment; That the applicant is not affiliated or does not hold more than 5% in another applicant in the same band; that the applicant is the real party in interest in this application and that there are no agreements or understandings other than those specified in this application; That the applicant has not been granted a radio frequency spectrum license by the Authority within the designated range, to which the application relates;

Self-Certification in Auction Applications (Con’t) that the applicant is aware that, if upon inspection, this application is shown to be defective, the application may be dismissed without further consideration, and certain fees forfeited. Other penalties may also apply; except as explicitly provided in the Rules, that the applicant has not entered into and will not enter into any explicit or implicit agreements or understandings of any kind with parties not identified in this application regarding the amount to be bid, bidding strategies or the particular license on which the applicant or other parties will or will not bid; that if a bidding credit eligibility is claimed, the applicant is eligible for any special provisions set forth in the Rules applicable to this auction and consents to audits, as set forth in the Rules, to verify such status; and

Self-Certification in Auction Applications (Con’t) that the applicant is and will, during the pendency of its application, remain in compliance with any service specific qualifications applicable to the licenses on which the applicant intends to bid including, but not limited to, financial qualifications.

Recommendations Develop auction application without subjective evaluation criteria (no hybrid approach) Minimizes litigation risk Minimizes entry costs Include self certification language on pre-auction application to include: Eligibility requirements Technical capabilities Financial capabilities Collusion rules

Recommendations Facilitate robust competition Consider incentives for new entrants Facilitate Low entry costs to increase competition Keep it simple Consider assigning 2.5 and 3.5 GHz licenses in separate processes Implement a simple SMRA auction design that is well tested Use robust commercially available software Make it easy for participants to understand and participate Use a straightforward bidder interface

Recommendations Eliminate collusion Establish strict, enforceable anti-collusion rules Eliminate strategic gaming Do not reveal bidder identities before or during the auction Minimize demand reduction Keep it secure Encrypt bids Provide transparency in the process Publish bidder identities after the auction

Spectrum Auction Recommendations for ICASA in South Africa

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