Are Spectrum Auctions the Way to Go?

The DoT has recommended auctioning of spectrum. In theory, auctioning spectrum seems to be the most efficient and transparent mechanism, which would apparently find out its “true” market value. But in practice, most winners of spectrum auctions the world over have gone bust because of their unrealistically high bids. 3G auctions in Germany and UK resulted in customers shelling out more from their pockets

By Ravi Visvesvaraya Prasad

Allocating electromagnetic spectrum efficiently is one of the most complicated techno-economic problems. If you ask twenty economists what is the best way to allocate spectrum, you will get twenty different answers.

On the face of it, auctioning spectrum seems to be the most efficient, open and transparent mechanism, which would apparently find out the “true” market value of spectrum. The problem is that in practice, spectrum auctions all over the world have failed miserably, for reasons that are not understood well. The open bidding process, which works so well for works of art, for some little understood reasons, does not work well for spectrum auctions.

Following the seminal work of the Nobel Prize winning economist Ronald Coase in the 1950s, there have been hundreds of PhD theses on the comparative advantages and disadvantages of different types of spectrum auctions – Sealed Bid, Simultaneous Ascending Price Auctions, Anglo-Dutch, German Rules, Clark-Groves, Rothkopf-Harstad, Milgrom-Weber, Perry-Reny, Combinatorial Auctions etc.

When the telecom sector in India was opened to private sector participation in 1992, the Indian government examined in depth whether spectrum should be auctioned or not to ensure its effective utilisation and to prevent hoarding. Several expert committees were of the considered opinion that spectrum should not be auctioned but should be released by the government in tranches as subscribers were added. They thought that operators would pass on the cost of winning an auction to their subscribers, thereby hindering the spread of telecom to the common man.

India had a negative experience with Sealed Bid auctions – the so-called “Winner’s Curse” - which was manifested in the controversy surrounding the very high bids for basic and cellular telecom licences in 1995. The winners of the Sealed Bid auctions (mainly Himachal Futuristic Communications Ltd) were not able to honour their high bids and had to be bailed out by the Vajpayee government by the new National Telecom Policy of 1999 by moving to a revenue sharing regime. This “Winner’s Curse” also occurred in the spectrum auctions in USA and the 3G auctions in Europe, where the highest bidders were not able to honour their astronomical bids and went bankrupt. It is noteworthy that this happened with several types of auction designs – Sealed Bid, Simultaneous Ascending Price Auctions, Anglo-Dutch, German Rules, Combi-natorial Auctions etc. In USA, NextWave Telecom, which had won the 1996 auctions by bidding 4.8 billion dollars, went bankrupt almost immediately after making the down payment of 500 million dollars. There was a nine-year long litigation which went all the way up to the US Supreme Court, during which period other operators also were prevented from offering services. This led some economists to formulate theories such as that the highest two bids should not be considered at all, and that the license should be awarded to the third-highest bidder or the fourth highest bidder. The apparent reasoning is that the highest bidders do not possess an in-depth understanding of the business, and that the middle level bidders would be more realistic.

On the face of it, the Simulta-neous Ascending Price Auction seems to be the most open and transparent system for allocating spectrum. However, for reasons which are not fully understood as yet, the Simultaneous Ascending Price Auction, which works so well for works of art, does not work well for spectral auctions. Leading economists have dubbed three of its major flaws as “The Coordination Problem”, “The Demand Reduction Problem”, and “The Bidder Participation Problem”, which require a detailed knowledge of Game Theory to understand. The basic concept is that as bidders begin to obtain more information about the strategies of their competitors, they begin to alter their own strategies very rapidly, sometimes in ways which turn out to be detrimental to all the bidders.

Spectrum auctions in USA failed because of “The Coordination Problem”, and the Combinatorial Auction design which had been recommended to the US government by several leading economists, turned out to be too complex to implement in practice. The 1,800 MegaHertz GSM auctions in Germany failed to realise the expected revenues due to “The Demand Reduction Problem”, which left only two bidders for two licences at the opening reserve price. The 3G auction in Switzerland failed due to “The Bidder Participation Problem”, which left four bidders for four licences, at the opening reserve price. It was only in Germany for 3G, and to some extent in UK for 3G, that spectrum auctions were successful. And this was because Germany auctioned what is called “Abstract Spectrum” and not “Concrete Spectrum”. And in UK, it was not a totally free-market auction, since the rules were formulated to discriminate against the incumbent, British Telecom, and in favour of new entrants. Even though the German and UK 3G auctions realised several times the revenues that were expected for the exchequer, the number of subscribers is much fewer than expected as the 3G services are highly overpriced since the winners passed on the high cost of winning the auctions to their subscribers. It is noteworthy that after the negative experiences with spectrum auctions in USA, Netherlands, Austria, Switzerland, and Italy, several countries, notably Malaysia, Singapore, Japan, South Korea, Ireland, Luxembourg, France, Finland, Norway, Spain and Sweden decided against auctioning spectrum, and instead, allotted it on a fixed fee basis to licencees.

The Group of Ministers on Information Technology and Telecom (GOTIT) set up by the Vajpayee government in 1998 took a deeply considered decision not to go in for spectrum auctions in view of the negative experiences of other countries. The High Level Committee further endorsed this view in July 2003 and again in April 2004. They were of the opinion that the release of spectrum in small tranches after subscribers were added would be a sufficient safeguard to prevent hoarding.
More importantly, auctioning spectrum would violate the legal contracts that the Indian Government has signed with the cellular operators. DoT’s Order No. J-14025/200(17)/2004-NT (GSM) dated 29 March 2006, allocating spectrum to GSM (Global System for Mobile Communications) operators on a revenue sharing basis (as a percentage of Adjusted Gross Revenues of the operator, starting at 2 % of AGR and going up to 6 % of AGR) and laying out the roadmap for future spectrum allocations up to 15 MegaHertz, constitutes a legally binding contract, especially since it was arrived at as an out-of-court settlement between the government and the cellular operators whereby the GSM operators withdrew all pending litigation against the government. Further, in its letter of 12 April 2007, the DoT reiterated its agreement with the principle of revenue sharing. The eminent jurist Fali Sam Nariman has given the opinion that “It is not now open in law for DoT to change from revenue share basis / subscriber linked allocation to an allocation only by auction even if this would be more transparent or would earn the government more revenue… Such a changeover would be arbitrary, discriminatory, and violative of Article 14 of the Constitution…”

Other leading lawyers have endorsed Mr Nariman’s opinion. C.S. Vaidyanathan has stated: “Migration to a revenue share regime qua spectrum charges was the result of a specific contracted settlement between the government and the industry. This has been acknowledged and admitted by the government as recently as in its letter dated 12 April 2007. The Government cannot renege on its contractual obligations by auctioning spectrum or in fact pricing it in any other way except by way of revenue share.”

Anil B. Divan has stated: “In my view, any proposed auction of 2G spectrum will clearly be in conflict with not only the existing policy and licensing framework but also the contractual rights arising from the settlement between the government and the GSM industry. The government cannot introduce auction procedures to make such allotments…”

C. Aryama Sundaram added: “”In a situation where the paucity of spectrum / bandwidth is recognised and accepted in the market, it would not be open for the State
to attempt to auction the 2G spectrum without first ensuring the availability of spectrum to meet the requirements of the incumbents in the field…”

According to media reports, in an open auction, the government would realise approximately Rs 5,000 crores as the price of spectrum , and it is alleged that this is being given away at a fee of Rs 1,651 crores for a countrywide license. However, under the present system of revenue sharing at upto 6 % of Adjusted Gross Revenues, it is quite likely that the government will receive much more over the life term of the license. According to figures released by the Telecom Regulatory Authority of India (TRAI), for the quarter ending in June 2007, GSM operators Bharti paid Rs 188.17 crores as spectrum charges to the government, Vodafone Essar paid Rs 128.28 crores, Idea paid Rs 59.55 crores, Aircel paid Rs 20.28 crores, Spice paid Rs 7.79 crores, and BPL Mobile paid Rs 6.88 crores as spectrum fees for Mumbai alone. Even the public sector Bharat Sanchar Nigam Ltd paid 84.57 crores as spectrum fees to the government for the quarter ending in June 2007, and Mahanagar Telephone Nigam Ltd paid Rs 6.67 crores for Delhi and Mumbai. Moreover, the figures filed with TRAI show that CDMA (Code Division Multiple Access, a rival technology to GSM) operators Reliance Communications paid Rs 50.65 crores as spectrum fee, Tata Teleservices paid Rs 32.82 crores, and HFCL Infotel paid Rs 0.29 crores for the quarter ending in June 2007.

Even if the government would earn Rs 5,000 crores by auctioning spectrum, changing a policy that has worked reasonably well till this stage will violate the contracts already entered into between the DoT and the GSM operators, and open the door to years of litigation. This will freeze all progress in the telecom sector and prevent the spread of telecom to the common man and the rural poor.
In fact, this litigation has already started. On Tuesday, October 23, 2007, the Cellular Operators Association of India (COAI) along with five GSM operators – Aircel Cellular, Bharti Airtel, Idea Cellular, Spice Communications, and Vodafone Essar - filed a petition before the Telecom Disputes Settlement and Appellate Tribunal (TDSAT) against the Department of Telecommunications and TRAI, challenging DoT’s decision of 19 October 2007. In this decision, DoT had permitted CDMA operators to offer GSM services. Within a few hours of DoT’s announcement, the largest CDMA operator, Reliance Communications of the Anil Ambani group, paid the DoT Rs 1,651 crores as license fee for offering GSM services on a nation-wide basis. The second largest CDMA operator, Tata Teleservices, also announced its decision to offer GSM services in 22 circles. TDSAT effected a de-facto stay and the DoT committed that it would not go ahead with allocating spectrum to any applicant until the next hearing on 12 November 2007.