Consultation on Issues Related to Spectrum Auctioning

7. Financial Aspects of Auctions

7.1 Bid Payment

An issue which was frequently raised in previous public consultations was the potentially difficult financial burden that lump-sum bid payments could place on some winning bidders just at the time they are beginning to invest in infrastructure. To overcome this, it was suggested that winning bidders be permitted to pay the amount of their winning bid in instalments over a long term horizon.

A potentially serious drawback with an instalment payment system is that a smaller up-front payment encourages speculators to enter the bidding process. For example, a firm may not have a viable business plan which requires the use of a spectrum licence at the moment an auction is called; however, it may anticipate that the licence will be worth a substantial amount to other firms in the not too distant future. In this case, a firm may enter the auction in the hope of securing a licence inexpensively and then capitalizing on reselling it at a later date. The risk to a speculator may not be that large if the licence value turns out to be less than anticipated, since the speculator can simply stop making the annual payments and forfeit the licence. The participation of speculators may prevent an efficient assignment of licences since they may win licences which would otherwise go to firms who want to use the licences immediately to start a wireless service.

Setting a payment schedule for the winning bidders to follow thus involves a tradeoff. On one hand a large up-front payment may place a financial burden on some firms genuinely interested in the spectrum while a payment which is too small may encourage participation by speculators. In an attempt to balance this tradeoff, the Department proposes that winning bidders pay 25 per cent of the amount of their bids within 30 days of the auction closing date. The remaining 75 per cent would be paid in future instalments.

A number of options are available as to how the payment schedule for the remaining 75 per cent could be structured. Bidders will factor any payment schedule into their bidding strategies: the proviso being, of course, that the schedule be made absolutely clear prior to the auction. Given this discounting process that bidders will undertake, the choice of payment schedule should be essentially revenue-neutral for the government in present value terms. These options include the following:

  • A terminal payment date, say the end of year five or year ten, could be specified. The remaining 75 per cent of the bid amount would be payable in equal annual instalments (i.e. 15 per cent of the original bid amount per year if five years were chosen or 7.5 per cent of the original bid amount per year if ten years were chosen). After this terminal payment date had been reached, no further payments would be required in either the initial or subsequent licence terms. The terminal payment date could correspond to the end of the initial licence term, but would not necessarily have to. This option has the advantage of relieving both the licensee and the government of the administrative burden of collecting payments after the terminal payment date.
  • Instead of specifying a terminal date for bid payment, the remaining 75 per cent could be made payable in equal annual instalments over the initial term of the licence (i.e. 5 per cent per year for a fifteen year licence), with that same annual amount (e.g. the 5 per cent) being required in each year of a successive licence term if the licence is renewed.
  • Should the policy be to re-auction licences after each term, the payment for the subsequent term would of course be established in the "re-auction".

Most, if not all, of the other administrations around the world who have implemented spectrum auctioning have chosen either to require auction payments in an up-front lump-sum amount, or have specified terminal dates for auction payments where up-front lump-sum payments have not been required. Australia appears to be the only administration which has chosen to re-auction licences after each licence term.Footnote 33

It is important to note again that licence payments fairly established in an auction process would not be altered in any way after the auction, nor would licensees be subject to any other form of licence fees for the spectrum in question.

7.2 Pre-Auction Deposits

Based on the academic literature on auctioning and the experiences of other administrations, the Department feels that the integrity of an auction is enhanced by requiring all bidders to submit a pre-auction deposit. The deposit should be large enough to dissuade frivolous bidders from trying to enter the auction process while not so large that sincere bidders are unable to participate; additionally, the deposit should be large enough so that it covers all of a bidder’s likely bid withdrawal and forfeiture penalties (for a description and explanation of bid withdrawal and forfeiture penalties, see Sections 8.5.5 and 8.5.11 below). Since the size of these penalties will depend on both the number and value of the licences that a bidder wishes to bid on, a bidder will be asked beforehand to indicate the number of licences it is interested in. A bidder’s deposit will generally be based on the population or number of households located within the geographic areas of the licences it is interested in acquiring.

8. Auction Design and Rules

8.1 Auction Design Principles

Auction design is an extremely important matter. A badly designed auction may result in inefficient assignments, delayed deployment of services, and lost resource rents for the Canadian public. When initiating an auction, the rules of the auction must be clearly specified beforehand, and to the greatest extent possible, account for all possibilities which may arise during the course of the bidding. Usually, in the context of the radio spectrum, several licences in many different contiguous areas need to be assigned at the same time. In this instance, the auction design must address two key issues: the winner's curse and licence interdependencies.

8.1.1 The Winner's Curse

The winner's curse refers to the observation that the winning bidder is often the firm that has the most over-optimistic estimate of a licence's value. Winning the bidding, in this sense, conveys the bad news to the winner that everyone else estimated the licence's value to be less. In a sealed-tender auction, bidders who anticipate the winner’s curse bid cautiously. An ascending multiple round auction which is open and in which bidders can gather information about their rivals' value estimates from the bids they make, helps to reduce bidder uncertainty and encourage more confident bidding.

For a multiple round auction to reduce the probability that a bidder overestimates a licence’s value, bidders must have time to process information during the auction, so the pace of bidding must not be too fast. A measured pace allows bidders to evaluate bidding information and review strategy. Such pacing can be achieved by using a multiple round auction format, with the results of the previous round announced before the next one begins.

8.1.2 Licence Interdependencies

Spectrum licences are interdependent, that is, firms typically value them as part of a collection. For example, a firm whose business plan calls for establishing a regional or nationwide presence may have to purchase several licences to implement the plan. The licences may then complement each other geographically: the value of a collection of licences to the firm may exceed the sum of the values the firm would pay for the licences individually. Different licences may also substitute for each other: various frequency bands over a given geographic area might be very similar from the bidders' points of view. The auction form must be flexible enough that bidders are able to construct their preferred licence aggregations. The simultaneous multiple round auction form was devised to achieve this flexibility. This auction format has been used successfully by a number of administrations.

8.2 The Simultaneous Multiple Round Auction

In the simultaneous multiple round auction, multiple licences are open for bidding at the same time, and remain open as long as there are acceptable bids placed on any of the licences. Bidding occurs in a sequence of rounds, with the results of each round announced to the bidders before the start of the next round. Unless the number of licences and bidders is small, the auction is best run by computer, with on-line bidding.

The main reason for using a simultaneous multiple round auction is that spectrum licences are interdependent. For many of the licences there is a close substitute: a similar licence that covers the same region and the same amount of spectrum. Licences can also be complementary: a licence may be more valuable if the holder also has the licence for a contiguous region.

Efficiency in a spectrum auction - which means assigning the licences to the firms that value them the most - often is manifested by some bidders winning multiple licences, because licences can be complementary. Typically, the seller has less information than the buyers about how the licences should be aggregated. This is partly because the technology may be new, but also because different bidders may have different, mutually inconsistent preferred aggregations (for various reasons, such as their other lines of business and their local expertise). The simultaneous multiple round auction was designed to let market processes establish the shape of the licence aggregations.

Both features of the auction form - the simultaneous bids and the multiple round (ascending) bids - aid efficiency. The multiple round bids let bidders see how highly their rivals value each licence and which aggregations they are seeking. By the time equilibrium is approached, each bidding firm knows whether it is likely to be able to construct its preferred aggregation, and roughly how much it is going to cost. With all licences open for bidding simultaneously, a bidder has flexibility to seek whatever licence aggregation it wishes, as well as to switch to a backup aggregation if its first-choice aggregation becomes too expensive.

As well as aiding licence aggregation, the simultaneous multiple round auction diminishes the possibility that the winning bidder overestimates the value of a licence because it allows bidders to observe and respond to each others’ bids. Also, simultaneous multiple round bidding makes it likely that substitute licences will fetch similar prices, because, in practice, bidders will switch across the substitutes if their bid prices differ significantly, bidding up any lower-priced licences.

8.3 Alternative Auction Formats

The standard alternative auction forms include a single round sealed-bid and sequential sales of either the sealed-bid or multiple round bid varieties. Single round sealed-bid and sequential auctions are easy to administer, and work reasonably well for selling certain kinds of items. They do not work well, however, for collections of interdependent spectrum licences.

The single round sealed-bid auction neither encourages efficient aggregation nor ensures that similar items will fetch similar prices. In a single round sealed-bid auction, bidders must bid blind, unable to know how high they must bid to win a particular licence. Only by good luck does a bidding firm win all the licences it needs for its business plan; bad luck can mean either that a firm wins more licences than it needs or that it wins a collection that it cannot use with any plausible business plan. Simultaneous single round auctions of spectrum licences were used by some other administrations with disappointing results.

Another alternative is to conduct a sequential auction - an auction in which the licences are sold one at a time, in sequence. However, this alternative is problematic as well, for three reasons. First, identical items can sell for quite different prices; in practice, items sold later in the sequence most often fetch less than items sold earlier. Second, such auctions encourage strategic bidding that disrupts efficient licence assignments. For example, a firm might engage in predatory bidding, hoping to force its budget-constrained rivals to pay higher prices for the initial licences in the sequence in order to handicap them in later bidding, thereby allowing the firm to acquire the later licences for a lower price. Such strategies may prevent bidders from acquiring efficient collections of licences. Third, the sequential form still requires guessing that hinders licence aggregation. When the first licences are being sold, a firm must bid without knowing whether it will win the complementary licences offered later. Later, a firm may wish to rebid on a licence already sold if it discovers it needs that licence to complete its set; but in a sequence of auctions it cannot go back.

Sequential auctions and simultaneous sealed-bid auctions pose severe problems for bidders for spectrum licences. Both present the bidders with a large amount of risk and the prospect of regret. In a sequential auction, the bidder must guess about future prices when deciding how high to bid for the early licences in the sequence. Later in the sequence the bidders are likely to discover that they bid either too high or too low for the early licences. In a single round sealed bid auction the bidders must choose their bids for each licence without knowing which other licences they are going to win, and without having any information about the strength of their competitors’ interest in the licences. Bidders are more confident when bidding in a simultaneous multiple round price auction.

8.4 Proposed Approach

Industry Canada concludes that each of the traditional auction forms - simultaneous sealed bids, with the price being either the highest or second bid, or sequential bids -has major defects as a way of selling spectrum licences. The simultaneous multiple round auction is not subject to these defects. The simultaneous multiple round auction was novel when the FCC first used it to sell nationwide paging licences in the United States in July 1994. By now it has a track record. At least eight large-scale spectrum auctions have been run in the United States and additional simultaneous multiple round auctions have been run in New Zealand (broadcasting licences in 1995 and 1996) and Mexico (paging licences in 1996). These auctions are widely judged to have been successful in efficiently assigning spectrum.

The Department therefore proposes to use simultaneous multiple round auctions, in most if not all cases, when assigning spectrum licences for which there is mutually exclusive demand. User-friendly bid tracking and auction management software is being developed to implement this type of auction format. This software makes remote access electronic bidding feasible and secure, which will allow bidders the convenience of submitting bids from a wide array of locations. Remote access electronic bidding will mean bidders will not have to incur travel and accommodation costs in order to be in one physical location for the duration of the auction. These cost savings to the bidders can be substantial when an auction takes weeks to close - a situation which can occur if there are many properties to be sold.

8.5 Auction Rules

The rules for the simultaneous multiple round auction call for a related set of licences to be offered for sale at the same time. Bidding is organized into a series of rounds. At the beginning of each round, bidders are provided with information that includes, at a minimum, the standing high bids on each licence and information about the bidder’s own eligibility for bidding. New bids for a licence are required to exceed the standing high bid by at least the minimum bid increment. In each round bidders are offered an opportunity to withdraw bids, subject to a penalty. A minimum pace of bidding in the auction is established by the "activity rule," which penalizes bidders who are inactive by reducing their eligibility. The rounds continue until there are no new bids on any licence.

The Department’s proposals regarding some of the details of the auction are described below.

8.5.1 Eligibility

Before the auction begins bidders are asked to indicate how many licences they may want to bid on during the course of the auction. This total number, or in some cases, a measure of the bandwidth and populationFootnote 34 covered by the licences that a bidder wants to bid on, defines a bidder’s eligibility. The purpose of this information is to assist in the development of activity rules (discussed in more detail below) which are used to hasten the speed of the auction.

8.5.2 Reserve Prices and Minimum Opening Bids

In accordance with the principle that all spectrum users should make a contribution toward the costs of spectrum management, reserve prices will be established for licences up for auction. As for the level of the reserve price, there are two competing influences. High reserve prices have the disadvantage that there may be no bidder willing to bid at that level, even though there is a bidder who would value winning the licence; that is, high reserve prices can lead to an inefficient outcome. On the other hand, low reserve prices can contribute to long, drawn-out auctions if bidding starts out at levels far below eventual selling prices.

As economic efficiency is Industry Canada’s primary auction objective, reserve prices will be set at quite modest levels. However, minimum opening bids set above the reserve price are seen as a useful way to speed up the auction, avoiding the waste of time and resources when prices are perhaps unrealistically low.

Opening bids would be established at some level above the reserve price to provide an auction "jump-start". In each subsequent round, if a licence has not yet received any bids, the minimum bid on the licence will be reduced by a fraction of the initial minimum until the reserve price is reached. In that way, if a licence has received no bids for the first few rounds, the minimum bid would drop to the level of the reserve price. The Department anticipates that there could well be instances where spectrum licences for remote or less populated parts of the country are awarded for the modest reserve price.

With this proposed procedure, a bidder faced with a minimum bid exceeding its value or its estimate of the likely price could exercise a waiver (see discussion on activity rule waivers in Section 8.5.9 below) and wait for the minimum bid to fall. If the bidders are allowed five waivers during the auction, as has been the rule in recent US auctions, then the loss of a waiver is likely to be a sufficient penalty to encourage bidders to enter the bidding early when the minimum bid is still high, thereby helping to bring the auction to a timely close.

8.5.3 Duration of the Rounds

In a simultaneous multiple round auction the bidding progresses in a series of rounds. A round is an interval of time where bidders have the opportunity to assess the standing high bids on each licence and submit bids of their own. The length or duration of a round must be sufficient to allow bidders time to process the requisite information, plan strategies and submit bids. Typically, the duration of a bidding round will not be constant throughout the auction. Early on, when the bidders are still becoming familiar with the auction method and software, bidding rounds should be quite long. It is common to have only one or two rounds in the first day of bidding. As the auction proceeds and bidders become more comfortable with the bidding process, the rounds can be shortened to reduce the overall time of the auction.

8.5.4 Activity Rules

In a simultaneous multiple round auction, bidders may bid cautiously, waiting to see how the others bid while not revealing their own intentions. If all participants bid in this manner, the auction could take inordinately long to close. The activity rules are designed to prevent the bidders from holding back, so the auction proceeds at a reasonable pace. Before the auction, each bidder must specify how many licences he wishes to bid on (see the discussion on eligibility above). A bidder is defined to be active on a particular licence if either he has the standing high bid from the previous round or he submits an acceptable bid (one which is at least one bid increment above the current standing high bid) in this round. There are multiple stages - three has been common, each containing an unspecified number of bidding rounds. In the first stage bidders must be active on licences that add up to a certain percentage of their desired totals (for example, one-third); in the second stage the percentage is increased (perhaps to two-thirds); and in the final stage bidders must be active on one-hundred per cent of their desired totals. If a bidder falls short of the required activity level, the number of licences it is eligible to bid on shrinks proportionately. An auction begins and continues in stage one until bidding activity declines to an unacceptable level (say new bids come in on only five percent of licences). At this point, the auction can move to stage two - and similarly to stage three later in the auction.

8.5.5 Bid Withdrawals

In the event that a bidder makes a bid which he later wants to change, that bidder should be given the opportunity to withdraw it. To encourage meaningful bids, however, a bid withdrawal penalty needs to be imposed. It is natural to have this penalty correspond to the potential loss in revenue caused by the withdrawn bid. If the licence for which the bid has been withdrawn ends up selling for more than the withdrawn bid, no penalty should be charged to the bidder. If the licence ultimately sells for less than the withdrawn bid, the penalty usually has been the difference between the withdrawn bid and the eventual final selling price. The total withdrawal penalties owed by each bidder would be due as a lump-sum amount shortly after the close of the auction.

As a measure to reduce the overall time of the auction, while not compromising the auction’s efficiency, the Department proposes to allow bidders to place and/or withdraw bids at the same time during a round, as opposed to having two distinct phases - one for bid submission and one for bid withdrawal - during each round.

8.5.6 Minimum Bid Increments

Minimum bid increments, like activity rules, are a necessary ingredient to help hasten the auction’s progress. For a bid to be acceptable it must be larger than the current standing high bid by the minimum bid increment. Increments can be set in percentage terms (say, five percent) or in absolute dollar amounts. Bid increments can and should be changed during the course of an auction. For example, at the beginning of an auction when bidding activity is likely to be high, bid increments can be relatively large. As the pace of the bidding falls below a certain threshold, bid increments can then be reduced. The rules for changing bid increments should be laid out with a fairly high degree of precision prior to the auction; however, to ensure the auction closes in a reasonable amount of time, there should be flexibility to "override" the rules regarding bid increments. Of course, all bidders would be given prior notice well in advance of any proposed changes to the size of the bid increments.

8.5.7 Non-Discretionary Bidding

In somewhat of a departure from simultaneous multiple round auctions that have been run elsewhere, the Department proposes the use of non-discretionary bidding. What this means is that rather than bidders being offered the opportunity to enter any amount that exceeds the standing high bid by at least the required minimum bid increment, bidders would instead have the choice of giving either a "Yes" or "No" response as to whether they wish to bid an amount equal to exactly the standing high bid plus the required minimum bid increment. Such non-discretionary bidding has a number of advantages:

  • It drastically simplifies submission of bids, eliminating the errors that sometimes occur when a bidder must fill dozens (or even hundreds) of boxes with potentially quite large numbers.
  • It allows rounds to be more brief and more frequent, both because the mechanics of entering and checking bids are simpler and because the prices, which never jump in the revised design, are more predictable. This also reduces the need for frequent executive oversight during the bidding, saving costs for the bidders.
  • It completely eliminates opportunities for bidders to send messages through their bid amounts, and also eliminates certain other kinds of strategic bidding.

The Department believes the use of non-discretionary bidding will be of benefit to all parties involved in a spectrum auction.

8.5.8 Tie Bids

In the case where two identical bids are submitted for the same licence, a tie-breaking rule must be used. A natural rule in this instance is to declare the first bid submitted in the round as the high bid in that round. Tie bids would obviously be a much more common occurrence with non-discretionary bidding than with discretionary bidding.

8.5.9 Waivers

Waivers are designed to prevent a bidder from losing eligibility when it does not satisfy the activity requirements in a given bidding stage. The purpose of waivers is to protect bidders against possible mistakes they might make during the course of an auction or to allow a bidder to maintain eligibility in the case of technical or communication problems. Typically, each bidder is given five waivers.

8.5.10 Close of the Auction

A simultaneous multiple round auction closes when a round goes by without any acceptable bids having been submitted on any licences. In exceptional circumstances, and after all participants have been notified in advance, any round can be declared as the final round.

8.5.11 Forfeiture Penalties

After the conclusion of the auction, any bidder who has submitted the high bid on a licence but fails to comply with the specified payment schedule forfeits his right to the licence. Furthermore, the bidder is required to pay a penalty in the amount of the difference between the forfeited bid and the eventual selling price of the licence, provided this is positive. An additional amount may be charged to account for the administrative expenses incurred to reassign the licence. The total forfeiture penalties owed by each bidder would be due as a lump-sum amount shortly after the amount of such penalties has been determined.

9. Incumbent Treatment in an Auction Environment

Given the trend towards using auctions as a mechanism to assign new spectrum licences, there is the question of how incumbent licensees, who may have received their licences through a non-market based mechanism, should be treated under the new regime. The Department wishes to maintain a spirit of fairness among industry players and recognizes that new licensees will pay market value for the spectrum while many spectrum incumbents, who might be direct competitors to auction winners, pay licence fees which do not necessarily reflect market value. The difference between the two systems could mean that new spectrum users would pay amounts significantly greater than those paid by incumbents. The Department seeks comments on how a "level playing field" can be ensured with respect to this fee issue.

Of course any attempt to bring licence fees closer in line with market-based prices as reflected in auction payments, would have to take account of the differences in the terms and conditions of the licences involved. For example, many incumbents are now required to spend a certain percentage of their gross revenues on research and development. If the incumbent finds conditions such as this restrictive, then the conditions serve to reduce the value of the licence. Furthermore, new licensees may have more rights in terms of how they choose to use the spectrum compared to incumbent licensees. New licensees may also have more flexibility in terms of transferring spectrum to other parties. The added freedom which may be granted to new licensees will certainly raise the value of their spectrum licences relative to older licences which have more restrictions. Any method of readjusting fees charged to incumbents so that they more closely reflect market prices, will have to discount winning bids to the extent that they reflect an increase in property rights and not the value for the spectrum itself. Conversely, incumbents may see advantages in both accepting the "full" increase in their fees and receiving a concomitant increase in the rights bestowed by their licences.

Input is sought on the subject of adjustments to the fees and/or licence terms and conditions of incumbent licensees and on appropriate methodologies for making these adjustments.

10. Instructions for Filing Comments

Comments may be submitted in writing and/or in electronic format (comments submitted in electronic format should be in either WordPerfect or Microsoft Word - please specify the software, the version number, and the operating system used in a covering note). Address your submission to:

CONSULTATION ON AUCTION RELATED ISSUES
Radiocommunications & Broadcasting Regulatory Branch
Industry Canada
300 Slater Street
Room 1489D - Jean Edmonds Tower North
Ottawa, Ontario
K1A 0C8

We can also receive comments electronically via the Internet at:
auctions@ic.gc.ca

Comments sent via email should be prefaced by the statement "Attached are comments in response to the consultation on auction related issues" in the body of the email message.

To ensure your comments are considered, your submission must be received within 90 days after the publication of the notice in the Canada Gazette.

Submissions received in response to this document will be made available for public viewing for a period of one year following the closing date for filing submissions. These submissions may be seen in the libraries of the Department at 365 Laurier Street, 2nd Floor, Ottawa, or the Department’s spectrum management offices in Moncton, Montreal, Toronto, Winnipeg, and Vancouver.

This document is available electronically via the Internet at the following address:

http://www.ic.gc.ca/eic/site/smt-gst.nsf/eng/sf01435.html

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