Maximizing the Success of the Incentive Auction

Posted by | January 24, 2014 | Public Safety, Wireless | 2 Comments

I prepared a report for the Expanding Opportunities for Broadcasters Coalition and Consumer Electronics Association entitled Maximizing the Success of the Incentive Auction, which was filed at the Federal Communications Commission on November 4, 2013. The executive summary is reprinted below and the full paper can be viewed here. – – – 

The incentive auction will not succeed if the policies adopted by the Federal Communications Commission (FCC) fail to attract the participation of enough television broadcasters. If the FCC adopts proposals to restrict the participation of Verizon and AT&T in the incentive auction and “score” the value of television broadcast stations, it would discourage the participation of broadcasters and increase the likelihood that the auction will fail. If the auction fails, the recommendation of the 9/11 Commission to create a nationwide interoperable broadband public safety network would remain unfulfilled, the spectrum crunch would remain unresolved, and consumers would pay the price.

This paper provides empirical data regarding the costs of restricting the eligibility of large firms to participate in FCC spectrum auctions. The data demonstrates that restrictions on the participation of large firms in previous FCC spectrum auctions:

  • Delayed the provision of new wireless services to sixty-eight percent (68%) of the public by a weighted average of nearly seven (7) years,
  • Reduced auction revenue by lowering net bids by thirty-one percent (31%) to sixty-one percent (61%), and
  • Failed to substantially benefit wireless competition.

Given that eligibility restrictions are likely to reduce auction revenue and result in the assignment of licenses to comparably less efficient firms without substantially benefitting wireless competition, the FCC imposes such restrictions only when an open auction would pose a significant likelihood of substantial competitive harm in specific markets and the restrictions would be an effective way to address that harm.

There is no significant likelihood that the competitive positions of Sprint and T-Mobile would be substantially harmed by competing in an open incentive auction and no credible evidence that restricting the participation of Verizon and AT&T would be an effective way of addressing any potential harm. Both Sprint and T-Mobile have recently strengthened their competitive position in the mobile market through substantial spectrum and subscriber acquisitions in the secondary market and by obtaining billions of dollars of additional investment from their foreign patrons. The FCC also amended its rules last year to provide Sprint with a nationwide block of contiguous spectrum below 1 GHz and found that the T-Mobile can compete effectively without such spectrum. In this competitive market environment, there is no rational justification for insulating these particular firms from competitive bidding. This is especially true in the incentive auction because the expected reduction in revenue would reduce the incentive for broadcasters to participate.

Lowering the prices paid to broadcasters by “scoring” television stations based on factors irrelevant to the value of the spectrum for mobile use would be inconsistent with the authorizing statute and would further discourage the participation of television broadcasters in the auction. To induce substantial broadcaster participation, the incentive auction must offer television licensees (1) an opportunity to sell their spectrum rights for substantially more than they are currently worth (2) at a price that is substantially more attractive than their alternative options. Scoring stations in order to pay television licensees less than they are willing to accept for relinquishing their spectrum rights would give them an incentive to pursue their alternative options rather than participate in the auction, which could cause the auction to fail altogether. Substantial Delays in Service to the Public

To assess the impact of FCC eligibility restrictions on auction participation, this study compares the results of the initial auctions for the restricted C and F blocks in the PCS band (1996-1997) with the unrestricted initial auctions of similar spectrum in the other PCS blocks (1995-1997), the AWS-1 band (2006), and the 700 MHz band (2002-2008).

The firms responsible for net winning bids on seventy-seven percent (77%) of the initial C block licenses in the PCS band were unable to meet their obligations to provide service to the public. Their defaults delayed regular service to eighty-two percent (82%) of the total population coverage in the C block by a weighted average of six (6) years and ninety-eight (98) days. In the initial auction of the PCS F block, firms defaulted on nineteen percent (19%) of the available licenses, which delayed regular service to twenty-three percent (23%) of the total population coverage in the F block by a weighted average of seven (7) years and one hundred eighteen (118) days. The failure of bidding restrictions to assign the spectrum in these blocks to firms capable of serving the public delayed service to a total of sixty eight percent (68%) of the population coverage in one-third of the PCS spectrum by a weighted average of six years, nine months, and seventeen days.

closed PCS blocks

Some spectrum assigned in the initial C and F block auctions still remains unused today, more than seventeen years after the initial C block auction ended and the initial F block auction began.

The impact of license defaults in the unrestricted PCS blocks was trivial in comparison. In the initial auctions for the PCS A, B, D, and E blocks, license defaults delayed regular service to less than two-tenths of one percent (0.15%) of the total population coverage in those blocks.

open PCS blocks

License defaults had a similarly trivial impact on the initial auctions of the unrestricted AWS and 700 MHz bands. There have been no license defaults in the AWS band, and license defaults have delayed regular service to less than one-tenth of one percent (0.09%) of the total population coverage in the 700 MHz band. Substantial Reductions in Auction Revenue

The empirical data also demonstrates that bidders paid at least thirty-one percent (31%) and as much as sixty-one percent (61%) less for restricted spectrum than bidders who competed for unrestricted spectrum.

reductions in revenue

Assuming the incentive auction would generate $19 billion in net bids without eligibility restrictions, restricting the bidding on one-half of the available spectrum would reduce auction revenues by a minimum of $2.945 billion and as much as $5.795 billion – reductions representing from forty-two to eighty-three percent (42-83%) of the auction revenue designated by Congress for public safety.

city center sitios para solteros No Substantial Benefits to Competition

The FCC imposed bidding restrictions on large firms in the PCS C and F block auctions in an effort to promote sustained competition in the PCS band by small firms and to prevent strategic behavior (e.g., foreclosure) by large firms. These restrictions did not, however, result in widespread long-term participation by small firms in the wireless industry. Most small firms who won restricted spectrum licenses in the C and F block sold their licenses to large entities after the restrictions on resale expired. Today small firms (i.e., firms other than the four largest wireless firms) hold only sixteen percent (16%) of the spectrum in the C block and thirteen percent (13%) of the spectrum in the F block.

current PCS holdings

The lack of significant variation in small and large firm ownership among these blocks indicates that the eligibility restrictions in the C and F blocks did not serve their intended purpose of promoting widespread competition by small firms in the long-term. They did, however, have the unintended consequence of delaying the assignment of one-third of the PCS spectrum to the firms that valued it the most highly and were the most likely to provide timely service to the public.

The Costs of Eligibility Restrictions Would Outweigh the Benefits

These empirical findings demonstrate that eligibility restrictions in FCC auctions have imposed substantial costs on consumers, wireless firms, and the government without providing the expected benefits. After the failures of the initial PCS C and F block auctions, the FCC adopted a standard for evaluating eligibility restrictions that is designed to ensure that their potential benefits outweigh their potential costs. This standard requires a finding that an open auction would “pose a significant likelihood of substantial competitive harm in specific markets” and that eligibility restrictions are an “effective way” to address the harm. The FCC concluded that this is a more discerning standard than the substantial market power standard and that it requires more than a mere showing that incumbents have the incentive and ability to engage in foreclosure (i.e., there must also be evidence that such behavior is likely to occur and that eligibility restrictions would be effective in eliminating its occurrence). The FCC adopted a more discerning standard because because the benefits of spectrum assignments to consumer welfare (and not to particular competitors) are determined by the relative use values of potential bidders (irrespective of their foreclosure values).

A filing by the Department of Justice (DOJ) stating that imposing bidding restrictions in the incentive auction “could improve the competitive dynamic among nationwide carriers” fails to meet this standard. The DOJ premised its comments on the coverage characteristics of the incentive auction spectrum, which occupies frequencies below 1 GHz. Though the DOJ has found that spectrum below 1 GHz may improve a firm’s ability to compete efficiently in sparsely populated rural areas, both the FCC and the DOJ have recently found that wireless firms can compete effectively on a nationwide basis without spectrum below 1 GHz. For example, in its analysis of the AT&T/T-Mobile merger, FCC staff found that, despite T-Mobile’s lack of substantial spectrum below 1 GHz, if AT&T were to raise prices, “enough customers would instead select a product offered by T-Mobile or some other firm as to make the price increase unprofitable.” This and other recent FCC findings are inconsistent with the notion that Sprint and T-Mobile cannot compete effectively without spectrum below 1 GHz.

Assuming the FCC could articulate a consistent rationale for finding a significant likelihood of substantial harm in specific markets due to the potential for foreclosure based on the coverage characteristics of spectrum below 1 GHz, it would have to demonstrate that restricting the eligibility of Verizon and AT&T only on a nationwide basis would be effective in eliminating that harm. The potential for foreclosure is inherent in all markets with scarce inputs, and all firms, including Sprint and T-Mobile, derive some degree of foreclosure value from the acquisition of exclusive spectrum rights. If the FCC were to impose eligibility restrictions based on coverage concerns related to the propagation characteristics of spectrum below 1 GHz, those restrictions would not be effective unless they were applied to all firms that hold spectrum below 1 GHz in specific markets. Sprint already holds a nationwide, contiguous block of mobile broadband spectrum below 1 GHz, and has the incentive and ability to engage in foreclosure against T-Mobile similar to that of Verizon and AT&T. In these circumstances, an eligibility restriction that excluded Sprint would not be effective in eliminating the potential for foreclosure based on coverage concerns. A restriction based on coverage would also be ineffective in urban markets, where capacity is the primary competitive concern, and in the specific markets in which T-Mobile already holds spectrum below 1 GHz.

Imposing eligibility restrictions on Verizon and AT&T would similarly be ineffective at preventing foreclosure based on capacity concerns. The other factors identified by the DOJ as relevant to the incentive of Verizon and AT&T to foreclose (i.e., the factors unrelated to the propagation characteristics of the spectrum) are also applicable to the other nationwide mobile firms. These factors indicate that Sprint and T-Mobile are likely to have relatively strong incentives to engage in foreclosure, though they are less likely to have the ability to engage in foreclosure relative to Verizon and AT&T unless the government intervenes. e potential unintended consequence of the DOJ’s proposed foreclosure remedy is that it would give firms with relatively strong incentives to foreclose (Sprint and T-Mobile) the ability to foreclose by mitigating the costs and risk that otherwise deter foreclosure in unrestricted auctions by providing them with a government-subsidized opportunity to acquire spectrum at a substantial discount with no risk that their primary rivals could obtain that spectrum instead. Their costs and risks would instead be borne by broadcasters, who would receive less for their spectrum than it is worth, and ultimately, by consumers and the government in the form of delayed service to the public, lower auction revenue, and the potential to leave the national public safety network unfunded.

Scoring Television Stations Would Discourage Broadcaster Participation

Scoring each television station to account for the population served by the station in order to lower the prices paid to broadcasters would contradict the statutory requirement that a television licensee receive “the amount it would accept for voluntarily relinquishing some or all of its spectrum usage rights.” Congress understood that the success of the incentive auction would depend on inducing a substantial number of television licensees to voluntarily sell their spectrum rights by offering them (1) an opportunity to sell their spectrum rights for substantially more than they are currently worth (2) at a price that is substantially more attractive than their alternative options. The FCC and Congress have both recognized that, if the incentive auction fails, broadcasters have other options for transitioning their spectrum. By artificially lowering the amount a television licensee would be willing to accept for relinquishing its spectrum rights, including the opportunity to pursue alternative options, scoring would threaten the viability of the auction.