Are auctions right for telecom?

Dec 17 2010, 08:56 IST
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High bids in auctions leads to huge costs for bidders—a phenomenon described as winners’ curse. High bids in auctions leads to huge costs for bidders—a phenomenon described as winners’ curse.
SummaryHigh bids in auctions leads to huge costs for bidders—a phenomenon described as winners’ curse.

Any doubts about the independence of service prices from auction bids should vanish when one looks at market prices of telecom services

High bids in auctions, especially of much sought after mobile licences, can lead to huge additional costs for successful bidders—a phenomenon often described as the winners’ curse. In a capital intensive sector like telecom, staggeringly high bids can leave little for rollout. But, counterintuitive as it sounds, it is easy to see how high bids don’t necessarily raise prices.

Economists regard market entry costs as sunk costs. If the markets are competitive, passing on sunk costs to customers would be counterproductive for a new entrant as it can’t expect to succeed in most markets without matching, if not bettering, the prices offered by competitors. This is especially true for generic services, such as mobile telephony. Any player attempting to recover the high costs caused by an auction of a licence or of spectrum, will risk losing customers to competitors. Its business plan must factor in this basic reality. To be profitable, its options include cutting other costs more effectively and designing value- added services that improve margins.

Any doubts about the independence of service prices from auction bids should vanish when one looks at market prices of telecom services. Mobile call rates in Delhi fell drastically after the fourth player’s entry in 2001 even though its licence fee (determined through an auction) was several times higher than that of earlier private entrants. BSNL and MTNL, the third players in each circle where they were operating, had got their licences free. Today, 3G prices on offer by Tata Docomo and Reliance hardly reflect the billions paid in the 3G spectrum auction.

This does not mean that high bids are desirable. High costs might deter investors or reduce incentives to roll out services in less lucrative markets. If auctions deter players from creating much-needed infrastructure, the issue of price becomes academic.

The chief advantage of auctions lies in their perceived transparency, especially when there are several competitors in the fray for a limited number of licences or resources like spectrum. Here, auctions would seem unavoidable. But there are many ways to design auctions. For instance, an upfront payment for bids made, as happened in the auction of the fourth cellular licence and recently in 3G and BWA auctions, ensured that no one defaulted. An option to pay up after a few years may well have raised the bids but also the risk of default. On the other hand, an obligation for bidders to roll out services simultaneously in urban and rural areas would probably dampen bids but could result in faster and more equitable rollout. If rules required the successful bidder to offer cheap services, it might serve another policy goal even if revenue receipts from auctions would fall.

The challenge is to design better auctions that help pursue the other equally important goals, like rollout, without compromising on transparency. This is not difficult especially since some of the best experts in game theory that deals with the subject of auctions are Indian!

The author is director, Com First (India) Pvt Ltd

Prashant Singhal

Simultaneous auction with multiple-round clock can create financial challenges, resulting in stretched balance sheets And dragging down services uptake

From 1994 till date, the Government of India has allocated spectrum/ licences through various methods such as the beauty parade, competitive bidding and on first-come-first basis. But determining the ‘best’ approaches for spectrum management is a highly subjective discussion.

Allocating spectrum through auction or competitive bidding aids in discovering the market price of the scarce resource. With a well-designed and transparent auction, there is a strong tendency for the licences to go to the parties that value them the most, and the treasury obtains much-needed revenues in the process. Simultaneous auction with multiple-round clock may reduce the fiscal deficit of the Indian government but can create a wide gap and financial challenges in the telecom sector, resulting in stretched balance sheets.

In India, auctions have fostered innovation and competition in communication services making it the second-largest wireless market in the world with over 680 million subscribers. The effective price per minute for an outgoing mobile call has declined from around Rs 16.40 per minute in 1995 to almost Rs 0.30 today. In less than a decade, a mobile phone has transformed from being a luxury that few could own to one of the prime essentials of an average Indian existence. The country’s 2G success story continues unabated. And with 3G services on the anvil, the sector is geared to completely revolutionise the wireless experience.

However, 3G mobile technology worldwide has been a victim of excessive hype in the early part of the 21st century. The optimism around 3G failed to create the kind of success the industry was dreaming of, perhaps with the notable exceptions of Korea and Japan.

Developed counties paved the way for 3G allocations in 2000 and by the end of September 2010, 3G comprised around 14% of total wireless subscribers worldwide. The disappointing uptake of 3G suggests that operators around the world have been struggling to turn a profit on their 3G investments.

Characterised by expensive licence fees, especially in European countries during the early 2000s, 3G has been a painful experience for many operators. Price paid per habitant for 3G licences due to overbidding in the UK and Germany was excessive at $595 and $559 respectively, with total 3G licence outgo at $35.4 bn and $45.85 bn. Strict mandatory roll-out obligations, as part of the licensing conditions, made matters even worse. Some European operators wrote off their 3G licence investments while others surrendered their licences altogether to the regulators when the prospect of recovering the cost of the outlay in the foreseeable future seemed extremely bleak. These operators that decided to stay the course have struggled to generate the kind of revenue streams needed on the 3G networks to recoup investment costs. This failure is largely attributed to the prices paid by the operators in winning the auctions, which was replicated on the average cost that was charged to the end consumer for the services, which led to low take-off of subscriber growth.

On the other hand, Japan and Korea’s 3G feat can be credited to the economical licence fee operators had to pay through beauty parade or comparative selection processes. Price paid per habitant for 3G in Korea was as low as $66 and operators in Japan had to pay no up-front fees. Today, 3G penetration in Japan stands at 95%, making it the leader in 3G followed by Korea at nearly 77%.

Service uptake depends upon innovative offerings and competitive tariffs. The latter is the function of the price operators have to pay to acquire the licences and of outlay in capital expenditure for the roll-out.

Telecom companies in India have acquired 3G and BWA spectrum with the total revenue to the exchequer amounting to $22.8 bn. Telecom companies paid around 46% of their total market value for buying the airwaves, which is colossal. As per estimates, amount lent by banks to 3G and BWA spectrum payments (excluding external borrowings and cash from internal accruals) is at about 2% of the total bank advances and 19% of total net worth of all Indian banks, which is significant. Now, the challenge is to roll out the network for monetising these airwaves. Operators will need to invest around $10 bn in the next 3-5 years for network roll-out. High auction prices and capital expenditure would force most players to avoid competitive game plans and evade launch of disruptive tariff plans. The success of 3G will largely depend upon how quickly telcos roll out applications, primarily of mass appeal. Affordability is the caller tune for 3G!

The author is partner and telecom industry leader, Ernst & Young. Views are personal

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