As the 700 MHz auction approaches, we are writing to clear up a common misconception about the nature of spectrum auctions and the impact of various rules on auction revenues.Auctions, spectrum auctions, market design

Andrzej Skrzypacz

Peter Cramton

Robert Wilson

Simon Wilkie

English

Research Papers in Economics

 
 
July 30, 2007 
 
 
 
The Honorable John M.R. Kneuer 
Assistant Secretary for Communications and Information 
National Telecommunications and Information Administration 
U.S. Department of Commerce 
1401 Constitution Avenue NW 
Washington, DC 20230 
 
 
Dear Assistant Secretary Kneuer, 
 
As the 700 MHz auction approaches, we are writing to clear up a common misconception 
about the nature of spectrum auctions and the impact of various rules on auction 
revenues. 
 
We are economists specializing in auction theory and practice and in telecommunications 
industry structure. Robert Wilson was one of the original designers of the auction format 
that has been used in all FCC spectrum auctions. Peter Cramton has advised the FCC and 
several foreign governments on the design and implementation of spectrum auctions and 
participated in dozens of auctions as a consultant. Andy Skrzypacz teaches game theory 
and auction strategy at Stanford University. Simon Wilkie was Chief Economist at the 
FCC from 2002-2003. We are currently serving as advisors to Frontline Wireless. 
 
At last Thursday’s Senate Commerce Committee you stated that “Maximum flexibility 
does tend to lead to maximum revenues.” While we appreciate the intuitive appeal of this 
viewpoint, we must point out that it has no basis in auction theory nor has it borne out in 
over a decade of practice both in the U.S. and abroad. In fact, the open access, wholesale, 
and designated entity provisions currently under consideration by the FCC are likely to 
increase auction revenues. 
 
Open access, wholesale, and designated entity rules motivate new entrants to enter the 
auction, which increases demand for spectrum and intensifies bidder competition, driving 
up prices. Without these kinds of entry-promoting conditions, incumbent providers will 
face little competition in the auction and valuable licenses will sell for a song.  
 
To understand why, one must consider the current structure of the wireless market, a 
market in which firms literally require a license from the government in order to 
compete. Verizon and AT&T enjoy economic rents from their stranglehold on low-
frequency cellular spectrum, which gives them a coverage advantage that leads to higher 
revenue yield and market share than the other operators. Verizon and AT&T have a 
strong incentive to pay a “blocking premium” to maintain this position. They should be rationally willing to pay prices higher than the true operating value of the 700 MHz 
licenses in order to stave off competitors and to preserve oligopoly rents.  
 
When non-incumbent bidders decide whether to enter the auction, they weigh the high 
costs of bidding against their odds of winning. An FCC auction is a costly project, 
requiring serious bidders to commit many millions of dollars for capital carrying costs 
and war room operations, not to mention months of senior executive time preparing for 
and participating in the auction. In order to rationally participate in the auction, new 
bidders (and their investors) must believe they have a sufficient chance of winning that 
the risk-adjusted return outweighs the high participation costs. 
 
In a “maximally flexible” auction, unfortunately, the odds of outbidding the incumbents 
are low enough that potential entrants do not participate. Absent rules to encourage new 
competitors, the incumbents’ willingness to pay a high blocking premium chills demand 
in the auction. Ironically, even though the incumbents would be willing to pay high prices 
if needed to block entry, the lack of bidder competition actually allows them to pay very 
low prices. Thus the incumbents win in two ways: they protect their profits and they get 
the new licenses for scarce spectrum at low prices. 
 
To see how restrictions on auction participation can increase revenue, consider the 
auction William Safire called the “the greatest auction in history,” the A and B block 
auction of PCS licenses. In this auction, the FCC imposed eligibility restrictions through 
the policy of spectrum caps. Wireless incumbents were prevented from purchasing 30 
MHz licenses in geographic areas in which their combined holdings would exceed the 
spectrum cap of 45 MHz. Despite the protests of the incumbents at the time, the A and B 
block auction turned out to be a noted success, and it is widely regarded as having 
facilitated new national and regional market entrants and true competition in wireless 
markets. 
 
The open access, wholesale, and designated entity rules should have a similar effect in 
the 700 MHz auction. They will promote entry by new firms with different business 
models than the incumbents. In so doing, they will facilitate new capital formation, 
increase bidder activity, and boost auction revenues. And, it should be emphasized, they 
will only apply to a limited slice of spectrum, leaving the incumbents free to win the 
majority of the spectrum without any restrictions at all.  
 
Of course, revenues should not be the primary goal of the FCC for the 700 MHz or any 
other auction. Indeed, Congress directed the FCC to primarily consider the efficient 
allocation of spectrum when administering auctions for this precious national resource. If 
incumbents can foreclose entry, then the FCC has failed in its mission. Simple rules 
mandating open access and wholesale on a limited amount of the spectrum will provide 
for a robust increase in competition that will benefit consumers and taxpayers. They open 
entry for many retail service providers, new devices and uses of the wireless technology. 
We hope they would lead to the creation of the wireless Internet. The designated entity 
credit is a proven mechanism to stimulate auction competition and should continue to be 
available to new entrants.  
In establishing the rules for this historic auction, the FCC should examine the substantial 
economic theory, auction theory, and empirical evidence, and make a reasoned 
determination based on what is best for consumers, taxpayers, and social welfare. By 
these measures, the proposed rules do very well indeed. 
 
Sincerely, 
 
/s/   
Peter Cramton 
Professor of Economics 
University of Maryland 
 
/s/   
Andy Skrzypacz 
Associate Professor of Economics 
Stanford University 
 
 
/s/   
Simon Wilkie 
Executive Director 
USC Annenberg Center for Communications 
Law and Policy 
 
 
/s/   
Robert Wilson 
Adams Distinguished Professor of Management 
Stanford University 
 
 
cc:  Meredith Atwell Baker 
  Deputy Assistant Secretary 

Economist Letter to NTIA on 700 MHz Spectrum Auction

http://www.cramton.umd.edu/papers2005-2009/economist-letter-on-700mhz-auction.pdf

Economist Letter to NTIA on 700 MHz Spectrum Auction

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Research Papers in Economics