3G: Going, Going, Gone!

This is the orignal (unabridged) version of my Economic Times editorial piece (Oct 31, 2006) on the upcoming sale of spectrum in India.

3G - Going, Going, Gone!

The brutal pun notwithstanding, these are interesting times if you care about the air above you. The issue here is about value. Economic value of the 25 MHz of spectrum that is soon to become available to the seven or so licensed cellular operators operating through the country. Technical constraints specified by the IMT-2000, make feasible three indivisible chunks spectrum that can be sold (5 MHz, 10 MHz, 15MHz). You don’t have to be mathematical genius to realize that a maximum of five spectrum slots (of 5 MHz each) can be sold. With potentially seven operators vying for five slots we have a scarce resource, which begs the question of deciding which cellular firm gets how much spectrum and at what price.

Prior to delving into matters of mechanism design and valuation elicitation, let us establish a few fundamental facts. No one entity owns the air above us! Period. It belongs to you and me and all our neighbors and our neighbor’s neighbors and so on ad infinitum. Profit maximizing cellular operators that wish to use the air need to pay the Government for the privilege to do so. In 2000, in a 3G spectrum auction designed by Professors Binmore and Klemperer, telecom operators in the UK, with a population roughly 60 million, paid $34 billion for five licenses. In 2001, in tiny Slovenia, with a population 1.9 million, the price of the single license awarded was $87.5 million. To put things in perspective, at the time of writing there are 117 million paying mobile subscribers in India, with no telling where we will be by 2007, when 3G services roll out.

The fundamental question here is determining a fair and transparent mechanism that decides the allocation and pricing of a scarce national resource. Common sense suggests that the allocation should be efficient. In economic terms, allocative efficiency is maximized when the mechanism is able to identify and transfer the resource to the firm that values it the most. The TRAI, like any good regulator, is also concerned about protecting the consumer. This translates to doing what it can to ensure lower prices and better services for the consumer. Finally, subject to other constraints, the mechanism should not leave the public’s money on the table. Based on prior practice in a host of countries, it is reasonable to claim that choice is between an auction and a so-called “beauty contest.” In the latter firms submit business plans and the government identifies which companies are the best. In contrast, in the case of auctions, firms are forced to put their money where their mouth is.

To gain a better understanding of the comparison of the two approaches let us examine the source of the value from 3G. The expected value of the 3G technology, a future technology, to any firm is going to depend on the nature of applications and services it provides, the perceived value to the consumer of its’ offering relative to that of the closest competitor and the slice of the Indian mobile market (of roughly 320 by 2010) million, it can capture. One simple and grossly sub-optimal heuristic comes to mind! How many paying subscribers will be willing to watch a 255kbs live video stream of an Indian v. Pakistan cricket match while sitting in a commuter train from one of Mumbai’s suburbs to the city? How much will they be willing to pay for such a service, or for watching a Bollywood blockbuster on a quick train ride from Delhi to Chandigarh. The bottom line is that nobody knows what future 3G services will be offered, by what firms and at what price. The information asymmetry is grossly in the favor of the firms, with their deep pockets and a battery of pinstripe consultants they can hire.

The regulator has to design a mechanism that seeks this information to the extent it can, and making sure that the signals it receives are credible. One sure way to achieve this information elicitation in a fair and transparent manner, and protect the consumers’ interests, is to carefully design an auction that facilitates price discovery (firms will come in with their initial valuation estimates and the mechanism should facilitate it’s revision), determines an efficient allocation and which culminates in a lump-sum payment by the winning bidders to the government. I will argue that in the Indian context, an equivalent fair and transparent beauty contest cannot be designed (notwithstanding high auction prices and related financial difficulties faced by operators in some countries), simply on the virtue of the fact that it is almost impossible to hold anyone accountable to the business plans they present. Any allocation of this sort cannot, ex ante, come close to guaranteeing efficiency, that is allocating the resource to the firms that will make the best use of it.

There are other technical and economic auction design issues that the authority will do well to seek expertise on. They will be the subject of another piece. However, it is worth bringing up a key point that may not be obvious to the casual reader. It may not be obvious why high auction prices paid by companies for the spectrum will not be passed onto the consumer. The key to this insight lies in viewing the lump-sum auction fee as a sunk cost that is part of doing business risk, similar to say an infrastructure company building a toll-bridge with the expectation that people will pay to cross it. Of course, that depends on what alternative people have to that bridge, which is where the issue of competition comes in. As long as the auction design ensures that there is significant (four to five players) competition in the market, prices for future 3G services in India will depend on what the market forces determine. A lump-sum sunk cost is the only fool-proof way to prevent strategic high bidding by some operator, who can then renege and renegotiate based on say political clout in a different political climate.

The TRAI has boldy and correctly invited everyone to the dance floor. Let the music begin!