Hutch Valutaion and Indian Mobile Market - IK@W

In case you have not checked out Indian Knowledge @ Wharton, this week is a good time to start. There is a story that gives a 360 view of the Hutch valuation in the context of the larger Indian mobile market. As is typical of K@W it tempers what industry experts have to say with views and analysis from academia, including faculty from ISB:-)


So, any further thoughts, predictions on how this is going to play out?

The Hutch $20B+ Valuation

Wanted to start a thread on the current bidding war for Hutch! We talked about this in the first Business Intelligence Using Data Mining (BIDM) class today in the context to mobile companies managing churn - keeping subscribers from switching to competition. Studnets alluded to the impressive subscriber growth and the higher than average ARPU that Hutch enjoys. Are there any spectrum issues? There is definitely more to the story...Thoughts??

India's Emerging Mobile Internet: The Spectrum of Choices

(As appeared in the Dec 31, 2006 issue of Business Today, by Ravi Bapna and Arun Sundararajan)

Yahoo India's screaming billboards remind anybody who hasn't woken up to the fact that the Internet in India is coming soon to a mobile phone near you. Several concurrent trends suggest that this is not wishful thinking. Data from the second quarter of 2006 indicates that mobile phone sales currently exceed PC sales by a factor of fourteen! The disparity is greater in the rural areas, home to 71% of the population. In September 2006 alone, more than 6M new mobile subscribers joined one of the seven licensed operators, taking the mobile user base past the 120M mark. Contrast this with a total of less than 8M wireline Internet subscribers, suggested by the June 2006 data from the TRAI (http://www.trai.gov.in/trai/upload/PressReleases/377/pr9oct06no95.pdf). A PC sold in India isn’t always connected to the Internet, while all mobile devices have basic data messaging capabilities, and not surprisingly, the same report also suggests increasing congestion levels on mobile networks. Together with a rapidly expanding economy, and an increasingly active consumer society, the elements are ripe for a forthcoming mobile based Internet revolution.

Yet, much of this future depends on some key policy decisions that are currently on the desk of the DoT. Foremost, as India gears up to undertake the most ambitious expansion of its mobile infrastructure yet, it is critical that the right companies are allocated the spectrum necessary to (a) accommodate the projected staggering growth in mobile usage, and (b) roll out the advanced high-speed wireless technologies that will form the backbone for mobile electronic commerce in the near future. While much of the debate is being carried out under the banner of spectrum allocation for high bandwidth “3G” services, its context is larger and the policy implications are wider.

It is useful to begin by establishing that the spectrum in question, a certain electromagnetic chunk of the air above us, is a scarce resource, and one that belongs to the public at large. Cellular operators need access to this spectrum to carry voice and data over their networks, and companies around the world have paid a range of prices, from $0 in countries such as Luxembourg and the Czech Republic, to $87.5 million in Slovenia, all the way up to $34 billion for five licenses in the UK. However, it is important to realize that to roll out a new generation of mobile services, spectrum is necessary but not sufficient. The realized value of this public resource and whether the promise of 3G to the common man will be fulfilled also depends on the extent of infrastructure and equipment deployment to follow. The true capacity of 3G depends on not just the frequency of spectrum, but on the extent of massive capital investments in infrastructure (for instance, the density of base stations) that companies choose. Further, better infrastructure implies more bandwidth and greater coverage, which in turn provides a richer infrastructure for mobile commerce. This is important because whether the upcoming allocation of spectrum translates into the ability of a Mumbaikar to watch a streamed Bollywood classic on the long commuter train ride home, or the ability of a rural farmer to get customized instructional help on nurturing the latest fruit varietals given his micro-climate, or an enterprise capability to seamlessly string together a mobile video-conference on the fly also depends on subsequent entrepreneurial activity in mobile application and commercial development.

To summarize, the value proposition of 3G lies in making the spectrum available efficiently, ensuring adequate subsequent infrastructure roll-out and providing the right incentives for innovation in providing the content and commerce that will follow.

Allocating 3G Spectrum and Subsidizing Infrastructure Deployment

Given that we have upto seven operators vying for five 3G slots that are being vacated by the Defense, a well designed lump-sum fee spectrum auction is an effective way of identifying the most capable companies. Yes, an auction is clearly better than a "beauty contest" in which allocation decisions can often be flawed because of politics or an incomplete understanding of the true capabilities of the contenders. However, it is equally important that we utilize the current state-of-the art in spectrum auction and mechanism design. This includes allowing for bidders to use so called “bundle bids” to express complementarities in their valuations for getting, say, an extended urban area or a certain contiguous region to derive economies of scale. Under such a scheme, bidders could jointly bid for say Delhi and Punjab and Haryana, or submit a bid that reflects synergies in the market for Mumbai and Maharashtra. These synergies are natural if one factors in the ability to share marketing and customer service infrastructure and reduce roaming charges to subscribers. While bundle auctions are mathematically complex, significant recent advances have been made in reducing the computational burden of such auctions. For instance, the Adomavicius and Gupta combinatorial auction from the University of Minnesota presents a user-friendly and real-time English auction-like version of such a mechanism.

It is also worth noting that India's mobile market is brutally competitive, and the desire to win will likely cause companies to overbid for their licenses. This is risky, because the winning firms may end up saddled with excessive debt and an inability to raise the capital needed to profitably build out their infrastructure. This in turn will hurt the evolution of mobile commerce in the country.

Keeping in mind the need for rapid infrastructure buildout following the allocation of spectrum, we recommend that the license revenues be utilized to subsidize the future deployment of infrastructure. This can be achieved by providing the winning firms infrastructure buildout subsidies that are proportionate to their winning bids and their subsequent on-the-ground activity. This will favor those companies that have the desire, capability, capital and plans to deploy the best infrastructure possible over ones who bid a lot for spectrum and then don't build out sufficiently. True, this could inflate spectrum bids, since companies will adjust for getting back some of their bid as a subsidy. But this is a not necessarily a bad thing, because it aligns private and social incentives, by committing the winning companies to putting in future infrastructure. The key idea is that once the spectrum is won, the cost of the winning bid is sunk, and the subsidy gives companies steeper returns from infrastructure deployment, which increases their incentives to do so, and accelerates both the pace and quality of the backbone for mobile ecommerce.

Will the Indian Mobile Net be Neutral?

In case you are wondering why the subsidy should be give to the operators and not, say, to the future content and commerce providers, you are onto something fundamental. A passionate debate along similar lines is now under way in the US, under the banner of “net neutrality”. Should an ISP be allowed to charge you higher rates for visiting Google rather than Yahoo? Is it in the spirit of the Net to start looking inside data packets to ascertain where a packet is going, or what application it belongs to? Should a VOIP packet at a given router be preferred over a WWW packet, or priced differently? Should a minority inner-city neighborhood be given the proverbial bypass on the information superhighway?

Once the spectrum is won, and sufficient infrastructure is put in place, it is reasonable to assume that carriers will need to do what they can to recoup their investment and maximize their rate of return. They will be tempted to translate their control over the channel into discriminating in favor of content providers who are either owned by them, or who pay them better licensing fees in exchange for access. This reduces the incentives of independent content providers to innovate, because of what economists call a threat of "holdup", and a fear that they will not get enough returns on their innovation because the infrastructure provider will extract disproportionate economic rents. A similar story played out for a long time in the past with long distance telephony in the US, where the local access provider charged the long-distance providers a hefty percentage per minute. Currently, the wireline Net is neutral in the US, and the debate isn’t likely to end soon. The key lesson for us in India is that we have to be careful not to commit to policy that gives the infrastructure owners too much power, since they could strangle future innovation in content, commerce and application development. But yet, they have to have enough skin in the game to feel comfortable spending billions on the spectrum and infrastructure so that the content and commerce emerges.

All told, there is a delicate balance to be struck, one that calls for a national debate and the use of global thought leadership. The future of ecommerce in India rests on it.

(Ravi Bapna is faculty member at the Indian School of Business and is the Executive Director of the Centre for IT and the Networked Economy. Arun Sundararajan is a faculty member at NYU's Stern School of Business and Director of the IT Economics track at NYU's Center for Digital Economy Research)

The Information Systems (IS) Residency Program

The IS residency program at CITNE is designed to host and mentor late stage PhD students from leading research universities around the globe with an interest in pursuing ICT centric research that is applicable to business and society. The program will match students with host companies on the basis of their research interests, their methodological skills and the research needs of the host companies. A typical residency will last anywhere from four to six months but could be extended to a maximum of a year on a case by case basis. In addition, for the duration of the residency, the students will be treated as Research Associates at CITNE, ISB and will be given equivalent of graduate student housing, travel money and a research grant to cover expenses. They will also be encouraged to take equivalent of PhD level methodological courses that are offered to Academic Associates at ISB.

Topics can range from, but not be limited too, software engineering excellence, 3G mobile-commerce, Web 2.0, the economic impact of peer-to-peer and Grid computing models, understanding the determinants of innovation diffusion, search optimization, auction design and evaluating the impact of ICT of firm and economic performance.

Our initial partnership in this project is with the QAI and Bill Curtis’ Workforce Development Global Center of Excellence (WD CoE) in Bangalore.

For Late Stage Graduate Students

You will be required to submit a five page research proposal that clearly demonstrates the applied and relevant nature of your research problem. You are also encouraged, but not required, to list potential industry host companies where you would like to pursue your research. Applications should be submitted as nominations by your dissertation advisor or your Dept.’s PhD program coordinator.

For Host Companies

Companies seeking to collaborate with late stage PhD students, any by extension their advisors, from the leading research universities around the world are encouraged to view this program as a way to get world-class, unbiased and generalized insights and analysis into future trends, products, services, processes and business models. They are encouraged to provide specific problems they would like to seek collaborations on, and will be required to provide a senior mentor who will guide the PhD student’s research within the firm. Additional thought leadership will be provided by CITNE and WD CoE mentors.

Cost

Each graduate student residency will cost the host company a sum of INR 6 lacs (USD 13,333) for a period of upto six months. This money will be used to fund the student’s stipend, travel, research allowance and administrative overheads. The program is developed on a cash-neutral basis.

About CITNE at ISB

CITNE, ISB's Center for Information Technology and the Networked Economy is multi-disciplinary research center aimed at fostering rigorous and relevant ICT centric research and education to maximize the global competitiveness of the ICT industry and in promoting the country’s economic development. CITNE is conceptualized as an atrium of minds, where a free flow of ideas takes place between IT researchers, practitioners, graduate students and entrepreneurs.

QAI is a leading global consulting organization addressing knowledge intensive industry sectors such as the IP/BPO space and delivers multi-faceted interventions to enhance the innovation and competitiveness of organizations.

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!

hmm, so i have a blog

ended up creating this in order to post a comment on amardeep singh's fantastic blog. lets see how it evolves...