Writing for Economics

In the year 2000, there were auctions of spectrum rights for third generation mobile telephones in several European countries. These auctions generated very different amount of revenue in different countries. How can this be explained?

Auction theory as a very useful brunch of game theory is of the great interest of modern economists. Among other reasons of its popularity stands direct importance of its ideas to modern businesses and governments. Nowadays any business sector is more or less competitive, which requires all it's participants to be dynamic and creative. Modernization and expansion is a vital part of modern business world. Governments, as owners of resources that allow businesses to expand and modernize, are always ready to sell those resources as it will eventually help businesses and certainly bring revenues.

The best way for government to sell available resources is to declare an auction. That's where auction theory comes into play. Modern auction theory is a very powerful tool for designing auctions of very profitable kind. Proper auction design will rise maximum amount of money for the government and provide companies with resources they need. However actions that maximize profits for the government have a direct influence also on the life of the citizens, as Dixit puts it: "...because of significant contributions the budget, auctions affect important macroeconomic magnitudes, such as interest rates".

So, auctions held by government, and to be more specific properly designed actions directly influence the life of modern country. In this essay I would like to make a kind of short review of auctions of spectrum rights for third generation mobile phones held in Europe in year 2000. The peculiarity of these auctions lies in the fact that revenues that were generated by European governments are different as a result of differently designed actions they held. This fact allows as to trace features of the auctions that were successful and resulted in relatively high revenues for the government.

There were 6 European countries to held spectrum right auctions in 2000. They were: United Kingdom, Austria, Germany, Italy, Netherlands and Switzerland. Let's start with United Kingdom as it was the first country to hold such kind of auctions.

Strategy that United Kingdom had chosen was selling 5 licenses during classical ascending auction. Auction resulted in huge revenues: 650 euros per capita. Firstly it should be said that auctions as any normal business activity should be competitive in order to be effective. UK spectrum auction was relatively competitive attracting 13 participants. There are several reasons why this action attracted so many participants. Firstly, UK was the first country in the world to hold spectrum rights auction. Participants were not completely aware of the usefulness of 3G cell phones, but were eager to get competitive advantage in the new generation mobile communication technology. Secondly, UK sold 5 licenses to the market with 4 major phone operators. This fact attracted new entrants, since at least one of the licenses can be potentially won by new entrants to the market. Both this facts generated highly competitive auction environment and limited possible collusions. Result of the auction was a huge success for UK government.

The next country to run spectrum rights auction in 2000 was Netherlands. This auction raised 170 euros per capita. Reason of such flop, comparing to the British result was lack of competition. When auction were run there were 5 major phone operators for 5 licenses to be sold. Few entrants decided to participate in the auction, since everybody was sure that 5 licenses will be distributed among market leaders. Another factor that made things even worse was the fact that that was an ascending auction. In this case with few participants there is a risk of collusion among market leaders. Netherlands would have generated much more money if they would some how encourage competition and change the action design in such a way that it would be possible for participants other than market leaders to place bids independently of each other to reduce collusion (sealed bid).

Italy generated 240 euros per capita and attracted 6 participants. Italy intentionally reduced amount of participants by imposing a requirements that participant of the auction must satisfy. Such situation combined with the fact that Italian auction was ascending could result in possible collusions among competitors. As a result wrong auction design resulted in low revenues.

Swiss auction was a real flop. They generated only 20 euros per capita. Here amount of participants was also artificially limited by allowing participants to join into the groups. And the price that government accepts was also reduced for some reason. Number of participants was sufficient to run profitable auction, but combination of officially permitted collusions and low reserve price resulted in absolutely insufficient revenues.

German and Austrian auctions were similar. Number of participants in both countries' auctions was low, which means that there were risks of collusion. Both countries sold licenses in blocks, allowing "number of winners be determined by bidders". Additionally Austrian government set a very low reserve price. Germany and Austria generated 615 and 100 euros per capita in revenue respectively. Germany designed auction in such a way that bids of two main market players were rationalized in a way that it resulted in high revenues.

Generally, the main difference in revenues generated from spectrum rights auctions can be explained by the difference in chosen auction design. Different auction design results in different amounts of money in revenues. Countries that tried to facilitate competitive bidding and limited the possibilities of collusion enjoyed high revenues.

Klemperer say that what really matters in auction design is "robustness against collusion and attractiveness to entry". Exactly the combination or lack of one of this factors resulted in the difference in the revenues generated by European countries. Any country that wants to increase revenues from auction must try to facilitate the competition among bidders by trying to make participation in auction as attractive as possible and eliminating any barriers for participation. There should be no cooperation between participants, as it will result in lower bids and as a consequence in low revenues. Countries should not choose auction design that facilitates collusion, as ascending auction in our case.

Of course there are several other reasons for difference in revenues, among them there is a fact that UK as a country that run the first spectrum rights auction in the world, might have enjoyed high revenues simply because participants were new to the licenses and had no idea of their true value. Overall economic situations in the counties as well as political might also result in differences in revenues. But the main reason for difference in profitability of the spectrum licenses auctions is difference in auction designs which were effective in some countries and not in the others.

BIBLIOGRAPHY

A.K. Dixit and S. Skeath, Games of Strategy, 2nd edition, Norton, 2004

Paul Klemperer, Auctions: Theory and Practice Electronic version of book on http://www.paulklemperer.org/index.htm

In the year 2000, there were auctions of spectrum rights for third generation mobile telephones in several European countries. These auctions generated very different amount of revenue in different countries. How can this be explained?

In the year 2000, European auctions of 3G mobile telecommunication licenses raised over 100 billion euros in government revenues. The countries that participated were United Kingdom, Netherlands, Italy, Switzerland, Germany and Austria. There was a big differential between revenues raised in each country with United Kingdom leading at 650 euros per capita and Switzerland coming in last at 20 euros per capita. The reasons for this big discrepancy in revenues is likely due to poor auction designs and the sequence in which the auctions took place.

When it comes to auction design, the two crucial components are attracting entry and preventing collusion. Ascending auctions encourage bidders to act collusively and deter weaker potential bidders as they know that the stronger bidder will always out bid him. On the other hand, (first-price) sealed-bid auctions act in the opposite direction from ascending auctions. It does not give bidders a chance to collude and encourages weaker bidders to participate. However, the disadvantage of using a sealed-bid auction is that it is more likely to lead to inefficient results than an ascending auction. The reason for this is that sometimes bidders with a lower value may beat opponents with a higher value. Hence, there is no perfect auction design and they must be customized to suit different environments and targets.

United Kingdom was the first to hold the auctions and they are a good example of how a well-planned auction design and good marketing strategies can lead to a favourable outcome. As there were five licenses and 4 incumbents, they had an ascending auction. To prevent collusion, each license could not be shared and each bidder was allowed no more than one license. Also, the fact that at least one license was available to new entrants lead to fierce competition from nine new entrants. To top it all off, UK had a solid marketing strategy which was planned over three years (1997 - 2000). All this helped contribute to UK raising 39 billion euros and being the most successful out of all the countries that took part in the 3G auctions.

Netherlands, Italy and Switzerland made the mistake of following UK and carrying out an ascending auction when a sealed-bid auction would have served them better. This resulted in revenues less than that achieved by UK.

In the case of Netherlands, they had five licenses and five incumbents. This deterred new entrants as well as facilitated collusion. For example, Deutsche Telekom colluded with local incumbents to bid for a 3G license. A sealed-bid would have worked better as this would have discouraged joint bidding, raise higher revenues as well as give new entrants a glimmer of hope.

Italy had their auction next but failed to learn from Netherlands and UK. Their auction design was not robust and failed to adapt to the environment in Italy. They adopted the UK design but had the additional rule that if bidders did not exceed licenses, the number of licenses would be reduced. They did not realize that having one more bidder than license does not assure that the outcome will be competitive. Also, Italy had failed to anticipate that firms would react differently to those in Netherlands and UK as they now had more information. Hence, weaker bidders were discouraged by previous auctions and did not bother to participate and since the participation rate was low, it made it easier for the strong bidders to collude. A bad auction design that was not tailored to the Italian environment and a low reserve price resulted in Italy only earning less than 25 billion euros.

Switzerland was the most unsuccessful amongst all the countries that held the auctions. It raised only 20 euros per capita in its ascending auction and this can be attributed to an unfeasible auction design, badly formulated rules and an absurdly low reserve price. Since the beginning, weaker bidders were deterred by the auction form. They felt that they did not stand a chance against the strong bidders and hence did not bother participating. This resulted in little competition. Furthermore, The Swiss government committed auction suicide when they permitted last-minute joint-bidding! This resulted in nine bidders colluding to become just four. The last mistake that the Swiss government made was to set a reserve price that was way too low. Since there were four licenses and four bidders, bidders ended up paying only the reserve price.

Germany and Austria chose a more complicated auction design.

Germany's auction design was an ascending auction of twelve blocks of spectrum from which bidders could create four three-block licenses or six two-block licenses. Germany's auction design was very susceptible to collusion and deterring new entrants but they were lucky and managed to earn high revenues.

Austria, on the other hand, adopted Germany's auction design but was not so lucky and only earned 100 euros per capita. The reason for this was that there were 6 bidders competing for 12 blocks of spectrum and a very low reserve price (one-eight of the reserve price in Germany). So instead of trying to get three blocks of spectrum, the bidders divided the 12 blocks of spectrum equally and paid the reserve price. This reason lead to Austria earning less per capita revenue than UK and Germany.

The other factor that affected the amount of revenue earned by each country was the sequence in which the auctions took place. Looking at the results of the 3G auctions held in 2000, it can be seen that the most successful auctions were the first of their type (United Kingdom and Germany). The reason for this is that between auctions, bidders learnt from previous auctions, came up with new strategies and learnt more about their rivals. However, the auction designs remained almost the same and were unable to keep up with the new ideas the bidders had come up with. This resulted in the later auctions not being as successful as the first.

In conclusion, the reason for the different revenues earned amongst the countries that took part in the 3G auctions is due to the auction designs and the sequence in which they took place. Revenues depend on how well the auction design is able to attract entry and prevent collusion. Also, it has to be able to adapt to new environments. For example, a good auction design takes into account the information bidders have and the knowledge they have gained from previous auctions. A sensible reserve price is of high importance as well and should not be overlooked like in the case of Switzerland and Germany. Lastly, auction design is not "one size fits all" and the failure of the government to design an auction that suited the country's environment lead to different revenues being earned.

References:

A.K. Dixit and S.Skeath, Games of Strategy, 2^nd edition, Norton, 2004

Professor Kenneth Binmore, "Economic Theory Sometimes Works"