Why is auctioning satellite spectrum based on a % of AGR a suboptimal auction design?
This auction design lacks scalability and efficiency while also fostering arbitrage opportunities, necessitating constant rule adjustments by the government to maintain control.
The auctioning of satellite spectrum is a topic of debate that is being passionately discussed among all stakeholders. One of the proposed models is the auctioning of satellite spectrum using % revenue share as a metric. The idea is to artificially restrict the number of winners, and allow only those to win who end up bidding the highest value in terms of % revenue share (i.e. % of AGR) payable on a yearly basis. The purpose of this note is to show how the auctioning spectrum using % revenue share is a bad auction design (actually the worst of all models) - requiring the GOI to keep changing rules in perpetuity for managing the opportunities of arbitrage emanating out of this design.
% Revenue Share Auctions Will Create Opportunities For Arbitrage
This auction model does not scale. In other words, it opens not only opportunities for arbitrage but will make it extremely difficult for the GOI to manage it in the future. Let me explain with an example. Assume, an operator wins 2500 MHz (Uplink + Downlink) of spectrum in a revenue share auction held today at X % Rev Share in the KA/KU band. Then at an auction held sometime later, it wins 7000 MHz (Uplink+Downlink) at a different band (let’s say V Band) at a different Y % Rev Share. Then the values of the weighted average % Revenue Share for different values of y are listed in the table below.
Assume that in the next auction (i.e. Auction2), if the operator acquires a large quantum of airwaves at lower Rev Share numbers (the value of high-frequency bands might be low due to poor propagation and other technical challenges), then it will be able to pull down the overall (Weighted Average) Rev Share number even for the airwaves which it had acquired in the earlier auction (i.e is Auction1) to a much lower number (Col No. 6), thereby significantly lowering its license fee obligations.
Now why this is such a big problem and can’t be fixed? The reason is that the only way to aggregate different spectrum bands with different revenue shares is by taking a weighted average, as it is not advisable to segregate revenues emanating from different blocks of airwaves - a practice that we don’t even follow now due to the risk of promoting misreporting driven by the intent to save license fees.
Fixing A Floor For “% Rev Share” Will Make The Auctions Defunct
The statement is true for all scenarios as there could be various options that the regulator can use in order to fix a floor number of revenue share. Let’s analyze each of the options.
Now we know that all terrestrial licensees (across the board) pay a license fee of 8% revenue share, and outflows due to spectrum auctions are on top of it as deferred payments of yearly installments over a period of 20 years. Now assume the floor (the minimum amount they have to pay) is fixed as 8% for the satellite players as well.
Option 1 - Fixed Floor Independent of Qty of Spectrum
The Floor could be fixed at 8% for all kinds of satellite spectrum irrespective of the type of band and quantum of spectrum bid. Therefore bidding always starts a 8% for all spectrum/bands and anything above will get fixed as a “Total Revenue Share”.
The fundamental problem with this option is the value of all spectrum (irrespective of quantity) is treated at par.
For example, an operator holding 500 MHz spectrum will pay the same quantum of revenue share as those holding 2000 MHz - making the whole auction totally defunct. This will be absolutely the case when the auction closes at the Reserve Price - the most likely outcome unless the number of winners is artificially restricted to a very low number - bad thing to do as satellite spectrum is not scarce.
Option 2 - Variable Floor Dependent of Qty of Spectrum
In this case, let’s assume the Revenue Share is fixed at 8% for a minimum of 500 MHz of spectrum. Now assume that for 2500 MHz the operator pays 10% - an increase of 0.1% for every 100 MHz. For the sake of consistency, all future auction for all bands needs to start at a Reserve Price of 8%. If not then the auction will hold no meaning as the Weighted Average of the total revenue share will get driven down to a number much lower than 8% - making the auction totally defunct. The following figure explains.
Hence, the fundamental problem with this option is that it forces us to treat the value of all bands as identical due to the requirement of starting the auction at an identical % Revenue Share number (in this case 8%), and therefore preventing us from “Market Price Discovery” - one of the key reasons for holding auctions. Otherwise, the overall revenue share number will get driven down to a very low value as explained earlier.
% Revenue Share Model Does NOT Support Mixed Usage
Now the world is moving towards mixed usage of spectrum - both for satellite and terrestrial service. This is done to ensure the spectrum is used efficiently and the maximum value can be unlocked. Now “% Revenue Share” Model will prevent us from leveraging flexible usage of the spectrum. Doing so will create huge practical difficulties as applying the “% Revenue Share” Model on the terrestrial spectrum will totally disturb the existing licensing regime. How?
Applying a weighted average formula will end up increasing existing operators’ license fees if the spectrum gets sold at a higher value of % Revenue Share than the operators are already paying (segmentation of revenues from different blocks of terrestrial spectrum is not a current practice and is NOT advisable).
Conclusion
There are many more issues with the “% Revenue Share” Auction (actually auction of satellite spectrum as such) which I leaving out from the current note to keep it simple and focused. As stated multiple times (in many of my articles), auctioning of “Satellite Spectrum” is an extremely Bad Idea, and the “% Revenue Share” Model is the Worst of all the Models that are up for discussion.
In my humble opinion, Auctioning Spectrum for Satellite service should be avoided at all costs, as it will end up creating more problems than we are trying to solve. And therefore the assignment of such a spectrum should ONLY be done administratively - A practice that is followed by all leading economies of the world. It is in India’s interest to NOT try to invent the wheel. India should focus energy on making regulation simpler than complex, as that alone will enhance investor’s confidence and increase growth that we all are desperately looking forward to achieving.