Spectrum Auctions in New Zealand

20. Radio spectrum auction methods have changed over the years, generally following increased understanding of participants' characteristics, spectrum demand, and technological developments.

Past Auction Methods

21. Radio spectrum was initially sold in New Zealand using a second price tender system, which involved interested parties submitting a sealed bid, with the bidder who submitted the highest bid winning the auction and paying the second highest offer price. The logic behind requiring the highest bidder to pay the second highest bid was that it encouraged participants to bid their true valuation of the spectrum; whereas in a first-price auction, the incentive is to bid a price just higher than the estimate of the highest valuation among the bidder's rivals, which means that bidders must undertake the complex task of estimating rivals' valuations, in addition to assessing their own business case.

22. The results of the second price tenders held in New Zealand attracted some criticism as the return to the Crown was below what some people considered to be the true value of the spectrum. This may have resulted from:

• very thin markets at the time of the auction resulting in large differences between first and second placed bids (in one case the high bid was $100,000, while the second place bid was only $6);
• lack of information concerning the value of the spectrum; and
• instances where only nominal bids were placed and no reserves were set, meaning that some licences were essentially given away.

23. With the unintended results from the second price tender system, New Zealand moved to a first price tender system in 1991. This method was well understood by participants, easily administered and did not draw the same criticisms as the second price tenders in relation to the return to the Crown.

24. The first price tender system does, however, have problems, the most notable being the notion of "bidders regret". Bidders regret can roughly be described as the winning bidder placing a value on the item that is out of line with other bidders' valuations and therefore making the unhappy discovery that it has over-estimated the item's value and that it has paid more than the item's value and/or that it could have been obtained at a lower price.

25. Participants in both types of tenders felt that they resembled a lottery, as they only had one opportunity to bid for each lot and, given that information on the market value was limited, if they miscalculated there was no opportunity to adjust their bids.

26. Both the second and first price tender systems also create problems where spectrum licences being offered are considered to be complementary or substitutable. Exposure risks occur for bidders that see licences as complementary (i.e., synergies between the licences result in their group value being greater than the sum of their individual values) and a bidder does not win all the licences they wished to obtain. Morten and Spiller (1998) describe exposure risk as:

27. Where licences are substitutable, bidders in a sequential or single round auction are not able to switch between licences to allow them to obtain a licence at the lowest price that will meet their needs.

Current Auction Methods

28. New Zealand adopted the simultaneous ascending auction in 1996 and has used this system for six out of the last eight auctions. In 2002/2003 a simple closed tender was used for the allocation of one management right that remained unsold in two previous auctions. In 2004 outcry auctions were used for the allocation of three spectrum licences that had been unsold in a previous simultaneous ascending auction.

Simultaneous Ascending Auction

29. A simultaneous ascending auction (SAA) is essentially several outcry auctions held at the same time - bidding is held over multiple rounds where all lots are auctioned at the same time. Interested parties have the opportunity to bid on all available lots, bidding on lots is simultaneously closed when no new valid bids are received on any lot. Bidding rules aim to prevent participants from colluding, to decrease competition, and to ensure the auction is not drawn out over an unreasonable length of time.

30. By auctioning the lots at the same time over multiple rounds additional information is provided to participants in the form of other bidders' valuations. This addresses concerns that tenders often operate as a lottery owing to lack of information and bidders' inability to reassess their valuation and change their bids. This form of price discovery also limits the winner's curse as the highest bids are announced at the end of each round.

31. The mechanics of the SAA coupled with an auction rule allowing the withdrawal of bids, enable bidders who see the licences as substitutable to move from lot to lot (or between groups of lots), based on their relative price. Similarly, as bidders are able to assess their ability to obtain a group of lots they see as complementary, they can modify their bidding strategy or withdraw from the auction as the situation dictates.

32. In New Zealand the SAA was last used in Auction 6 (2003) to allocate AM, FM, and analogue television broadcasting licences. The licences were split into four schedules and four separate SAAs were held at the same time. The licences were grouped according to their substitutability. The bidding rules used in Auction 6 allowed control over:

• Bidding rounds - duration of bidding rounds and the period between rounds outlined in a time schedule, may be changed by the auction manager.
• Minimum bids - ability to specify a minimum bid above the highest standing bid as well as setting reserve prices.
• Withdrawal of bids - once a bidder withdraws three bids in a Schedule they will no longer be permitted to bid in that schedule.
• Bidder activity - bidders will be disqualified from making further bids if they fail to either be the standing high bidder or make a valid bid, in any two consecutive rounds in any schedule.

33. The overarching objective of the auction process, ensuring that spectrum licences went to those who valued them the most, was generally met in Auction 6. However bidding tactics resulted in two licences remaining unsold after the standing high bidders withdrew their bids and the remaining eligible bidders were not interested in these licences. This suggests that the SAA rules may need to be refined. Semi-commercial and non-commercial participants, who have not been able to obtain Crown reserved spectrum, criticised the method of allocation as they were unable to win licences given their financial constraints. The duration of the auction was also a week longer than expected.

Remaining Issues

34. While SAAs have been successful, issues of exposure, efficient allocation, parking,⁷ and collusion still remain, although they are not always experienced in New Zealand. These issues are discussed below.

35. Exposure issues remain in SAA systems as limits are placed on the number of withdrawals in order to ensure that the auction ends in a timely fashion and to limit collusion. If participants fail to obtain all the complementary licences they seek they may be left to pay more than their resulting valuation of the licence(s) acquired. This may also result in another bidder who has a higher valuation not being able to obtain the licence, resulting in an efficiency loss.

36. Activity rules used to date in New Zealand, in which the activity measure is not linked to the size (e.g. total coverage based on a MHz × population basis of licences) of the licences, have been criticised as creating a problem referred to as "parking". This tactic may also result in participants who are genuinely interested in the licence being "parked on", paying a higher price for the licence than what would have otherwise been required, or missing out all together. In other countries' auctions (e.g. Australia, Canada, the USA) where activity measures and rules are linked to the relative size of licences, parking is a much less pronounced phenomenon.

37. Collusion has not been seen as a major problem in New Zealand but, overseas, bidding methods have been used to signal intentions to other participants, often around indicating preferred licences and corresponding market splitting.⁸ Thus, the winning bids are below the winning bidders' valuations, lowering the return to the seller.

Outcry Auction

38. On 8 October 2004 three oral outcry auctions (collectively referred to as auction 7) were held to allocate three FM broadcasting licences. An auction house was contracted to auction the licences sequentially, with a reserve price of $1,000. This method was preferred to other options, including the simultaneous ascending auction, as it could be quickly organised and was administratively simple and inexpensive. Furthermore, the expected value of the licences was not high and the rules were easily understood by participants.

39. The auction process was deemed a success with the three licences of similar coverage being allocated at approximately the same price to three different bidders. This outcome supported Chan's (2003) assertion that where identical items are being sold and bidders only demand one licence, winning bids in sequential auctions will tend to converge.

⁷ "Parking" refers to a bidder placing a bid on an item that it does not really want to win (and has little chance of winning "accidentally") in order to preserve its ability to bid later on an item that it does want. A bidder engages in a parking strategy to avoid tipping its hand to other bidders and to avoid driving up the price on the items it does want. It also provides the opportunity for the bidder to react to competitors' bidding on their desired lots by bidding on lots held by that competitor.

⁸ Market splitting involves bidders reducing their demand (sometimes significantly) for items so as to close the auction at relatively low prices. The bidder gives up the possibility of winning more items, but it expects to pay a sufficiently lower price for the items it does win that it more than compensates for the lost opportunity to win more items.