Variables Impacting on Auction Design

Bidders' Valuations

66. The way bidders form valuations for lots varies from independent private valuations to common valuations. Bidders' position on this range influences what form the auction should take.

67. Private value is specific to a particular bidder and is not correlated with other bidders' valuations. An auction design that reveals others' bids is not a necessary feature on a pure private values context.

68. Common value is that part of a lot's value that is correlated among bidders. The winner's curse - the risk of "over-bidding" - is important when common value is present and tends to cause bidders to bid below what they would otherwise bid. Information made available to bidders that improves their confidence in their valuations and bids - such as round by round results in an ascending auction format - tends to encourage bidders to bid up to their maximum willingness and ability to pay.

69. Generally the value placed on the resource will be based upon both private information (for example the cost of production) and common set of factors affecting all parties (such as the future market price of the end service/good).

Bidders' Symmetry

70. The appropriate auction design can depend on how symmetrical the bidders are. For example, if bidders vary substantially in their valuations, budgets, and information, or if there is a large dominant bidder perceived by other bidders as being inclined to win at any cost simply by countering bids by other bidders, then a sealed-bid auction may be preferable over an open ascending auction. In this scenario weaker bidders, or those who perceive themselves as being weaker, would be more attracted to a sealed-bid auction because they are more confident they could win and win at a profitable price. However, this does raise the possibility of an inefficient outcome if the weaker bidder wins.

Bidder Collusion

71. Explicit collusion occurs when bidders agree to coordinate their bidding behaviour so as to reduce prices below competitive levels. Tacit collusion occurs when bidders coordinate their behaviour without an explicit agreement in place. Bid signalling, and strategic demand reduction involving two or more bidders, are examples of tacit collusion in an auction.

72. In addition to generally prohibiting explicit collusion (most nations' competition laws prohibit collusion in general, and in some cases "bid rigging" specifically) some auction rules also serve to limit the ability of participants to signal to each other, such as placing limits on the withdrawal of bids and controlling the form of valid bids. Limiting information about the identity of bidders (reporting all bids or only high bids in each round without identifying bidders) can also make collusion more difficult.

73. Particular auction designs, like ascending auctions, are more prone to collusion through signalling than single round auctions such as tenders. Single round auctions also are less prone to collusion as bidders are unable to retaliate within the auction against parties who "cheat" on a collusive arrangement.

Bidder Participation

74. Bidder participation is an important consideration in the design of auctions as it can impact on the level of revenue achieved and provide information on the value of spectrum for later auctions or for resource pricing. Increasing the number of participants increases the depth of valuations, such that the resulting auction value is more reflective of the actual value.

75. Encouraging participation can also impact on competition in the downstream market and improve efficiency. Auction designs that are only attractive to incumbents discourage other participants and therefore possible competition in downstream markets. Preserving the market power of incumbents may not be the socially optimal choice if the existing market is not competitive. Where the level of downstream competition is in question, it may be appropriate to set a cap (including a cap of zero in some cases) on the number of lots certain (e.g. an incumbent with market power) or all bidders can win.¹³

Participation Costs

76. The level of bidder participation can be affected through costs outside that of paying the winning bid for the resource. These costs include those associated with forming a valuation, preparing bids and participating in the auction. As the cost of participating in the auction increases, the value placed on the resource decreases, lowering the number of potential participants.

77. If the cost of forming valuations is high this could reduce the numbers willing to participate. In such cases, it is in the seller's best interest to reveal as much information as they have to assist in the valuation. Also, where a level of commonality in valuation is present, some form of ascending auction design may be appropriate and adopting this auction format would help mitigate the high costs of forming valuations.

78. Bid preparation costs include the method of submitting bids, calculation of bids, and interpretation of previous results. These costs influence the attractiveness of participating. A method used to reduce these costs includes limiting what bids can be submitted. In some cases bid options are provided at certain increments above the previous high bid, say 5%, 10% and 15%. If each round's results are to be publicly announced they should be in an accessible format.

79. Other participation costs could include requiring deposits, cost of travel, the purchase of computer software, the duration of the auction and post auction procedures.

Strategic Announcements

80. Bidder participation can also be affected by strategic motives. Bidders known to have large financial resources could influence the participation of others by publicly announcing their intention to win the auction and thus hopefully deterring competition and acquiring the resources cheaply and possibly limiting the competition in the down stream market for which the resource is used.

Auction Type

81. The type of auction can impact on participation, particularly through allowing the aforementioned effects to be prevalent. The use of well known and tested methods can ease the cost of participation, leading to higher participation, whereas the use of a new method can have the opposite effect unless this is outweighed by the benefits of the new design.

82. Ascending type auctions provide valuable information reducing the cost of bid preparation and lessening the winner's curse. However, this type of auction can discourage participation when a financially strong bidder is present as the chance of winning the resource decreases and potential bidders opt out to avoid the cost of participation.

83. Single-round tenders may encourage a greater number of participants as there is a greater chance of winning. However the cost of preparing valuations may be greater due to the lack of information in the form of other participant's bids. Participants may also discount their bids to avoid the winner's curse.

Lot Structure

84. Lot structure can also affect participation. Matching lots to the number of incumbents in an ascending auction does not encourage new entrants to participate as the possibility of winning could be deemed low. Large groupings of resources, rather than a number of smaller lots that can be aggregated, discourage the participation of smaller bidders, through both budget constraints and not allowing business cases built on smaller bundles. Conversely lots still need to support a feasible business case on their own and there are costs to participants when attempting to aggregate licences.

Relationship among Lots

85. The number of lots and their interrelationship has to be factored into the auction design. Lot characteristics can be summarised as follows.

Substitutable

86. Lots are perfect substitutes for a bidder if the bidder is indifferent between them. For example, a bidder may be indifferent between 10 MHz lot A in Auckland and 10 MHz Lot B in Auckland; the lots are substitutes for the bidder, and it will choose between them purely on the basis of price.

Complementary

87. Complementary lots are those where the value of the group of lots is greater than the sum of the individual values of the constituent lots. In this situation, unless package bidding is available, bidders can only express the synergy value by including it in their bids on one or more of the individual lots. Allowing bid withdrawals reduces the risk of the exposure problem that occurs when a bidder has placed a bid on one lot greater than its valuation for that individual lot and then cannot win the complementary lots.

Substitutable and/or Complementary

88. In some cases it may not be clear if lots are substitutable or complementary; they may be both and could be viewed differently by different individuals. Fortunately auction designs used for the allocation of complementary licences also accommodate substitutable licences.

Neither Substitutable nor Complementary (or Only One Lot Is Being Sold)

89. In this case a single, independent auction can be held for each lot in question. One caveat to that is if a bidder is interested in the lots in two or more of the auctions and the bidder has a budget constraint. With separate auctions, a bidder will need to guess how much it should allocate its budget across the auctions in case the prices across the auctions will prove to constrain its budget.

¹³ The cap could be extended to the amount of spectrum within a band that any party can control, regardless of how it was obtained (whether in a government auction or the secondary market).