1. Introduction

This memorandum presents our review of the final draft PwC-NZIER report on recommendations for developing a methodology for pricing the renewal of spectrum rights for cellular services in New Zealand.¹

Our review of the PwC-NZIER report was supplemented by three conference call discussions with the authors and MED staff, one in December 2005 before we had seen an early draft of the PwC-NZIER report, one in March 2006 after we had read an early draft PwC-NZIER report, and one in April 2006 after we had read the final draft.

Our consulting agreement with the Ministry asked us to consider:

• The completeness of the PwC-NZIER report vis-à-vis a set of tasks, i.e., whether the PwC-NZIER report:

1. Reviews earlier work and views of cellular operators
2. Assesses whether a price-setting formula, developed [sic] is a suitable means of calculating the market value of spectrum for cellular rights, either in its original or amended form
3. Proposes alternative approaches that might better meet policy objectives if the formula is not deemed appropriate
4. Identifies a preferred approach, stating adequate reasons and an appropriate length of renewal
5. Proposes a methodology for the implementation of the preferred approach

• The appropriateness of the assumptions used
• The logic of the arguments presented
• The reasonability [sic] of the conclusions

We understand that the authors previously conducted a peer review of the original Covec formula² and the authors discussed this formula with us during the initial teleconference in December 2005. The PwC-NZIER report states that several discussions were held with cellular operators to canvass their views.³ The PwC-NZIER report opines on the suitability of the Covec formula, proposes alternatives, identifies a preferred approach, and proposes a methodology (at a high level) for implementation of the preferred approach. Below we discuss the appropriateness of key assumptions, the logic of the arguments supporting the authors’ choice of a preferred approach, and the reasonableness of the conclusions. The PwC-NZIER report does not suggest an appropriate length of renewal for the spectrum rights, but we understand that the authors and the Ministry continue to examine this issue. Thus the PwC-NZIER report appears to be largely “complete” according to the Ministry’s criteria.

We recognize that the authors were given a difficult methodological task. The PwC-NZIER report rightly notes the difficulties inherent in all the approaches that are discussed.

The PwC-NZIER report recommends that the price setting formula used to approximate the market value of the spectrum rights allocated to licence holders be based on an Incremental Optimized Deprival Value (ODV) methodology, adjusted to reflect the reality of the New Zealand market and with some additional cross-checks on values.⁴

Like all methodologies that may be considered for determining the market value of an item other than a true market test (like an auction), the Incremental ODV methodology has some significant limitations in that it is impossible to fully replicate the reality of the marketplace in the Incremental ODV model and its output will necessarily be dependent upon on a number of judgements and assumptions made without full information. However, our conclusion is that the recommended methodology is reasonable, and may well be the most practical valuation approach to take given the greater difficulties inherent in alternative approaches.

2PwC-NZIER report, 2.3.

³PwC-NZIER report, 6.11.

⁴PwC-NZIER report, 1.2.