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4. The incremental OBV based approach

Incremental ODV - The core approach

Benchmarking the ODV value

Peer review

Questions on the incremental ODV-Based pricing approach

 

  1. PwC and NZIER recommended incremental ODV as a primary pricing approach for the renewal of cellular rights and benchmarking as a way of verifying the ODV value.
     

Incremental ODV - The core approach

  1. Incremental ODV determines the renewal price by calculating the incremental costs that a generic New Zealand cellular operator, operating an optimal network, would incur to maintain the quantity and quality of services to its customers if deprived of spectrum at the margin (maintaining the same revenue). This calculation is based on scenarios of expected levels of network traffic and service quality levels, by year, up to the end of the renewal period. It impacts on an operator's future cash flows from the cost side of its operations.
  2. Incremental ODV is akin to the Administered Incentive Pricing (AIP) approach or the SmithNERA methodology, pioneered in the U.K. and where it is applied to spectrum for mobile and fixed link services. The AIP approach calculates the costs that an operator would incur to maintain the same quantity and quality of services if a unit of spectrum is added to its holdings. PwC and NZIER recommended depriving, instead of adding, spectrum at the margin as this is the business situation being considered in the renewal process.
  3. Calculating the incremental ODV value is a feasible engineering exercise, where costs can be transparently determined, unlike a simulated auction, where inputs are mostly speculative in nature.
  4. There is a trade-off between spectrum and network configuration (simply thought as the number of cell sites); they may be substituted for each other to maintain a given level of service. The network configuration required to substitute for a marginal decrease in spectrum for a given level of service depends on the technical rate of substitution between these two inputs.
  5. For periods shorter than say, 20 years, ODV estimates may not be available if optimum spectrum is less than one increment more than the minimum bandwidth required to operate a network. In such cases, the optimum spectrum will need to be `constrained' to be no less than a certain number of MHz so a value for incremental ODV can be calculated.
     

Benchmarking the ODV value

  1. The incremental ODV value will be benchmarked against New Zealand and overseas spectrum values. Benchmarking is not considered simple and transparent and therefore, would not be suitable as a primary pricing approach. It can, however, add value by being able to provide greater confidence that the incremental ODV value will be a good proxy for actual spectrum prices. Benchmarking will take account of differences in the relevant markets, geographical differences, exchange rates, and dates of the transactions.
  2. If the ODV value significantly deviates from actual spectrum values, it may then be adjusted, to the extent judged necessary, based on the outcomes of the benchmarking exercise.
  3. The overall approach is detailed in Table 2.
     

Table 2: The proposed pricing approach (Incremental ODV, benchmarked against New Zealand and overseas spectrum values)

Step 1

Determine the marginal value of the radio spectrum, as calculated by an incremental ODV methodology, based on deprival of the marginal unit of spectrum.

    1. Specify scenarios for expected levels of network traffic, by year - break the country down into bands of traffic density (and hence, network/spectrum requirements).
    2. Specify service quality levels (call blocking rate).
    3. Determine the optimal, modern-equivalent network technology (this also specifies the minimum spectrum package).
    4. Determine the optimal network configuration (lowest cost to deliver given service quality).
    5. Determine the spectrum package required to support the optimal network configuration.

    6. Scope the deprival scenario.

      1. Specify the incremental spectrum package of which the operator will be deprived (based on the characteristics of the optimal technology).
      2. Specify the optimal (lowest cost) network configuration for the reduced spectrum holding.

    7. Determine the difference between the two scenarios.

      1. Determine the change in number and/or type of sites required and any other changes in assets.
      2. Determine the change in operating and maintenance activity.
    8. Apply average or standard costs to each quantified change to determine the change in costs; hence, the marginal cost of the unit of spectrum.
    9. Apply probabilities against the scenarios and perform an expected value calculation on these, discounting the change in costs to the time of renewal at a generic operator's cost of capital.

Step 2

Analyse precedents from New Zealand and overseas to benchmark the incremental ODV result. Possible approach:

    1. Gather 2G auction prices.
    2. Adjust to per MHz price.
    3. Adjust for population.
    4. Adjust for population density.
    5. Adjust for the intensity of competition and regulation in the market.
    6. Convert to New Zealand dollars.
    7. Identify a trend/range in pricing over time.
    8. Multiply back up to the New Zealand market size.
    9. Apply to spectrum holdings.
    10. Identify a trend in pricing.

Secondary market transactions:

    1. Identify secondary market transactions.
    2. Value adjustment for stake (controlling? minority?).
    3. Estimate proportion of price paid applicable to spectrum licences.
    4. Calculate price per subscriber.
    5. Adjust for market sizes, competition and regulation, and exchange rates.
    6. Identify applicably trend/range.
    7. Multiply back up to New Zealand market size.
    8. Apply to spectrum holdings.
    9. Identify a trend in pricing.

Step 3

Check that the incremental ODV result is within reasonable range from benchmark values.

 

Peer review

  1. CRA International, the peer reviewers, supported the use of incremental ODV as a primary valuation approach and benchmarking as a means of verifying the ODV result, given the inherent difficulties and speculative nature of alternative approaches.
  2. The peer reviewers' report is released together with this paper and the PwC-NZIER report.
     

Questions on the incremental ODV-Based pricing approach

2. The recommended pricing approach

Issue 2.1
Is the proposed incremental ODV approach, benchmarked against New Zealand and overseas spectrum values, a reasonable and appropriate approach in calculating a market value for the renewal of management rights in the 800 MHz and 900 MHz bands? Why or why not?

Does this approach meet all policy objectives (fair market value, fair return to the Crown, transparent and simple to administer)? Why or why not?

Issue 2.2
Are there factors or inputs that should or should not be considered in the proposed methodology? Why or why not?

Issue 2.3
Do you have any comments on the benchmarking to be applied to the ODV-calculated value?

Issue 2.4
Do you have any other comments on the recommended approach?

Do you have any other comments on the consultants' report and peer reviewers' feedback?

Issue 2.5
If you do not agree with the proposed approach, what alternative approach would best meet all policy objectives?

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Last updated 3 April 2008