4. Optimal deprival value

The PwC-NZIER report notes that the recommended Incremental ODV methodology is similar to the Administered Incentive Pricing (AIP) system used in the UK.⁶ We note that the AIP scheme was designed to provide spectrum users who had received spectrum rights in the past, generally on a first-come first-served basis, with price incentives to be more efficient in their use of spectrum on essentially a channel-by-channel basis:

“The marginal opportunity cost of spectrum is defined as the value of spectrum resulting from a small change in spectrum used. The marginal increase or decrease in spectrum chosen should reflect the minimum amount that is likely to be of practical benefit to the user, for example, in the case of a cellular network this should take account of typical cellular re-use patterns.

This amount differs by service. For example, for … cellular or PAMR services it is the number of channels required to populate a single cell ‘cluster’, taking account of typical planning parameters.”⁷ (Emphasis added.)

In the context of setting renewal prices in New Zealand, since licences will not be subdivided by either frequencies or geography, the relevant increment is all the spectrum authorized by the licence in question, not the “minimum amount that is likely to be of practical benefit to the user”. In the New Zealand context, since spectrum is not scarce, most operators likely would incur no additional costs if they were deprived of a sufficiently small increment of spectrum. On the other hand, the deprival of all the spectrum that has been licensed to an operator would result in the operator losing all its profits, and the corresponding deprival value would be high. We conclude that a methodology based on deprival value is sufficiently flexible to yield a range of values that would include a reasonable renewal price. A critical component of the methodology would be the increment of spectrum that is used as an input to the Incremental ODV methodology. It is therefore important that the spectrum increment used in the Incremental ODV methodology be based on well-founded assumptions and analysis.

We understand that the Incremental ODV methodology will be used to evaluate spectrum for a generic licence owned by a generic operator.⁸ To the extent that the actual licence up for renewal is significantly different from the generic licence used in the analysis, the calculated spectrum value could differ significantly from the value that might be obtained at auction.

For example, we understand that some of the spectrum rights in question are not being used by the right holders at this time, several years after their acquisition at auction. Furthermore, it appears unlikely that network capacity constraints would force the holders to begin use of these frequencies in the foreseeable future. Thus, the incremental value of such a right may be quite low for the current right holder. In contrast, the proposed Incremental ODV methodology implicitly assumes that any given spectrum right is part of the generic operator’s “core spectrum”, rather than one licence that may be held in addition to other licences that provide the holder with the full technical capability to operate a wireless network.

If the calculated value is too high, the incumbent can refuse to renew the licence at the proposed price, attempting instead to win the licence at a subsequent auction at a lower price. Given this alternative, little harm will result, since the auction will result in a fair value, and the transactions costs of a possibly superfluous auction are low.⁹ If the calculated value is too low, it is likely that the rights holder will renew its licence at that favourable price. The harm to the government is likely to be low since it has obtained “fair market value” as defined by its chosen methodology. The government may have lost an opportunity to extract rent from the licence holder, but, since rent extraction is not a primary government goal, no harm to the government results.¹⁰ For these reasons, we concur with the Incremental ODV-based approach recommended in the PwC-NZIER report.

In addition, we agree with the PwC-NZIER report that the calculation of a renewal price will require a significant element of judgement.¹¹ We agree with the PwC-NZIER report that while benchmarking may not be as reliable as the Incremental ODV, it could serve as a useful check on the results of the Incremental ODV approach. As the PwC-NZIER report points out, values based on benchmarks need to account for differences across the benchmarks in fundamental factors affecting spectrum value.¹² Adjustments for some differences (such as exchange rates) may be possible, but adjustments for other differences (such as market size or competition) may not be straightforward. In these cases, it may be possible to use regression analysis to help develop an “apples to apples” comparison. That is, a measure of spectrum value per megahertz-pop (the product of the quantity of spectrum and the population covered by the licence) can be regressed on important factors affecting spectrum value (such as market size, level of competition, income, number of businesses in the area, etc.), and the resulting equation can be used to calculate the value of the specific licences of interest. Even with this extension of the benchmark methodology, we concur with the PwC-NZIER report’s decision to use Incremental ODV methodology as its primary valuation approach, and benchmarking as a means of verifying the results of the Incremental ODV analysis.

⁷“An Economic Study to Review Spectrum Pricing” (study prepared for the UK Radiocommunications Agency), Indepen, Aegis Systems and Warwick Business School, February 2004, p.46.

8PwC-NZIER report, 7.12

⁹PwC-NZIER report, 4.4.

¹⁰PwC-NZIER report, 2.25. We understand that the Government’s and Ministry’s objectives do not include the limitation of profits by or extraction of economic rents from the current spectrum users. However, the cited objectives that speak of a “fair financial return” indicate that the Crown does wish to share in the resource rents attributable to the spectrum in the renewal term, just as the Crown shared in such rents during the first licence term via the proceeds of the initial auctions.

¹¹PwC-NZIER report, 7.15.

¹²PwC-NZIER report, 7.16-7.18.