The covec approach

The general approach taken by Covec to the price setting formulae is to:

• use the original price paid at auction for a spectrum right as a base price; and

• apply to that price a simple growth factor (referred to by Covec as "z") which is intended to reflect the change in value of the spectrum between the original auction and the reallocation.

This approach has the advantage of simplicity, but does rely on:

• Being able to identify and calculate a growth factor that is a suitable proxy for growth in net cash flows (from which the value of the spectrum right is ultimately derived);
• Assumptions that the:
  • growth factor is essentially the same for each licensee to which it is applied (i.e. market shares are constant over time);
  • growth factor is stable over time (i.e. there has been and will be constant growth over the 40-year period under consideration); and
  • original auction prices were "correct" (i.e. that the expectations on which the auction bid was made have proven to be accurate as the market has developed over time).

Covec propose using changes in industry revenues over a 40-year period ² as the growth factor. For changes in revenues to be a suitable proxy for changes in net cash flows requires the additional assumption that profit margins are constant over the relevant period.

Given the assumptions outlined above, the approach is therefore best suited to situations where:

• Robust data on historical industry revenues is available;
• It is possible to forecast future revenues with some degree of certainty;
• The industry is relatively mature and not subject to dramatic change from technology or some other factor and therefore:
  • revenues can be expected to follow a generally more stable growth path over the long term; and
  • the auction prices reflected expectations that have proven reasonably correct (i.e. the base prices are still valid in relation to the current and future market);

Covec acknowledge these issues in their report (Development of Price Setting Formulae for Commercial Spectrum Rights at Expiry - 8. Other Spectrum Rights and Licenses).