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Stanford GSB News

 

Auctioning off the Nation’s Airwaves

June 1994

STANFORD GRADUATE SCHOOL OF BUSINESS—The Federal Communications Commission will use a new type of government auction to sell radio spectrum licenses for wireless technologies later this year. The auction was devised in part by Stanford economists Paul Milgrom, PhD '79, and Robert B. Wilson, Atholl McBean Professor of Economics at the Business School.

Called a "simultaneous ascending-bid auction," the FCC auction differs from familiar public auctions in which the items are sold in a one-at-a-time sequence, says Milgrom. In contrast to auctions for wine or antiques, where the pieces are valued independently, the value of a spectrum license to a bidder can depend on the other licenses that the bidder acquires.

For example, a license to use a portion of the radio spectrum in Northern California -- say, for cellular telephone service -- may be more valuable if the bidder can acquire a license to use the same band in Southern California at low cost, Milgrom says. Unlike sequential auctions, the simultaneous auction allows bidders to learn something about the prices of all the licenses before having to make their final bids on any single license.

"The U.S. government makes extensive use of auctions to sell Treasury bills; mineral, oil, and timber rights; and emissions permits," Milgrom says. "But this is the first time that game theory has been used to forecast how the rules of the auction game are likely to affect outcomes, to test those predictions in laboratory experiments, and to use the results to devise and implement superior designs for federal government auctions."

Most of the major communication companies sought out economic experts who could analyze the FCC auction proposal. Milgrom and Wilson worked on the auction design model as consultants to Pacific Bell. Business School economics professor Jeremy Bulow consulted for Bell Atlantic.

At issue for the government was how to auction off fairly and efficiently 2,562 licenses for 10-, 20-, and 30-megahertz communications bandwidths that were recently allocated to personal communication systems -- the next generation of cellular phones and other wireless communication devices such as two-way pagers and handheld computers. Overall, the sale will more than triple existing capacity for this type of use. The White House Office of Management and Budget has estimated that the access to the airwaves is worth about $10.2 billion to companies that would provide various wireless services on a local, regional, or national basis. Previously, the FCC first awarded licenses by public hearings and later by lottery. The latter provided windfalls to individual citizens who could sell their rights to the highest bidder. Last year, Congress decided an auction was the preferable method to provide opportunities for broad competition and protect taxpayers' interests.

The FCC's initial proposal allowed bidders to submit sealed bids for a national combination of licenses in either 30-megahertz band before taking part in a sequence of auctions for individual licenses. Then the sealed bids would be opened and compared to the sum of the individual bids, and the winners determined.

"It sounded sensible to a lot of people, but it isn't," says Milgrom, who determined that the rules gave the national bidders an advantage over local stations and tended to reduce the price the government would get for the licenses overall. Sequencing the sales by region also would create bias in prices, depending on where the sales started and ended. The problem, he says, is that "the values of the licenses are interdependent, so that the whole is worth more than the sum of the parts."

As an alternative, Milgrom proposed that the FCC sell all the licenses simultaneously in an ascending-bid auction that might take six weeks to two months to finish. In this scenario, each bidder offers a sealed bid for the licenses he or she is interested in, the bids are opened at the end of the day, and the highest bid is listed as the lowest acceptable bid for another round of sealed bids the next day. The process continues for each license until no new bids are received for it.

At first, Milgrom says, critics said such an auction would be too complicated for the government to run and for bidders to bid. However, he says, "We provided them with software that could keep track of the auction" and showed them that, from a bidder's standpoint, the problem is no different from deciding what to purchase from among thousands of listings on the New York Stock Exchange.

"You look only at those properties you are interested in," Milgrom says. "As long as you have ample time to reconsider your situation before the next round of bidding, then once one license gets too expensive for you, you can switch from bidding on an expensive 30-megahertz band to bidding on a collection of less expensive 10-megahertz bands."

To compare the performance of the Milgrom-Wilson design to the government's proposal, Pacific Bell sponsored experimental tests of the two. The experiments show that the government's originally proposed design had a bias toward national bidders. "The national bidders won licenses 92 percent of the time when they were the bidders with the highest values, but they also won 53 percent of the time when the regional bidders had a higher total value." In the simultaneous auction design, the national bidders won 88 percent of the time when their value was higher than the regional bidders but never won when their value was lower.

The simultaneous auction is likely to take longer, Milgrom says, "but so do sales of major companies take a long time. There are billions of dollars at stake here, and there is no reason to rush it when we are talking about permanently affecting the structure of a new industry."

—by Kathleen O'Toole