April 2011 Archives

April 14, 2011 7:57 PM

Boardwalk, Park Place, and Spectrum: NAB's Mistaken Understanding of Monopoly Auctions

Yesterday, NAB President Gordon Smith speculated that the proposed AT&T/T-Mobile merger could reduce the amount of money the Treasury might have previously expected to receive from voluntary auctions of unused broadcast spectrum.  Mr. Smith, a former U.S. Senator from Oregon, theorized that if he were still in the Congress (which must authorize any re-purposing of spectrum from broadcast to mobile wireless) he would have second thoughts about the proposed voluntary auction, based on the amount of money it would produce with one potential bidder removed. 

Mr. Smith reasoned that an auction with one fewer bidder would, necessarily, yield lower prices for the auctioned commodity--in this case, spectrum. But, here's where it helps to better understand that spectrum is unique, scarce, and owned by a monopoly--the United States Government.

Chairman Genachowski, to his credit, has been earnestly and convincingly explaining at every opportunity--from the White House Spectrum Summit to the NAB Show--the importance of voluntary auctions to relieve the impending spectrum shortages facing the country.  The facts are stark. Wireless broadband demand is quickly out-stripping spectrum capacity in the aggregate. 

For some firms, the crisis is even more urgent. Just this week, the CEO of U.S. Cellular, voted best mobile carrier by Consumer Reports for 2011, made the same point to Congress.  AT&T cites an 8,000 percent increase in mobile data demand over the last four years as the motivating factor in its proposed acquisition of T-Mobile.  Indeed, even without the AT&T acquisition, T-Mobile also lacked the spectrum capacity to migrate to LTE.  

So, what about Mr. Smith's observation? In an auction for goods that have substitutes, Mr. Smith's auction theory has some merit.  In an auction for antique furniture, for example, the removal of one bidder (who might uniquely value one item over another) might well affect the total auction value.  However, that's not the situation here.

The spectrum market, as Chairman Genachowski has effectively explained, is characterized by a type of market failure known as "shortage", or a situation where demand for the available quantity of a product exceeds the available supply.  Those of you old enough to remember can recall the Arab Oil Embargo

In this situation, a cartel controlling a significant portion of the world's available oil decided to refuse to supply oil to the United States.  Demand for oil could not be quickly displaced to another substitute.  As a result, the price of oil quadrupled and gas prices increased daily, resulting in long lines at the pump and gasoline rationing.

Now, imagine you were a trucking firm at that time.  Supply of an indispensible input has been constricted for all firms.  Let's say some trucking companies merged, so that there were fewer colors of trucks waiting in the gas lines.  But, there wouldn't be fewer trucks, because consumers still demand transportation for all the same products.  Will the price of gas really change just because there are fewer colors on the trucks in the gas line?

Of course not; and this is the fallacy of Mr. Smith's argument, which--if taken to its rational conclusion--contradicts itself.   Anyone that has ever played the game Monopoly understands that the hypothetical monopolist is willing to pay the highest price for scarce property.  Like Boardwalk and Park Place, a spectrum monopoly is very valuable--and would garner the highest revenue for the government.

In the case of additional spectrum, the government is the monopoly supplier in a shortage environment.  If it simply wanted to capture the greatest amount of money, it would sell the spectrum in one big block to the highest single bidder--in effect auctioning off market power.

Fortunately, the Communications Act requires the FCC to structure its auction rules in a way that allows the most participation by the most firms.  Do the provisions of the Act, which requires small firms to be able to compete for spectrum with large firms, reduce the government's returns from an auction?  Probably, but the public benefits from the vibrant competition produced by these auction rules.  As a former Senator, Mr. Smith should understand this.