The Biggest Auction Ever
The first auction was “The Biggest Auction Ever: The Sale of the British 3G Telecom Licences” (Binmore and Klemperer 2002). The biggest ever auction was held in the United Kingdom over the months of March and April 2000 and involved the sale of the third generation (3G) mobile spectrum licences.
Klemperer was part of a team with other members, including Ken Binmore, Tilman Borgers, Jeremy Bulow, Philippe Jehiel and Joe Swierzbinski (this was the result of a successful bid for the assignment by the ESRC Centre for Learning and Social Evolution based at UCL; Klemperer’s role was as the auction specialist). The team had started to advise the British government on the design of the auction three years earlier in 1997. The starting point was the view that ‘a well-designed auction is the method most likely to allocate resources to those who can use them most valuably’ (ibid.: C75). The only practical alternative was a beauty contest: government officials or experts choosing the most attractive bid, a process notoriously open to issues of political and legal influences. Auctions could also raise a lot of money for the public purse.The aims of the UK auction were to assign the spectrum efficiently, to promote competition and to realise the full economic value. The auction was designed to meet these objectives taking into account the specific features of the British telecoms market. Early on in the process, the team recognised that it was very important to encourage entry and not to restrict competition to the existing 2G suppliers. Whilst the possibility of a royalties-based payment scheme was considered, this was ruled out as inferior to the one-off sunk cost payment which would involve less distortion in the operations of 3G after the auction.
The government initially proposed that the auction should be for a fixed number of four licences with no bidder getting more than one licence.
Since the then current number of 2G incumbents was also four, there was a real concern that no potential entrant would be willing to bid against the (likely much-stronger) incumbents in an ascending auction—precisely the concern that Klemperer had raised in his 1998 Wallet Game paper discussed above— and that a pure sealed-bid auction would risk substantial inefficiency. So, the team went for a version of Klemperer’s (1995b, 1998) Anglo-Dutch auction: the four licences would be auctioned with an English ascending price auction until there were five bidders left. Then the five bidders would make a sealed bid for the licences and the four highest would get the licences and pay the fourth highest bid. In the end, however, the government decided to issue five licences. As such, since one licence was the most any one firm could be allocated, at least one new entrant would be guaranteed to win, and a simultaneous ascending auction was used.The auction was a great success from the perspective of the government raising revenue. There were 13 bidders at the start of the process. In the end, the new entrant (Hutchison Whampoa, under the brand 3 Mobile) won the largest licence A, the four incumbents the other licences with total revenue of $34bn, which was used by Chancellor Gordon Brown to pay down the public debt. Binmore and Klemperer found that ‘Auction design is a matter of “horses for courses”, not one size fits all; each economic environment requires an auction design that is tailored to its special circumstances’ (Binmore and Klemperer 2002: C94).
There were, however, many critics in the popular press who argued that the weakness of the auction was the (standard economists’) belief that, since the auction payments were sunk costs, the prices consumers would pay in the United Kingdom would be unaffected. Soon after the auction, The Guardian newspaper ran an article titled “Consumers Pay the Price in 3G Auction”, claiming, ‘Those countries which opted for the beauty contest route—namely France, Portugal, Spain, Norway and Finland—face no such embarrassing post mortems and are likely to enjoy far more sophisticated 3G services as a result’ (Osborn 2000: 33).[228] These fears do not seem to have been borne out in practice.[229] There was also a telecoms crash in 2001 in which the market value of shares in telecommunications companies across the developed world fell significantly and many jobs were lost in the UK and elsewhere.
But Klemperer argued that the auction itself was not at fault: he pointed out that some of the firms that fared worst in the telecoms crash were ones who had bid unsuccessfully in the United Kingdom (citing NTL); that the fees paid in all the European 3G auctions amounted to only one-fortieth of the losses in the crash they allegedly caused; that the US telecoms sector lost more than four times as much money in the crash as its European counterpart (although there were no 3G auctions in the United States); and that the mobile industry lost a greater percentage of value in the crash than fixed-line operators (which suffered no auctions) (see Klemperer 2002b: 21).Klemperer (2002a, c, 2003) explained why he thought the British auction was much more successful in meeting its objectives than most of the other 3G auctions held in Europe (there were almost simultaneous auctions held in Austria, Germany, Holland, Italy and Switzerland): ‘[M]any auctions— including some designed with help of leading academic economists—have worked badly' (Klemperer 2002a: 169). His judgement about the other European spectrum licence auctions was that, ‘These other auctions were fiascos primarily because they were poorly designed' (ibid.). Auctions are often wide open to collusion. For example, in a German ascending auction in 1999 two bids were made by two large German telecoms companies which meant they had half each. The companies then stopped bidding, which in Klemperer's analysis was collusive ‘live and let live' (ibid.: 171) behaviour. The other key issue in practice is to allow entry to occur in the auction process rather than restricting auctions to incumbents. ‘In an ascending auction, there is a strong presumption that the firm that values winning the most will be the eventual winner, because even if it is outbid at an early stage, it can eventually top any opposition' (ibid.: 172). So, Klemperer believes that in many contexts an ascending auction favours stronger firms and incumbents against weaker firms and potential entrants. A good auction design needs to address these issues.
4.2