MEMORANDUM
TO:
FROM:
SUBJECT:
DATE:
ROBERT HAGA
ADRIAN LAMBIE
TOWARDS REVERSE AUCTIONS
10/03/07
1. INTRODUCTION
1.1. UNIVERSAL SERVICE OVERVIEW
1.2. ADVANTAGES OF REVERSE AUCTIONS
1.3. REFERENCES
1.3.1. ACADEMIC COMMENTARY
1.3.2. FCC SPECTRUM AUCTIONS
1.3.3. INTERNATIONAL EXPERIENCE
2. MECHANICS
2.1. SERVICE DEFINITIONS
2.2. CARRIER ELIGIBILITY
2.3. BIDDING
2.3.1. COMPLEMENTARITIES
2.3.2. INDIVIDUAL BIDDING
2.3.3. COMBINATORIAL BIDDING
2.4. ALLOCATION OF SUBSIDIES
2.5. ENFORCEMENT
3. CONCERNS
3.1. STATUTORY COMPLIANCE
3.1.1. FEDERAL
3.1.2. STATE
3.2. BIDDER COLLUSION
3.3. STRANDED INVESTMENTS
4. CONCLUSION
1
MEMORANDUM
TO:
FROM:
SUBJECT:
DATE:
ROBERT HAGA
ADRIAN LAMBIE
TOWARDS REVERSE AUCTIONS
10/03/07
1. INTRODUCTION
1.1. UNIVERSAL SERVICE OVERVIEW
Simply put, universal service describes the policy objective of making affordable voice
telephone service to everyone.1 Prior to the 1984 breakup of the Bell monopoly, efforts to
achieve universal service were funded primarily through a system of implicit subsidies, whereby
the more lucrative parts of telephone networks supported the more expensive parts.2 Since that
time however, a transition has been made towards explicit subsidies in the form of state and
federal universal service funds.3 These funds are supported largely by taxes levied upon various
telephone services, in particular long distance communications.4 Discuss high costs / CHCF
here…
1.2. ADVANTAGES OF REVERSE AUCTIONS
A fundamental advantage of reverse auctions is their promise to minimize information
discrepancies between regulators and carriers. Under the traditional model of subsidy
distribution, regulators must estimate the cost of providing basic service in a given area, then
make a corresponding level of subsidy available to any carrier willing to accept COLR
1
47 U.S.C. § 254(b) (2006).
Fraser, Telecommunications Competition Arrives: Is Universal Service Out of Order, 1 (1995).
3
Id.
4
47 U.S.C. § 54.706 (2000).
2
2
obligations for that area.5 This process is inherently inefficient to the extent that regulators
compute inaccurate estimates. Recognizing that carriers themselves are better situated to
estimate their own costs, reverse auctions compel carriers to reveal these costs to regulators. As
bidding progresses, the value of combined return (maximum basic rate plus subsidy) should
approximate the actual cost incurred by the most efficient carrier.6 More accurate cost data
should beget increased efficiency, allowing regulators to reduce maximum basic rates and/or the
size of universal service funds.
In addition to revealing actual costs, reverse auctions are likely to reduce them in at least
two ways. First, competitive bidding provides a direct incentive for carriers to trim costs and
profit margins to efficient levels. In doing so, carriers are will likely seek to capture efficiency
gains from the optimization of existing technologies and the introduction of new ones,
converting them into cost savings for universal service. Second, to the extent that reverse
auctions are combinatorial (allowing carriers to submit a single bid for multiple areas), they
encourage economies of scale or synergies. Specifically, a COLR will likely be able to serve a
given area more inexpensively if it also serves adjoining areas. The reasons for this phenomenon
are multiple, but center around the possibility of serving multiple areas with shared backbone
infrastructure.7
Finally, reverse auctions are responsive to change over time. The cost models relied
upon by the traditional subsidy distribution process tend to be complex and unwieldy, requiring
large datasets to describe market conditions.8 Changes in conditions can only be reflected by
extensive updates which are expensive, time consuming, and often hotly contested by affected
5
Typically, the subsidy will equal the estimated cost of basic service minus the maximum acceptable basic rate.
Frank Kelly and Richard Steinberg, University of Cambridge, A Combinatorial Auction with Multiple Winners for
Universal Service, 6 (1998).
7
See generally Peter Cranton, Yoav Shhoham, and Richard Steinberg, MIT, Combinatorial Auctions (2005).
8
Examples of such models include the Hatfield/HAI model, VzCost, and the FCC’s SynMod.
6
3
parties.9 Reverse auctions eschew these difficulties by placing the burden upon carriers to
develop accurate understandings of the market. Thus, where harnessing an emerging technology
would necessitate comprehensive revisions of cost models, regulators need only conduct an
iteration of reverse auctions to capture its benefits. This flexibility can also be used in response
to demographic changes and evolving service definitions promulgated by regulators.
1.3. REFERENCES
1.3.1. ACADEMIC COMMENTARY
1.3.2. FCC SPECTRUM AUCTIONS
1.3.3. INTERNATIONAL EXPERIENCE
While reverse auctions for universal service support would be new to the United States,
they have previously been utilized in a number of foreign countries.10 Some of the most
successful examples can be found in South America, where Brazil, Chile, and Peru used
competitive bidding to deploy thousands of private lines and public payphones in unserved and
underserved areas.11 Other countries have encountered more difficulties. In Australia, a reverse
auction pilot program was instituted in 2000 to promote competition in rural markets largely
monopolized by incumbent, Telstra.12 The inability of this program to elicit substantial interest
among Australian carriers is likely attributable, at least in part, to the extreme remoteness of the
areas at auction.13 India presents an example of a largely failed auction system.14 In 19 of 20
areas for auction, only the incumbent, BSNL, submitted a bid. In most instances, those bids
9
CPUC rulings R. 93-04-002 and R. 93-04-003 are illustrative.
James Stegeman, Dr. Steve Parsons, Robert Freiden, and Mike Wilson, Controlling Universal Service Funding
and Promoting competition through Reverse Auctions, 8 (2006).
11
Id. at 9-10.
12
Id. at 11.
13
Id.
14
Roger Noll and Scott Wallsten, Telecommunications Policy in India, 26-27 (2004).
10
4
were equal to the maximum allowable subsidy.15 A probable explanation for this failure is that
the relatively large size of auction areas prevented smaller local carriers from bidding.16
Considerable caution should be exercised in applying lessons from these foreign
precedents to reverse auctions in California. Most foreign auctions involved largely
undeveloped or “greenfield” markets, and many were limited to the installation of public
payphones in rural population centers.17 Also, population density is considerably in California
higher than in the remote areas at issue in the South American and Australian cases.18
Notwithstanding these differences, the international experience supports at least two important
conclusions which are germane to California. First, winning bidders frequently relied upon
wireless technologies, specifically cellular and Very Small Aperture Terminal (VSAT)
networks.19 This underscores the importance of technological neutrality in conducting efficient
auctions. Second, regulators must take pains to avoid underbidding by crafting auction areas
which are not overly large or insufficiently profitable. The use of Census Block Groups (CBGs)
in a combinatorial framework would seems likely to satisfy these requirements.
2. MECHANICS
2.1. SERVICE DEFINITIONS
Before universal service auctions can be conducted, the obligations of winning bidders
must be clearly defined. Specifically, regulators must stipulate quality, bandwidth, and
reliability standards, as well as carrier of last resort (COLR) obligations. Since 1997, the FCC
has issued a series of rulings identifying services which are eligible for USF support.20 While
15
Id.
Id.
17
Stegeman, supra n. 10, at 13.
18
Id.
19
Id. at 13-14.
20
62 Fed. Reg. § 32862 (1997). See also 63 Fed. Reg. § 33585 (1998); 47 C.F.R. § 54.101 (2007).
16
5
they may be a good start, these service definitions are frequently accused of bias in favor of
wireline technologies.21 Future revisions should be carefully crafted to ensure compliance with
the principle of technological neutrality, already theoretically endorsed by the FCC.22 Coverage
is also a key variable. In California, carriers designated as COLRs are required to serve all
business and residential customers within their respective territories upon request.23 However, it
would be unfeasible to require that winners immediately provide such universal coverage, since
carriers may well win CBGs in which they are not the incumbent. Instead, reduced short-term
coverage targets (e.g. 70 percent coverage) should be set and periodically increased until service
availability approaches 100 percent.
Because universal service auctions can only be conducted periodically24, forward-looking
service definitions are indispensable. To fulfill this requirement, regulators have to effectively
project service needs for the duration of the winner’s franchise. Failure to do so could increase
default among winning bidders, necessitating early auctions to adjust subsidy levels or locate
alternative carriers. Regulators must also take pains to avoid service definitions which exclude
emerging technologies. Technological neutrality and dialogue with industry leaders will be
particularly important in this regard.
2.2. CARRIER ELIGIBILITY
Rigorous screening of would-be bidders is essential to minimizing defaults and
preserving the integrity of the auction process. Not only must bidders be operationally capable
of fulfilling COLR responsibilities, they must also make an adequate showing of financial
21
The Cellular Telecommunications and Internet Association (CTIA), and industry advocacy group, asserts that in
2004, wireless service providers received only about 7 percent the funds distributed from the federal Universal
Service Fund.
22
12 FCC Rcd 87, 101 (1996).
23
This mandate appears in CPUC decision D.96-10-066.
24
For the purposes of this memo, it is assumed that auction winners will be awarded 10 year franchises.
6
fitness. By compelling bidders to shave profit margins, reverse auctions are structurally prone to
producing untenable financial situations, and even bankruptcies. Also, require a bond for
auctions…
2.3. BIDDING
2.3.1. COMPLEMENTARITIES
Auction items are described as complementary for a bidder when they are worth more to
her together than they are separately. Thus, bidder 1 may be willing to pay price a for item A,
price b for item B, and price a+b+c for item A and item B. In this scenario c represents the
synergy value. Complementarities may be said to exist where c>0. A problem arises where
another bidder successfully competes for item B individually, leaving bidder 1 only with item A,
despite having paid price a+(c/2). However, there are at least two means to avoid this outcome.
Bidder 1 could be permitted to withdraw her bid on item A after learning that she did not win
item B. Alternatively, bidder 1 could condition her bid for item A on the acceptance of her bid
for item B, effectively bidding on item AB. This is referred to as a combinatorial auction. Both
options are discussed below.
2.3.2. INDIVIDUAL BIDDING
FCC spectrum auctions operate using ascending bid, simultaneous-close structure.25
Bajari and Fox describe this structure as follows:
“each auction lasts multiple rounds, where in all [spectrum] licenses are available for
bidding. During a round, bidding on all licenses closes at the same time. Simultaneous
bidding allows bidders to assemble a useful package of licenses from those available,
without the risk of a necessary license to complete a package being unavailable because
of an early close.”26
25
Patrick Bajari and Jeremy Fox, University of Michigan, Measuring the Efficiency of an FCC Spectrum Auction, 6
(2007).
26
Id. at 7.
7
Indeed, the FCC’s rules were explicitly designed to allow for complementarities.27 However,
because combinatorial bids are not allowed, bidders that try to assemble packages of
complementary licenses incur the risk of winning only a partial package at a total price
exceeding its value. The FCC rules do allow bids do be withdrawn, but generally subject a
withdrawing bidder to a penalty equal to the difference between the amount of the withdrawn bid
and the license’s final winning bid.28
International reverse auctions have largely relied on similarly-structured bidding systems.
More on Peru…
2.3.3. COMBINATORIAL BIDDING
In response the perceived shortcomings of individual bidding, economists have
developed a number of models for combinatorial auctions. The first and most influential of these
was developed by William Vickery.29 The Vickery auction is a one-shot sealed bid auction in
which each bidder makes a separate bid for each possible subset of items. Thus, in an auction for
item A and item B, bidders must each submit bids for item A, item B, and item AB.30 More
generally, in an auction for N items, bidders must each submit 2N-1 bids. It is then up to the
auctioneer to compute an assignment of the items which maximizes his revenue.31 While this
type of auction has been shown to achieve efficient results, it cannot be applied directly to
reverse auctions for universal service support. The CPUC presently classifies over 7,000
California CBGs as high cost.32 If bidders were each required to submit 27,000-1 bids,
determining a revenue-maximizing assignment of CBGs would be a mathematically intractable
27
FCC Report to Congress on Spectrum Auctions, WT Docket No. 97-150, 16-17 (1997).
28
Id. at 20.
William Vickery, Counterspeculation, Auctions, and Competitive Sealed Tenders (1961).
30
A bidder who does not value a given item or combination of items is, of course, free to bid 0.
31
Vickery, supra n. 29, at 2.
32
See http://www.cpuc.ca.gov/static/telco/public+programs/advisory+boards/chcfb.htm.
29
8
problem, or “NP complete.”
The Adaptive User Selection Mechanism (AUSM), introduced by Banks et al., offers one
solution to the intractability problem.33 AUSM auctions differ from the Vickery model in
several respects. Bids are not required for all possible subsets of items, and bidding takes place
continuously rather in discrete rounds.34 While the auction is open, bidders may submit as many
individual or combinatorial bids as they wish, but a new bid will be accepted only if it exceeds
the total of all the bids it displaces.35 The most distinctive innovation of AUSM auctions is the
use of a “standby queue” on which bidders may post bids that cannot, by themselves, displace
existing bids but which become available for use in new combinations.36 For example, suppose
bidder has placed a combinatorial bid of 20 for item ABCD. Bidder 2 is interested in acquiring
item AB for a price of up to 15, but has no interest in item CD. He may post a bid of 11 for item
AB on the standby queue. If bidder 3 is willing to pay up to 15 for item CD, then she may lift
bidder 2’s bid from the standby queue and submit it, together with her own bid of 10 for item
CD, thereby creating a bid of 21 for item ABCD and displacing bidder 1. Thus, AUSM auctions
shift the burden of determining optimal allocations to bidders, leaving the auctioneer with the
mathematically tractable problem of verifying that bids comply with auction rules.
Discuss Verizon’s clock proxy proposal here…
2.4. ALLOCATION OF SUBSIDIES
Subsidy allocation must chart a middle path between two undesirable extremes, best
described as “winner take all” and “everybody wins.”37 Most auctions for the sale of assets
33
Jeffrey Banks, John Ledyard, and David Porter, Allocating Uncertain and
Unresponsive Resources: An Experimental Approach (1989).
34
Paul Milgrom, Stanford University, Putting Auction Theory to Work: The Simultaneous Ascending Auction, 19
(1999).
35
Id.
36
Id.
37
Stegeman supra n. 10, at 20.
9
(including the FCC spectrum auctions discussed above) conform to the winner take all model, as
it creates the strongest incentive to submit low bids. However, granting universal service
subsidies exclusively auction winners would effectively create a substantial entry barrier for
competing carriers. In addition to harming consumers, such restricting of market forces is
inconsistent with the spirit and language of state and federal legislation.38 Conversely, under the
everybody wins model, the winning subsidy level for a given area would be offered to all carriers
willing to assume COLR obligations in that area. This approach is equally problematic, as
carriers would have no incentive to bid less than the maximum allowable subsidy. By awarding
competitors the same subsidies as auction winners, everyone wins becomes indistinguishable
from “winner gets nothing.”39
In lieu of these alternatives, most modern commentators agree that only winning carriers
should receive the subsidy levels for which they bid, with reduced subsidies available to
qualifying competitive carriers.40 These reduced subsidies would likely be expressed as a
percentage of the winning bid. Proposed percentages vary widely from 60% to 90%.41
Ultimately, this is a policy decision which requires the regulator to strike a balance between the
principle of competitive neutrality and the necessity of incentivizing low bids.
2.5. ENFORCEMENT
Subsidy dispensed on a per-line basis.
3. CONCERNS
3.1. STATUTORY COMPLIANCE
3.1.1. FEDERAL
38
See generally 47 U.S.C. § 254(b) (2006); see also CPUC decision D. 96-03-020.
Stegeman supra n. 10, at 20.
40
Id. at 21-22.
41
Alltel Wireless comments to WC Docket 05-337, 3 (2007); Stegeman supra n. 10, at 22.
39
10
3.1.2. STATE
3.2. BIDDER COLLUSION
3.3. STRANDED INVESTMENTS
Concerns over the potential of reverse auctions to strand investments focus on two
scenarios. However, neither appears to pose a substantial threat. In the first scenario, a carrier
fails to win the reverse auction for an area in which it is the incumbent. Provided that the
regulator has adopted a subsidy allocation policy similar to that discussed above, the incumbent
carrier will not be required to surrender its infrastructure. Rather, it may continue its operations
in the area while receiving subsidies at a percentage of the winning level.42 To ease this
transition and prevent service interruptions, Stegeman proposes an interim period during which
subsidy levels would be gradually adjusted.43 Weller correctly points out that requires the
incumbent to make Unbundled Network Elements (UNEs) to the winning carrier.44 However,
this obligation exists independently of universal service, and certainly cannot be equated with
stranding the incumbent carrier’s investments. Of course, the incumbent carrier may elect to sell
all or part of its facilities to the winning bidder. Merger between the two is also a possibility.45
The second concern is that incumbent carriers will avoid making long term investments
in infrastructure in light of the uncertainty created by reverse auctions. To the extent that this
restates the first concern, it rebuttable for the same reasons. Additionally, regulators may combat
protectionist tendencies by requiring bidders to meet certain buildout benchmarks.46 In
greenfield markets like those in South America, such requirements are routine.47
42
Whether this represents a gain or decrease depends upon what subsidy, if any, the incumbent carrier received
before the auction.
43
Stegeman supra n. 10, at 30.
44
Dennis Weller, Auctions for Universal Service Obligations, 29-30 (1998).
45
Id. at 30.
46
Alternatively, promises to invest in infrastructure could be weighted as auction criteria.
47
Stegeman supra n. 10, at 8-10.
11
4. CONCLUSION
Reverse auctions are feasible…
Use HM 5.3 to set maximum “reserve” subsidies…
Pilot programs first…
12