Spectrum fees: saying the quiet part out loud

In 2001, while looking at the relative failure of the Swiss UMTS auction, Wolfstetter noted that:

The revenue from the efficient sale of radio spectrum is one of those rare examples of a distortion-free tax. Most other taxes, from sales to income tax, exert enormous efficiency distortions […] The bottom line is that, even if efficiency is the primary objective, one should sell radio spectrum by a mechanism that maximizes revenue in the class of efficient mechanisms.

Wolfstetter E, 2001, “The Swiss UMITS Spectrum Auction Flop: Bad Luck or Bad Design?”, available at https://www.econstor.eu/bitstream/10419/62728/1/725384379.pdf

This assertion was in line with the consensus that prices paid for spectrum at auction should be considered as sunk costs – they would have no impact on business decisions of the operators going forwards, and so there was no downside to high spectrum fees resulting from highly competitive auctions.  Such an assertion was repeated by Kwerel:

Standard economic theory predicts that sunk costs are irrelevant to the pricing and output decisions of firms. A sunk cost is one that is not escapable. It does not vary with output or even if the firm goes out of business, and thus should have no effect on any business decision. The amount paid for a spectrum license in an auction is such a sunk cost. Once it is paid, the payment cannot be recovered from the government and it does not vary with output. Therefore, the historical cost of winning bids at auctions should have no effect on the price or availability of spectrum-based communications services for customers.

Kwerel E, 2000, “Spectrum Auctions Do Not Raise the Price of Wireless Services: Theory and Evidence” available at https://wireless.fcc.gov/auctions/data/papersAndStudies/SpectrumAuctionsDoNotRaisePrices.pdf

Various papers produced at the start of the 2000s seemed to reinforce this – Morris (2005) and Bauer (2003) looked at how consumer prices seemed to be unaffected by spectrum prices, while Cambini & Garelli (2007) looked at the impact on overall revenue.  However, no paper directly looked at potential impacts on the investment decisions of firms directly, and for many years mobile operators have been arguing against the idea the high spectrum fees would have no impact on their network deployment plans – even if simply due to availability of finance.

It has been convenient for regulators to ignore these pleas, as they continued to use auctions to assign spectrum to operators in an ‘economically efficient’ way – that is, giving spectrum to those who would be able to extract the most private profit from it. Such auctions have, on occasion, extracted large sums from the operators, and at times this has directly affected the value of spectrum to the firms who found that they could not invest in their network to make best use of the spectrum once their cash flow had been restricted.

Back in 2017, the GSMA published a study with quantitative evidence that high spectrum spend in Europe directly led to “lower quality and reduced take-up of mobile broadband services”. This has been followed by many other papers examining the way that network deployment is affected by availability of finance and the cost of spectrum.

This evidence may have finally had an effect. In the white paper published last week, the European Commission stated:

in certain cases where spectrum bidders ended up paying higher prices due to artificial scarcity created by auction design, this has been associated with a reduction in investment capacities and delays in services deployment by providers of electronic communications networks and services. Ultimately, it is the consumers and business users who have paid the price in terms of suboptimal quality of services, which ultimately negatively impacts EU’s economic growth, competitiveness and cohesion.

European Commission (2024), “How to master Europe’s digital infrastructure needs?”, available at https://digital-strategy.ec.europa.eu/en/library/white-paper-how-master-europes-digital-infrastructure-needs

It’s not clear why the scarcity of spectrum here is ascribed to the auction design, rather than the reality of physics meeting a defined number of operators, but the outcome of this thinking is clear – high spectrum prices can lead to low investment and poorer quality of service. Based on this, the concept of ‘cashless’ auctions has been proposed, with operators not paying a fee for spectrum directly but instead committing to certain investment levels. Other reasons for these auctions – such as allowing for social welfare and other efficiencies – do not stand up to scrutiny, so these seem to be a direct response to the relationship between spectrum fees and investments.

Over time, spectrum prices have been falling in any case, due to high costs of entry reducing the potential for new operators in markets and the increased availability of spectrum. Yet prices at auctions are still high, and there could have been a significant negative impact on network deployment already. Finding some way to reduce the cash requirements of future awards can help spur investment.

Regulators must consider this in future spectrum awards – but this is only one change needed; we will look at some of the other issues in future notes.