Hong Kong’s hybrid approach to 3G spectrum renewal creates a “freerider” problem for the incumbents

Hong Kong’s Office of the Communications Authority (OFCA) has decided to adopt a hybrid approach to the renewal of incumbents’ 3G spectrum. OFCA will distribute two thirds of the spectrum to the incumbents through an administered allocation process and the remaining third will be put up for auction. The incumbents have the opportunity to reacquire the spectrum through the auction but it also opens up the opportunity for a new player (and many are speculating the China Mobile Hong Kong is the primary candidate) to acquire the spectrum.

When incumbents value spectrum one of the most significant sources of spectrum value attributed to spectrum in an auction is the ability to block new market entry. This “blocking value” can be very high for incumbents, especially in mature markets, as a new player seeking to win share to drive economies of scale often sparks a value destroying pricing or commission war – the experience of Three entering the UK market is a good case in point.

China Mobile may place a high strategic value on gaining access to 3G spectrum in Hong Kong and so the cost of blocking in the auction could be high. All the incumbents have an incentive to block new market entry. However, in an ideal world an incumbent would prefer “freeride” and rely on another incumbent to pay any premium for market entry. This creates a coordination problem for the incumbents and this risk is that they fail to “reach agreement” through their bidding strategies as to who will take the responsibility for blocking. The result may well be that new entry occurs despite all incumbents being heavily incentivised to avoid it.

Written by Graham Friend, Managing Director, Coleago Consulting

An upset in Norway following an auction of existing spectrum assets

In my article on spectrum renewal by auction, which was recently published on www.telecoms.com, I highlighted the potential risks that the Norwegian regulator, the NPT, was taking in renewing spectrum using a first price sealed bid auction. http://www.telecoms.com/197611/uncertainty-and-risk-the-results-of-spectrum-renewal-by-auction/ In the article I asked whether Norway would provide the first real upset and whether an incumbent would be deprived of key spectrum assets.

The NPT announced the results of the auction today and whilst incumbents Telenor and NetCom secured spectrum in the key 800, 900 and 1800MHz bands the other incumbent, Tele2, failed to win any spectrum at all. Tele2’s CEO, Mats Granryd made clear in the company’s press release that they regarded the auction outcome as an upset. Granryd said, “We are obviously not satisfied with the outcome of the auction, but we will continue to build on our strong position in Norway.” Instead of Tele2 securing spectrum, the mysterious Telco Data secured a robust portfolio of spectrum assets comprising 2×10MHz in the 800MHz band, 2×5MHz in the 900MHz band and 2×20MHz in the 1800MHz band.

So what contributed to this upset?

The choice of auction format is the primary candidate. In a first price sealed bid auction bidders effectively write a number down in an envelope and the highest bidders win and pay the amount they each bid. In such an auction it makes sense to bid less than the value you place on the spectrum or, as game theorists like to say “shade your bid.” The challenge, however, is to determine how much to shade your bid. Shade aggressively and if you are successful in the auction you create significant value. The risk, however, is that you shade too aggressively and someone with a lower valuation, but who shaded less aggressively, wins the spectrum.

Coleago Consulting has supported operators in over 60 spectrum auctions and we have worked on behalf of both incumbents and new entrants. As markets have matured it has become increasingly apparent that the business case for new market entry is not an attractive one and heroic assumptions are often required just to turn the business case positive. Tele2, as the smallest player in the Norwegian market, may well have taken the view that they only needed to outbid a new entrant and that a new entrant would have had a very low valuation. As a result Tele2 may have decided to shade very aggressively in the hope of securing spectrum at a low price and thus create significant value. The combination of very aggressive shading from Tele2 however and a super charged new entrant business case is likely to have generated the upset.

Written by Graham Friend, Managing Director at Coleago Consulting

Brussels on attack over pay-TV rights

Territorial restrictions placed on TV anywhere apps adds another dimension to the UK pub test case with regards to the single EU market for digital services

The week-end edition of the Financial Times (23 Nov 2013), lead with “Brussels on attack over pay-TV rights”, reporting on the anti-trust probe by European commission over pay –TV rights. This was prompted by the case of the British publican fined for showing football to UK customers using a satellite card from Greece.

The UK pub test case is only the tip of the iceberg in the challenge rights holders and the digital media industry face.  TV anywhere apps such as “Virgin TV Anywhere” or “Sky Go” give consumers the ability to watch the subscribed channels away from home over the internet. However, a British pay-TV subscriber on holiday in Spain wanting to watch a Premier League football match on his iPad would find the viewing blocked because access is only allowed from within the UK.  In the physical world this is akin to a British holidaymaker being blocked from reading a book on the beach in Spain, with the excuse that the book was bought London.

I am sure that pay-TV operators would like to grant their customers access from anywhere within the EU because this would add value to their service. The problem lies with the country based approach to TV rights. The 2011 judgement with regards to the Premier League may not have considered the issue because at that time TV-anywhere apps did not yet exist. The EU is keen to promote the “connected continent” and should take vigorous steps to ensure that consumers are free consume digital media anywhere within the EU, regardless from which EU country the service is played out.

Written by Stefan Zehle, CEO, Coleago Consulting

Misguided approach to EU intervention on roaming charges

In her speech on the 9 July 2013, Neelie Kroes, Vice-President of the European Commission responsible for the Digital Agenda, reiterated her assault on roaming charges within the EU. There is talk of regulatory intervention to eliminate roaming charges within the EU.

While mobile operators may earn good margins on roaming, a mandated elimination of roaming charges is ill conceived because mobile operators in different EU countries face different costs. One of the most significant investments made by mobile operators is in buying spectrum.  For example, for the 800MHz digital dividend spectrum, operators in Denmark paid €0.30 per MHz per head of population (€/MHz/pop) whereas in France, operators paid €0.67/MHz/pop i.e. 123% more.  Some cash strapped EU countries set high reserve prices for spectrum €0.58/ MHz/pop in Italy vs. €0.10/MHz/pop in Denmark. Coupled with differences in deploying 4G LTE coverage, this translates into hundreds of million euro differences in capex.

Furthermore there are significant differences in the timing of spectrum allocations and hence the deployment of LTE which translates into huge cost differences for mobile data. Assuming investors like to earn similar returns, these cost differences will result in different wholesale and retail prices. Therefore it does not make sense to mandate the same retail prices regardless of the country in which the traffic occurs.

If the EU and its member countries are really so keen on a single telecoms market, why not start by allowing operators regardless of their country of operation to select a national telecoms regulator of their choice to regulate them.  I suspect the Danish regulator would attract quite a few “customers” whereas the Italian and Greek regulators might go out of business. The resulting reduction in regulatory costs could be passed on consumers in form of lower retail prices.

Written by Stefan Zehle, CEO, Coleago Consulting

Towards a single EU telecoms market

In a speech delivered at Mobile World Congress 2013, Neelie Kroes, European Commissioner for Digital Agenda, called for the creation of a single telecoms market in the EU. Kroes iterated that it would be of great benefit to the European telecoms industry as well as consumers. There are numerous aspects to this, but mobile telecoms and notably spectrum allocation is most notably one of the focal points.

In recent times, common EU policy has led to the harmonisation of mobile spectrum and technology in the form of GSM at 900MHz and 1800MHz. One could argue that it is this which kicked off the global boom in mobile communications as a result of delivering low equipment prices (terminals and network) as well as international roaming. The benefits to both the European industry and users are undeniable. Mobile communications is now a global business and with the inclusion of multiple LTE bands on chipsets, harmonisation is perhaps a little less important from the technology perspective, but it still matters from a business perspective.

Spectrum allocation mechanisms and prices paid by operators are driven by national policy objectives. Some governments (e.g. Finland) rightly think that spectrum should be made available to operators as cheaply as possible since ultimately this generates the greatest benefit to society. Others (e.g. Ireland and Greece) focus on immediate cash generation. Views on competition may also differ. The 800MHz auction rules in France are a good illustration of a government ensuring the survival of the 4th entrant, whereas in the highly competitive UK market, competition does has not been a big issue in the recent spectrum auction.

These policy differences result in very different costs for mobile operators and yet there is an assumption that prices, notably wholesale prices should be standardised across the EU. Clearly there is a contradiction.

Another key point in pushing for an EU wide approach to telecoms regulation is that cross-border mergers should be made easier in the EU. The fragmentation of telecoms services provision within the EU is a barrier to the single market. An innocent bystander might ask a whole series of questions which demonstrate that the current EU mobile and fixed regulatory environment is unsatisfactory, for example:

—Why is it that a call on a mobile network within a country tends to be included in the bundle whereas a call to a neighbouring country is usually priced at a premium?

—Austria has a smaller population than Bavaria, so why does T-Mobile run Austria as a separate business from its German operation?

—Why are mobile numbers portable within a country but not within the EU?

The current structure of the EU telecoms industry and markets are an artefact of national telecoms regulation. Faced with competition from global OTT players who are not bound by national regulatory regimes, it is the European telecoms companies who suffer. Both industry and end-users would greatly benefit from a truly EU wide approach to telecoms policy and regulation.

Written by Stefan Zehle, CEO, Coleago Consulting

Is time running out for the Combinatorial Clock Auction format?

Earlier this month, I attended the Spectrum Management Forum 2012 in Munich and was interested to hear several presenters criticise the Combinatorial Clock Auction (CCA) format. The CCA format which has clock and supplementary rounds where bidders bid on indivisible packages of spectrum and where prices paid are determined by a second price rule has in the last few years found increasing favour by many governments for spectrum auctions. Under the second price rule, the price a winner of a particular package pays for its spectrum is determined entirely by competitors’ bids.

Supporters of the CCA format, claim that it results in more economically efficient outcomes and reduces aggregation risk where there may be complementarities between lots e.g. between high and low band spectrum.

Most of the criticisms of the CCA format relate to the fact that it is incredibly complex to prepare for, that the outcome is not very transparent and it can lead to perverse results. But there are other issues that for instance competitors can “game” the system and drive up prices paid by other bidders by bidding on larger packages that they do not sincerely want to win. In addition it represents a difficult issue for companies to deal with from a corporate governance point of view in terms of establishing bid limits and deciding whether to bid sincerely.

We can confirm that complexity is a serious issue as one CCA auction that we have been involved in required our client to value more than one hundred thousand different spectrum packages to prepare for the supplementary round. In terms of strange results there have been several auctions where there have been very large disparities in prices paid e.g. the 2012 Swiss multi-band auction and the 2010 Danish 2.6GHz auction.

We have worked with most major auction formats and while CCA was introduced with good intentions we are starting to doubt that the benefits outweigh the disadvantages.

Written by Scott McKenzie, director, Coleago Consulting

Wireless Industry Consolidation in the USA: AT&T’s blocked acquisition of T-Mobile

The troubles of T-Mobile go back many years and are related to inferior spectrum holdings: “We were late with 3G”, said Neville Ray, SVP, engineering and operations T-Mobile USA, in March 2009. Since then T-Mobile acquired spectrum in several auctions and launched 3G, but it still has an inferior spectrum position. Spectrum auctions, beloved by the FCC, often cause reduced competition in wireless markets because the business case for spectrum auctions always looks better for larger operators. One of the largest components in deciding how much to bid for spectrum is the value arising from denying spectrum to rivals. If the US government had wanted more competition at network level it could have chosen a method of spectrum allocation other than unfettered auctions.

However, developments in the wireless industry have moved the goalposts and sooner or later the Justice Department will have to relent on its opposition to the proposed acquisition.  In developed wireless markets there is now very little growth in the wireless industry revenue, i.e. the industry is mature.  At this point of the industry life cycle management focus shifts from seeking revenue growth to taking out costs, for example through consolidation.

The physical network is increasingly a commodity, whereas there is increasingly fierce competition at retail level. In many markets consolidation at network level went hand in hand with increased competition at retail level with the launch of multiple Mobile Virtual Network Operators (MVNOs) and branded resellers. If the Justice Department and the FCC are concerned with competition they could make approval conditional on incorporating provisions into the acquisition that make it easier for MVNOs to enter the US market. Having said that, T-Mobile’s case is not helped by the smoking gun in T-Mobile’s past: In October 2009 Deutsche Telekom’s CFO Timotheus Hoettges insisted there was no need for further consolidation of the US wireless market: “There are four national players in the US market for 300 million households, while in Europe, where we have 350 million households, there are 50-70 operators.”

Written by Stefan Zehle, CEO, Coleago Consulting

Making sense of recent European spectrum auctions

Regulators across Europe are busy this year auctioning spectrum in the 2.6GHz spectrum frequency range as well as other frequencies including the 800MHz Digital Dividend. 800MHz spectrum is clearly of great value to operators as the equivalent US auction demonstrated. The low frequency allows the radio signal to propagate further which means that fewer base stations and hence capital expenditure is required to provide coverage compared to higher frequencies such as 2.6GHz. This makes the spectrum ideal for supporting mobile broadband services at manageable levels of cost. The lower frequency range also provides better in-building penetration and as mobile broadband usage seems to be predominantly in-doors, this further increases its attractiveness. The first significant auction of spectrum in the 800MHz band is currently taking place in Germany and bidding levels have already reached 0.67 $/MHz/Pop. At this level the price paid is greater than the prices paid in the heady days of the Dot Com book for 3G spectrum in Denmark and Austria but it is still considerably lower than the US 700MHz auction average of 1.18 $/MHz/Pop. If German prices reached this level it would also put them on a par with the auctions of 3G spectrum in the Netherlands and Italy at the start of the new millennium. Prices would then have to increase by more than three fold to reach the German 3G auction price levels. Prices may well continue to move higher but with few other benchmarks available it is too early to draw any significant conclusions regarding this spectrum band but at present the bidding levels look reasonable.

In contrast to 800MHz there has been much greater activity in relation to 2.6GHz spectrum. Norway, Finland and Sweden auctioned their spectrum in 2007, 2008 and 2009 respectively. This year the Netherlands and Denmark have already concluded their 2.6GHz auctions, the auction in Germany is on-going and at least a further six 2.6GHz auctions are expected at some point during 2010 (France, Spain, Poland, Portugal, Switzerland and Belgium are all expected to hold auctions this year). Mobile operators will be busy preparing their 2.6GHz business cases in preparation for the auctions and in doing so they will be attempting to make sense of the results of the spectrum auctions that have already taken place. This is no easy task when the highest price paid so far in Europe (Sweden, May 2008) is almost 135 times greater than the lowest (the Netherlands, April 2010). Analysis is further complicated by the fact that in most auctions the paired spectrum (FDD) has commanded a premium to un-paired (TDD) spectrum which in some cases attracted no bids at all (Netherlands). However, in the case of Finland the result was reversed with the TDD spectrum priced at a premium to FDD.

Attempting to make sense of these results requires the consideration of a great many factors. The timing of the auctions is important as some occurred before the start of the on-going financial crisis. The licence conditions attached to the spectrum, such as coverage requirement, should also be considered. These vary from regulator to regulator and the more onerous the coverage requirements, for example, the less valuable the spectrum. However, in the end, the final price paid in an efficient auction will determined by relative levels of spectrum supply and demand. The regulators have taken different approaches when it comes to supply and have auctioned blocks ranging from 2x5MHz to 2x20MHz and everything in between. Caps on total spectrum holdings have also been imposed in some cases. The fewer unique blocks that are offered the greater is the potential for demand to outstrip supply. On the demand side the most significant factor is the number of incumbent operators and in Europe this varies from 2 in Norway to 4 in markets like Denmark and Sweden. There has also been demand from new entrants usually arising from the existing cable operators such was the case in the Netherlands. In addition to the number of potential bidders demand will also be influenced by operators’ expectations of future mobile data traffic. Mobile data traffic is growing exponentially and no one has a clear view of where demand levels will be in 15 or 20 years time which is the typical term for the new spectrum licences. Not only must operators contend with uncertainty over traffic levels there also remains uncertainty over what levels of data throughput can actually be achieved when technologies such as LTE and MIMO are implemented in this frequency range and have matured. On the issue of TDD versus FDD it would seem that there is a reasonably clear trend that the FDD spectrum is more valuable than the TDD spectrum however this is not always the case and the relative valuations can vary significantly.

Despite a reasonable number of 2.6GHz auctions having taken place it is almost impossible to draw any firm conclusions especially as the design of each auction is also subtly different which can have a major impact on participant’s bidding strategies and ultimately the price paid. As a result, for any operator facing a 2.6GHz auction little conclusive insight can be drawn from the results of the 2.6GHz spectrum auctions to date. Therefore in order to prepare for an auction a country, operator and auction specific business case will be required to value the spectrum and to allow the operator to bid with confidence.