Appendix C to the Notice of Proposed Rulemaking
Supplement to Appendix C: Auctionomics/Power Auctions Option for Forward Auction (February 1, 2013)

Incentive Auction Rules Option and Discussion

Auctionomics and Power Auctions have submitted this exhibit to the Incentive Auction NPRM at the request of the Commission’s staff. Its purpose is to elicit more focused comments and to present a specific option that integrates all the key elements of the Incentive Auction design for television broadcast spectrum. There may well be other options that also are likely to achieve the goals of the Incentive Auction.

The Incentive Auction has three distinct components. One is a Reverse Auction, in which television broadcasters may offer to relinquish certain broadcast rights in exchange for cash compensation. These relinquishments may include going off-air, sharing a channel, or moving to a lower broadcast television band. The second component is a Forward Auction, in which bidders may offer to buy newly created flexible use licenses. The Reverse and Forward Auctions are connected by a third component, the Clearing Rule, which sets and revises the quantities to be transacted in the Reverse and Forward Auctions and determines when the Incentive Auction as a whole should end.

All three parts of the design raise novel challenges and in this document we present an auction design option that addresses each of these components.

Reverse Auction: Broadcasters bid to voluntarily relinquish spectrum rights

For the Reverse Auction, the most unusual challenge arises because the quantity of spectrum cleared depends not only on the broadcast licenses relinquished in the auction but also on how the remaining broadcast stations – the ones that are not sold – are assigned to channels. Additional complications arise because the Reverse Auction must account for more possibilities than simply selling broadcast rights. In exchange for compensation, some stations may be willing to switch from broadcasting on a UHF channel to broadcasting on an upper VHF or lower VHF channel; others may be willing to engage in channel-sharing, combining their digital signals to be carried on a single channel; and still others may be willing to tolerate some increase in the area where their signals suffer interference.

Despite these complexities, the auction process needs to be simple and easy enough to encourage and facilitate the participation of a wide array of broadcasters. In particular, the auction we propose – a descending clock auction – is designed to make it very easy for broadcasters to make optimal bids.

As a simple example of how the descending clock auction works to clear a fixed number of channels, suppose that the FCC needs to clear three stations in some market and that five stations have indicated a willingness to sell at the reserve price. Suppose that all five stations are broadcasting from the same location, so clearing any three would meet the FCC’s needs. During the auction, the FCC offers a sequence of declining prices until one station says “no.” At that point, four stations are still offering to go off-air, and the FCC just needs three, so there is still excess supply. The FCC continues to lower the offered price until a second station says “no.” At that point, just three stations remain. There is no longer excess supply, so the auction Incentive Auction ends. The two stations that exited the auction are assigned channels, and the three remaining stations are paid the last offered price to go off-air.

More generally, stations within a market may have different coverage areas, so they are not fully interchangeable as in the simple example. Also, bidders may offer to move to a lower band, e.g. from UHF to upper VHF, rather than offer to go off-air. Nevertheless, the auction will look similar from the broadcasters’ perspective.

Prior to the auction, the FCC will set a reserve price or maximum payment for going off-air and also reserve prices for moving to a lower band. To participate in the auction, a broadcaster must choose at least one option at its reserve price. As the auction proceeds, the FCC will offer the broadcasters progressively lower prices. Once a broadcaster says “no” to its current offers, it exits the auction and is guaranteed a channel in its pre-auction band. As this happens, the FCC will check every active bidder to determine whether it still would be possible to assign that bidder to its pre-auction band, given the set of bidders that have exited so far. For those active bidders whose exit is feasible, the price offers for different relinquishment options may be reduced with the goal of reducing excess supply in the UHF and VHF bands. The auction will continue until so many bidders have exited that all excess supply is eliminated and the FCC needs to accept the bids of all the non-exited bidders in order to meet its provisional clearing target. At the end of the auction, every bidder that has not exited will receive its last selected relinquishment option and be compensated according to the last accepted price offer for that option.

This auction has several attractive properties. First, it guarantees that two stations that broadcast in the same band with the same coverage area will receive identical price offers for all relinquishment options. Second, it asks only for the information it needs: no winning bidder reveals any information about how low it would have been willing to go. Third, it makes bidding well very simple. For a bidder that is considering only the option of going off-air rather than maintaining its UHF license, the hardest part of bidding will be to determine its value of continuing to broadcast. Once it knows that value, the rest is easy. The bidder cannot do better than to agree to accept any price greater than its value of continuing to broadcast and then to exit if its offered price falls lower than that. By bidding in this way, the station will obtain its best possible price for going off-air, and will not go off-air if that price is below the value it assigns to staying on-air. The auction is equally simple for a station that is deciding whether to continue UHF broadcasting or to exchange its license for a VHF license plus cash compensation. For this broadcaster, the hard problem is to determine how much value it would lose from switching bands. The optimal bidding strategy is equally easy: the station should remain in the auction unless the price it is offered for moving to VHF falls below this value. If the offered price does fall below this level, it should exit.

Bidding is easiest for broadcasters like those described that are considering just one option besides continuing to broadcast. A broadcaster that is considering multiple options, such as going off air, sharing with another bidder, or switching to a lower band, must track and evaluate multiple price offers and decide which one it considers best. But the bidder still has nothing to lose by participating: a bidder that Incentive Auction considers all of the price offers to be too low always has the option to reject them all, exit the auction, and be assigned a channel in its current band to continue broadcasting.

To make bidding easy for bidders, this auction proposal has been designed so that all the computational challenges fall on the FCC. Essentially, the computational problem for the FCC is to determine how much it can lower the prices it is offering to broadcasters, and in what order, while still getting enough “yesses” to meet its provisional clearing target. In order to do this, the FCC must calculate during the auction which stations are in “excess supply” in the sense that the provisional clearing target could be met without accepting the station’s bid, taking account of interference rules and treaty obligations with Canada and Mexico. At each round of the auction, the FCC will decrement the prices offered to bidders in excess supply, and rounds will continue until there are no stations in excess supply. The rules of the auction option described here also include a processing rule to determine which stations become winners if several stations decide to exit the auction or move bands in a given round, but the FCC cannot implement all of these changes together while meeting the provisional clearing target. The Reverse Auction section below contains more details.

Forward Auction: Bidding for new flexible use licenses

The main challenges for the Forward Auction arise from uncertainty about how many licenses will be available for sale and how they might be encumbered (which cannot be predicted with certainty before the Reverse Auction is complete), possible variations in the amount of bandwidth available in different areas, and the desire for a faster process compared to past FCC auctions. A faster Forward Auction is valuable because the outcome of the Reverse Auction cannot be determined until the nearly completed Forward Auction lets the FCC decide how much it can afford to pay to clear spectrum. Long delays in the Forward Auction could raise costs and discourage participation in the Reverse Auction.

Our primary option for the Forward Auction is an ascending clock auction that is an evolution of the FCC’s long-used SMR (“simultaneous multiple round”) design. The changes it incorporates should permit the auction to be completed in a fraction of the time that would be required by a traditional SMR auction, with no loss of efficiency or added difficulty for bidders. The three key changes are as follows:

  1. Licenses are generic.

    During the main phase of the auction, bidders specify how much spectrum they want in a particular geographic area, e.g. 40 MHz (20 MHz uplink + 20 MHz downlink), rather than specific frequencies (e.g. blocks A, B, D, F). The auction winners are assigned specific frequencies in a separate “assignment phase” of the auction.

  2. The design is a clock auction.

    At each round, the FCC announces prices for the licenses, raising the prices of the licenses that were in excess demand in the prior round. The bidders then state their demands, that is, the amount of spectrum in each area they wish to buy at the announced prices.

  3. There are no provisionally winning bidders designated at the end of each bidding round; intra-round bidding is used instead.

Intra-round bidding ensures that prices never increase so much that the number of units demanded for a type of license falls from above to below the available supply, leaving licenses unsold when there are willing buyers. Intra-round bids allow bidders to express the price points in the interval between the start-of-round and end-of-round prices at which they would change their demands and to specify how their demands would change.

This clock auction option reduces the number of rounds required for completion in two ways. First, compared to the SMR, it often compresses several rounds into one, since bids are for quantities rather than specific frequencies. For example, in an auction with four similar licenses and five bidders, an SMR can take four rounds of bidding for the prices of the four licenses to rise by one increment. In this clock auction option, the same price increase happens in a single round. Second, the clock auction with intra-round bidding permits the auctioneer to name larger prices increments without the danger of overshooting that an SMR auction with similar increments would suffer. The reason is that bidders in the clock auction are permitted to make bids at fractional increments. For example, a bidder can specify that when prices have increased by half of the auctioneer-specified increment, the bidder will reduce its demand or to switch demand from one product to another.

The clock auction also has the benefit that identical licenses will sell for the same price, something that is not guaranteed in the traditional SMR design.

Clearing Rule

Finally, designing an effective Clearing Rule that links the outcomes of the Forward and Reverse Auctions presents additional challenges. The Clearing Rule needs to ensure that the quantities of wireless broadband licenses to be sold in the Forward Auction correspond to what can be supplied using the broadcast licenses acquired in the Reverse Auction. This correspondence is more complicated for the Incentive Auction than for ordinary commodity auctions, on account of two factors. First, assuming the flexible spectrum is licensed in multiples of 5 MHz, the number of paired 5MHz wireless broadband licenses that can be created in any area is not strictly proportional to the number of unpaired 6MHz broadcast channels cleared. This non-proportionality is described in more detail in the next section. Second, the numbers of wireless broadband licenses available in different areas cannot be determined independently, both because some broadcasters’ service areas may overlap several wireless broadband license areas and because there are benefits to having a consistent band plan across the nation.

To align bidding in the Forward and Reverse Auctions, the Clearing Rule sets a series of targets for the number of licenses to be sold in each region in the Forward Auction and for the number of UHF broadcast channels to be cleared. The Clearing Rule also sets Closing Conditions determining when the auctions can end based in part on the Net Revenue (the difference between the Forward Auction proceeds and the corresponding procurement cost in the Reverse Auction). The auctions begin with an initial provisional spectrum target that is set high, aiming to buy the rights necessary to achieve that target in a descending auction and to sell the corresponding flexible use (e.g., wireless broadband) licenses in an ascending auction. If running the Reverse and Forward Auctions with the initial provisional spectrum target satisfies the Closing Conditions, the Incentive Auction closes. Otherwise, the provisional spectrum target is reduced and the auctions continue.

The rest of this document describes these proposals and their logic in greater detail, beginning with a discussion of the conversion of channels into paired bands.