1 / 50

Economic Models to Value Spectrum

Economic Models to Value Spectrum. Rohit Prasad Associate Professor, MDI Gurgaon International Workshop on Spectrum Management National Institute of Communication Finance April 29, 2013. Agenda. Tragedy of the Commons Pricing Practices Difference between market and administered prices

tammy
Download Presentation

Economic Models to Value Spectrum

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Economic Models to Value Spectrum Rohit Prasad Associate Professor, MDI Gurgaon International Workshop on Spectrum Management National Institute of Communication Finance April 29, 2013

  2. Agenda • Tragedy of the Commons • Pricing Practices • Difference between market and administered prices • Economic Models • Reflections on the 2013 auction

  3. Thermometer Test

  4. Tragedy of the Commons

  5. What is being valued? • The right to exclusively transmit signals for a specified • Service • Technology • Frequency range • Geographical area With rules on power levels etc.

  6. Why is it being valued? • Why are exclusive rights given? • Why are these rights valuable?

  7. Tragedy of the commons • If operators are given free access to a scarce resource there will be congestion/overuse and reduction of social welfare • Toll is recommended • In the absence of spectrum sensing technology, even without scarcity, there could be congestion (unlike roads) Hence exclusive rights

  8. Why rights valuable? • Those given rights earn supernormal profits, and these supernormal profits represent the value of the rights

  9. Example Consider a common pasture of a village where the five people can potentially graze their cattle. Each head of cattle costs Rs. 100 which can be raised at 13% interest. Thus Rs. 13 is the marginal cost of putting another cattle to pasture. As the number increases the value reduces due to the lower availability of pasture per cattle.

  10. Exercise 1: How many cattle will graze? Exercise 2: How many cattle should graze?

  11. Solutions • Toll • Exercise 3: What should be the toll • Privatization • Exercise 4: What is the value of the pasture?

  12. Thermometer Test

  13. Mechanisms to discover value

  14. Mechanisms to discover value • Market mechanism • Operators gather data and build models, based on which they place bids in an auction • Bureaucratic mechanism • Bureaucrats gather data and build models, based on which they decide on an administered price • May use a discount • Administered price may be different from value

  15. Pricing Practice • Captive users use radio frequencies for their communication network • not in the business of providing telecom service • Commercial users in the business of providing telecom services using radio frequencies • Most spectrum in control of government agencies – captive users

  16. Pricing Practice • Auctions • License (2G spectrum) in 1995 • Migrated to revenue share in 1999 • License (2G spectrum) in 2001, 2012-2013 • 3G, BWA spectrum in 2010 • 2001 to 2012: 2G ‘spectrum price’ benchmarked to value discovered in 2001 auction • administered price progressively diverges from market value

  17. Pricing Practice

  18. Sample Calculation for Captive Spectrum • A. Royalty charges for single carrier radio spectrum (Usually below 1 GHz). • Annual Royalty per Carrier (in Rs.) = MxW, where, M is distance factor and W is bandwidth factor • Values of M are:

  19. Limitations • Band neutral • Demand neutral • Geography neutral • Technology neutral

  20. Administered Price for UAS License

  21. Subscriber Linked Criteria • Additional spectrum beyond startup amount allocated on the basis on subscriber milestones and attracts additional usage charges

  22. Sample Subscriber Linked Criteria

  23. Difference between market and administered price

  24. Difference between market and administered price • Administrative pricing in India has tended to be • focused on capabilities rather than demand • unchanging over long periods (static) rather than responsive to • changing conditions ( dynamic) • driven by engineers rather than economists • Non-transparent

  25. EXTERNALITIES AND MARKET INEFFICIENCY An externality refers to the uncompensated impact of one person’s actions on the well-being of a bystander. • Externalities cause markets to be inefficient, and thus fail to maximize total surplus. • Two types of externalities • Negative : Adverse Impact on the bystander. • Positive: Beneficial Impact on the bystander.

  26. Externalities: Examples Negative Externalities: • Automobile exhaust • Cigarette smoking • Carbon emissions of telecom towers Positive Externalities: • Research into new technologies • Diffusion of mobile telephony and data services • Provision of basic services • Productivity increase

  27. EXTERNALITIES AND MARKET INEFFICIENCY • Negative externalities lead markets to produce a larger quantity than is socially desirable at lower price • Tax needed • Positive externalities lead markets to produce a smaller quantity than is socially desirable at higher price • Subsidy needed

  28. Economic Models of Valuation

  29. Economic Models of Valuation • “Nothing is more useful than water; but it will purchase scarce anything. A diamond on the contrary, has scarce any value in use, but a great quantity of other goods may …be had in exchange of it.” Adam Smith

  30. Economic Models of Valuation • Focuses on demand as well as supply • Values something in terms of the additional surplus earned by its possession ( opportunity cost) • Explicitly factors externalities

  31. Economic Models • Cash Flow • Production Function • Benchmarking with closest market value

  32. Thermometer Test

  33. Cash Flow Method • Imagine you get access to a park • Using some playground equipment I am able to earn Rs. 100 of revenue • My costs are Rs. 40 • What is my profit? • If I had put the investment I made in the park in the next best alternative I would have made Rs. 35 • What is my ‘supernormal profit’? • Exercise 5: What is the value of the park to me?

  34. Cash Flow Method • 25/(1+r) + 25/(1+r)^2 + … • Problem: the earning in the alternative investment cannot be determined without knowing the value of the park • So we are going to have to solve an equation! • Assume park was being given for a year • Let the rate of interest be 10% • Denote value by v • Earning in alternative investment = v.10% • Then v = (60 – v. 10%)/(1+ 10%) Profit

  35. Suppose park being given in perpetuity • V = (60 – v. 10%)/(1+ 10%) + (60 – v. 10%)/(1+ 10%)2 + (60 – v. 10%)/(1+ 10%)3 + … • Using formula on sum of geometric series, • V = (60 – v. 10%)/ 10% • V = 60/(2. 10%)

  36. Application to Spectrum • Start with ‘representative firm’ with subscribers in proportion to its spectrum holding, 6.2 MHz • Cash Flow in a Year = Revenue – (License Fee +Spectrum Charge + Network Cost + Administration, Marketing, & Operational Cost) • Revenue = subscribers . ARPU • Network cost assessed by taking average number of BTSs held by operator with 6.2 MHz of spectrum • Admin, marketing and operations 28% of revenue • Assume return on investment in alternative use is 20%

  37. Extracting Value of 1800 MHz • Let the percentage of 900 MHz spectrum be 60% • Then 60%. Value of 900 MHz + 40%. Value of 1800 MHz = value of blended spectrum • Let ‘k’ represent the additional productivity of 900 MHz spectrum • This is different in different markets 60%. K. Value of 1800 MHz + 40%. Value of 1800 MHz = value of blended spectrum Solve equation for value of 1800 MHz

  38. Table 7: Price of contracted spectrum 1800 MHzRs. Crore per MHz 2010 (20 year license)

  39. Thermometer Test

  40. Production Function Method • Production function gives the total number of subscribers that can be serviced, for any given combination of spectrum and BTSs • Derived by statistical estimation using data on subscribers, spectrum and BTSs of operators in relevant circles over relevant years • Allows estimation of the number of BTSs saved by possessing an additional unit of spectrum • Cost of BTSs saved represents value of spectrum

  41. Method of estimation • We estimate a Cobb Douglas production function • Very general specification that encompasses diminishing returns, economies of scale • Used widely in the literature

  42. Data • We use a panel data collected over 7 years across all the 23 circles for different GSM operators providing services in their respective circles • Estimate statistically significant values of A, β, γ • Ln A = -6.83 • β = 1.23 • γ = 0.66 • Limitation: Data not available at sub-circle level

  43. Model for Allocative Efficiency First Order Condition Price Ratio Quantity Ratio Productivity Ratio Seminar @ NUS

  44. Benchmarking with Auction Values • Many methods • Sector -specific • General • Sector-specific • Value in 2001 . Percentage increase in revenue per MHz/Percentage increase in BTSs • Adaptive expectations • Such methods are relevant at proximate times

  45. Limitations of Economic Models • Sensitive to assumptions • Difficult to factor externalities

  46. Auctions • Need to guard against collusion ( reserve price) • Possibility of winner’s curse

  47. Failure of 1800 MHz auction • Divergence between value of 1800 MHz and 2100 MHz • 1800 MHz 40-50 % in value • More valuable in cat B and cat C circles • That is why benchmarking reserve price to 2100 MHz resulted in poor bidding in Metros but OK results in cat B and cat C

  48. Concluding Thoughts • Economists and engineers both invaluable for valuation • Academics and practitioners need to provide inputs • Auctions cannot be discarded without understanding reasons for failure • New technological possibilities Can NICF lead the way?

  49. Thank you

More Related