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What Really Matters in Auction Design
Paul Klemperer
A
uctions have become enormously popular in recent years. Governments are now especially keen, using auctions to sell mobile-phone licenses, operate decentralized electricity markets, privatize companies and for many other purposes. The growth of e-commerce has led to many business-to- business auctions for goods whose trade was previously negotiated bilaterally. Economists are proud of their role in pushing for auctions; for example, Coase (1959) was among the rst to advocate auctioning the radio spectrum. But many auctions—including some designed with the help of leading academic economists—have worked very badly. For example, six European countries auctioned off spectrum licenses for “third-generation” mobile phones in 2000. In Germany and the United Kingdom, the spectrum sold for over 600 euros per person ($80 billion in all, or over 2 percent of GDP). But in Austria, the Netherlands, Italy and Switzerland, the revenues were just 100, 170, 240 and 20 euros per person, respectively. To be sure, investors became more skeptical about the underlying value of the spectrum during 2000 (and they are even more skeptical today). But this is just a fraction of the story. The Netherlands auction was sandwiched between the U.K. and German auctions, and analysts and government ofcials predicted revenues in excess of 400 euros per person from the Italian and Swiss auctions just a few days before they began (Michelson, 2000; Roberts, 2000; Total Telecom, 2000; Klemperer, 2002). These other auctions were ascoes primarily because they were poorly designed. So what makes a successful auction? What really matters in auction design are the same issues that any industry
y Paul Klemperer is the Edgeworth Professor of Economics, Oxford University, England. His
e-mail address is paul.klemperer@economics.ox.ac.uk , and his website is http://www. paulklemperer.org.
Journal of Economic Perspectives—Volume 16, Number 1—Winter 2002—Pages 169 –
regulator would recognize as key concerns: discouraging collusive, entry-deterring and predatory behavior. In short, good auction design is mostly good elementary economics. By contrast, most of the extensive auction literature (as summarized in, for example, Klemperer, 1999a, 2000a) is of second-order importance for practical auction design. The auction literature largely focuses on a xed number of bidders who bid noncooperatively, and it emphasizes issues such as the effects of risk aversion, correlation of information, budget constraints and complementarities. Auction theorists have made important progress on these topics from which other economic theory has beneted, and auction theory has also been fruitfully applied in political economy, nance, law and economics, labor economics and industrial organization, often in contexts not usually though of as auctions (Klemperer, 2001a). But most of this literature is of much less use for actually designing auctions. This paper will list and give examples of some critical pitfalls in auction design and discuss what to do about them. We show that ascending and uniform-price auctions are both very vulnerable to collusion and very likely to deter entry into an auction. We consider including a nal sealed-bid stage into an otherwise-ascending auction to create an “Anglo-Dutch” auction, and we emphasize the need for stronger antitrust policy in auction markets.
Collusion
A rst major set of concerns for practical auction design involves the risk that participants may explicitly or tacitly collude to avoid bidding up prices. Consider a multiunit (simultaneous) ascending auction. (This is just like the standard auction used, for example, to sell a painting in Sotheby’s or Christies—the price starts low, and competing bidders raise the price until no one is prepared to bid any higher, and the nal bidder then wins the prize at the nal price bid. However, in this case, several objects are sold at the same time, with the price rising on each of them independently, and none of the objects is nally sold until no one wishes to bid again on any of the objects.) In such an auction, bidders can use the early stages, when prices are still low, to signal who should win which objects and then tacitly agree to stop pushing up prices. For example, in 1999, Germany sold ten blocks of spectrum by a simultaneous ascending auction with the rule that any new bid on a block had to exceed the previous high bid by at least 10 percent. Mannesman’s rst bids were 18.18 million deutschmarks per megahertz on blocks 1–5 and 20 million DM per MHz on blocks 6 –10; the only other credible bidder—T-Mobil— bid even less in the rst round. One of T-Mobil’s managers then said (Stuewe, 1999, p. 13): “There were no agreements with Mannesman. But [T-Mobil] interpreted Mannesman’s rst bid as an offer.” The point is that 18.18 plus a 10 percent raise equals approximately 20. It seems T-Mobil understood that if it bid 20 million DM per MHz on blocks 1–5,
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von der Fehr and Harbord, 1998; Newbery, 1998; Wolfram, 1998, 1999). In addi- tion, a frequently repeated auction market such as that for electricity is particularly vulnerable to collusion, because the repeated interaction among bidders expands the set of signaling and punishment strategies available to them and allows them to learn to cooperate (Klemperer, 2002). Much of the kind of behavior discussed so far is hard to challenge legally. Indeed, trying to outlaw it all would require cumbersome rules that would restrict bidders’ exibility and might generate inefciencies, without being fully effective. It would be much better to solve these problems with better auction designs.
Entry Deterrence and Predation
The second major area of concern of practical auction design is to attract bidders, since an auction with too few bidders risks being unprotable for the auctioneer (Bulow and Klemperer, 1996) and potentially inefcient. Ascending auctions are often particularly poor in this respect, since they can allow some bidders to deter the entry, or depress the bidding, of rivals. In an ascending auction, there is a strong presumption that the rm that values winning the most will be the eventual winner, because even if it is outbid at an early stage, it can eventually top any opposition. As a result, other rms have little incentive to enter the bidding and may not do so if they have even modest costs of bidding. Consider, for example, Glaxo’s 1995 takeover of the Wellcome drugs company. After Glaxo’s rst bid of 9 billion pounds, Zeneca expressed willingness to offer about 10 billion pounds if it could be sure of winning, while Roche considered an offer of 11 billion pounds. But certain synergies made Wellcome worth a little more to Glaxo than to the other rms, and the costs of bidding were tens of millions of pounds. Eventually, neither Roche nor Zeneca actually entered the bidding, and Wellcome was sold at the original bid of 9 billion pounds, literally a billion or two less than its shareholders might have received. Wellcome’s own chief executive admitted “there was money left on the table” (Wighton, 1995a, b). While ascending auctions are particularly vulnerable to lack of entry, other auction forms can result in similar problems if the costs of entry and the asymme- tries between bidders are too large. The 1991 U.K. sale of television franchises by a sealed-bid auction is a dramatic example. While the regions in the South and Southeast, Southwest, East, Wales and West, Northeast and Yorkshire all sold in the range of 9.36 to 15.88 pounds per head of population, the only—and therefore winning— bid for the Midlands region was made by the incumbent rm and was just one-twentieth of one penny (!) per head of population. Much the same happened in Scotland, where the only bidder for the Central region generously bid one-seventh of one penny per capita. What had happened was that bidders were required to provide very detailed
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region-specic programming plans. In each of these two regions, the only bidder gured out that no one else had developed such a plan.^2 Another issue that can depress bidding in some ascending auctions is the “winner’s curse.” This problem applies when bidders have the same, or close to the same, actual value for a prize, but they have different information about that actual value (what auction theorists call the “common values” case). The winner’s curse reects the danger that the winner of an auction is likely to be the party who has most greatly overestimated the value of the prize. Knowing about the winner’s curse will cause everyone to bid cautiously. But weaker rms must be especially cautious, since they must recognize that they are only likely to win when they have overes- timated the value by even more than usual. Therefore, an advantaged rm can be less cautious, since beating very cautious opponents need not imply one has overestimated the prize’s value. Because the winner’s curse affects weak rms much more than strong ones, and because the effect is self-reinforcing, the advantaged bidder wins most of the time. And because its rivals bid extremely cautiously, it also generally pays a low price when it does win (Klemperer, 1998). The bidding on the Los Angeles license in the 1995 U.S. auction for mobile- phone broadband licenses illustrates this problem. While the license’s value was hard to estimate, it was probably worth similar amounts to several bidders. But Pacic Telephone, which already operated the local xed-line telephone business in California, had distinct advantages from its database on potential local custom- ers, its well-known brand-name and its familiarity with doing business in California. The auction was an ascending one. The result was that the bidding stopped at a very low price. In the end, the Los Angeles license yielded only $26 per capita. In Chicago, by contrast, the main local xed-line provider was ineligible to compete, and it was not obvious who would win, so the auction yielded $31 per capita even though Chicago was thought less valuable than Los Angeles because of its lower household incomes, lower expected population growth and more dispersed pop- ulation (Klemperer, 1998; Bulow and Klemperer, 2002). For formal econometric evidence for the FCC auctions more broadly, see Klemperer and Pagnozzi (2002). Of course, the “winner’s curse” problem exacerbates the problem that weaker bidders may not bother to participate in an ascending auction. GTE and Bell Atlantic made deals that made them ineligible to bid for the Los Angeles license, and MCI failed to enter this auction at all. Similarly, takeover battles are essentially ascending auctions, and there is empirical evidence that a rm that makes a takeover bid has a lower risk of facing a rival bidder if the rm has a larger shareholding or “toehold” in the target company (Betton and Eckbo, 2000). Because outcomes in an ascending auction can be dramatically inuenced by a seemingly modest advantage, developing such an advantage can be an effective predatory strategy. An apparent example was the 1999 attempt by BSkyB (Rupert Murdoch’s satellite television company) to acquire Manchester United (England’s
(^2) While I have advised the U.K. government on several auctions, I have never had anything to do with television licenses!
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to take more than one license, the sale price was determined by the reserve price, which was just one-thirtieth of the U.K. and German per capita revenues and one-ftieth of what the Swiss had once hoped for!
Other Pitfalls
Reserve Prices Many of the disasters above were greatly aggravated by failure to set a proper reserve price (the minimum amount the winner is required to pay). Take the previous example. It was ridiculous for the Swiss government to set its reserve at just one-thirtieth of the per capita revenue raised by the German and U.K. governments for similar properties. Since the government’s own spokesman predicted just ve days prior to the auction that twenty times the reserve price would be raised, what was the government playing at? Inadequate reserve prices also increase the incentives for predation and may encourage collusion that would not otherwise have been in all bidders’ interests. A stronger bidder in an ascending auction has a choice between either tacitly collud- ing to end the auction quickly at a low price or forcing the price up to drive out weaker bidders. The lower the reserve price at which the auction can be concluded, the more attractive is the rst option. This factor may have been an important contributor to several of the ascoes we have discussed.
Political Problems Serious reserve prices are often opposed not only by industry groups, but also by government ofcials for whom a very embarrassing outcome is that the reserve price is not met, the object is not sold, and the auction is seen as a “failure.” Similarly, standard (rst-price) sealed-bid auctions—in which the bidders si- multaneously make “best and nal” offers, and the winner pays the price he bid— can sometimes be very embarrassing for bidders, as BSCH (Spain’s biggest bank) found out when Brazil privatized the Sao Paulo state bank Banespa. When the bids were opened, BSCH’s managers were horried to learn that their bid of over 7 billion reals ($3.6 billion) was more than three times the runner-up’s bid and that they were therefore paying 5 billion reals ($2.5 billion) more than was needed to win. In other auctions, meanwhile, losers who have just narrowly underbid the winners have found it equally hard to explain themselves to their bosses and shareholders. So rms, or at least their managers, can oppose rst-price auctions. On the other hand, a second-price sealed-bid auction—in which the winner pays the runner-up’s bid— can be embarrassing for the auctioneer if the winner’s actual bid is revealed to be far more than the runner-up’s, even if the auction design was both efcient and maximized expected revenue. McMillan (1994) reports a second-price New Zealand auction in which the winner bid NZ $7 million but paid the runner-up’s bid of NZ $5,000. New Zealand should have set a minimum reserve price that the winner had to pay, but even if that had been politically possible, the
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winner would probably have bid more than it had to pay, so this might have been an economically but not politically sensible auction.
Loopholes In some cases, the auction rules may leave gaping loopholes for behavior to game the auction. In 2000, Turkey auctioned two telecom licenses sequentially, with an additional twist that set the reserve price for the second license equal to the selling price of the rst. One rm then bid far more for the rst license than it could possibly be worth if the rm had to compete in the telecom market with a rival holding the second license. But the rm had rightly gured that no rival would be willing to bid that high for the second license, which therefore remained unsold, leaving the rm without a rival operating the second license! As another example, McMillan (1994) reports an Australian auction for satellite-television licenses in which two bidders each made large numbers of different sealed bids on the same objects and then, after considerable delays, defaulted on those bids they did not like after the fact—since the government had neglected to impose any penalties for default. More recently, the U.S. spectrum auctions have been plagued by bidders “winning” licenses and subsequently de- faulting on their commitments, often after long delays. (Spectrum auctions in India also recently fell into the same trap.) If default costs are small, then bidders are bidding for options on prizes rather than the prizes themselves. Furthermore, if smaller, undernanced rms can avoid commitments through bankruptcy, then an auction actually favors these bidders over better-nanced competitors who cannot default.
Credibility of the Rules It may not be credible for the auctioneer to punish a bidder violating the auction rules when just one bidder needs to be eliminated to end an auction, because excluding the offending bidder would end the auction immediately, and it might be hard to impose nes large enough to have a serious deterrent effect. Fines of hundreds of millions or even billions of dollars might have been required to deter improper behavior in some of the European third-generation mobile-phone license auctions. In the Netherlands sale, for example, six bidders competed for ve licenses in an ascending auction in which bidders were permitted to win just one license each. One bidder, Telfort, sent a letter to another, Versatel, threatening legal action for damages if Versatel continued to bid! Telfort claimed that Versatel “believes that its bids will always be surpassed by [others’... so it] must be that Versatel is attempting to either raise its competitors’ costs or to get access to their... networks.” Many observers felt Telfort’s threats against Versatel were outrageous. However, the government took no action—not even an investigation. As a result, Versatel quit the auction, and the sale raised less than 30 percent of what the Dutch government had forecast based on the results of the United Kingdom’s similar auction just three months earlier. Ascending auctions are particularly vulnerable to rule breaking by the bidders,
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to merger control will tend to create an overly concentrated industry. The Turkish asco discussed earlier was a spectacular example of how an auction can be biased toward generating a monopoly. 5 But this outcome is not the only socially suboptimal possibility. A rm with a large demand may prefer to reduce its demand to end the auction at a low price, rather than raise the price to drive out its rivals, even when the latter course would be socially more efcient (Ausubel and Cramton, 1998). There can also be too many winners if rms collude to divide the spoils at a low price. In the Austrian third-generation mobile spectrum sale, for example, six rms competed for twelve identical lots in an ascending auction and, not surprisingly, seemed to agree to divide the market so each rm won two lots each at not much more than the very low reserve price. Perhaps six winners was the efcient outcome. But we certainly cannot tell from the behavior in the auction. It was rumored that the bidding lasted only long enough to create some public perception of genuine competition and to reduce the risk of the government changing the rules. Thus, it may sometimes be wiser to predetermine the number of winners by auctioning off fewer larger licenses, but limiting bidders to one license apiece, rather than to auction many licenses and to allow bidders to buy as many as they wish.
When is Auction Design Less Important? The fact that collusion, entry deterrence and, more generally, buyer market power is the key to auction problems suggests that auction design may not matter very much when there is a large number of potential bidders for whom entry to the auction is easy. For example, though much ink has been spilt on the subject of government security sales, auction design may not matter much for either price or efciency in this case. Indeed, the U.S. Treasury’s recent experiments with different kinds of auctions yielded inconclusive results (Simon, 1994; Malvey, Archibald and Flynn, 1996; Nyborg and Sundaresan, 1996; Reinhart and Belzar, 1996; Ausubel and Cramton, 1998), and the broader empirical literature is also inconclusive. Of course, even small differences in auction performance can be signicant when such large amounts of money are involved, and collusion has been an issue in some government security sales, so further research is still warranted. 6
Solutions
Making the Ascending Auction More Robust Much of our discussion has emphasized the vulnerability of ascending auctions to collusion and predatory behavior. However, ascending auctions have several
(^5) Similarly, the recent July 2001 Greek second-generation spectrum auction led to a more concentrated telecom market than seems likely to be socially efcient. (^6) These views are personal. I have advised U.K. government agencies on the related issue of the sale of gold. See Klemperer (1999b) for more discussion.
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virtues, as well. An ascending auction is particularly likely to allocate the prizes to the bidders who value them the most, since a bidder with a higher value always has the opportunity to rebid to top a lower-value bidder who may initially have bid more aggressively.^7 Moreover, if there are complementarities between the objects for sale, a multiunit ascending auction makes it more likely that bidders will win efcient bundles than in a pure sealed-bid auction in which they can learn nothing about their opponents’ intentions. Allowing bidders to learn about others’ valua- tions during the auction can also make the bidders more comfortable with their own assessments and less cautious, and it often raises the auctioneer’s revenues if information is “afliated” in the sense of Milgrom and Weber (1982). A number of methods to make the ascending auction more robust are clear enough. For example, bidders can be forced to bid “round” numbers, the exact increments can be prespecied, and bids can be made anonymous. These steps make it harder to use bids to signal other buyers. Lots can be aggregated into larger packages to make it harder for bidders to divide the spoils, and keeping secret the number of bidders remaining in the auction also makes collusion harder (Cramton and Schwartz, 2000; Salant, 2000). Ausubel’s (1998) suggested modication of the ascending auction mitigates the incentive of bidders to reduce their demands to end the auction quickly at a low price. Sometimes it is possible to pay bidders to enter an auction; for example, “white knights” can be offered options to enter a takeover battle against an advantaged bidder. But while these measures can be useful, they do not eliminate the risks of collusion or of too few bidders. An alternative is to choose a different type of auction.
Using Sealed-Bid Auctions In a standard sealed-bid auction (or “rst-price” sealed-bid auction), each bidder simultaneously makes a single “best and nal” offer. As a result, rms are unable to retaliate against bidders who fail to cooperate with them, so collusion is much harder than in an ascending auction. Tacit collusion is particularly difcult since rms are unable to use the bidding to signal. True, both signaling and retaliation are possible in a series of sealed-bid auctions, but collusion is still usually harder than in a series of ascending auctions. From the perspective of encouraging more entry, the merit of a sealed-bid auction is that the outcome is much less certain than in an ascending auction. An
(^7) This applies in many “common values” and “private values” settings (Maskin, 1992), but is not necessarily the same as maximizing efciency. When bidders are rms, it ignores consumer welfare (which is likely to favor a more widely dispersed ownership than rms would choose), and, of course, it ignores government revenue. We assume governments (as well as other auctioneers) care about revenue because of the substantial deadweight losses (perhaps 33 cents per dollar raised) of raising government funds through alternative methods (Ballard, Shoven and Whalley, 1985). Resale is not a perfect substitute for an efcient initial allocation, because even costless resale cannot usually ensure an efcient outcome in the presence of incomplete information (Myerson and Satterthwaite, 1983; Cramton, Gibbons and Klemperer, 1987).
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best strategy of a bidder who knows its own value is just to bid up to that value, and winners’ payments are determined by the bids of nonwinners. So “pay-your-bid” sealed-bid auctions may discourage potential bidders who have only small amounts to trade and for whom the costs of obtaining market information might not be worth paying. For example, in March 2001, the U.K. electricity regulator replaced the problematic uniform-price auction we described earlier by an exchange market followed by a “pay-your-bid” sealed-bid auction, which makes collusion harder, because bids can no longer be used as costless threats. But a major concern is that the new trading arrangements may deter potential entrants from investing the sunk costs necessary to enter the electricity market.^9 However, the entry problem in many-unit auctions is much less serious if small bidders can buy from larger intermediaries who can aggregate smaller bidders’ de- mands and bid in their place, as, for example, occurs in auctions of Treasury bills. And the entry problem is also alleviated if smaller bidders are permitted to make “noncom- petitive bids,” that is, to state demands for xed quantities for which they pay the average winning price, as is also the case in some Treasury bill auctions.
The Anglo-Dutch Auction A solution to the dilemma of choosing between the ascending (often called “English”) and sealed-bid (or “Dutch”) forms is to combine the two into a hybrid, the “Anglo-Dutch,” which often captures the best features of both and was rst described and proposed in Klemperer (1998). For simplicity, assume a single object is to be auctioned. In an Anglo-Dutch auction, the auctioneer begins by running an ascending auction in which price is raised continuously until all but two bidders have dropped out. The two remaining bidders are then each required to make a nal sealed-bid offer that is not lower than the current asking price, and the winner pays the winning bid. The process is much like the way houses are often sold, although, unlike in many house sales, the procedure the auctioneer will follow in an Anglo-Dutch auction is clearly specied in advance. Another auction with similar features—and probably similar motivations to the Anglo-Dutch—is W.R. Hambrecht’s OpenBook auction for corporate bonds. The early bidding is public and ascending, but bidders can make nal sealed bids in the last hour. Although all bidders are permitted to make nal bids, higher bidders in the rst stages are given an advantage that is evidently large enough to induce serious bidding early on (Hall, 2001, p. 71). The process also has some similarity to auctions on eBay (by far the world’s most successful e-commerce auctioneer), which are ascending auctions, but with a xed ending time so that many bidders often bid only in the last few seconds in essentially sealed-bid style. eBay attracts far more bidders than its rival, Yahoo, which runs a
(^9) Also, the new arrangements may not fully resolve the collusion problem anyway since the market is so frequently repeated (Klemperer, 1999b).
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standard ascending auction with a traditional “going, going, gone” procedure that does not close the auction until there have been no bids for 10 minutes. The main value of the Anglo-Dutch procedure arises when one bidder (for example, the incumbent operator of a license that is to be reauctioned) is thought to be stronger than potential rivals. Potential rivals might be unwilling to enter a pure ascending-bid auction against the strong bidder, who would be perceived to be a sure winner. But the sealed bid at the nal stage induces some uncertainty about which of the two nalists will win, and entrants are attracted by the knowl- edge that they have a chance to make it to this nal stage. So the price may easily be higher even by the end of the rst ascending stage of the Anglo-Dutch auction than if a pure ascending auction were used. The Anglo-Dutch should capture the other advantages of the sealed-bid auc- tion discussed in the previous section. Collusion will be discouraged because the nal sealed-bid round allows rms to renege on any deals without fear of retaliation and because the Anglo-Dutch auction eliminates the stage of the ascending auction when just one excess bidder remains, at which point the rules against collusion and predation may not be credible. Consortium formation will also be discouraged. Imagine there are two strong bidders for an item. In an ascending auction they are unlikely to be challenged if they form a consortium, so they have an incentive to do so. But in an Anglo-Dutch auction, forming the consortium would open up an opportunity for new entrants who would now have a chance to make it to the nal sealed-bid stage. So the strong rms are much less likely to bid jointly. But the Anglo-Dutch should also capture much of the benet of an ascending auction. It will be more likely to sell to the highest valuer than a pure sealed-bid auction, both because it directly reduces the numbers allowed into the sealed-bid stage and also because the two nalists can learn something about each other’s and the remaining bidders’ perceptions of the object’s value from behavior during the ascending stage. When the Anglo-Dutch auction is extended to contexts in which individual bidders are permitted to win multiple units and there are complementarities between the objects, the ascending stage makes it more likely that bidders will win efcient bundles than in a pure sealed-bid auction. Finally, I conjecture that the ascending stages of the Anglo-Dutch auction may extract most of the information that would be revealed by a pure ascending auction, raising revenues if bidders’ information is “afliated,” while the sealed-bid stage may do almost as well as a pure sealed-bid auction in capturing extra revenues due to the effects of bidders’ risk aversion, budget constraints and asymmetries. This suggests the Anglo-Dutch auction may outperform ascending and sealed-bid auctions even if it attracts no additional bidders. In short, the Anglo-Dutch auction often combines the best of both the ascend- ing and the sealed-bid worlds.
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generally be restricted to entities that exist when the auction is rst announced, although exceptions would clearly be necessary. The antitrust agencies’ response to predation in auction markets has also been feeble. Dominant bidders such as Glaxo and Pacic Telephone in the examples above are apparently allowed to make open threats that they will punish new entrants. For example, Glaxo’s letting it be known that it “would almost certainly top a rival bid,” would roughly translate to an incumbent rm in a “normal” economic market saying it “would almost certainly undercut any new entrant’s price.”1 1 Regulators should take such threats seriously and treat auction markets more like “ordinary” economic markets.
Tailoring Auction Design to the Context
Good auction design is not “one size ts all.” It must be sensitive to the details of the context. A good example of this lesson—and of our other principles—is afforded by the recent European third-generation (UMTS) mobile-phone license auctions. The United Kingdom, which ran the rst of these auctions, originally planned to sell just four licenses.^12 In this case, the presence of exactly four incumbent operators who had the advantages of existing brand names and networks suggested that an ascending auction might deter new rms from bidding strongly in the auction or even from entering at all. So the government planned an Anglo-Dutch auction. An ascending stage would have continued until just ve bidders remained, after which the ve survivors would have made sealed bids, required to be no lower than the current price level, for the four licenses.1 3^ The design performed ex- tremely well in laboratory experiments in both efciency and revenue generation. But when it became possible to sell ve licenses, an ascending auction made more sense. Because no bidder was permitted to win more than one license, at least one license had to be sold to a new entrant. This would be a sufcient carrot to
1 1 (^) Similarly, Pacic Telephone’s remark that “if somebody takes California away from us, they’ll never make any money” seems to correspond to threatening that “if anyone tries to compete with us, we’ll cut the price until they lose money.” Further, Pacic Telephone’s hiring of an auction theorist to explain the winner’s curse to competitors might correspond to hiring an industrial economist to explain the theory of the difculties of entering new markets to potential entrants. 1 2 (^) I was the principal auction theorist advising the U.K. government’s Radiocommunications Agency, which designed and ran the recent U.K. mobile-phone license auction. Ken Binmore had a leading role and supervised experiments testing the proposed designs. Other academic advisors included Tilman Borgers, Jeremy Bulow, Philippe Jehiel and Joe Swierzbinski. 1 3 (^) It was proposed that all four winners would pay the fourth-highest sealed bid. Since the licenses were not quite identical, a nal simultaneous ascending stage would have followed to allocate them more efciently among the winners. The sealed-bid stage could be run using an ascending mechanism that would hide the actual bids even from the auctioneer, if this would reduce political problems. See Klemperer (1998, 2001b, 2002), Radiocommunications Agency (1998a, b) and Binmore and Klemperer (2002) for more details.
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attract several new entrants in the U.K. context in which it was very unclear which new entrant(s) might be successful. 14 Because licenses could not be divided, bidders could not collude to divide the market without resort to side payments. As a result, the problems of collusion and entry deterrence were minimal, and a version of an ascending auction was therefore used for efciency reasons. The auction was widely judged a success; nine new entrants bid strongly against the in- cumbents, creating intense competition and record-breaking revenues of 22.5 bil- lion pounds. The Netherlands’ sale came next. Their key blunder was to follow the actual British design when they had an equal number (ve) of incumbents and licenses. It was not hard to predict (indeed, prior to the auction, an early draft of this paper, quoted in the Dutch press and Maasland, 2000, did predict) that very few entrants would show up. Netherlands antitrust policy was as dysfunctional as the auction design, allowing the strongest potential entrants to make deals with incumbent operators. In the end, just one weak new entrant (Versatel) competed with the incumbents. As we have already discussed, with just one excess bidder in an ascending auction, it was unsurprising when the weak bidder quit early amid allegations of predation, at less than 30 percent of the per capita U.K. prices. Six months later, the Dutch parliament began an investigation into the auction process. A version of the Anglo-Dutch design would probably have worked better in the Netherlands context. There are reasons to believe Versatel would have bid higher in the sealed-bid stage than the price at which it quit the ascending auction. In addition, the fear of this would have made the incumbents bid higher. Further- more, the “hope and dream” that a sealed-bid stage gives weaker bidders might have attracted more bidders and discouraged the formation of the joint-bidding consortia. The Italian government thought it had learned from the Netherlands asco. It also chose roughly the U.K. design, but stipulated that if there were no more “serious” bidders (as dened by prequalication conditions) than licenses, then the number of licenses could, and probably would, be reduced. At rst glance, this seemed a clever way to avoid an uncompetitive auction, but (as I and others argued) the approach was fundamentally awed. First, it is putting the cart before the horse to create an unnecessarily concentrated mobile-phone market to make an auction look good. Second, our earlier discussion demonstrates that a rule that allows the possibility that there will be just one more bidder than license does not guarantee a competitive ascending auction! Also, it was clear that the number of likely entrants into an ascending auction was much smaller than it had been for the United Kingdom, in large part because weaker potential entrants had gured out
1 4 (^) In large part, this was because the United Kingdom ran the rst third-generation auction. Going to market rst was a deliberate strategy of the auction team, and the sustained marketing campaign was also important. The U.K. auction attracted 13 bidders who then learnt about others’ strengths, and none of the eight subsequent auctions had more than seven bidders.
What Really Matters in Auction Design 185
with the French beauty contest mean that France has not only missed its govern- ment’s originally planned date for allocation of the spectrum (already by a year at the time of writing), but also missed European Union deadlines. In conclusion, the most important features of an auction are its robustness against collusion and its attractiveness to potential bidders. Failure to attend to these issues can lead to disaster. Furthermore, anyone setting up an auction would be foolish to follow past successful designs blindly; auction design is not “one size ts all.” While the sealed-bid auction performs well in some contexts, and the Anglo- Dutch auction is ideal in other contexts, the ascending auction has also frequently been used very successfully. In the practical design of auctions, local circumstances matter, and the devil is in the details.
y I was the principal auction theorist advising the U.K. government’s Radiocommunications
Agency, which designed and ran the recent U.K. mobile-phone license auction described here, and have advised several other U.K. government agencies, but the views expressed in this paper are mine alone. Although some observers thought some of the behavior described above warranted investigation, I do not intend to suggest that any of it violates any applicable rules or laws. I am very grateful to many colleagues, including Sushil Bikhchandani, Nils-Henrik von der Fehr, Tim Harford, Emiel Maasland, Margaret Meyer, Mike Rothkopf, David Salant, Rebecca Stone, Timothy Taylor, Chuck Thomas, Tommaso Valletti, Michael Waldman, Mark Williams and especially my coauthors Jeremy Bulow and Marco Pagnozzi, for helpful advice.
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