The 700 MHz Auction

Pasadena, Calif.--The much-talked-about 700 MHz auction kicks off on Thursday, January 24, with 214 applicants contending for 1,099 spectrum licenses being auctioned by the Federal Communications Commission.

The rules of Auction 73, as it is called, are new. The auction will implement for the first time a system called "package bidding," which was designed by California Institute of Technology economics professor Jacob Goeree and economics professor Charles Holt from the University of Virginia. Under package bidding, bidders vie for groups of licenses rather than just one at a time.

The system was tested and refined through a series of laboratory experiments in which more than 200 Caltech undergraduates participated over the course of two years.

When the FCC approached Goeree and Holt in 2004, it asked them to test auctioning software the FCC had already built. The two rebuilt a downsized version of that software and commissioned Caltech undergrads to test it. The students came into the computer lab on weekends, placing bids in simulated auctions for hours at a time. They competed with each other so realistically that, says Goeree, their intelligent bidding mimicked professional auction behavior. "They even found bugs in the software because they're so smart," he says.

The FCC wants all buyers to be able to compete equally in Auction 73, and wants to make the most money in the process. But the program it had devised was too complex. "We tested the plane the FCC built and it didn't fly that well," says Goeree. The FCC's program was inefficient-it allowed too many potential combinations of bandwidths and geographic regions. It didn't maximize profits, or potential wins for the bidders. Most of all, it alienated bidders with its intricacies. Goeree and Holt tested related auction designs but these didn't fly well either and were still too complex. So they created a new method.

"We had a very simple idea for how to do it," says Goeree. In December 2006 they called the FCC and presented their approach, called Hierarchical Package Bidding (HPB). It groups the available licenses for all bands into packages according to a hierarchy with a fixed number of levels or tiers.

Band C, considered by far the most commercially attractive and comprising $4.6 billion in reserve price, has twelve licenses and occupies the 746-757 and 776-787 MHz frequency ranges. For this band, different bundles of regions have been packaged on two levels. Testing by Goeree and Holt showed that even this simple two-tiered format performed dramatically better than the FCC's previous setup.

On level two, 12 individual licenses are available. Level one is more complex and consists of three packages: a 50-state package will constitute eight of the 12 licenses, another two of the 12 licenses will be made of other U.S. Pacific territories, and an Atlantic package will combine the U.S. Virgin Islands, the Gulf of Mexico, and Puerto Rico for the final two licenses.

The HPB method gives small players a prayer at winning in the high-stakes game. In the two-level system, participants can bid on either of the levels simultaneously. Less wealthy bidders can also afford to compete at level 2, where licenses will be cheaper. Collectively, individually smaller bids at this level could add up to more than what is bid at the nationwide level.

At the close of each bidding round, the software calculates the total money bid at each level. The software then advises bidders on their next move should they want to stay in the game. There would be no need to calculate; the bidders would just make sure they could afford the suggested bid. "It solves the complexity for them," says Goeree. It also means that if each bidder at level two or follows the advice in unison, they can all move on to the next round. Of course, whoever can't follow the suggestion will get shut out.

In an October 2007 public notice, the FCC declared, "The HPB auction format was chosen in part because it mitigates issues inherent in some other package bidding formats that give bidders interested in large packages an advantage over bidders interested in individual licenses."

Goeree's main concern about his hierarchical system was that making packages of licenses without information about bidder preferences would fail to meet bidder interests. The HPB offers prepackaged units, but companies might only be interested in an intermediate choice that matched their needs more closely. They might therefore refuse to bid on Goeree's setup. "It turned out I was wrong. The HPB auction actually performed better," Goeree says. He found that allowing his volunteer testers to build their own packages resulted in overlapping regions and too much extra complexity.

"In fact, we will use HPB in part because the mechanism for calculating [prices] is significantly simpler than other package bidding pricing mechanisms," the FCC reported in October. "In addition, we find that . . . HPB procedures in general strike a careful balance between permitting bidders adequate bidding flexibility and discouraging insincere and anticompetitive bidding behavior."

Given the stakes and the number of licenses, the auction will likely last for several weeks. There will be several bidding opportunities per day, but just like in art auctions, the bidding ends only when the money runs out.