Verizon's “Perfect Storm”: A Reason Why 700 MHz Band's C Block Cleared On the Cheap

Some critics of the 700 MHz Band Auction (Auction 73) attribute the failure of C Block — which consisted of large Regional Economic Grouping (REAG) licenses — to clear at the kinds of premium over the licenses in the AWS-1 auction that the Economic Area (EA) and Cellular Marketing Area (CMA) in the A, B, and E Blocks did to the fact that C Block had wireless Carterfone service rules attached.

However, careful analysis of the dynamics of the auction suggest that interaction of the auction’s combinatorial bidding, eligibility and activity rules, and the way in which minimum acceptable bids were calculated created a “perfect storm” in which Verizon was able to scoop up the two most populous REAGs for nearly half a billion dollars less than bidders were willing to pay earlier in the auction. This had a seriously depressing effect on the price at which C Block cleared and had nothing to do with the wireless Carterfone service rules.

More below…

In Auction 73 the FCC for the first time authorized combinatorial or package bidding only on the C Block. Under the combinatorial bidding rules, three packages were offered: Package 50 States (consisting of REAGs 001-008), Package Atlantic (consisting of REAGs 010 and 012), and Package Pacific (consisting of REAGs 009 and 011). Bidders could bid either on individual REAGs or a package in any round; the provisionally winning bid would be calculated in accordance with the rule:

“For licenses in the C Block subject to HPB, the FCC Auction System will determine which combination of individual and package bids yields the highest aggregate gross bid amount, taking into consideration each bidder’s highest bid on each license or package submitted up to that point in the auction. These bids become the provisionally winning bids for the round” [Auction of 700 MHz Band Licenses Scheduled for January 24, 2008, DA 07-4171, October 5, 2007, 64].

Thus, only if the total of the bids on all the individual REAGs in the package exceeded the bid on that package – in auction jargon, if the package were broken – could a bidder on an individual REAG in that package win that REAG. In other words, if a bidder wanted only one or two REAGs which were included in the Package 50 States, two conditions had to obtain: (1) the total amount of the bids on the eight REAGs in Package 50 States had to exceed the amount of the bid on the Package 50 States (i.e., the package had to be broken), and (2) the bidder had to have the high bid on that one or two REAGs.

The eligibility and activity rules in Auction 73 mattered, too. Initial eligibility in Auction 73, the maximum number of bidding units on which a bidder may be active, was determined by the sum of the bidding units required for each license selected on the bidder’s FCC Form 175. The activity rules required that a bidder be active on 80% of that bidder’s eligibility in every round (i.e., either bid on licenses or packages in that round or hold the provisionally winning bid (PWB) on licenses or packages the bidding units of which equaled 80% of the bidder’s eligibility) or lose eligibility. The rules provided that:

“A bidder’s activity level in a round is the sum of the bidding units associated with any licenses covered by new and provisionally winning bids. The bidding units associated with a given license will be counted only once in a bidder’s activity calculation for the round, even if the bidder places a bid on the license and a bid on a package containing the license” [Auction of 700 MHz Band Licenses Scheduled for January 24, 2008, DA 07-4171, October 5, 2007, 45-46].

A bidder’s eligibility in the next round of Stage One of the auction was set at 5/4ths (125%) of that bidder’s eligibility (i.e., activity level) in the immediately proceeding round:

“During Stage One, reduced eligibility for the next round will be calculated by multiplying the bidder’s current round activity (the sum of bidding units of the bidder’s provisionally winning bids and bids during the current round) by five-fourths (5/4)” [Auction of 700 MHz Band Licenses Scheduled for January 24, 2008, DA 07-4171, October 5, 2007, 48].

When paired with the auction’s bidding eligibility and activity rules, combinatorial bidding had an unforeseen and almost certainly depressing effect on the prices at which the individual REAGs in Package 50 States eventually cleared.

In Round 17 a high bid of $4,713,823,000 on Package 50 States exceeded the reserve price. That meant that the wireless Carterfone service rules would take effect. A number of bidders had bid on individual REAGs in the Package 50 States, but the sum of these bids did not exceed the total bid on Package 50 States. While the anonymous bidding rules precluded release of the identity of the high bidder on Package 50 States in any given round, the high bid amount for each license and package was announced at the end of each round, and speculation in the press correctly identified the Package 50 States bidder as Google Airwaves. The bid placed on Package 50 States in Round 17 remained the provisionally winning bid until Round 26, when QUALCOMM’s bid on REAG 004 broke the package.

This table shows the dynamics leading to this outcome (the bids are in millions of dollars).

During the twenty-five rounds that the Google Package 50 States bid was provisionally winning (it was provisionally winning from the first round), a number of bidders which had bid on individual REAGs earlier shifted strategies to bid on other licenses and no longer had sufficient eligibility to reinstate their non-PWB earlier bids on those REAGs as this table shows.

In other words, 46.15% of bidders lacked sufficient eligibility to reinstate bids or place new bids on REAGs after the package was broken in Round 26. This accounts in large part for Verizon Wireless’ ability to place unchallenged winning bids on seven of the Package 50 States REAGs in Rounds 27-30. The fact that 71.43% of those bidders with sufficient eligibility to continue seeking REAs after the package was broken did so, makes it unlikely that the wireless Carterfone condition was the deterring factor. Uncertainty arising from the interaction of the combinatorial bidding eligibility, activity, and anonymous bidding rules were a crucial determinant of who still had the eligibility to persevere after the package was broken.

Verizon’s success in C Block was in many respects a “perfect storm” interaction of the combinatorial bidding, eligibility, and activity rules with the procedure used by the FCC to calculate minimum acceptable bids.

On REAG 001 (Northeast) Verizon was able to win the license in Round 29 with a bid of $502,774,000, which was $101,850,000 less than Alltel’s bid of $604,624,000, but since Alltel’s bid was not provisionally winning because the package had not been broken when it was made, the minimum acceptable bid for REAG 001 in Round 29 was only $502,774,000 and Alltel no longer had sufficient eligibility to reinstate the lapsed bid.

A similar situation occurred with REAG 006 (West), where Verizon won the license in Round 30 with a bid of $319,798,000, which was $364,096,000 less than Bluewater WGireless’ bid of $683,894,000 in Round 6, but the minimum acceptable bid for REAG 006 in Round 30 was $319,798,000 because Bluewater Wireless’ bid was not provisionally winning since the package had not yet been broken; Bluewater Wireless did not have sufficient eligibility to reinstate the lapsed bid.

In short, this “perfect storm” enabled Verizon to obtain the two most populous REAGs for nearly half a billion dollars less than earlier bidders were willing to pay, but those bidders lacked sufficient eligibility to challenge Verizon after the package broke in Round 26.