Auctioning

Auctioning is increasingly becoming the mechanism of choice in allocating resources such as licenses. Many countries around the globe have recently auctioned spectrum licenses for use of UMTS. No doubt many of the governments that have opted to use the mechanism of an auction as opposed to other mechanisms, did so because of the possibility to earn remarkable profits.
1. First come, first served
2. Lottery
3. Beauty contest
4. Auction
Each of these mechanisms has its own characteristic that sets it apart from the others and limits its application. Whether the choice for a particular mechansims is appropriate depends greatly on both the aim of the government as well as on the to be allocated resource. If a government wishes to issue a license in line of a concession procedure, a beauty contest is best. If the aim is to level the playing field for economic activity, an auction might be best. If it would be unethical to price a license, perhaps a lottery would be most appropriate.

Auctioning and other license allocation mechanisms

Governments throughout the ages have been required to assign permits or licenses to private entities. It always concerns conferring a specific and special right or abrogation of a duty to an entity, forming a departure from the general norm. Frequently this implies that the applicants for the permit or license outnumber the available permits or licenses.
In order to allocate these licenses a number of mechanisms are available:
1. First come, first served
2. Lottery
3. Beauty contest
4. Auctioning

1. First come, first served

This mechanism is straight forward as it simply allocates licenses to the first to come as long as there are available licenses.
Pro:
– The general principle of allocation is clear and in itself fair
– The administrative costs are low due to the simplicity of the mechanism
– Low risk of law suits
– Transparent
Con:
– Government has no control over who get the license
– This mechanism does not allow for complex license requirements
– No guarantee of efficient allocation
– If license trading is permitted it will allow windfall profits (through a second private market)
– First come, first served can be unfair if there is no level playing field
– Process is likely to break down if the value of the license is high and the numbers very limited (i.e. everybody tries to be the first)
Appraisal:
The main obstacle with this allocation method is that the allocation is based on time of sign-up. This has two implications:
1. The procedure to measure time of sign-up and subsequently the allocation ranking has to be clear and precise;
2. The process is unable to differentiate between applicant signing up at the same time, so the mechanism has to avoid such a circumstance (queuing for a counter is a good strategy, using the internet is riskier);
3. This mechanism is vulnerable to unlevelled playing fields, which allow some quicker access than others (i.e. people living near the sign-up office. If such discrimination is unwanted, care must be taken in the design.
This unsophisticated allocation mechanism is totally therefore unsuitable for anything but low value and quite numerous licenses.

2. Lottery

A lottery works on the principle of random allocation.
Pro:
– Transparent allocation rule
– Non-discriminatory process
– Low risk of law suits
– Relatively low administration costs
Con:
– Government has no control over who get the license
– This mechanism does not allow for complex license requirements
– No guarantee of efficient allocation
– If license trading is permitted it will allow windfall profits (through a second private market)
– Contains incentive to sign up for lottery in great numbers raising the administrative costs
Appraisal:
Characteristic of this allocation model is that it is the only one that relies on luck. Other than the registration of the applicants, no administrative cost have to be made as the process is straightforward. Nonetheless, the design of the process is important for a number of reasons:
1. The setting of a moderate registration fee can reduce the number of applicants to a workable number;
2. Registration on the basis of name, social security number etc. allows the permitting of only one entry per candidate evening out the odds. Registration on a non-individual basis will allow playing of the odds;
3. Allowing license trade will always cause second hand trade of licenses regardless of the chosen allocation mechanism, but with a low entrance lottery, the number of non-final users speculating to earn rent on the licenses will increase.
Design of the lottery is therefore necessary to avoid perverse effects. Another issue that has to be considered is whether the to be licensed right should be subject to a process of sheer luck. Especially with low entrance lotteries, winners had to do very little to win, even though they may value the win only slightly. This could be perceived to be extremely unfair to the losers (Green card lottery, University entrance lottery).

3. Beauty contest

Beauty contests are the most predominant form of administrative allocation processes. It requires applicant to make a proposal on how they intend to use the license. After having heard all of the proposals, the administrator awards the license to the party with the most attractive proposal. The attractiveness is rated on the basis of the goal the government has set for giving the license. Relative to other allocation mechanisms, beauty contest allow the government the greatest degree of stipulating the situation that has to come into existence after the license has been granted.
Pro:
– Ample opportunity to select the most suitable candidate
– Contract between government and candidate (i.e. enforceable output)
– Allows for bargaining
– Good chance at efficient allocation
Con:
– Process requires clear selecting criteria
– Susceptible to lobbying, rent seeking activities, favouritism
– High risk of law suits
– Opaque selection process (inherently subjective process, confidential information)
– High administrative costs
– Slow process
Appraisal:
This allocation method is basically the normal procedure for giving a concession. Typically the government has a very particular situation in mind that has to be brought about while costing as little as possible. More information on this topic can be found in our module “Concessions”.

4. Auctioning

The auctioning of licenses has become increasingly popular amongst governments. Undoubtedly it is the possibility to extract a hefty license fee from the market that appeals to policymakers worldwide. The actual design of auctions ranges from simple sequential auctions to more complex simultaneous ascending auctions. Purpose of auctions is generally to ensure an efficient and equitable allocation or licenses as an aspect of market regulation.
Pro:
– Efficient allocation
– Transparent allocation process
– Non-discriminatory process
– License fee (government perspective)
– Easier access to new market entrants
– Low risk of law suits
Con:
– Collusive behaviour
– Government has no control over who get the license
– Difficult to choose appropriate auction strategy
Appraisal: Characteristic of this mechanism is that it enables the most efficient and optimised allocation of all allocation mechanisms. Since the license is awarded to the highest bidder, it is the person or entity that values the license most and who subsequently pays the most who will buy it. As such this allocation mechanism is the most business-like mechanism available and is fits well with policies aimed at liberalizing the economy.
This method is not suited well for the allocation of licenses with extensive preconditions to its use. Any precondition attached to the license is likely to disrupt the auctioning process as it causes otherwise prospective parties to drop out due to the diminished intrinsic value of the license, thus causing a thinning out of the number of bidding parties. Since this mechanism relies on competition to effectuate the most efficient allocation, measures reducing competition are likely to diminish the efficiency of the achieved allocation. If extensive preconditions are required, a beauty contest or other administrative procedure is more appropriate.
The more complex auctioning designs can be quite expensive in terms of administration costs. Auctioning is therefore best applied to relatively high-value licenses in order to cover the administrative expenses.