Spectrum Pricing: Administrative Incentive Prices
The total supply of spectrum is fixed, but technology affects the extent to which it can be utilized. In terms of the efficient use of spectrum, spectrum managers should be concerned with two separate issues.
- First, the assignment of spectrum rights within a particular frequency band.
- Second, the allocation of spectrum to categories of use.
Administrative Incentive Prices (AIP) can influence both assignment and allocation, though in practice there is likely to be much greater discretion over the assignment of rights in the short to medium term, as international agreements may constrain spectrum allocations.
This Practice Note is premised on the AN ECONOMIC STUDY TO REVIEW SPECTRUM PRICING prepared by INDEPEN, AEGIS SYSTEMS AND WARWICK BUSINESS SCHOOL in February 2004. The following guidelines provide a summary of recommendations and advise on important subjects related to Administrative Incentive Prices including:
- Relevant Objectives and Principles
- Practical Approaches
- A workable Methodology
I - Objectives
The preeminent policy objective for spectrum pricing is that it should be done in a way which promotes spectrum efficiency. Spectrum efficiency does come with a cost and the spectrum manager should attempt to find an optimal cost/benefit tradeoff. Secondly, use of the spectrum provides considerable benefit to the national and regional economies and this benefit should be maximized. Managing radio frequency spectrum costs money and someone has to pay these costs. That someone should be those who benefit from the use of the spectrum: a user pay principle should apply. Finally, important social and cultural objectives can be advanced by use of the spectrum and spectrum pricing should facilitate the achievement of social and cultural objectives.
The setting of spectrum prices ought to be consistent with efficiency and consequently enable the maximization of total welfare or surplus, leading to what may be termed the social optimum. Spectrum is an input, and in a competitive economy the use of inputs is efficient where marginal rates of substitution are equal across all the firms using the input. In the absence of constraints on spectrum use and where spectrum is regarded as homogeneous, efficiency is attained when the value of spectrum to society at the margin is equal across different users and uses. In other words, we should not be able to re-allocate spectrum to bring about an improvement in welfare without harming the welfare of another user. This is illustrated in Figure 1 below.
Figure 1: Demand for competing uses of spectrum
A price for spectrum that achieves an efficient allocation between different uses is the price that equates the marginal benefits of spectrum for use A and B at the value at S*. The grey vertical solid line at S_ shows the existing inefficient allocation of spectrum between these two services. At this point of allocation, the marginal benefit of spectrum in use A exceeds the marginal in use B and overall efficiency could be improved by allocating more spectrum to use A and less spectrum to use B moving the point of intersection to S*. The setting of spectrum prices can aid in achieving efficiency by providing incentives for these reallocations to occur.
II - Principles
The following tests can be applied to help in deciding which frequency bands and services should be subject to AIP:
- Is there excess demand for spectrum now or in the near future from existing uses?
- Can the spectrum be used for another purpose and, if so, is there excess demand from other uses?
- Is it practically feasible to collect AIP fees given possible constraints due to avoidance or illegal use?
- Are there any policy or political factors that prohibit the use of AIP?
III - Practical Approach
Bands that suitable for applying AIP in the UK context meet the conditions of excess demand, there being an alternative use, and few or no international allocation or national policy impediments included. The bands are as follows:
- Fixed Links
- Scanning Telemetry
- Personal Mobile Radio
- Public Mobile Networks
- Broadcast TV and Radio
IV - Methodology
The proposed methodology developed in the Indepen 2004 report suggests that AIP in shared bands or in bands where spectrum can be reallocated between services should be set between the marginal opportunity cost for the current use and the next highest value.
AIP using marginal values are calculated according to the following steps:
1. For a given frequency band the current and other potential uses are identified. These uses may be variants of the same allocation category (e.g. PMR and cellular mobile) or alternative allocations such as broadcasting and fixed link services.
2. Determine the marginal private value (i.e. opportunity cost) of spectrum for the current use of the band and other uses by calculating a use which has a higher marginal value than the current use.
3. If there is a use with a marginal private value higher than the current use then set the AIP between the two values, but towards the bottom end of the range.
4. If there is no use with a marginal private value higher than the current use of the band then set the AIP at the marginal value for the current use.
Externalities, other market failures and specific policy objectives should be achieved through other instruments (e.g. interference management, price and other regulation and state funding). This is desirable on efficiency grounds.
AIP in Practice
Experience in the UK has now demonstrated (anecdotally) that AIP has promoted efficiency more effectively than trading where government or other not-for profit entities are important spectrum users. The reason is that such agencies may be more responsive to an actual cost (with AIP) than an opportunity cost (with trading), as cost minimization is likely to be an important objective for these entities. AIP promotes efficiency more effectively where trading has been slow to emerge, or where the best way to define the rights to be traded is unclear. However, trading avoids the need and hence costs associated with identifying AIP, and may be dynamically superior since prices can evolve in response to expected changes in technology and preferences.
INDEPEN, AEGIS Systems, and the Warwick Business School, February 2004. An Economic Study to Review Spectrum Pricing.