Thursday, Oct 02, 2014

Not a high price to pay

Whether or not firms face a ‘winner’s curse’ is a commercial question. They must believe that there was an economic rationale for their bids, or they would not have paid so much. PTI Whether or not firms face a ‘winner’s curse’ is a commercial question. They must believe that there was an economic rationale for their bids, or they would not have paid so much. PTI
Written by Oliver Latham | Posted: February 26, 2014 12:39 am | Updated: February 26, 2014 9:43 am

Consumers won’t bear the costs of high bids for 2G spectrum.

The 2G auction earlier this month was, from the point of view of government revenues, a roaring success, raising Rs 61,000 crore. The astronomical amounts telecom companies bid for spectrum are causing an increasing number of commentators to argue that they overpaid and now face a “winner’s curse”. Whether or not this is the case is a purely commercial question, although lay commentators should bear in mind that the firms themselves must believe that there was an economic rationale for their bids, or else they would not have agreed to pay so much in the first place.

The more contentious question is whether this “winner’s curse” will harm consumers, either through higher prices as providers pass the tremendous spectrum costs on to consumers or through a slower roll-out of advanced telecommunication services because the burden of paying for spectrum reduces the cash available for investment. Standard economic theory would say that the first mechanism is fallacious, while the second seems implausible.

Let’s start with the former claim — that higher spectrum costs will be passed on to consumers. The first question to ask is, suppose spectrum had been handed out free of charge, what price would a telecom company charge consumers? Presuming that it is competently managed, the answer is obvious: it would charge the price that makes it the greatest possible profit, given the competition it faces from other firms in the industry.

Now suppose the firm had paid Rs 10,000 crore for its spectrum, would it charge a higher price than if it had paid nothing at all? The answer is no: in the first case, the company was charging the price that gave it the highest possible profits given the competition it faces. Since the spectrum auction has not changed the level of competition in the industry, it must be that firms will charge the same price as if they had paid nothing. Intuitively, any attempt to recoup the cost of spectrum by gouging consumers will be counterproductive — a firm that tries to do so would drive its customers to competitor companies and see its profits fall.

Moving on to the second claim — that higher spectrum fees could reduce the money available for telecom companies to invest in new technology and services. This argument has a ring of truth about it. Surely, if firms have spent crores of rupees on spectrum licences, they will have less to spend on other things?

However, this argument neglects the possibility that firms can fund investment through borrowing. continued…

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