How Spectrum Auctions Work

As we proceed into the 2020s, it’s becoming clear that mobile devices will succeed television and radio broadcasters as the dominant form of wireless media and communication—and thus take their place as the primary source of traffic on the country’s airwaves. Now, the FCC’s challenge is to free up spectrum for these new cases by matching incumbent spectrum license holders with fresh-faced cellular data providers wanting exclusive rights to a specific frequency.

In 1800, British astronomer and composer William Herschel conducted an experiment to measure the temperatures of different colors of light. Using a glass prism, he refracted white light into a spectrum of colors, and then slowly moved the bulb of a thermometer under each color to measure its heat.

Surprisingly, he found that the highest temperature reading occurred when he moved his thermometer just beyond the red end of the spectrum. Herschel had accidentally discovered infrared light—a type of light that lies beyond the visible portion of the electromagnetic (EM) spectrum.

As it turns out, visible light makes up just a miniscule fraction—about 0.035%—of all EM radiation in the universe. Experiments, discoveries, and inventions devised throughout the rest of the 19th century soon gave humanity the ability to manipulate non-visible light in earnest.

In November 1886, Heinrich Hertz (for whom the unit of frequency would later be named) first produced and transmitted radio waves in his laboratory—a critical discovery that enabled Italian electrical engineer Guglielmo Marconi to invent the radio, which he called the “wireless telegraph”, in 1895.

Spectrum Licensing Before 1982

The radio rapidly found practical use cases. By the turn of the 20th century, radios found themselves aboard ships, which used them to stay in contact with people on land and other ships at sea.

Then, on December 12th, 1901, just six years after Marconi first debuted his invention, he sent the world’s first transatlantic radio broadcast, making possible long-distance wireless communication.

Long-range radio stations soon popped up across America. On November 2nd, 1920, Pittsburgh radio station KDKA went on air for the first time, having received a license to broadcast from the U.S. Department of Commerce just two weeks prior.

Further advances made radios affordable for consumers. By the end of the Roaring ‘20s, over 600 radio stations were on air, and over 100 million radio devices were in use across the country.

However, the radio’s explosion in popularity created one crucial problem: radio waves, like roads, are a scarce resource. Just as cars cannot travel in opposite directions on the same lane without running into each other, radio stations cannot broadcast at the same frequency without generating interference.

Unfortunately, that’s exactly what happened. The spectrum of the 1920s was essentially a free-for-all where radio stations could transmit at whatever frequency they pleased. As a result, broadcasts often overlapped, and “listeners of one program were frequently interrupted” by other stations’ broadcasts.

To control the airwaves, the federal government passed the Radio Act of 1927, which created the Federal Radio Commission (FRC). The FRC established licensing requirements for radio stations, only approving those that it deemed were “in the public interest, convenience, or necessity”. The Commission also partitioned the spectrum, ensuring that certain radio stations could broadcast exclusively at specific times and between certain frequency bands.

For the next half century until 1982, the method used by the FRC—and later the Federal Communications Commission (FCC), which succeeded the FRC on June 19th, 1934—to license broadcasters remained unchanged. To transmit across the airwaves, applicants simply had to appear before the FCC in what is today known as a comparative hearing and demonstrate that they could meet the aforementioned “public interest” standard.

But this standard was “hardly objective”, and it meant that comparative hearings often involved little other than “lawyers and lobbyists arguing that their plans and clients were most deserving of a valuable but free government license.”

Spectrum Lotteries: 1982 to 1994

Apart from being subjective, comparative hearings were also time-consuming and administratively cumbersome. By the early 1980s, the FCC was fighting a backlog of thousands of broadcasting applications, and it needed a more efficient way to allocate spectrum licenses.

In early 1982, Congress passed a directive that gave the FCC the option to abolish comparative hearings in favor of a lottery system. Despite pushback from the majority of the Commission, who argued that a “lottery [system] would save no time”, it was implemented anyway in 1983.

The results, disappointingly, were about as expected. In flooded 400,000 applications, many sent in by “application mills”—sham companies that attempted to win a spectrum license so that it could be resold for profit.

While the lotteries themselves could be conducted quickly, the process benefited speculators in favor of legitimate applicants, who had to wait “years for secondary markets to reassign licenses to the parties that valued them the most.”

After a decade, the FCC realized that the lottery system was untenable. In a 1997 report to Congress, the FCC lamented in retrospect that “the ten year delay in cellular licensing [during which lotteries instead of auctions were held] cost the U.S. economy the equivalent of two percent of Gross National Product.”

Spectrum Auctions: 1994 Onwards

As part of the Omnibus Budget Reconciliation Act of 1993, Congress gave the FCC a one-year deadline to create a competitive bidding system for allocating spectrum licenses.

Though legislators hoped that this new system would make up for the shortcomings of both the prior competitive hearing and lottery arrangements, no auction system for assigning spectrum licenses had ever been implemented before—making Congress’ directive an unusually entrepreneurial one.

To create this auction system, the FCC enlisted the help of Stanford economics professor Paul Milgrom, widely regarded today as the “father of modern auction theory”. Together with FCC economists Evan Kwerel and Alex Felker, Milgrom devised a simultaneous bidding system that allowed all auction participants to place bids on all spectrum licenses that were on the block—all at once.

After bids were placed, high bids from that round would become starting bids for the subsequent round of simultaneous bidding. Multiple rounds of bidding would occur until a high bidder for each spectrum license was identified.

The Commission approved the design, and in late July 1994, the FCC conducted the world’s first simultaneous ascending auction, where it sold ten spectrum licenses after 47 rounds of bidding for a grand total of $617 million.

The money itself also represented an important milestone: for the first time since the FCC’s inception six decades earlier, it would generate revenue for the U.S. Treasury. Rather than giving away licenses for free—or worse, inadvertently lining the private pockets of unscrupulous speculators—the Commission could use auction proceeds to self-finance its administrative costs and divert the excess towards funding other important government services.

Nearly 30 years and more than 100 spectrum auctions later, and the FCC has generated over $258 billion for the Treasury—a success that has been deservingly lauded as a “taxpayers’ bonanza”.

Spectrum Auctions in the 21st Century

As we proceed into the 2020s, it’s becoming clear that mobile devices will succeed television and radio broadcasters as the dominant form of wireless media and communication—and thus take their place as the primary source of traffic on the country’s airwaves.

Now, the FCC’s challenge is to free up spectrum for these new cases by matching incumbent spectrum license holders with fresh-faced cellular data providers wanting exclusive rights to a specific frequency.

Recent activity, like the FCC’s auction for Advanced Wireless Services between late 2014 and early 2015, for example, involved the assignment of 1,611 licenses to 31 bidders after 341 rounds of bidding. The auction raised $41 billion, besting the Commission’s previous record-holding 700 megahertz (MHz) auction in 2008 by over $22 billion.

However, the FCC’s single biggest auction to date so far came just two years ago, when it conducted the 3,7 GHz Service auction. After 97 rounds of bidding, the Commission awarded 5,684 spectrum licenses and sent over $81 billion to the Treasury—nearly a quarter of all funds remitted to federal coffers since spectrum auctions first transformed the FCC and the nation’s airwaves 29 years ago.

At The Spaventa Group, we’re tuned into the latest developments in wireless and smart technology. As the physical and digital world collide, new discoveries and innovations will arise, giving enterprising investors the opportunity to earn dramatic returns.

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