Kotak Institutional Equities has an interesting report that draws parallels between the famous dollar auction game and the Indian telecom sector. The dollar auction game was used by economist Martin Shubik, a pioneer of game theory, to illustrate a concept known as “escalation of commitment”. Since the highest bidder wins the dollar, and the second highest bidder loses all that he/she has bid, those playing the game tend to keep bidding higher amounts to avoid losing what they have already bet.
Shubik says it is not uncommon for the person conducting the game to end up with $3-5 for every dollar that was auctioned. In such scenarios, the winning bidder would have ended up paying roughly between $1.5 and $2.5, with the losing bidder ending up losing a similar amount, give or take a few cents. Of course, the winning bidder’s losses will be lower when compared to the second highest bidder, since he gains the auctioned dollar, but both end up losing when bidding is competitive.
Could the fate of India’s largest telecom companies be the same? Every passing day, they increase their bids to gain a higher share of the market. They are doing this by increasing capital expenditure, and a willingness to fund large operating losses in the hope of a glorious future, where all of this will be recouped.
In the three-headed slugfest between Bharti Airtel Ltd, Reliance Jio Infocomm Ltd and the Vodafone-Idea combine, each entity has already spent somewhere between ₹2 trillion and ₹3 trillion in gross capital investments.
But the sharp rise in investments, especially since the entry of Reliance Jio, has also led to a shrinking of the market size. As the chart above shows, industry revenues have fallen by about a third since Reliance Jio’s entry. And this is before the new entrant’s latest salvo that involved a sharp cut in post-paid tariffs and international calling rates. Who knows what lies next?
In this backdrop, even a sizeable 50% market share may not amount to much in terms of profit potential. “We have seen spectrum auction bids and commercial decisions add up to an ‘escalation of commitment’ and undesirable outcomes, as things stand today,” Kotak’s analysts write in the report.
“The game (between telecom firms) has the potential to reach a stage where aggressive bids are placed just to force another player to exit; such aggression again reduces the size of the prize but a player can still look at the trade-off between reduced size of the prize and potentially higher share of it as a net positive. Commitments escalate easily,” they add.
Such scenarios haven’t been restricted to dollar-auction games in the past; they have played out often in real-life scenarios as well. In a paper published in the Journal of Marketing, researchers Eyal Biyalogorsky, William Boulding and Richard Staelin say that the occurrence of “escalation of commitment” phenomenon is a well documented one. They cite the examples of “the Vietnam War and Desert Storm, the Apollo moon missions, the Campeau–Federated merger, the coffee wars between Philip Morris and Procter & Gamble, the National Basketball Association draft etc.”, adding that the tendency to escalate commitments can be disastrous for firms, especially in hyper-competitive markets.
Kotak’s analysts say, “It is possible for a net-positive win-win outcome to emerge when players realize that the size of the prize and the cost associated with getting to a particular share matter as much as the share itself.” But this will involve so-called de-escalation bids, such as increasing tariffs and similar sane decisions. Now, who wants to bet on that?