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History of US Telecommunication: Monopoly and Competition Telecom Service/Policy Chae Y. Lee US Patent No. 174,465 “Improvements in telegraphy” 1830 Samuel Morse - First telegraph demonstrated 1856 Western Union Co. - Telegraph service Morse code uses information theory to minimize the number of symbols required to send a message 1874 A.G. Bell - Put speech over wire by varying the electrical current as the density of air waves vary when sound is produced

2 Alexander Graham Bell Inventor

1847 -1922 The most successful men in the end are those whose success is the result of steady accretion. —Alexander Graham Bell 3 Telecom Service/Policy Chae Y. Lee US Patent No. 174,465 “Improvements in telegraphy” 1876. 2. 14. 1st Telephone patent by Gardiner Hubbard for A.G. Bell Electrical transmission of sounds and the idea of variable resistance for converting voice to electrical signals Elisha Gray filed a caveat later that same day A few hours made all the difference 1876. 2. 17. First actual conversation over a practical telephone using telegraph line

4 Telecom Service/Policy Chae Y. Lee Bell Telephone Co.

1877. 7. 9. Issued shares: 5000 (Bell: 10, Gardiner Hubbard:1387) –First advertisement (1877) stated “… are now prepared to furnish telephones for the transmission of articulate speech through instrument not more than twenty miles apart.” 1877 First switchboard, six subscribers

5 Telecom Service/Policy Chae Y. Lee Bell Telephone Co.

1878 First telephone exchange, New Haven, 21 subscribers $38/month, average income $20/month 10,755 telephones (1878. 6.) Theodore Vail hired as general manager 1880 54,000 telephones

6 Telecom Service/Policy Chae Y. Lee Bell’s virtual monopoly for 17 years: patent extended from 1876 to 1893 Western Union (WU) was a formidable rival to the Bell Co. WU had a monopoly on telegraph, with transmission facilities from coast to coast WU developed a variable resistor transmitter that was superior to Bell’s and entered telephone Business

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Telecom Service/Policy Chae Y. Lee Bell’s virtual monopoly for 17 years: patent extended from 1876 to 1893 In November 1879 the litigation between WU and Bell was settled out of court WU gave up all patent rights, exchanges and telephones. In return Bell gave 20% of rental receipts for 17 years Bell formed AT&T to provide long distance lines and services

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A.G. Bell makes the ceremonial call to open telephone service from New York to Chicago, Oct. 18, 1892. 9 Telecom Service/Policy Chae Y. Lee Bell’s virtual monopoly for 17 years: patent expired in 1893 In 1893 patents started to expire Independent companies started up all over the country There were competing phone companies in the same area and they were not interconnected Inconvenience to the customer

10 Telecom Service/Policy Chae Y. Lee Technological Milestones

1881. 1. 12. 1st long distance circuit between Boston and Providence: 45 miles using a single galvanized iron wire 1884 New York to Boston: 292 miles using copper wire 1891 First automatic switch invented by Alman Strowger

11 Telecom Service/Policy Chae Y. Lee Changing Times

Bell was losing it’s monopoly grip In 1900 had 800,000 telephones in service, independents had 600,000 1903 Bell System 1,278,000 in 1,514 exchanges, Independents 2,000,000 in 6,150 exchanges Bell prices typically $125 per year for business, independents $70 Competition forced Bell to reduce price

12 Telecom Service/Policy Chae Y. Lee Full Attack

AT&T fought for a larger market through technology growth, (W.E.) purchased in 1882 from WU By 1900, W.E. dominated telecommunications manufacturing, but sold only to Bell System In addition to rate cutting, Bell began buying independent companies The main weapon of attack was AT&T’s refusal to allow others to connect to their networks Several states passed laws requiring interconnection, but AT&T always won in court 13 Telecom Service/Policy Chae Y. Lee Trouble in Growth

Competition forced AT&T to expand and grow Between 1902 and 1907, debt grew from $60M to more than $200M Stock high of $186 in 1902 $88 in 1907 Bell System had 3,132,000 phones to the independent companies 2,987,000 Poor service and anti-competitive tactics Long distance service had reached the limits, excessive noise and delays in connections Coast-to-coast service not possible

14 Telecom Service/Policy Chae Y. Lee New president named Theodore Vail in 1907

Vail observed that cheap rates depended on high use, which made possible cheaper rates Vail pushed against competition in telephone service, seeing that it provided no useful advantage over an enlightened regulated monopoly AT&T’s improved financial situation was the opposite of that of independents As any independent had problems, financing was cut off, AT&T then purchased them at discount

15 Telecom Service/Policy Chae Y. Lee Regulated Monopoly by Vail

WECo became the manufacturing arm of the Bell system Vail transformed the Bell into the modern Bell system Bell Telephone Laboratories A public relations group Philosophy: “A regulated monopoly best serves the public.” Policy that public services are best provided by a single source , End-to-end service, Value of service pricing 16 Telecom Service/Policy Chae Y. Lee Regulated Monopoly by Vail

Universal service: Price initial cost for a telephone and basic local service low enough to almost everyone Provide coast-to-coast network End-to-end service: Responsible for service from manufacturing to installation, operation and maintenance Value of service pricing: Same service for the same price Service based on value, not cost

17 Telecom Service/Policy Chae Y. Lee Regulated Monopoly by Vail

Bell continued to buy independent companies Bell had 81% of lines and 41% of geographic area More than 1400 independents served 19% of lines

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Telecom Service/Policy Chae Y. Lee Monopoly and the Kingsbury commitment

In 1908 Bell bought 30% of WU In 1913 the Justice filed a law suit against Bell Bell was accused of violation of antitrust law Settlement provisions (The Kingsbury Commitment): Divestiture of Western Union Buy no more independents without ICC (Interstate Commerce Commission, pre-FCC) approval Interconnect with other telephone Co.

19 Telecom Service/Policy Chae Y. Lee The Kingsbury commitment

Big win for both AT&T and the independents: Monopolies of telephone service and one ‘shared’ network Local service provided by either AT&T or independent companies Long distance service essentially all AT&T Regulated monopoly in local service with unregulated monopoly in long line service No effective interstate regulation until after FCC in 1934

20 Telecom Service/Policy Chae Y. Lee The World War

In 1918, during the World War the federal government took over the telephone company It promised security and reduced rates, but the actual result was that both local and long distance rates went up

21 Telecom Service/Policy Chae Y. Lee Graham Act

In 1921 the Graham Act exempted telephony from the Sherman Antitrust Act It reinforced the concept that telephony was a “natural monopoly” By 1929 Bell became the first company to achieve $1 billion in revenue with 500,000 stockholders

22 Telecom Service/Policy Chae Y. Lee Technology Advances

Work on wireless technology (radio) advances Long distance and overseas advances during WWI 1915 First transcontinental call, NY to SF 1927 Trans-Atlantic short-wave call, NY to London Broadcast radio and television, AM/FM, TV Integration of research and development; Bell Laboratories formed in 1925

23 Telecom Service/Policy Chae Y. Lee Regulatory Actions

1930s Western Electric’s monopoly of telecom manufacturing 1934 Communication Act The FCC (Federal Communications Commission) in the role of Spectrum Management and Interstate regulation The PUC (Public Utilities Commission) in the role of State regulation Long line service regulated by FCC and local service by PUC Left the Bell System with an intact monopoly and vertical integration

24 Telecom Service/Policy Chae Y. Lee The Communication Act of 1934

Beginning of regulation by the federal government It established the jurisdiction of the FCC It reinforced the Kingsbury Commitment It established the principal that the telephone industry operated best in the public interest as a regulated monopoly

25 Telecom Service/Policy Chae Y. Lee The Communication Act of 1934

FCC began an indepth study and investigation of AT&T, a comprehensive record of the company’s activities from 1876 By 1939 AT&T had assets of $5 billion, served 83% of the telephones, owned 91% of the telephone plant, provided 98% of the toll service and 100% of the international traffic

26 Telecom Service/Policy Chae Y. Lee Post 1934

The stability introduced by the Kingsbury Commitment and the ‘blessing’ of the 1934 Act allowed AT&T to prosper Competition was eliminated The creation of Bell Laboratories provided a form of vertical integrated research, from fundamental to applied Focus on planning, on efficiency and quality in order to meet the universal service goal

27 Telecom Service/Policy Chae Y. Lee Post 1934

Twisted pair systems Coaxial cable systems 1935 First coaxial cable, NY to Philadelphia 1938 First crossbar central office switch installed High frequency radio for wireless point to point trunk system 1947 First microwave (point-to-point service) AT&T by 1939 $5B in assets 83% of telephones (90% manufactured by W.E.) 91% of telephone plant 98% of long distance, 100% of transoceanic

28 Telecom Service/Policy Chae Y. Lee Summary

Bell’s virtual monopoly for 17 years based on the US patent (1876-1893) Western Union (WU) was a formidable rival to the Bell Co. Independent Co. started service in 1893, but no interconnection - competition Bell’s full attack: WECo, independent Co. purchased Regulated Monopoly by Vail in 1907 The Kingsbury Commitment in 1913 Communication Act of 1934: Regulation by the federal government, FCC 29 Telecom Service/Policy Chae Y. Lee Too Successful?

1948 US DoJ files antitrust suit alleging that W.E. effectively monopolized the market for telephone and related equipment AT&T argued necessary for quality and cost savings Concluded with the Consent Decree in 1956 which allowed essentially no change in structure Required AT&T to license patents, limited them to common carrier (regulated) services

30 Telecom Service/Policy Chae Y. Lee The Consent Decree of 1956

In 1949 the Justice filed a new suit against AT&T under the Sherman Antitrust Act One of the objectives was an attempt to introduce competition into the manufacturing and supply of telephone equipment

31 Telecom Service/Policy Chae Y. Lee The Consent Decree of 1956

Charges No effective competition WECo’s products were subsidized by the rate payers giving them an unfair advantage over competitors in telephone equipment manufacturing The Justice asked for: Divestiture of WECo from the rest of AT&T Split AT&T into three companies

32 Telecom Service/Policy Chae Y. Lee The Consent Decree of 1956 Consent Decree of 1956 (an out-of-court settlement): WECo not separated WECo could not sell their products outside the Bell System (except to the government) Bell would engage in basic common carrier business only (NOT the enhanced data processing service) Bell agreed to grant non-exclusive license and technical information to any applicant

33 Telecom Service/Policy Chae Y. Lee Terminal Equipment Activities: Hush-a-Phone (invented in 1921) A cup that is attached to the transmitter of the phone for privacy Bell pressured stores not to sell, citing the ‘foreign attachments’ rule in tariffs Prior to 1968, it was illegal to attach any foreign (not WECo) equipment to the telephone or telephone equipment Hush-a-phone filed suit against AT&T Lost case in 1955 with FCC, won in Appellate court in 1956 34 Telecom Service/Policy Chae Y. Lee Terminal Equipment II: Carterfone

A device which connected local phone line to a radio receiver Carter filed antitrust suit in 1965, case remanded back to FCC AT&T claimed possible harm, none demonstrated 1968, FCC found Carterfone violated AT&T’s tariff, but that the tariff itself was illegal 1968, Carterfone decision made it possible to attach non AT&T equipment to the telephone line

35 Telecom Service/Policy Chae Y. Lee Terminal Equipment II: Carterfone

• This is a device which was invented by Thomas Carter. It connects a two-way mobile radio system to the PSTN. The base station of the mobile radio system supplied electrical power for it. • It was electrically connected to the base station of the mobile radio system, and the electrical parts were encased in bakelite. When someone on the radio wished to speak to someone on phone, or "landline", the station operator at the base would dial the number and place the handset on the Carterfone. The device was therefore acoustically connected to the Public Switched Telephone Network, and did not have the capacity to damage the PSTN. 36 Telecom Service/Policy Chae Y. Lee More Competition after WWII

Carterfone: Antitrust suit in 1965 Carterfone decision in 1968: made it possible to attach non AT&T equipment to the telephone line Move to terminal equipment deregulation Any equipment may be attached to network, as long as it meets certification standards Competition in long distance service 1956 First trans-Atlantic telephone cable 1962 Telecommunications Satellites 1969 MCI decision 1980’s Fiber cable

37 Telecom Service/Policy Chae Y. Lee Terminal Equipment Deregulation

Several States tried unsuccessfully to block terminal deregulation as the loss of terminal revenues raised the cost of local service 1983, all terminal equipment or CPE (Customer Premises Equipment; $14B in AT&T book value) is deregulated

38 Telecom Service/Policy Chae Y. Lee Computer Inquiry I in 1971

Unregulated data processing service vs. regulated communication service Telco wanted data processing services IBM wanted to use telephone network for data processing Vague definitional dividing line between primarily data processing and primarily communications

39 Telecom Service/Policy Chae Y. Lee Computer Inquiry I in 1971

Enhanced service can be provided under separate structure - separate subsidiary AT&T and 23 operating Co. cannot service the data processing due to 1956 Consent Decree Hybrid services became routine during the 1970s

40 Telecom Service/Policy Chae Y. Lee Computer II decision in 1980

AT&T Dataspeed 40/4 (“smart terminal” designed to communicate with a computer + some processing functions) as a component of Dataphone Digital Service Communications equipment vs. data processing equipment Deregulation of all CPE, No interconnection fee Bringing market forces to the CPE industry rather than protecting consumer’s rights with regulation FCC sought to separate equipment from regulated monopoly service AT&T was allowed to provide unregulated services through its separate subsidiary

41 Telecom Service/Policy Chae Y. Lee Computer II decision in 1980

An attempt to eliminate regulated competition by reducing the scope of regulation An attempt to provide maximum opportunity for free market forces

42 Telecom Service/Policy Chae Y. Lee Network Competition

In 1978 FCC allowed other common carriers to provide long distance service in competition to the Bell system Subscribers had to dial additional digits to get to the network and even more digits to identify themselves to the carrier

43 Telecom Service/Policy Chae Y. Lee Network Competition

1983, MCI $1,521M gross revenues, Southern Pacific $740M This $2.3B was equal to 6% of the switched toll revenues in 1983 Just before divestiture the Bell system served about 84% of the 180 million telephones The 1600 independent companies served the other 16%

44 Telecom Service/Policy Chae Y. Lee Network Competition

The Bell Operating Companies (BOCs) and the independents had a monopoly and provided service within their geographic areas while Long Lines (LL, a department of AT&T) provided inter-company services. All companies were interconnected There was a “division of revenue” or “separations on revenue” generated by traffic that crosses boundaries This was a very complex, difficult and laborious process

45 Telecom Service/Policy Chae Y. Lee Divestiture

In 1974 the Justice filed a suit against AT&T for violation of the Sherman Anti-trust Act In part it was initiated by complaints from terminal equipment providers and other common carriers, such as MCI

46 Telecom Service/Policy Chae Y. Lee Divestiture

Assigned to Judge Harold Greene in 1978 Charges: Bell was attempting to obstruct competition in the terminal equipment and common carrier parts of the business The Justice argued: New technology made the 1956 Consent Decree obsolete The suit was based on post 1956 conduct by AT&T and that the FCC’s decisions had tended to open areas to competition

47 Telecom Service/Policy Chae Y. Lee Divestiture

The Justice asked for: Divestiture of WECo Separation of LL from local exchange carriers (LECs) Separation of from AT&T AT&T’s response: Fight to the end, NO consent decree this time Not in violation of anti-trust laws Even if we are, we are exempt from those laws anyway AT&T provides good service at reasonable rates, AT&T is a national resource and the envy of the world

48 Telecom Service/Policy Chae Y. Lee Divestiture

An out-of-court settlement with the Modified Final Judgement (MFJ) to go into effect January 1, 1984 The MFJ ordered AT&T to divest the BOCs AT&T keeps long distance service, WECo and Bell Labs AT&T free to enter other markets

49 50 Telecom Service/Policy Chae Y. Lee 4 RBOCs after the Telecommunication Act of 1996 Verizon Bell South SBC QUEST

51 Telecom Service/Policy Chae Y. Lee Divestiture (Breakup) The BOCs are to recombine into seven Regional BOCs (RBOCs) RBOCs provide local service including toll (monopoly) within Local Access Transport Areas (LATA) RBOCs cannot provide service across LATA boundaries, even within their own territory RBOCs provide point of presence (POP) within each LATA for inter-exchange carriers (IXC) with equal access to all carriers POP: physical location within a LATA where the IXCs interface with LECs RBOCs can serve basic transport only, not ‘enhanced’ services (as defined in Computer Inquiry I, II)

52 Telecom Service/Policy Chae Y. Lee US LATA Map The BOCs are to recombine into seven Regional BOCs (RBOCs) RBOCs provide local service including toll (monopoly) within Local Access Transport Areas (LATA) RBOCs cannot provide service across LATA boundaries, even within their own territory RBOCs provide point of presence (POP) within each LATA for inter-exchange carriers (IXC) with equal access to all carriers POP: physical location within a LATA where the IXCs interface with LECs RBOCs can serve basic transport only, not ‘enhanced’ services (as defined in Computer Inquiry I, II)

53 54 Telecom Service/Policy Chae Y. Lee Divestiture

RBOCs created BellCore (Bell Communications Research) to perform common engineering, planning, and other functions better done as a consortium Competition between IXCs for inter-LATA traffic Major IXCs: AT&T, MCI and Sprint

55 Telecom Service/Policy Chae Y. Lee Computer III in 1985

Integration of computer processing capability (enhanced service) into the network (regulated service) Credit card call; requires validation of the card by accessing central data base 800 services; requires translation of the 800 numbers into an ordinary routing number by accessing central data base

56 Telecom Service/Policy Chae Y. Lee Computer III in 1985

FCC’s experience with the computer II rules 1. No clear line between basic and enhanced services 2. Computer II rules prohibits the integrated services that would not be offered separately. e.g., “Custom Calling II” for voice storage service 3. The rules prohibit general network improvements by restricting the use of computer technology

57 Telecom Service/Policy Chae Y. Lee Computer III in 1985 LEC could provide enhanced services without using separate subsidiaries FCC adopted an approach to providing safeguards for companies that were both customers and competitors of the LEC: Two primary components of Computer III to protect CLEC 1. Open Network Architecture to protect against discrimination; break down the network into a number of building blocks (basic service elements, unbundled network elements), each of which would be offered separately under tariff at nondiscriminatory rates to all customers 58 Telecom Service/Policy Chae Y. Lee Computer III in 1985 2. Regulated and nonregulated portion of the business could share assets and personal subject to cost accounting safeguards to protect against cross- subsidy: Cost allocation rules need to be approved by FCC No cost switch from nonregulated side to regulated side

59 Telecom Service/Policy Chae Y. Lee Summary

Consent Decree of 1956: an attempt to introduce competition in equipment business allowed basic common carrier business only Deregulation of Terminal Equipments Hush-a-phone, Carterfone, Computer Inquiry I, II, III Network competition: local, long line Divestiture and MFJ

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