1. History and Regulation of the Telephone Industry

"Mr. Watson, come here, I want you." With these historic words Alexander Graham Bell called to his assistant Thomas Augustus Watson over the so-called "telephone," and an industry was born.

The place: 5 Exeter Place, Boston, Massachusetts
The time: evening, March 10, 1876

As with all inventions, the road had not been smooth. For years Graham Bell (as he liked to be called) had been experimenting with a harmonic telegraph. It should be possible, he reasoned, to send six tones over the same wire at the same time and cause six reeds attached to the receiving end to be operated. Furthermore, if all worked well, varied combinations of these six pitches could reproduce human speech.

Simultaneously he was working on a scheme that utilized the varying resistance of a wire. A diaphragm, which would be vibrated by the human voice, was attached to a wire that was dipped into a mixture of acid and water. In theory, as the diaphragm moved downward, forcing more wire into the acid, the resistance of the wire would be decreased. As the diaphragm moved upward, the wire would be withdrawn from the conducting liquid, and its resistance would be increased. It was this device that was ultimately successful and that formed the basis for the telephone industry for many years.

A year later, on July 9, 1877, the Bell Telephone Company was formed, and Alexander Graham Bell became the company's electrician, at a salary of $3,000, and Watson became superintendent in charge of research and manufacturing. Unfortunately for Bell, the basic patents were due to run out in 1893 and 1894. But by this time, Theodore Newton Vail had been brought in as general manager, and he immediately set about establishing an organization strong enough to survive without a monopoly. "What we wanted to do was get possession of the field in such a way that, patent or no patent, we could control it," Vail said. The first step was to obtain a captive manufacturing facility, and this was accomplished in 1881 with the purchase of Western Electric Company.

Vail also sent his salesmen into the field to set up telephone exchanges in virgin territory. Generally, local promoters were encouraged to organize a local telephone company and sell stock. Thus, by 1885 Vail had established a vertically integrated supply division, a network of companies licensed by the parent, and a strong research and development arm. The expiration of Bell's basic patents in 1893 and 1894 was the starting signal for open competition. Independent telephone operating companies sprang up throughout the country; by the turn of the century there were approximately 6,000 of them, and these 6,000 provided service to some 600,000 subscribers. Through the years, mergers and acquisitions took their toll; at the present time there are approximately 1,300 local exchange carriers.

Unfortunately for the general public, all these telephones were not interconnected. Therefore, it was necessary for a subscriber to have two or three instruments in order to communicate with the total population of the city. However, the great asset of AT&T, which became the official name of the company at the end of 1899, was the control of all the long-distance circuits and its steadfast refusal to interconnect any other company to it.

This would never do, and the Justice Department filed suit in 1912. The world was angry with AT&T, and an AT&T vice president—Nathan C. Kingsbury—realized it. He recognized that the best demonstration of AT&T not being in a monopoly position was to point to thousands of independents apparently operating in harmony. To this end, AT&T agreed to provide interconnection arrangements to all independents. This 1913 agreement was henceforth called the Kingsbury Commitment.

By 1934 telecommunications had become so important to the country that Congress passed a Communications Act and, simultaneously, created the Federal Communications Commission (FCC). The section of this Act that has turned out to be most important has to do with what we now call universal service. It said: "For the purpose of regulating interstate and foreign commerce in communication by wire and radio so as to make available, so far as possible, to all the people of the United States a rapid, efficient, nationwide, and worldwide wire and radio communication service with adequate facilities at reasonable charges."

As a result of this principle, a support structure has been established whereby certain groups of subscribers (e.g., long-distance users, business subscribers, subscribers in locations where telephone service can be provided with relative ease, etc.) will pay more than true costs, and other groups of subscribers (e.g., subscribers in rural and other high-cost locations) will pay less than true costs.

In 1949 the Justice Department again filed suit against AT&T, claiming that Western Electric charged inordinately high prices from their customers (i.e., the operating telephone companies owned by AT&T), thus making it possible for the operating telephone companies to charge their subscribers inappropriately high rates. The suit dragged on, and a consent decree was reached in 1956. AT&T won; Western Electric need not be divested from AT&T, the Bell System would engage only in telecommunications business, and nonexclusive licenses would be granted to any applicant on fair terms. This was the final judgment. The eventual breakup of the Bell System in 1984 was accomplished through a modification of this final judgment, hence the modification of final judgment (MFJ).

Although the Bell System appeared to be the winner in this 1956 suit, over the next two decades they would lose battles, one at a time. There was the Hush-A-Phone case in 1955; the Carterfone case in 1968; MCI's "above 890" case in 1959, and the MCI case dealing with a long-distance route from Chicago to St. Louis in 1969. In November, 1974, the Justice Department once again filed suit to break up the Bell System. The case trudged on until 1978, when Judge Harold Greene took over. He moved things quickly, and on January 4, 1982, a terse announcement was issued by the Justice Department and AT&T saying that negotiations had been reopened. Then, on January 8, 1982, the news broke; AT&T had agreed to break up its $136.8 billion empire. It was agreed that AT&T would divest the local parts of the Bell operating telephone companies. It would keep its manufacturing facilities and its long-distance network. The agreement would take effect on January 1, 1984.

The twenty-two regional Bell operating companies (RBOCs) agreed to form seven regional holding companies (Bell Atlantic, NYNEX, BellSouth, Ameritech, U S West, Pacific Telesis, and Southwestern Bell). The agreement also said that the Bell operating companies would not be allowed to manufacture nor would they be allowed to get in the long-distance business within their territories. AT&T would not be allowed to get in the local-exchange business nor to acquire the stock or assets of any RBOC.

That remained the state of affairs until the passage of the 1996 Telecommunications Act. This Act threw most of the rules established in 1984 out the window and left the implementation of the Act to the FCC. There have been problems ever since. What did the Congress mean by "promote competition?" Should AT&T be allowed to get in the local-exchange business? (Answer: yes.) Should the RBOCs be allowed to get in the long-distance business? (Answer: yes, but only after passing a fourteen-point checklist.) What did "expanded universal service" mean? Should the RBOCs be allowed to merge? (Answer: yes. Bell Atlantic has merged with NYNEX; Southwestern Bell [SBC] has merged with Pacific Telesis and is planning to merge with Ameritech. Bell Atlantic intends to merge with GTE. If all of these are ultimately approved, there will remain four RBOCs). To date, many questions remain, and there is no assurance that they will be answered in the foreseeable future.

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