The Bell System divestiture: background, implementation, and outcome.

• Author: Weber, Joseph H.
• Position: The Enduring Lessons of the Breakup of AT&T: A Twenty-Five Year Retrospective

1. INTRODUCTION II. THE RISE OF COMPETITION III. THE ANTITRUST SUIT IV. NEAR-TERM RESULTS V. LONGER-TERM RESULTS VI. CONCLUSIONS I. INTRODUCTION

   The telephone industry in the United States started with the Bell patent in 1878. Telephones were introduced into many communities during the next twenty years. After the Bell patents expired, around the turn of the century, multiple telephone companies began operations in many cities. In many cases, these companies did not even interconnect, so people needed two or three telephone services in order to be in contact with all of their friends and customers. This chaotic situation also caused the carriers great financial difficulty.

   In 1907, Theodore Vail, having been installed as president of AT&T after the "Panic of 1907," proposed that telephone service in the United States be provided based on the philosophy of "one system, one policy, universal service." (1) This concept involved monopoly provision of service, coupled with pervasive government oversight and regulation. It was promoted in advertisements from 1908 and formalized in the so-called Kingsbury Commitment of 1913, (2) when AT&T was allowed to operate without governmental interference, but agreed to stop acquiring telephone companies and to interconnect with others.

   The Bell System followed that idea for half a century, fully integrating its systems and procedures to provide end-to-end service. In order to ensure a reliable supply of standardized equipment, it also designed and manufactured its own equipment. Bell Laboratories (Bell Labs)--created from a merger of the design department of the manufacturer, Western Electric, and the engineering department of the operator, AT&T--also embarked on an extensive and successful effort to perform the research necessary to promote technological progress in telecommunications.

   Using this model, AT&T successfully expanded telephone service in the United States until the 1950s, when universal service was essentially achieved. During this period, the concept of "service" was the predominant value within the organization, becoming almost a religion. "Independent" telephone companies, mostly in rural areas, were made partners in the system, encouraged by generous "settlement" payments from long-distance service.

2. THE RISE OF COMPETITION

   Starting in the 1960s, new technologies, many pioneered at Bell Labs, were stimulating competitive activities. There were four principal technologies that led to this: (1) large radio systems for carrying long-distance calls; (2) semiconductor devices built for computers that could be used for switches; (3) miniature connectors for telephones and other terminal equipment; and (4) tone signaling, that allowed signals to be sent over the network after a connection was established.

   Regulators, intent on limiting the rate of growth of the Bell System, tended to allow competitive entrance into various portions of the market, albeit slowly and unevenly. Competition began in the following areas:

   * Large companies began building their own private microwave systems for internal communications;

   * Telecommunications equipment manufacturers began building terminal equipment and customer switches that could be connected to the telephone network;

   * Other manufacturers began trying, with some success, to sell equipment to the Bell companies; and

   * MCI built a long-distance network using microwave radio systems, allowing people to make local calls to MCI's switches, and complete the calls by using tone signaling to get the necessary information to the MCI network. Others followed.

   The last development was not based on new technology so much as on pricing distortions that had grown up over the years. For many years, technological advances had benefited long-distance services more than local services. In order to maintain the stability of local pricing, long-distance prices were allowed to remain well above cost, the difference being used to reduce the cost of local service. MCI's idea exploited this arrangement. It used its own long-distance network and paid Bell only the subsidized price for local access.

   Bell objected furiously, guided in part by their sense of "service" and partly by financial considerations, but in a series of FCC and court decisions, Bell was gradually forced to give ground in a number of areas.

   Terminal equipment--telephones, customer switches, etc.--was deregulated. Bell had strongly defended its "end-to-end service" mantra, but a series of FCC decisions (Hush-A-Phone (3) and Carterfone (4)) weakened its position. It became apparent that customer-owned terminal equipment could be connected to the network without service degradation. The FCC finally adopted a set of interconnection standards and deregulated the provision of terminal equipment. Competition developed quickly, spurring innovation in that market. As a precursor of things to come, controversies quickly developed as to the location of the "network...