Telephone Industry, History of

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TELEPHONE INDUSTRY, HISTORY OF

One of the greatest factors in shaping the modern age may well have been the evolution of the telephone industry. The roots of the communication age are found in the history of that evolution, primarily in the United States, and particularly in developments created by one company: American Telephone & Telegraph (AT&T).

Early Organization

The telephone industry was not the first to use electricity as the fundamental basis of a communication medium. Telegraphy had been firmly established in the United States and much of the industrialized world before efforts began in the late 1870s to develop telephony as the primary telecommunications industry in the United States. Furthermore, Alexander Graham Bell's technical innovations and U.S. patents in telephony should not overshadow the fact that others deserve as much or more credit for invention of the telephone. Although Europe was slow to adopt the telephone, Germany deserves more credit for its invention than the United States, due to Philip Reis's efforts in 1861. Nevertheless, most subsequent technological innovations that have led to the modern state of the telecommunications industry have been the by-product of Bell's vision and organization. While technological developments and regulatory processes have been key influences in the evolution of the telephone industry, the pivotal force motivating this history has always been economics.

AT&T's history, which has provided the context for all other developments in the telecommunications industry, can easily be divided into two distinct periods. The first period extends from the founding of Bell's company in 1877 to its legally mandated divestiture in 1982 (in spite of its claims to be a natural monopoly). The second period involves the post-1982 history of the company.

The first period in the history of the Bell System may be divided further into three separate periods leading to the establishment of the AT&T monopoly. The first is the period from 1877 to 1900, which may be best identified in terms of the Bell System's effort to control all aspects of the telephone product. The second is the period from 1900 to 1925, which involves the evolution of AT&T, the company's focus on an expanding infrastructure, and the original meaning of universal service. The third period, from 1925 to 1982, is related to the events that eventually challenged the company's identity as a natural monopoly.

The origin of the telephone industry is best explained through the Bell System's progression throughout North America via control of product development. Bell received four of his U.S. patents between 1875 and 1877. One of Bell's original financial supporters for development of the telephone was Gardiner Hubbard, who eventually became Bell's father-in-law and was one of the founding members and the first trustee of the Bell System. The original Bell System was designed to protect Bell's telephone patents and to control the use of all patented equipment. The first commercial organization of the Bell System was an agreement signed by Bell, Hubbard, and George Sanders on February 27, 1875, called the "Bell Patent Association." Hubbard's business experience influenced the concept of the Bell organization. Before he became associated with Bell, Hubbard had worked as an attorney for the Gordon-McKay Shoe Machinery Company. Hubbard applied the shoe company's practice of leasing equipment and receiving royalties for products created by that equipment to the business strategy of the Bell Telephone Company (formally established on August 4, 1877). In other words, each telephone service provider in a local market would pay fees to the company for use of the Bell telephone patents. Telephone customers would buy only service from providers. Bell essentially owned and controlled the hardware. Thus, the first phase in the establishment of a Bell telephone monopoly through vertical integration had begun.

The need to continue product innovation was recognized during this early phase of organization. Thomas Watson, essential to Bell for product development during the original patent applications, had been brought into the organization exclusively for product development. Yet Bell's greatest rival for patent rights and the evolving telephone industry, Western Union Telegraph Company, had strong ties to the Western Electric Manufacturing Company, the largest producer of electronic products in the United States. It was through Western Electric that Western Union challenged Bell's patents and exclusive rights to the telephone. Elisha Gray, who applied for a caveat as a precursor to a telephone patent on the same day as Bell's patent was filed, was an employee of Western Electric. Western Union formed the American Speaking Telephone Company on December 6, 1877, using the associated talents of innovators such as Gray and Thomas Edison and the production capabilities of Western Electric.

The eventual confrontation between Bell and Western Union concerning exclusive rights to telephone licensing and production led to an outof-court settlement in 1879. Bell had opened the first U.S. commercial exchange in New Haven, Connecticut, in 1878, and by 1879, he had established several more local exchanges throughout the United States and Canada. The Bell System reorganized under the name American Bell Telephone on March 20, 1880. The company barely had survived with little working capital during its first years of operation, yet the philosophy of competition through product development and control remained firmly rooted in the Bell business strategy. American Bell began to recognize the value in interexchange, or "long distance," telephony during the 1880s, and it formed a subsidiary company on February 28, 1885, the American Telephone & Telegraph Company, to develop long-distance service. The acquisition of Western Electric from Western Union, however, gave the Bell System the foundation it needed to maintain control over product innovation. On November 26, 1881, the newly named Western Electric Company took over the research and product manufacturing unit of the Bell System under the supervision of Watson. Most essential technological developments leading to the modern telecommunications infrastructure have their origins in Bell System's acquisition of Western Electric. Subsequently, Bell System's research and development helped to establish the financial base that the company would need for further expansion.

The financial benefits of owning its own product development unit allowed the Bell System to focus on widening its market influence in one other way. Western Union had given the Bell System a part of its customer base in the 1879 settlement. The Bell System was based on the control of several exchanges throughout the North American continent. Bell attempted to gain European control for his company, but Edison beat Bell by establishing the Edison Telephone Company of Great Britain, Ltd., in 1878. Furthermore, Western Union controlled most of the wired infrastructure throughout the United States, essentially isolating the local exchanges that were controlled by the Bell System. Ironically, while Bell's vision for the telephone was the point-to-point use by the average customer, Edison and others thought that the device would be too expensive and complicated for an international, or even a national, telephone system to evolve. As in Europe, many in the United States thought that the telegraph would remain the only true communication network. Hubbard actually refused to finance much of Bell's early development of the telephone, believing instead that telegraphy would remain more profitable. Nevertheless, from 1880 to 1884, the Bell System began establishing long-distance lines that connected major cities throughout the New England area. While intercity telephony grew relatively slowly throughout the 1880s, perhaps due to the initially slow expansion of urbanization, the apparent financial benefits of connecting local exchanges through "long lines" motivated another change in strategy and corporate restructuring of the Bell System.

The AT&T Monopoly and Technical Advances in Telephony

AT&T became the parent company and long distance became the focus of the Bell System in 1900 due to several factors, including public fears that the company practiced unfair business practices in the local exchange market, technological advances that allowed for greater interconnectivity, and the leadership of Theodore Vail. Vail, related to Samuel Morse's associate Alfred Vail, accepted the position of general manager of the Bell Telephone Company in 1878. Vail was put in charge of AT&T in 1885 but resigned as the company's president in 1887. Vail's return to AT&T in 1907 is considered the true origin of the modern telecommunications industry. While Vail's conception of universal service at affordable rates proved to be a great marketing strategy with the public, it also would continue to redefine the logical progression of the entire industry. AT&T's interests in Western Electric were reorganized, and that division was renamed Bell Telephone Laboratories in 1925. Also in 1925, Vail's vision for AT&T's complete control of a national infrastructure was generally accepted throughout the Bell System. Frequently challenged but essentially unchanged until 1982, the corporate structure of AT&T was well established by 1925. AT&T led a corporate structure that included the original Bell operating companies and Bell Laboratories. AT&T became the world's largest business enterprise, a fact that led to the U.S. Department of Justice (DOJ) challenging its operation as a highly integrated corporate monopoly.

Many technological advances by AT&T and others improved the marketability and led to expansion of the telephone industry between 1925 and 1982. In 1951, Bell competitor General Telephone and Electronics Corporation (GTE) developed direct distance dialing (DDD), which gave telephone customers the ability to dial a long-distance number directly without the facilitation of a switchboard operator. However, direct-dialing technology was not widely accepted throughout the telephone industry until the late 1960s. Commercial international telephony between Europe and North America began in 1927 via radio telephony service established by the British Post Office and AT&T. The first intercontinental submarine telephone cable between Europe and North America was opened for service in 1956. In 1962, Arthur C. Clark's vision of the communication satellite was realized when Telstar became operational. Telstar, developed by Bell Laboratories, was nothing more than a microwave relay device. It is therefore ironic that microwave technology and the transistor, also developed by Bell Laboratories, indirectly put an end to AT&T's monopoly over the telephone industry. Other important technological firsts that were essential to the evolution of the telephone industry include Intelsat 1, which was a communication satellite that linked Europe with North America in 1965.

AT&T helped to establish almost all of the advances in telecommunications technology and used the strategy of monopoly to control the implementation of each innovation by the telephone infrastructure. Yet these technology-driven innovations pushed reconsideration of the indus-try's structure and viability as a natural monopoly. Competitive forces increased pressure to destroy the Bell System's control over the industry with each wave of technological advances. In 1949, the DOJ filed suit against AT&T for its dominance over product development. The suit was settled in 1956 with AT&T's agreement to stay out of new product developments and sales that included innovations such as computer technology. Also in 1965, the U.S. government, through the Federal Communications Commission (FCC), ordered AT&T to allow customers the right to attach non-AT&T electronic, devices to their telephones as long as these devices would not interfere with the telephone system. The FCC, which was established as the U.S. telecommunications regulatory agency through the enactment of the Communications Act of 1934, tended to approach telephone industry regulation based on a concept of universal service not necessarily intended by Vail in 1907. For the FCC, universal service meant universal access. In other words, instead of taking the perspective of AT&T's drive for expansion and total interconnectivity, the FCC tended to address universal service as the consumer's need for access to an essential facility for daily living.

By 1966, the U.S. government and the FCC began looking into possibilities of merging telecommunications and computer technology in the "Computer Inquiry I" review. While the benefits of merging the technologies became clear, the FCC realized that encouraging the unregulated development of computer-based services with regulated telecommunications services would be difficult. The FCC's 1968 Carterfone decision extended the 1965 ruling, allowing electronic equipment not produced by Bell Laboratories, including devices such as computers, answering machines, and facsimile (fax) machines, to be attached to AT&T lines. The Carterfone decision of 1968, which allowed non-AT&T electronic equipment to be attached to existing networks, relaxed U.S. federal regulations and was intended to encourage further technological innovation and competition.

Competition was again the central debate of the telephone industry in 1974. The DOJ, extending concerns originally raised in its 1949 suit, intervened in AT&T's monopoly once again in 1974. The DOJ attacked AT&T's right to maintain a highly integrated corporate structure, arguing that the control over local exchanges, long-distance services, and product development gave the company an unfair business advantage. The concern of the DOJ was that AT&T's corporate structure and massive capital base discouraged others from entering the telephone market, thus discouraging both competition and further technological innovation. Adding to the DOJ's complaint was the Execunet case concerning Microwave Communications, Inc. (MCI). In 1975, MCI petitioned for approval of Execunet, which was an interconnected, switched network. While the FCC did not originally support MCI's petition to use microwave technology to bypass AT&T lines, a federal court overturned the FCC decision in 1978. MCI's Execunet appeal, along with the DOJ's 1974 suit and its eventual outof-court settlement in 1982 (in which AT&T agreed to divest its operating companies), have been the most important influences on the modern structure of the telecommunications industry.

After Divestiture

The Bell System completed the process of divestiture in 1984. AT&T became a long-distance services provider exclusively, and Bell's operating companies were divided among seven regional organizations that were commonly known as Regional Bell Operating Companies (RBOCs), or Baby Bells. The RBOCs were being considered for entry into interstate long-distance service almost immediately after divestiture. They, along with AT&T, had been banned from entry into new unregulated lines of business since 1956. While competition in the long-distance market did increase, the level of competition in the U.S. market had not reached industry expectations by 1996. Just three major long-distance carriers, AT&T, MCI, and Sprint, and the incumbent RBOCs, controlled most of the national market. The Telecommunications Act of 1996 was enacted partly to increase competition in the telecommunications industry by allowing the RBOCs to enter new markets. What the 1996 act has served to do, however, is to allow any company in the industry to enter any other telecommunications market. Thus, where previously there were clear lines of separation between industries such as telephone and cable, barriers to cross-ownership essentially were removed by the 1996 act.

Not only have diverse technologies been allowed to merge, but the individual corporations that own these technologies have also begun to merge. While the industry's organization has been manipulated in order to create competition, the capital bases of many of the competing companies grant each a particular advantage by blocking the entry of smaller competitors into the marketplace. The merging of corporations grants each more competitive power. International mergers provide corporate giants with the power to dominate the telecommunications industry on a global scale. While the 1996 act was designed to create competition in the United States, it may be facilitating the creation of new telecommunications monopolies reminiscent of the system that Bell envisioned and helped to create in the late 1880s. Thus, AT&T's legacy of marketplace control continues to influence the structure of the modern telecommunications industry.

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Martin L. Hatton

Encyclopedia of Communication and Information