Is Telephony a Natural Monopoly?

For my entire career, I’ve heard it said that telecommunications is a natural monopoly. That was the justification for creating monopoly exchange boundaries for telcos and for issuing exclusive franchise agreements for cable companies. This historic reasoning is why the majority of Americans in urban areas are still stuck with duopoly competition that is trending towards a cable monopoly.

I worked for Southwestern Bell pre-divestiture and they were proud of their monopoly. Folks at Ma Bell thought the telephone monopoly was the best possible deal for the public and they constantly bragged about the low rates for a residential telephone line, usually at something less than $15 per month. But when you looked closer, the monopoly was not benefitting the average household. Long distance was selling for 12 cents to 25 cents per minute and a major percentage of households had monthly phone bills over $100 per month.

I’ve been doing some reading on the history of the telephone industry and found some history I never knew about – and which is different than what Ma Bell told employees for 100 years.

Alexander Graham Bell was granted many patents for telephone service in 1876. During the 18-year life of the original patents, Bell telephone held a monopoly on telephone service. Bell Telephone mostly built to large businesses and to rich neighborhoods and the country still predominantly communicated via telegraph. Bell Telephone was not considered much of a success. By 1894 there was still less than 5 telephones in the country per 1,000 population, and there were only 37 average calls per day per 1,000 people.

As soon as the patents expired, numerous competitors entered the market. They built to towns that Bell Telephone had ignored but also built a competing network in many Bell Telephone markets. By the end of 1896, 80 competitors that had grabbed 5% of the total telephone market. By 1900 there were 3,000 competitive telephone companies.

By 1907 the competitors had grabbed 51% of the national market and had also driven down urban telephone rates. AT&T’s returns (AT&T had officially become the name of Bell Telephone) had dropped from 46% annually in the late 1800s to 8% by 1906. After 17 years of monopoly, the country had only 270,000 telephones. After 13 years of competition there were over 6 million phones in the country.

The death of telephone competition started when Theodore Vail became president of AT&T in 1907. By 1910 the company was buying competitors and lobbying for a monopoly scenario. Federal regulators stepped in to slow Bell’s the purchase of telephone companies after Vail tried to buy Western Union.

In a compromise reached with the federal government, AT&T agreed to stop buying telcos and to interconnect with independent telephone companies to create one nationwide network. That compromise was known as the Kingsbury Commitment. Vail used this compromise to carve out monopoly service areas by only agreeing to interconnect with companies that would create exchange boundaries and further agree not to compete in AT&T exchanges. With almost the opposite result that federal regulators had hoped for, the Kingsbury Commitment resulted in a country carved into AT&T monopoly telephone service areas.

From that time forward federal regulators supported the new monopoly borders, cementing the arrangement with the Telecommunications Act of 1934. State regulators liked the monopolies because they were easier to regulate – state regulation turned into rate-making procedures that raised rates on businesses to keep lower residential rates. AT&T thrived in this environment because they were guaranteed a rate of return, regardless of performance.

The history of telephone service shows that the industry is not a natural monopoly. A natural monopoly is one where one provider can produce lower rates than are achieved by allowing competition. Competing networks forced lower telephone rates at the turn of the last century. After the establishment of the AT&T monopoly we saw monopoly abuse through high long distance rates that didn’t drop until MCI challenged the monopoly status quo. Today we have a world full of multiple wires and networks and the idea of natural monopoly is no longer considered as valid. Unfortunately, many of the vestiges of the regulations that protect the big telcos are still in place and still create hurdles to unfettered competition.

The First Transcontinental Call

StampLast week I highlighted a number of events in the history of telecom and over the next few months I am going to look at a few of them in more detail. One of the best stories in the industry’s history is about the completion of the first transcontinental phone call.

AT&T and a few other phone companies had begun building long copper routes between cities as early as 1885. For example, the route between New York and Chicago was completed in 1892. In the early days of the copper technology calls could be extended for some distance using load coils, a technology still in use today on rural copper networks. But that technology had a distance limitation of about 900 miles for a given call.

In 1908 Theodore Vail, the president of AT&T made it a company priority to have transcontinental calling even though the technology didn’t exist to make it work. The stakes were made higher in the following year when John J. Carty, the chief engineer at AT&T announced that AT&T would have the ability to make transcontinental calls in time for the 1915 exposition planned in San Francisco to celebrate the completion of the Panama Canal.

So the race was now on. AT&T announced that they would pay well to anyone who could bring them a technology that would help them extend calls farther. In 1912, inventor Dr. Lee de Forest brought an audion to AT&T’s engineering department. This was a three element vacuum tube that amplified the telephone signal enough to get AT&T’s attention. So AT&T bought the patent for the technology. By the following year in 2013 Dr. Harold Arnold, a physicist employed by AT&T perfected the invention by increasing the amount of vacuum and other tweaks, and the audion became a practical amplifier.

Now AT&T needed to build the copper routes to connect east and west and construction began in earnest. One June 17, 1914 the company completed the last connecting pole in Wendover, Utah that made the east-west connection. That event is commemorated by the US stamp shown above. The connection was made six months before the opening of the San Francisco exposition and so AT&T waited until January 15, 1915 to make the first official call on the network. (Obviously they tested it first!)

The first official call was completed at the opening of the Exposition. A large loop was created from Jekyl Island Georgia, the location of Theodore Vail, the president of AT&T, through Washington DC, New York, Boston, and on to San Francisco. Anybody at each of these sites could hear whoever was talking on the line. The first speakers on the call were Alexander Graham Bell in New York City and Thomas A. Watson, his former assistant in San Francisco. Dr. Bell repeated the same words he had first spoken over the telephone, “Mr. Watson, come here, I want you.” To which Mr. Watson replied, “It would take me a week now.” They were then joined on the line by Theodore Vail, President Woodrow Wilson, the Mayors of New York and San Francisco and others like J.P. Morgan.

The network involved in coast-to-coast calls was impressive. One call involved two physical and one phantom circuit and each circuit consisted of two wires, so it required six wires to complete and carry a call. And this was heavy gauge wire that used 870 pounds of copper per circuit mile. In those days, before the invention of multiplexing, only one call could be handled at a time over a given set of circuits. In the main line between coasts there were 130,000 poles. It was estimated at the time that one call tied up $2 million dollars of network investment.

After the first call the service was opened to the public. But calling was not cheap and a long distance call from New York to San Francisco cost $20.70 for the first three minutes and $6.75 for each subsequent minute. To put that in perspective, in today’s dollars that is equivalent to  $488 for the first three minutes and $159 per minute after. It generally took around ten minutes for operators to arrange a coast-to-coast call.

The aggressive extensions of the backbone networks connected more and more parts of the country to each other over time. Long distance in those early days was quite expensive and there was a lot more demand for use of the lines than the technology could handle. It wasn’t until well into the 1920s when rudimentary telephone switches, rotary dial telephones and multiplexing dropped the cost of long distance calls from the stratosphere to just reasonably expensive. And we all know where it went from there.