From the book The Rape of Ma Bell by Constantine Raymond Kraus and Alfred W. Duerig
Published by Lyle Stuart Inc., 1988 - hard cover
from pages 69 - 109
5 The Factory "... high-class service and low-class equipment do not coordinate."
—THEODORE N. VAIL, 1915
Western Electric was an invisible giant.
The general public knew the Bell Laboratories. Its name popped up in newspaper articles with regularity—its new inventions, its scientists winning Nobel prizes, Washington asking it to coordinate vital projects.
But Western Electric? It was usually confused with Western Union or Westinghouse.
When Vail bought Western Electric in 1881, it was the largest producer of electrical goods in the United States. One hundred years later it had grown to be one of the ten largest American manufacturers, employing a quarter of a million people and selling $7.7 billion worth of its own products and another $2.3 billion in products made by other companies.
It was AT&T's factory. Western Electric took Bell Laboratories' research and development work and turned it into product. It mass-produced the most durable telephones on the market at half the cost of its closest competitor. It also turned out complex microelectronic chips. It was the world's first producer of the 64 kilobit chip and later the 256 kilobit chip.
But the general public, unless an individual was in the habit of looking at the bottom of his telephone, hardly knew Western Electric existed, much less was aware of its immense size and scope.
The reason for this ignorance was twofold. One, AT&T owned 100 percent of Western Electric. So it was not listed separately on any securities exchange and its earnings and balance sheets were integrated with those of the rest of the Bell System.
Two, Western Electric didn't sell products directly to the public. It sold—with one exception—only to AT&T.
Of course, the Bell System was a gigantic customer, allowing Western Electric to have enormous production runs. Consequently unit prices were low. Also, because it had little competition, Western Electric didn't have to worry about cutting corners and could concentrate on quality production. Every Western Electric item was built to last virtually forever. Stories abound of vacuum tubes and relays in continuous service for more than sixty years. Electronic hobbyists put Western equipment high on their wish lists.
Having AT&T as its market was a mixed blessing. Western Electric prospered when the local Bell operating companies were growing and modernizing. On the flip side, a recession would bring a reduction in the local Bell's growth and Western Electric's business fell off dramatically. Unlike other companies in similar situations, Western Electric couldn't go looking for new customers to make up for the loss. Various government regulations precluded that.
When a local company's growth rate dropped from 4 per cent to 2 percent, it was hardly a disaster for it. However, that 2 percent reduction represented a 50 percent drop in new equipment and cable purchases from Western Electric. The only saving grace was that even if a local Bell company had no growth at all, substantial facilities were still required to take care of telephone movement. In addition there were modernization and plant replacement purchases.
This volatility in sales led to volatility in employment at Western Electric. Layoffs were common.The other Western Electric customer was also a large one. It was Uncle Sam who came knocking in times of national emergency.
The course of World War II might have been far different without the research of the Bell Laboratories and the production of Western Electric. During that war both Western and the Laboratories worked almost exclusively for the military, leaving ordinary telephone business to get along as best it could.
There was no time for home telephones with Western Electric producing more than 50 percent of U.S. radar (about 57,000 sets of seventy different types) along with 30 percent of all its military communications equipment. Western was also producing the M-9 gun director, which played such a vital role in the war. Later Bell Laboratories developed and Western Electric produced the first electronically guided missile, the BAT, a homing bomb that was put to effective use against enemy shipping.
The end of World War II saw the beginning of the Cold War. President Harry S Truman appealed to AT&T to take over the Sandia Corporation, a company which had been directing the design, manufacture, and storage of nuclear weapons.
The Bell System was initially reluctant to take on this assignment since it was so far outside the communications field. But government pressure prevailed. Today Sandia, under overall AT&T direction and employing some seven thousand people, is still handling this work.
AT&T's involvement with the nation's defense did not stop with Sandia. Western Electric engineered and installed the DEW (Distant Early Warning) line, BMEWS (Ballistic Missile Early Warning System), SAGE (Semi-Automatic Ground Environment System), the White Alice over-the-horizon communications system, and the Nike family of anti-aircraft missiles.
The government knew that AT&T was one contractor that delivered. When national panic set in after the Russians launched Sputnik, the world's first artificial satellite, in 1957, Washington again turned to the Bell System. The United States was behind, national prestige was at stake, and the country had to catch up. Bell Laboratories and Western Electric got the first communications satellite up in 1960. This was the passive reflector Echo balloon. It was followed in 1962 by the active Telstar, which contained transmitting and receiving equipment.
Then President John F. Kennedy had a dream—a man, an American man, on the moon. And not in some distant century or even some faraway decade. He wanted fast action. He wanted it done in ten years. The U.S. would not only play catch-up with the Soviet Union, it would surpass it.
The undertaking, christened the Apollo project, was to involve massive planning. In 1962, the government asked Bell to direct systems planning for the project. With that end in mind the Bellcomm Corporation was formed, drawing largely from Western Electric and other Bell System employee pools. The rest was history.
So it was that on July 20, 1969, six months ahead of Kennedy's deadline, Neil Armstrong took that first small step for man. The Bell System could share the nation's pride in that accomplishment.There was a tragic footnote to the Apollo project, one that might have been avoided if a Bellcomm recommendation had been heeded.
It had to do with using a pure oxygen environment in the Apollo capsule. Bellcomm scientists had counseled against it. They were worried about fire dangers.
Astronauts Gus Grissom, Ed White, and Roger Chaffee died when an Apollo capsule caught fire during ground tests on January 27,1967.Sometimes big is the only way to get things done.
There is a national mentality—no doubt brought on by the excesses of the Jay Goulds, the Cornelius Vanderbilts, and the Standard Oils of the last century—that big is bad.
As the song says, it ain't necessarily so. Some endeavors are not possible on a basement workshop scale. It took AT&T with its Bell Laboratories research and Western Electric manufacturing capabilities to design, build, and launch the first communications satellites. Telstar alone involved an investment of $60 million—in 1962 dollars.
While they are important to worldwide communications, satellites are not the be all and the end all. They have inherent limitations. Stationary satellites orbit at a height of around 22,300 miles. It takes noticeable time for signals to travel up and be returned. Trying to carry on a conversation, especially when more than one satellite connection is involved, often leads to people interrupting each other during the silent periods when the signal is en route.
So the Bell System poured money, lots of money, into an alternative—submarine cable. Again the system was geared up. By 1956 it had designed, manufactured, and installed the first transatlantic telephone cable. One of the most challenging aspects of the project was the more than 100 amplifiers that needed to be integrated with the cable on the ocean's floor. These amplifiers had to be built to last. Having to make frequent service calls to replace them at the bottom of the Atlantic was obviously not desirable.
This monumental undertaking cost some $50 million and was completely successful. The annual growth in the rate of transatlantic calling promptly jumped 25 percent.
This first cable only had thirty-six voice channels and was soon working at capacity. More cables were laid across the Atlantic and then the Pacific.
Meanwhile, an ingenious development called TASI (Time Assignment Speech Interpolation) was introduced in 1959. This multimillion dollar invention took advantage of gaps in conversation and even pauses between syllables. Other conversations got wedged into those gaps. With TASI, transoceanic cables could carry 50 percent more calls.
As big as these projects were in terms of cost, brain and manpower, they were dwarfed by another that consumed the attention of Bell Laboratories and Western Electric for two decades beginning in 1955.
Electronic switching.
Local and long distance dialing connections had been made using electromechanical switching systems that were expensive, slow, and took up a lot of physical space and electrical power.
Electronic switching was to change all that. And the key to its development was the concept of "stored program control." With this, an electronic memory, which could be easily altered, held the instructions for interconnecting calls rather than the masses of wires and relays used in older systems. In other words, the brains of the new machine was an electronic digital computer.
The project would have been much easier if it had been merely a question of developing and putting the new system into place. But it also had to work effectively with thousands of existing mechanical switching machines, some of them more than forty years old.
The first viable electronic central office switching system went into service in 1965. It took ten years of research, development—some failures—and more than $500 million. Without electronic switching, today's service demands could never have been met.
Still another large project was started in the early 1970s. This was the #4E four-wire electronic switching system, a time division switcher used to route long distance calls. In a four-wire system the transmitting and receiving paths are kept separate in the machine and not combined as they are in the more common two-wire switcher.
The 4E has no moving parts. All connections are made using solid state electronic components. Development cost? $400 million. Each machine's installed cost? $10 million. But each one can handle more than a half million calls per hour on more than 100,000 connected trunks. The future had arrived.
These are just some examples of what being big can accomplish. Some projects have immediate payoffs. After World War II, a plastic sheathing for cables was developed to replace the expensive lead covering used previously. This saved enough money in the Bell System to pay for the Laboratories' entire research budget for five years.
But other projects took years to pay off. The former Bell System could afford to carry the expense and go on to new projects. Big could be and was better at Bell. But therein lay the seeds of its destruction.
Vertical integration. One company handling the research, development, manufacture, engineering, installation, operation and maintenance—all the activities necessary to make a single phone call. Keeping these functions under one head gave ammunition to Bell's enemies. Western Electric's role, in particular, was to be a major factor in the demand for divestiture. Those gunning for Bell shouted "foul" over the one-supplier, one-customer relationship between it and the local Bell operating companies. "Unfair advantage" and all that, they yelled because the local Bells were "required" to buy from Western Electric, thereby eliminating the possibility of any competition.
Those frothing at the mouth for Bell's blood could make that claim all they wanted—and they did—and they could also be dead wrong—which they were.
The truth was the locals were expected to buy much of their equipment from Western, but were not required to do so. Many outsiders being told this pooh-poohed the distinction as a bit of semantic smoke. They contended that any operating company purchaser who bought elsewhere was looking forward to one fat reprimand, or worse.
That was just not the case.
Western Electric had to tout and sell its products as did any number of other suppliers of similar goods. The AT&T staff sometimes issued cautionary advice against a non-western Electric item, known as a general trade product. However, that wasn't to give Western some kind of extra advantage. Rather it was because the staff had not determined that the other product was good enough to get the Bell System seal of approval or that there would be limited maintenance support for these outside items.
Both authors were involved in many purchasing decisions for Pennsylvania Bell and know first-hand that Western Electric lost out on many occasions. Other companies got contracts for central office switching systems. Collins, Raytheon, and Nippon Electric sold microwave radio systems to Bell, and a whole host of other suppliers sold Bell test equipment and accessories. In each case, Western Electric representatives had touted the advantages of their products. In these cases, they didn't get the contracts. It happened.
Bell of Pennsylvania purchased almost none of its digital microwave radio equipment from Western for the same reason any other company would have passed it over. Western's competitors had better quality and lower-priced products. Period. Towards the end of the seventies and the beginning of the eighties, the same was true for digital switching equipment. Bell of Pennsylvania bought most of that from Northern Telecom.
No reprimands, harsh or otherwise, were ever handed down, nor were there even any suggestions from AT&T that this equipment should be bought from Western Electric.
On the other hand, it was true that local Bell companies did buy most of their equipment from Western. But for the same reasons they bought outside—on those items Western Electric had unbeatable quality and price. Western Electric supplied, almost exclusively, copper cable and wire, telephone instruments, multiplexing equipment, and most central office switching gear.
In 1972, the breakdown between Western and general trade products was 80 percent/20 percent. The Bell System spent approximately $1.2 billion that year on outside products. This increased gradually in subsequent years.
Top management was well aware that local Bell company purchasing decisions were being closely watched. John deButts said in 1972, "I must emphasize how important it is that the Bell Companies' judgments as to what to buy and from whom be able to withstand the most searching public scrutiny with respect to their objectivity."
Keeping completely objective when it came to purchases was emphasized. Western Electric got the business when Western was the best. A further indication is that since January, 1984, when corporate ties between AT&T and the local Bells were slashed, the locals have continued to buy heavily from Western.
An interesting, if somewhat distressing, footnote to divestiture shouldn't be overlooked. When Bell was intact, Western Electric manufactured replacement and modernization parts for systems that had been installed up to fifty years earlier. As long as a system remained in service in the Bell System, it was essential it work with newer equipment which was coming on line. Keeping obsolete equipment working was not profitable for Western. It did so because that was part of the obligation of a vertically integrated supplier.
Western is no longer a vertically integrated supplier for the Baby Bells, so it's hardly reasonable to expect the same level of support to continue after divestiture. General Motors, after all, doesn't make replacement fenders for 1935 Chevys just because there are still a few out there. This will force the scrapping of some older systems, and this will translate into higher consumer costs. Just one more item the American public will have to foot the bill for because of divestiture.
Naturally, predivestiture, Western had the replacement parts field pretty much to itself—no other company was interested—along with the large market for additions to central office equipment originally made by Western. In other cases, such as telephone instruments and cable, Western had a cost advantage over its competitors because of its mass purchases of raw materials and enormous production runs. But even more than that, Western's winning card was the close association with Bell Laboratories. Together they were able to produce quality, and quality is hard to beat.
Because it had these markets to itself, there was the potential for Western to play price games: to inflate the price of items where it had no competition so it could lower the price where it had.
ITT filed an antitrust suit charging just that. AT&T eventually settled out of court, agreeing to buy more ITT equipment. But Washington decided that where there was smoke and lawsuits, there must be fire. So it launched numerous investigations, spending millions, searching for evidence that Western was involved in unfair trade practices. Apparently it was inconceivable to the bureaucratic minds at the FCC that the company could actually produce superior products at low costs honestly.
Lo and behold, the investigations failed to turn up any evidence that Western had, in fact, played such games. Nothing. Despite all those millions of dollars spent, repeated analyses showed that Western Electric prices were below those of its competitors simply because of production efficiencies and volume.The strengths of the old Bell System were to become its Achilles heel. Critics could not believe that Western Electric products could cost so little and be so good without some sort of chicanery. Bell's top managers, brought up and instilled with corporate integrity, were not prepared for down-dirty streetfighting or the disaster that was on the horizon. Who in their right mind would endanger a national treasure such as Western Electric, particularly in combination with the Bell Laboratories? Who indeed?
John deButts, the AT&T chairman knew there was trouble in 1977. He predicted that "the [Federal Communications] Commission's policies . . . will force an alteration of our research and development priorities . . . to give more attention to relatively superficial product differentiation and— reluctantly—somewhat less fundamental systemic improvements of advantage to our entire customer body."
But in retrospect that prediction seems almost laid back and nonchalant. A breeze had started blowing and Ma Bell hardly noticed it.6 The Beginning of the Storm The winds began picking up.
Theodore Vail probably assumed the 1913 Kingsbury Commitment settled the antitrust bugaboo.
By letting independent companies plug into the Bell System and by agreeing not to buy up any more independents without federal approval, it was believed by Bell managers that Washington would stop gunning for AT&T under the Sherman Act.
It seemed pretty clear, when reasonable, informed people thought it through, that the telephone system was a public utility, a natural monopoly much like a gas or electric company. Why? Because a natural monopoly exists when the economies of scale dictate that one company alone can provide the customer with a service or product at a lower unit cost than two or more competing companies could. There are enormous underlying structural costs in the telephone transmission and switching network—the land, buildings, switching systems, power plants, right-of-way, conduit, cable, microwave towers, etc. Two companies competing means a duplication of all this—and two sets of facilities aren't needed to provide service.
Efficiency, then, is another key element in natural monopolies. Is it more efficient—and therefore more beneficial to the public—to eliminate competition and have only one company in the market?
Economists through the years have accepted telephone service as a natural monopoly. In citing the greater efficiencies of these monopolies, Harold Koonitz of the University of California at Los Angeles and Richard W. Gable of the University of Southern California wrote, "If competitive telephone, gas, water, electricity, or street-railway lines were allowed to build multiple lines down the city streets or across property, the result would be a confusing and inefficient mass of duplicating facilities. These might not only hamper use of the streets but impair the quality of service."
There's no getting around it, the telephone system is a natural monopoly. Once that's accepted, what British economist John Stuart Mill had to say 140 years ago about introducing competition into such a monopoly has to be considered. It was his widely accepted contention that when competition is introduced into a public utility operation the consumer must pay for the sum of the costs of all the competitors. In other words, plain and simple, the consumer is being gouged, taken, and ripped-off. And that is wrong.
Because of its wastefulness, Mill argued, competition in a public utility should be prohibited for the public good. However, the public utility monopoly must be carefully and properly regulated to avoid the user being overcharged with the regulators keeping in mind that the rate structure should be based on the principle of the "greatest good to the greatest number." Those who can afford to pay more should pay more so that the lower economic classes may also be served.With the Kingsbury Commitment, it was believed that Washington had accepted AT&T's status as a monopoly, and any future complaints the government had with its operation would be resolved through regulation.
But the commitment was only a lull—granted a long one—in the antitrust storm. Washington doesn't stay the same. New administrations bring new personalities and new attitudes, and few so dramatic as Franklin Delano Roosevelt's New Deal.
Up until then, federal regulation of the telephone industry had fallen under the umbrella of the Interstate Commerce Commission, which was really more interested in railroads than anything else. In 1934, Congress created the Federal Communications Commission. One of its primary functions was to oversee the interstate traffic of the telephone industry.
The first thing the chairman of its telephone division, Paul Atlee Walker, a reform-minded Quaker, did was start an investigation of all telephone companies that was soon narrowed down to only Bell.
AT&T president Gifford declared, "We welcome the investigation; there are no skeletons in our closet." The proceedings were long, exhaustive, and Walker was clearly biased against AT&T. When he finally issued his "Proposed Report"—largely his work and not that of the other FCC commissioners—it was an out-and-out attack on the company. He was especially upset over Western Electric's role, calling for competitive bidding in the purchase of equipment.
The final report, which came from the full commission and not just the fervent Walker, was considerably toned down— and virtually overlooked. The country was far more concerned with the frightening events taking place in Europe in 1939 than it was in who should manufacture telephones.
After the war, Holmes Baldridge, an attorney who had worked with Walker on the investigation, joined the Justice Department's antitrust division. Baldridge agreed with his former boss that AT&T's relationship with Western Electric was bad for the country. He pushed for and convinced Attorney General Tom Clark to file an antitrust suit in 1949, calling for the separation of Western Electric and Bell Laboratories from the rest of the Bell System.
Of course, some people found the suit illogical, coming at the same time the government was begging the Bell System to take on the management of the U.S. nuclear weapons facility in Sandia, N.M.
As AT&T President Leroy A. Wilson pointed out in 1949, "What the government asks in this lawsuit is that the courts break up and dissolve the very organizational unity and size this vital security job requires. We are concerned by the fact that this antitrust suit seeks to terminate the very same Western Electric/Bell System relationship which gives our organization the unique qualifications to which you refer."
Over the next seven years the suit ran a rocky and controversial course. Finally in 1956, an agreement in the form of a consent decree ended the suit.
At first glance, the agreement seemed to provide a basis for stability in the industry. Bell retained Western Electric and Bell Laboratories. In return, the company agreed not to branch out into other fields. It had to confine its activities to common carrier communications. Further, Western Electric would have only one market—the Bell System. And lastly, license and technical information developed in the Bell Laboratories would become available to any who applied for it.
These restrictions didn't seem too severe and most Bell System managers were pleased with the outcome.
"We kept Western Electric," Frederick R. Kappel, AT&T's president at the time, said, "but at some cost patent-wise. The decree . . . generally makes legal an integrated Bell System."
The unity of Bell had been preserved, although it took a while for the controversy surrounding the decree to subside. It was charged, for one thing, that Attorney General Brownell and the Eisenhower administration had caved in to AT&T pressure. A Congressional investigation was launched, but it did not lead to a reversal of the settlement.
So, all looked rosy for AT&T. Who then could have guessed that this victory was actually the first inexorable step towards defeat? It would have taken a crystal ball to have divined the land mines put in place by the consent decree. One was limiting the Bell System to common carrier activities. That seemed straightforward enough in 1956. However, with the onslaught of the computer revolution the difference between data processing (a no-no for Bell under the decree) and data transmission (allowable) became less and less distinct. This created problems for both Bell and its regulators.
In fact, the FCC would eventually launch three inquiries—Computer Inquiry I, II, and III—to establish rules for separating regulated communications from unregulated data processing, as the boundaries between them became fuzzier with the introduction of new technology. And even after all that, few were satisfied with the results.
The problems began around 1960 when the concept of computer time-sharing was invented. An early application involved the composing of a message at one computer terminal and having it printed at another.
Whoa! cried Western Union to the FCC. The computer companies offering these services were illegally engaging in common carrier communications. Western Union countered with a similar service.
Just one second there! screamed the computer data-processing firms. Western Union was going beyond its charter as a regulated common carrier and was competing unfairly by entering the unregulated information-processing business.
Who was right? The FCC didn't know, so in 1966 it set out to unravel the situation by establishing some rules for separating regulated communications and unregulated data processing. This proceeding was later called Computer Inquiry I and didn't conclude until 1971. One rule it came up with was any service that fell on the borderline between communications and processing of data would be considered a "hybrid" service. The FCC would then decide, case by case, whether or not the service should be regulated.It wasn't long before the commission was inundated by hybrid cases, many of which turned into long and bitter debates between the protagonists on both sides.
By 1976, the FCC decided it was time for some better definitions and rules. And so was born Computer Inquiry II. Out of this second inquiry, completed in 1980, came the notion of two classes of services—basic and enhanced.
Basic services were defined as the simple transmission of information without modification. These could be offered by existing common carrier companies such as AT&T, GTE, and Western Union.
Enhanced services were defined as those that acted on the content or format of transmitted information, and they encompassed videotext, protocol conversion, information storage, packet switching, and other modifications of transmitted data. These could only be offered by companies outside the regulatory arena or fully separated subsidiaries of AT&T. It is interesting to note—and perhaps to wonder why—only AT&T and not other common carriers had the separate subsidiary restriction. This ruling forced a costly organizational restructuring on AT&T in the midst of its other problems.
Computer II also required that all customer premises equipment, including ordinary residence telephones, must be sold through separate subsidiaries rather than continuing to be included as part of tariffed services. This was to get around any bickering over whether a particular type of equipment was a communications terminal or a data-processing device.
So the problem seemed to be settled at last. Except the separate subsidiary solution created its own set of problems. Certain advanced services such as centralized answering and recording couldn't be introduced. The physical separation of the equipment providing these services from the equipment providing basic telephone service was impossible. AT&T had to scrap the combined equipment it had already installed in several locations at the cost of several million dollars. While the separate subsidiary requirement might have been well-intentioned, it ended up costing the public advanced services and a lot of money for AT&T. AT&T has estimated the separate subsidiary requirements alone were costing it more than $1 billion annually.
Naturally, this led to Computer Inquiry III in 1984. One of its results was a 1986 FCC decision essentially eliminating the subsidiary requirement and substituting accounting rules to prevent subsidization of nonregulated services.
All of this description of the inquiries merely shows that what seemed clear-cut in 1956, wasn't.
Another land mine proved to be the decree's preventing Bell from following the natural paths opened up by its own technology into other lines of business such as computers. At the same time, the decree armed future Bell competitors with Bell's own technical information.
Still, what was important in 1956 was that the consent decree had reaffirmed the principle that the network over which calls are transmitted is a natural monopoly. Or at least that's what Bell managers thought. But it was only three years later in 1959 that the FCC made the first significant break in the natural monopoly principle with its Above 890 ruling. This allowed private companies to use available portions of the radio frequency spectrum above 890 megahertz for their own communications.
As it turned out, the ruling itself had little impact. Most companies found that using the Bell System for their internal communications was cheaper and more reliable than constructing and maintaining their own networks.
But the FCC didn't stop with Above 890. In June, 1968, came its Carterfone decision. The Carter Electronics Corporation of Texas manufactured a device that could connect private two-way radio systems with the telephone system. In other words, it wanted to introduce a "foreign" piece of equipment into the network. This was something AT&T had always fought against, arguing that the integrity of the entire system could be damaged by plugging in inferior equipment. The Bell System's tariffs had prohibited such interconnection.
Carterfone appealed to the FCC, and the FCC told AT&T to revise its tariffs.
A year later, the FCC went further. In August, 1969, it authorized a common carrier, Microwave Communications Incorporated (MCI) to construct point-to-point microwave radio systems and to sell private line services to individual business users. Initially, MCI said it was only interested in providing service between Chicago and St. Louis. MCI's chair man, William McGowan, specifically stated that his company had no intention of going beyond customized point-to-point service. MCI had no desire to compete with Bell System's long distance network.
That's what William McGowan said. So the FCC approved MCI's application, apparently believing that the company only wished to provide innovative services not available from AT&T. But what McGowan said and what McGowan did were two very different things. Within a shamefully short time, and much to the surprise and consternation of the FCC, MCI without any specific authorization starting offering long distance service in direct competition with AT&T.
The FCC was a bit upset and ruled that MCI's long distance service, called Execunet, was illegal. However, the federal appeals court begged to differ, and overruled the decision in July, 1977. The local operating companies were then required to give MCI connecting links for its long distance calls.
Both Carterfone and MCI, it was to turn out, were the first steps toward opening the telephone network to unrestricted competition. Why did the FCC want to do that?
The commission was apparently working with five assumptions that were largely fallacious and did not take into account technological and economic realities. The FCC, after all, was, for the most part, a group of lawyer-bureaucrats, not engineers, not scientists, not economists. The assumptions, it would seem, were:
1) To regulate interstate communications, the FCC must
regulate all communications.
2) Competition is preferable to regulated monopoly.
3) Big is inherently bad.
4) Charges for all services should be based on the actual cost of providing those services.
5) Customers should be encouraged if not required to own and maintain their equipment.
At a fast read, some of these assumptions might appear reasonable. However, none of them stand up to informed scrutiny. And further, they led to the destruction of the Bell System at an insanely high cost to the nation—and not just in dollars and cents.By making that first assumption, the FCC waded into deep and murky constitutional waters. The Communications Act of 1934 chartered the FCC to oversee and regulate interstate communications. Communications within states (and in a few instances in cities and counties) were regulated by local commissions. This arrangement was to be expected under the constitutional separation of powers between individual states and the federal government.
But the two hundred years since the Constitution was ratified have seen a gradual erosion of the states' authority with a concomitant increase of power in the federal government. Similarly, over a much shorter period of time, the FCC has been usurping the authority of various state regulatory commissions.
One justification for more federal control of telecommunications was the occasional difference in the cost of a call depending on whether it crossed a state line. For instance, at one time it cost more to call from Camden, New Jersey, to Newark, New Jersey, than it did from Camden to New York City, even though New York was farther away than Newark. The intrastate rate was set by the New Jersey Public Utilities Commission, the interstate by the FCC.
If all rate setting were to be done by the FCC, it was argued, such disparities would be eliminated. However that argument loses some credibility when it's realized that these and other disparities were well on the way to being eliminated through public pressure and without FCC intervention. One has to wonder whether the FCC began nibbling away at the states' powers out of a sense of fair play and concern for the public or whether it was just another case of bureaucratic empire building.
The FCC didn't send out an announcement one day that it was taking over from the states. It was more like ice-age glaciers inching down the countryside. Initially the FCC's control was largely through setting of depreciation rates. These rates affected net corporate earnings which were inevitably translated into the rates allowed by the state public utilities commissions. But the ante was upped late in 1973 when the FCC notified AT&T that state tariffs must be filed with the FCC. Following hard and fast on that, in January, 1974, the FCC announced that state commissions could take no actions on interconnections that were not in accord with federal policy. This took 25 percent of local companies' investment out of state control.
States did not seriously challenge these rulings or those that followed even though they weakened the authority of their own agencies. Perhaps they didn't understand what was happening. Only recently has there been an outcry from state capitals, then only after the FCC slapped access charges onto local telephone bills. The local bills had been the sacrosanct domain of the state.
Ironically, the access charge was forced onto FCC by divestiture. The local operating companies no longer got subsidies for local services from AT&T's profitable Long Lines. To offset this loss, local rates had to be increased by something called "customer access line charges." Thus, by forcing competition into long distance service, the FCC created a problem that it could only solve by, in effect, taking complete federal control over telephone rates. AT&T, after all, was out there competing for long distance customers with MCI, Sprint, and the others as the FCC had deemed desirable. It couldn't be expected to subsidize local service any longer.
Which leads to Assumption Number Two. "Competition is preferable to regulation."
As a people, Americans are competitive. We tend to equate competition with freedom. It's our inalienable right to have an equal chance at the gold ring. Regulation, it then follows, is linked with oppression. In our open society this reasoning is often true. However, most people would agree that it is not desirable to have two electric companies serving the same community. The duplication of power plants and distribution facilities not only wastes money, it's ugly.
So rather than have unrestricted competition, electric companies are given exclusive franchises for their services and their rates are regulated by government agencies.
Alfred E. Kahn of Cornell University and former chairman of the New York State Public Service Commission has defined a natural monopoly as existing if "the service is such that the consumer can be served at least cost or greatest net cost benefit by a single firm."
And that's where the controversy lies. Is telecommunications a natural monopoly? Will the public be best served if it is accepted as such?
Without going into great detail at this point, it can be said that some parts of the telephone business—exchange distribution, for instance—are clearly natural monopolies. Other parts—equipment manufacture—are not, and should be subject to competition. But in areas such as network services and terminal equipment, the lines get fuzzier and debate heats up.
Up until the late 1960s, the FCC treated the industry as a monopoly, subject to regulation. But then, without announcing a change in policy, it began substituting competition for regulation through its decisions. These actions, of fundamental importance to our nation's communications, were never explicitly debated and got very little public attention. But more incredibly, these decisions were made with little or no input from qualified economists or engineers. The lawyers and the bureaucrats of the Justice Department and the FCC made them without even examining the possibility that a regulated monopoly in communications could serve society better than unrestricted competition. This wouldn't be much different than throwing all the scientists out of NASA and letting a bunch of attorneys try to launch the next space probe.
What's more, competition in the long distance field was only possible when funded by the biggest steal in United States history. MCI, Sprint, and the others could not have competed with AT&T without help. It was economically impossible. The actual cost of providing a long distance connection through MCI et al., is from two to four times higher than a similar call on AT&T's network. But the MCIs were able to undersell Bell with the connivance of the FCC. For the commission required AT&T to pay the local operating companies and the independents $400 million for every $1 billion it earned in long distance revenue. What did the FCC require MCI and the others to pay the local companies? Next to nothing in comparison.
But why did MCI and Sprint deserve this boodle? Because competition—at whatever cost, it would seem—is better than regulation, naturally. Though Gene Kimmelman, director of the Consumer Federation of America, disagrees. "Regulation has gotten a bum rap," he said in 1987. "It has provided cheap service and innovation." But go tell that to the FCC.Assumption Number Three. Big is bad. No one can argue that big can be bad. The muckrakers such as Ida Tarbell documented that. Out of the excesses of the oil and railroad barons came the Sherman Antitrust Act of 1890 and the Clayton Act of 1914.
The antitrust division of the Department of Justice got the job of seeking out and prosecuting suspected violators of these laws. Over the years, its tendency has been to go after the largest and most visible targets.
There are two sides to every coin, something the Department of Justice at times has apparently forgotten. There is no doubt that a big corporation has more opportunity and capability to be bad than a smaller one. But it doesn't necessarily mean it will be. Also a big corporation has far more capability to be good. Being big and good can translate into greater efficiencies and lower prices, into more basic research. It can also extend to outside activities such as support for social welfare, education, or the arts.
Why label an enterprise "bad" because it's big and therefore has the potential to be bad? If that were so then anyone owning a gun could be called a criminal because someday, maybe, that person could use the weapon to commit a crime.
During the 1970s, the FCC seemed to accept outright the "big is bad" principle and applied it to Bell. Not only would the agency stop growth at Bell, it was determined to reduce its size. The concept of economy of scale apparently was never part of its thinking.
To prove that Bell was indeed bad, the FCC spent millions of taxpayer dollars on several investigations. Nothing significant was ever unearthed. One of the authors (Constantine Raymond Kraus), after retiring from Bell and setting up a consulting firm, was hired by the government to conduct an investigation. Specifically, he was asked to determine whether Western Electric prices were being set properly and whether the company was adhering to approved depreciation accounting practices.
He searched, but couldn't find anything of great import. In fact, the most significant aspect of the investigation was that the government never publicized the results.
Touche Ross, a highly respected consulting firm, was later hired by the FCC to do a complete review of Western Electric. In January, 1974, after a thorough investigation, Western Electric got a clean bill of health. Moreover, Touche Ross concluded that Western produced equipment efficiently and at lower costs than it could if it were not part of the Bell System. It also concluded that the relationship between Bell Laboratories and Western Electric was ideally suited for large-scale technical innovation at the lowest cost to customers.
And lastly, Touche Ross stated that Western Electric and Bell Laboratories should not be separated from the Bell System.
This report was directly opposed to the direction the FCC had been taking. In the case of Bell, big wasn't bad, Touche Ross was saying. On the contrary, it was good.
The FCC never published the findings of Touche Ross. If it had, how could it have justified what was to follow?Assumption Number Four. The charge for a service should be based on what it costs to provide that service. Bell had based its pricing philosophy on John Stuart Mill's concept of "the greatest good to the greatest number." The cost of the service did not matter as much as the value of the service.
This meant that a telephone call of given distance, duration, and time of day had the same charge as another call of similar distance, duration, and time of day even if one call actually cost more for the company to provide because of the way it was routed. Indeed, one call might represent a large profit to the company and the other a loss. Similarly, the monthly charge for a particular grade of service in a community was the same whether the customer lived next door to the central office or five miles away. If the value of service to the customer was the same—each one was getting the same service as far as they were concerned—then the charge was the same whether or not there was a difference in cost to the company.
This pricing philosophy led to universal telephone service in the United States, unheard of anywhere else in the world, although Canada came close. Historically, the FCC had condoned this pricing system. But its rulings in the 1970s clearly indicated it was abandoning the value of service concept for cost-based pricing. The Bell System read the writing on the wall and frequently argued that cost-basing of rates would undermine its system of internal subsidies that made telephone service affordable for everyone.
Bell analysts predicted that cost-based pricing would lead to a 50 percent reduction in long distance rates. Great for businesses and more affluent resident users. But it would also increase local rates by 100 to 500 percent, socking it to the poor who would be forced to discontinue their service.
Bell argued but the FCC wasn't listening.
The FCC push for cost-based pricing meant that individual segments of AT&T's operations would have to be analyzed more closely. This meant that Bell's ranks of these analysts, known as cost study engineers, swelled from less than 100 in 1972 to nearly ten times that a decade later. The additional cost in salaries alone—forget about office space and paperclips—approached $50 million a year.
The emphasis on cost-basing led to the development of something called "functional accounting," a complex computerized procedure that was supposed to relate every cost the Bell System incurred, no matter how small, to the activity causing it.
It cost almost a billion dollars to develop this functional accounting system. It cost even more to operate it. But not a penny of this in any way improved customer service. All it did was increase accounting costs in an effort to appease the irrational demands of the FCC.
In the end there was no pleasing the FCC. AT&T thought it could meet the commission's cost-basing demand, at least part way, by charging more per mile for transmission over lightly used routes than over denser ones. The FCC shot down this Hi/Lo tariff filing in January, 1974.
Over the years the FCC seldom gave AT&T any guidance on pricing procedures. One tariff filed by AT&T, for TELPAK service, languished in the bowels of the FCC for twenty years without being approved or disapproved.Assumption Five: Customers should own and maintain their telephone equipment.
Let's say a person, Mr. B., wants toast and blueberry jelly for breakfast. (Bear with us, this does have something to do with telephones.) So Mr. B. goes to Sears, pays $24.95, and takes his two-slice toaster home. He's paid his electric bill, so he plugs the toaster into the outlet, pops in his bread and within minutes, voila! Toast.
In the past, if Mr. B. wanted to call Aunt Gladys in Peoria, he had to contact the telephone company, which gave him end-to-end service. It hooked him into the system and it "lent" him a telephone. Then Mr. B. could call his beloved aunt.
To the FCC, this wasn't right. Why could Mr. B. own his toaster but couldn't own his phone? Why shouldn't Mr. B. be allowed to buy a telephone and plug into the telephone system and get the "juice" to run his phone just as he plugged into the electric lines?
Any engineer could have explained why not. It's really very simple.
Say that toaster from Sears, unlikely and as improbable as this may be, was a faulty toaster. And Mr. B. unknowingly plugs it in. Zappo. He blows a fuse or his circuit breaker shuts off, or, even worse, he injures himself or his property. That's the extent of it. His bad toaster shorting out Mr. B.'s electricity isn't going to affect the house down the block or the rest of the electric company's system. That's because Mr. B. receives electric energy but feeds nothing back into the distribution network. It's a one-way, incoming proposition.
That's not how the telephone system works.
Let's say Mr. B. covets the buffalo-shaped telephone on sale at Cheapo Charlie's. He buys it for $9.95 and brings it home. When he plugs it in, he's interconnecting with one large computer. And his little buffalo is a computer terminal. This is a two-way street. Mr. B. is receiving input from the system and also transmitting into it. When his crummy buffalo telephone gives up the ghost, that not only affects his being able to call out but also keeps poor Aunt Gladys from calling him, affecting her service.
Worse yet, equipment that is faulty or improperly operated can cause malfunctions and overloads in the central office switching equipment and that can affect everyone.
Despite all this, the FCC never could tell the difference between a toaster and a telephone.
Former FCC Chairman Mark Fowler once set forth two profound thoughts. One was that standards are unnecessary in the telephone industry. The marketplace, he said, would determine the standards. Of course, one may wonder how the uninformed lay customer is supposed to know what the standards should be. But if that thought makes little sense, consider the chairman's second one, that out of the chaos of competition would emerge the cheapest and best service for the customer. With any understanding of the telephone network, it is clear that the only thing to emerge from the chaos of competition will be chaos.
But it was based on such fallacious thinking that the FCC decisions paving the way for competition were apparently made. The rulings were many, separate, and often quite narrow. Nonetheless, they brought on the complete restructuring of our telecommunications network.
Perhaps what happened would be easier to accept if there were any evidence of the use of legitimate analysis, master planning, or any kind of overall strategy.
But the evidence there points to one disturbing conclusion.
The FCC was winging it.7 The Tempest While the FCC was merrily slipsliding down its twisted road to competition during the sixties and seventies, some of the longtime antitrust division lawyers at the Department of Justice were still smarting over Attorney General Brownell's consent decree of 1956.
There had been an unpleasant taste in their mouths, a taste of the department selling out to big business, that they had never quite gotten rid of.
They didn't believe the FCC could regulate AT&T any more. With an influx of young, liberal attorneys, hot off the radical campuses of the sixties, new life was breathed into the Department of Justice's old case against AT&T. Some may have seen the case as a chance to make headlines and boost careers. Others no doubt truly believed they were riding to the rescue of a public being victimized by a "predatory monopoly."
Investigations were again launched, after a good deal of intensive lobbying by MCI's president William McGowan, not exactly a disinterested observer. The Justice Department, for the third time, felt it had a solid case against the Bell System. It would charge that AT&T had tried to monopolize the long distance market by denying interconnection or making it hard for competitors to interconnect. That it had smothered equipment competition by forcing the local Bell companies to buy from Western Electric.
In some respects AT&T had been its own worst enemy. For instance, when the FCC decided that non-Western Electric customer premises equipment could be used as long as Bell provided protective interfaces, or couplers, Bell didn't rush to make these devices available.
There was a certain arrogance at AT&T, based partially on the belief that the federal government, when push came to shove, would not destroy a system that worked as well as Bell's.
The Department of Justice saw things differently and got its case together.
But this was 1974, and this was Watergate, and the Department of Justice was leaderless. (Had it not been, the department's lawyers might not have had the autonomy to carry on the investigations as they did.)
John Mitchell was out as attorney general. His successor, Elliot Richardson, had resigned in October, 1973, rather than fire Special Prosecutor Archibald Cox. And then for a while Nixon had too many other things on his mind to find a replacement for Richardson, so the department lay becalmed in the water. Then he named former Ohio Senator William Saxbe to the post.
Saxbe, it's been reported, wanted to clean up the image of Justice, which had been so tarnished during the Nixon years. What better way than don the white hat and haul some Big Bad Guy into court with a highly visible case. Saxbe decided to go ahead against AT&T.
There is some dispute as to whether Saxbe consulted Gerald Ford, who by then had replaced Nixon. What is known is that on Wednesday, November 20, 1974, while Ford was in Japan, the Department of Justice filed an antitrust suit against AT&T calling for a breakup of the gigantic company, and more specifically, for the separation of Western Electric and Bell Laboratories from the parent firm.
There is no such thing as a "speedy" trial in antitrust litigation. The federal government had gone after IBM, the country's largest computer company, six years earlier, and that case wasn't even close to the courtroom.
The size of the suit brought by Justice against AT&T was mind-boggling. It's believed that the 1974 filing was the largest such action on record and it didn't reach the courtroom for six and half years. It's estimated that seven billion—billion!—pages of material were examined of which one billion—billion!—were copied and entered as evidence.
AT&T created a complete facility in Orlando, Florida, just to collect and organize the paperwork. More than one thousand people were assigned to this job. Another three thousand AT&T employees worked full time on the defense, and thousands of others spent varying amounts of time, often during evenings and weekends, on the case.
It's impossible to say what all this activity actually cost, but the government and AT&T have admitted to direct charges of more than $400 million. That's direct, not total costs. A company with fifteen hundred employees was created solely to handle the splitting and transfer of stock in AT&T and the divested companies. An outfit named the American Banknote Company received more than five million dollars just to print the certificates.
Take one guess who in the end paid that bill. The taxpayers—which most Americans are—picked up the government's check and the telephone users—which most Americans are—AT&T's. But then again, who can complain? Think of all the social benefits that came out of this action—the salaries and fat fees for the army of lawyers, the thriving business for printers and paper manufacturers, the scads of extra tickets sold by the airlines who flew witnesses to and from hearings, to name a few.
Finally the years of preparation and legal skirmishes were over and it was time to enter the courtroom.
The case had been assigned to federal Judge Joseph Waddy. AT&T attorneys were hopeful. Judge Waddy appeared initially unimpressed by the government's case. But fate intervened, as if in some Greek tragedy, and Judge Waddy died of cancer. His cases were divided among other judges, and AT&T found itself facing Harold H. Greene, and its lawyers lost a bit of their hope.
Greene was new to the federal bench, but he had a strong, liberal background. The judge, whose family had fled the persecutions of Hitler's Germany, had worked under Bobby Kennedy in the Justice Department and had been instrumental in writing the Civil Rights Act of 1964 and the Voting Rights Act of 1965. He had been on the lowly District of Columbia municipal court for years before the Carter administration called him up to the federal bench.
When Greene got the AT&T case, he told lawyers from both sides he wanted to demonstrate that antitrust laws were enforceable, that business couldn't endrun them by pulling interminable legal ploys out of the huddle and keeping the cases tied up in court forever.
It was not an auspicious beginning for AT&T. Would Greene be showing that antitrust laws were enforceable if he decided for AT&T? Was he telegraphing from the start that AT&T didn't have a prayer?
During pretrial, both sides not only expended vast amounts of time and money assembling evidence, they looked for ways to settle out of court that would be acceptable to both AT&T and the Justice Department. Legislative solutions were considered. Several abortive attempts were made, some even initiated and strongly supported by AT&T, but they were all stalled in Congress. In early 1981, it looked as if one bill, S-898, actually had a chance for passage.
Both AT&T and Justice agreed that if Congress passed a suitable bill, it would be desirable to drop the antitrust suit. Judge Greene was petitioned to delay the trial to see what Congress would do with S-898. Greene refused. The best guess was he was angered by Justice's on-again, off-again approach to the case.
As it turned out, the bill was amended so many times that by the time it was finally passed by the Senate in October of 1981, it was no longer acceptable to AT&T. It didn't matter. S-898 never got out of the House.
Meanwhile, back at the White House.
The U.S. vs. AT&T, it should be remembered, was filed, went to trial, and was finally resolved under the administrations of two pro-business Republican presidents. Either man, as president and head of the executive branch under which the Justice Department falls, had the authority to stop the action. Future historians might scratch their heads over their failure to do so unless they keep in mind some extenuating circumstances. Both presidents, at the crucial times, were deeply occupied with other matters.
Late 1974, when the suit was filed, was a critical time for the office of the presidency and for the nation. As a result of the Watergate scandal, Richard Nixon became the first president in U.S. history to resign from office. One of Gerald Ford's first exercises of executive authority was to grant Nixon a full pardon. While Ford might have intended to put the Watergate affair behind and get the nation on to more pressing matters, he only managed to generate a storm of public protest and anger. This pardon may have well cost Ford election two years later.
Many Americans were infuriated by Ford's action, seeing it as interfering with due process of law. Once the AT&T suit was filed, Ford undoubtedly felt little inclined to incur additional wrath by squelching the case.
But what of Ronald Reagan? He was a man, who as candidate running for his first term, had used AT&T's good service and low rates as examples of what private enterprise could accomplish. He often contrasted the reductions in telephone rates over the years with rising cost of a first-class stamp to illustrate his theme that big government was harmful to the nation. And he'd add, "Of course, the government is suing the phone company."
Surely Reagan was against breaking up the Bell System.
Again, circumstances intervened. First, the case went to trial in January, 1981, within a week of Reagan's inauguration. The first months of any new administration are filled with confusion and high priorities. But there was more than usual transition chaos involved in this case. For one thing, both the newly appointed attorney general, William French Smith, and his deputy, Edward Schmults, had to disqualify themselves from participating in the case because they had been once closely involved with the Bell System.
It was not until late February that the next person in Justice's chain of command was appointed. He was Assistant Attorney General William F. Baxter.
Now here the plot thickens—and gets preposterously muddied. Baxter was a conservative, free-market advocate who had been known to call the U.S. Supreme Court "whacko," and who held that the Justice Department "penalized [big companies] because of their size." In 1977 he had said, "I think the telephone company is telling us the truth when it says that if more competition emerges in the specialized carrier areas in long lines, telephone rates are going to have to go up on the local loops at the expense of business use of long lines communications." This indicated he was aware of the adverse effects of competition.
But more importantly Baxter had also written that the AT&T case was "the one good thing the antitrust division has done in the last thirty years."
It's believed the Reagan administration was unaware of this quirk in Baxter's thinking.
To complicate matters even further, Baxter and the new Secretary of Defense, Caspar Weinberger, had a falling out caused by a misunderstanding.
Weinberger was one of at least three Reagan cabinet members—Malcolm Baldrige of the Commerce Department and John Block of Agriculture were two others—who strongly opposed the breakup of AT&T. Weinberger, not knowing that William French Smith had withdrawn from handling anything involved with the case, sent the Attorney General a strong letter urging that the suit be dropped. Along with it was a letter from the Joint Chiefs of Staff discussing military reasons why dismantling AT&T would be disastrous to the nation's defense. Some of the information in that letter was classified. Since Baxter had just been appointed, he had not yet received his security clearance.
Weinberger's letter, therefore, was put into a safe pending Baxter's clearance. When the Justice Department did not drop the suit, Weinberger thought his letter had been read and ignored. He testified before a closed hearing of the Senate Armed Services Committee about his call for dropping the suit and added that he had written the letter to the Justice Department.
As it happened the Wall Street Journal got hold of the secret testimony and ran a story on it. Baxter was angered and held a press conference in which he announced, "I do not intend to fold up my tent and go away because the Department of Defense expressed concern." He added that he thought the case had a "sound theoretical core, and I intend to litigate it to the eyeballs." Ronald Reagan, who favored a management style of consensus, had disagreement in his ranks. Perhaps he favored dismissal but wanted agreement among his subordinates. Perhaps he feared dismissal at that point, with all the baggage the case carried with it, would look as if someone was being paid off and he didn't want his own Watergate before his chair in the Oval Office was even warm. Maybe ... maybe Reagan will explain when he gets around to writing his memoirs. What is known is the case went forward. By this time, John deButts was no longer chairman of AT&T. The more unobtrusive, soft-spoken Charles Brown had taken his place. He was to be the leader of the defense with Baxter leading the prosecution and Greene in the role of judge and jury. The phalanxes of courtroom lawyers were headed by George Saunders for AT&T and Gerry Council for the government. And the cast would not be complete without mentioning the hundreds of witnesses who were called and cross-examined by both sides. The case went to trial in January, 1981, with the government presenting its arguments first. The testimony was enough to fill a small library. At the heart of the government's case was the claim that AT&T had engaged in anticompetitive practices, specifically by stonewalling on interconnections with MCI and others, and trying to restrict connections of non-Western Electric equipment. And it threw in for good measure the contention that the FCC was incapable of regulating AT&T as the company was then structured. AT&T argued that all its prices, services, and actions had been monitored and regulated by the FCC and the various state commissions and that AT&T had leaned over backwards to comply with all the directives of these regulatory bodies. Therefore, how could the company be in violation of the law? Furthermore, it argued that the FCC, not the Justice Department, had the expertise and the Congressional mandate to regulate the telecommunications industry. At the close of this phase of the trial, which lasted several months, AT&T made a motion for dismissal. Judge Greene denied the request in September saying, "The testimony and the documentary evidence adduced by the government demonstrate that the Bell System had violated the antitrust laws in a number of ways over a lengthy period of time . . . the burden is on the defense to refute the factual showings." Judge Greene's statement was interpreted by many as meaning he had already reached his decision—"guilty as charged." It was becoming more and more necessary for AT&T to find some out-of-court settlement. As George Saunders was later to observe, "We were confronted by a judge who wasn't hearing our side of the case. That was the concern." Judge Greene, some observers felt, was acting like a prosecutor in his questioning of Bell witnesses. Further, he had made it clear he believed that competition in the telecommunications industry would result in the cheapest and best service. At the beginning of 1982, the settlement came. On January 8, an agreement hammered out between the Department of Justice and AT&T was announced—the Bell System would be dismembered. The queen was dead. Long live the queen.8 The Death Knell "I fear that the breakup of AT&T is potentially the worst thing to happen to our national interests in telecommunications that will ever occur."
—BARRY GOLDWATER,
U.S. Senator from Arizona, 1983
It contained only three thousand words, that little document that broke up the largest corporation in the world. Three thousand words and it was remarkably simple considering the complexity of the underlying issues and the tons of paper which went into evidence.
The settlement was an alteration of the 1956 consent decree and was formally called the Modification of Final Judgment (MFJ).
Basically it had nine provisions.1) The 1956 consent decree was voided.
2) The Bell operating companies were to be totally separated from AT&T along with appropriate facilities and personnel. The companies were allowed some degree of consolidation—the number went from the then 22 to the present seven.
3) The operating companies were required to establish a single point of contact for national emergencies. They were allowed, if they wanted, to share a central staff to work on common problems.
4) Western Electric and Bell Telephone Laboratories could stay part of AT&T.
5) The license contract—the fixed percentage the local companies paid to AT&T for Bell Laboratories and other services—and the Western Electric supply contract were terminated.
6) Exchange service and interexchange service were separated. An exchange was loosely defined as a region containing not more than one Standard Metropolitan Statistical Area. To avoid confusion with prior telephone company usage of "exchange," which took in a much smaller area, the term LATA—Local Access and Transport Area—was coined for this larger area. Service within LATAs would be the province of the local operating companies.
7) The local companies (which predictably came to be called the Baby Bells) could not provide information services, such as cable television, or manufacture equipment.
8) The local companies had to provide equal access to their networks for all interexchange carriers (AT&T, MCI, Sprint, et a.l.) who wished to connect to them.
9) Within six months of Judge Greene's approval, AT&T had to provide a detailed Plan of Reorganization (POR), spelling out precisely how the provisions of the settlement would be implemented. These provisions were to be put into effect no later than eighteen months after Judge Greene's approval of them.
So why did AT&T agree to settle? Why didn't it brazen the suit out, as IBM did. (Ironically, on the same day the AT&T settlement was announced, IBM's antitrust suit was dismissed.) Why didn't AT&T go the full run of the trial in hopes of getting Judge Greene to see the merits of its case? Or even if the judge ruled against the company, there was the hope of getting the judgment overturned on appeal. And there was always the possibility the Reagan administration or a subsequent one would have eventually folded the Justice Department's tents and dismissed the case.
As it was, many Bell managers thought first reports of the settlement announcement were somebody's idea of a joke. There was total disbelief. Why come so far and then give up?
There were all sorts of explanations. One was Charles Brown's statement that pursuing the case would be long, costly and debilitating with far worse consequences to the company than the negotiated settlement. It should be remembered that Bell wasn't just fighting the Justice Department. The government's antitrust case was one of many. Private companies—notably MCI—had also sued AT&T for alleged anticompetitive or predatory behavior. MCI had already, in 1980, won a judgment of $1.8 billion, the largest such award to date. Later this judgment was partially reversed on appeal.
All in all, there were forty to fifty similar suits in varying stages of investigation, litigation, and appeal. Settlement of the government's case was expected to lead to a resolution of these other actions.
Brown also had internal factors to consider. The ten years of being under the cloud of the antitrust suit had taken a toll on the day-to-day operations of the entire Bell System. Rules and regulations were changing rapidly, complicating every manager's job. It was an all-pervasive presence, hanging over everyone's head and diverting attention from the day-to-day job of furnishing top quality telephone service. Few decisions were being made without considering what influence they might have on THE LAWSUIT. It's nearly impossible to provide top quality service under such circumstances.
Then, too, AT&T was not getting support from where it might have expected some. For instance, the labor unions representing more than half a million Bell System employees took no stand to protect their members' jobs.
And so Brown succumbed.
That's more or less the official view of events. However, one of the authors (Constantine Kraus) has a somewhat different perspective.
It came as a result of a luncheon conversation he had with John deButts at New York's Union League. It was 1979, a little less than a year after deButts retired.
DeButts had to give in, he told Kraus. It was all settled. The Bell Laboratories, Western Electric, and AT&T would stay together. The Long Lines subsidy of the local companies would cease and be replaced by an access charge to customers. And Charles Brown had gotten the chairmanship of AT&T with the proviso he would not fight Washington. It was all wrapped up, all settled.
It was 1979, a little more than a year before the U.S. v. AT&T went to trial.
AT&T was willing to take a loss, as long as that loss was on its terms.
Be that as it may, the official version of events was correct in one respect. Bell System management, distracted by the eroding effects of the FCC decisions and the suit, couldn't help but let other aspects of the business suffer. In particular, Bell Laboratories.
In the past AT&T top management had spent considerable time and energy overseeing the Laboratories' activities. The future was born there. But in the seventies, that time and energy had to be mobilized to meet the threats and assaults of the legislative, legal, and regulatory challenges.
It stands to reason that these distractions impeded progress. Without them, Picturephone service might have been introduced successfully. The network might have been completely digitized five or ten years sooner. Any number of new customer services might have been developed and made available. U.S. telecommunications was undoubtedly set back a number of years. This country has lost its place as the industry's world leader. We're now playing catchup with Europe and Japan.
It didn't have to be that way.
The pressures of the pre-divestiture years were not confined to Bell's top management. Employees at all levels were wracked by the uncertainty hanging over the system—and therefore hanging over their careers. Thousands had chosen to work for AT&T because of its stability and dedication to service. Suddenly the rules were changed. They were working for a rapidly changing organization with an uncertain future, where profit was sure to ride roughshod over service.
In many other industries, employees disturbed over their company's future start to send out resumes. But despite the perceived turmoil at Bell, tradition won out. Employees had signed on with Bell for life and the concept of jumping ship and getting a job somewhere else was still foreign. Most employees stayed with the company.
Still it wasn't easy. After the settlement it sometimes felt as if not only the rules had changed, so had the entire game. Bell Telephone Laboratories, Western Electric, AT&T, and Bell operating company employees had spent whole careers working together. Organizational lines weren't hard and fast, transfers between the different corporate entities were common and even expected as part of career development, and interorganizational secrets were almost nonexistent.
The one million employees had been united in an enterprise of which they were proud—providing what was undisputably the world's best telephone service while at the same time producing a constant flow of inventions to advance the communications art.
Then bingo! It was all changed. The environment of cooperation and easy access was gone. Employees were branded "Western Electric" or "Bell Operating Company," and they had to remember exactly for whom they worked.
In some buildings shared by two Bell entities, lines were literally drawn on floors to separate personnel and equipment—which in many cases were almost functionally inseparable. AT&T and operating company people who had once communicated freely had to get passes to visit each other. And it was verboten to talk about anything that might give an unfair advantage to potential competitors.
Bell employees were not just concerned about their personal futures in this tumult. They were even more frustrated because the dramatic changes in telecommunications policy and Bell's reaction to them violated every tradition of the business they had known. Moreover, they violated common sense.
Not too surprisingly, morale at Bell plummeted. A private survey conducted in 1981 indicated that morale there was among the lowest of any major corporation—a stark contrast to past surveys. While top management gave the situation much attention prior to divestiture, there's no evidence matters improved before the breakup.
Many employees felt the company they knew, their Ma Bell, had been brutalized and raped in front of them and they had been powerless to save her.But that didn't stop them from taking on the challenge and mandate of complying with the settlement provisions, with much of the same spirit they had previously displayed in times of national emergency or disaster.
While a vast majority of managers vehemently disagreed with having to dismantle what had been so carefully built, they accomplished, on schedule, a corporate divorce and asset distribution that many thought impossible.
As Michael Wines said in the National Journal in 1982, ". . . a Dutchman named Jan Asscher poised his chisel in 1908 over a 1 1/4 pound rock, lifted his jeweler's hammer, and deftly delivered a blow. When he finished, the object of his attack—the Cullinan diamond—had been reduced to 105 perfectly faceted, glittering gems. . . . The object is too cleave Ma Bell into at least two corporate giants. . . . The question now is whether the breakup will produce new corporate gems or a pile of considerably less valuable shards."
If the jeweler's hammer was to be forced into their hands, the Bell employees would become Jan Asscher. Thousands of managers worked long hours for two years on a task most found odious. But if it was to be done, they wanted to do it right. As Charles Brown put it. "What had to be done by our people was done with dispatch, with courage, and with 'class.' "
And so it was, on December 31, 1983, the books were closed on the Bell System and Ma Bell, as the world had known her, breathed her last.
Divestiture was complete.from pages 179 - 184
15 A Conspiracy
of SilencePANEL WARNS OF TELEPHONE INTERCONNECTION DANGERS A National Academy of Sciences panel yesterday warned that uncontrolled use of customer-owned telephone equipment could harm the nation's telecommunications system.
In a recently completed nine-month technical study, the group recommended that standards for such connections be set and strictly enforced to protect telephone service.—Washington Post
July 6,1970
WEINBERGER WANTS BELL ANTITRUST SUIT DROPPEDWASHINGTON—Secretary of Defense Caspar Weinberger yesterday asked the Justice Department to drop its antitrust suit against AT&T.
In a letter to Attorney General William French Smith, Weinberger said the breakup of the Bell System would greatly jeopardize national security.
The Defense Department maintains dismantling the Bell System, as called for in the suit, would seriously harm U.S. defense communications.—Louisville Courier-Journal
February 22,1981
COMMERCE SECRETARY SAYS BELL BREAKUP WILL
BRING BIG TRADE DEFICITWASHINGTON—Secretary of Commerce Malcolm Baldrige yesterday said the breakup of the Bell System would lead to an annual trade deficit in telecommunications equipment exceeding $1 billion.
In urging the dismissal of the federal suit against AT&T, he added that Japan would be the main beneficiary if AT&T were dismantled.—San Francisco Chronicle
May 15,1981
"All I know is what I read in the newspapers," humorist Will Rogers once said. He wouldn't have known any of the above information, because the stories never ran.
Have a television evangelist fall from grace in a motel room and it's front page, bannered across the top, hot stuff. Let a presidential candidate get caught with his pants down—figuratively, of course—on some Bahamian yacht, and the wire services are blasting details around the world. Watergate, Abscarn, Irangate, presidential intestines, all big news and covered ad nauseum in newspapers, magazines, and on the nightly network news.
The nation's press devoted seemingly endless pages and hours of coverage to the possible mishandling of $15 million in funds intended for Nicaraguan "contras," and yet there was hardly a whisper or a trickle of ink expended on a loss of several thousand times that as a result of the calamitous butchering of the Bell System.
If Will Rogers were alive today he might do well to ask why he wasn't allowed to know about the economic and technical blunders that led to telephone network competition and to the breakup of the Bell System. Why was this whole horrendous process practically kept a secret for more than twenty years? Where was the press? Why wasn't it pouncing on this multi-billion dollar ripoff of the public? Why wasn't it analyzing, dissecting, explaining? Where were the review-and-opinion pieces presenting the various sides of the issues?
One can only wonder if there wasn't some kind of conspiracy, a conspiracy of silence. For that is what there was—a harmful, negligent silence.Unfortunately the public never learns. Despite frequent, spectacular revelations of government corruption, venality, and wrongdoing, the American people cling strongly to their naive belief that their government leaders are inherently honest and intelligent.
The average John Q. doesn't want to entertain the thought that his "public servants" might have stolen billions of dollars from his own pocket so that a few wealthy entrepreneurs could line theirs. That a long succession of ill-conceived and stupid actions might have jeopardized our national defense, damaged our balance of trade, and crippled one of our nation's proudest resources—its telephone system.
All this would be inconceivable to John Q. unless—unless the media got on the story.
"Things don't get corrected until they're publicized" David Nyhan said in the Boston Globe in 1987. They don't even get noticed. The public depends on the press to alert it to crimes and malfeasance. The country is too large for information to be disseminated by word of mouth, over the back fence. Should the media ignore the Bell System's arguments about the high costs and penalties of contrived competition and divestiture, naturally the public will too.
Significant events such as Judge Richey's ruling in favor of AT&T were either buried behind the obituaries or ignored altogether. And there were no in-depth explanations of how MCI was able to undercut AT&T's prices on long distance service at the expense of the public and what the real cost to the public was.
What happened? Was the press caught napping? Was there some sort of incredible lapse in editorial judgment—the ongoing story was too dry, too complicated, too unimportant? It wasn't "sexy" enough? Or were there other factors involved?
One can only speculate.
For instance, it's a given that newspapers, magazines, television, and radio depend for their existence on advertisements—ads pay the way and make the profit. Keeping that in mind, it should also be remembered that competition in the telephone industry meant many new advertisers. All of a sudden there were MCI, Sprint, the Baby Bells, AT&T, equipment manufacturers—foreign and domestic—all competing for the market and competing for advertising space. It was surely the ad salesperson's dream come true.
It just can't be disputed there are far more pages of telecommunications advertising in the media now than before divestiture—the individual Bell companies, when part of AT&T, did little other than local advertising. Now all of them are in there touting their wares nationally.
While the media can insist there's a firm, impenetrable barrier between newsroom and ad department, and editorial content is kept separate, one can only wonder.
And then, if this silence didn't arise out of greed and coveting more advertising lines, might it have had something to do with the media's well-known liberal tendencies? Did the nation's journalists simplistically assume that big is bad, and all large monopolistic corporations natural enemies? That any informational release from a Big (shudder) Business should be tossed in the circular file cabinet as so much propaganda?
Or maybe the press didn't oppose the Bell breakup because of its own business interests. After all, most publishers foresee a bright future for Videotext type services. These have the capability of displaying and printing news and other information of public interest in the home and already have been extensively tested in various locations. Knight-Ridder publications and AT&T conducted one such trial in Coral Gables, Florida, in the early 1980s. Despite this collaboration, many publishers are afraid AT&T will get into this market as the producer of information as well as its transmitter.
It's been argued that AT&T's being allowed to extend its monopoly privileges into electronic publishing could have serious deleterious effects on First Amendment rights, that AT&T would then be in the position of limiting and controlling information. Thus, anything that would damage the Bell monopoly would work to the advantage of the publishers.
But, of course, this argument is no longer debatable since Judge Greene has barred AT&T from entering the publishing field, at least for several years. In view of that, one again might wonder if it was a coincidence that Judge Greene and divestiture got very little opposition from the press.
Of course, AT&T didn't do very much to get more favorable press. Direct appeals to the public through advertising were scarce. The company did get cranked up one time, when it was lobbying for Congressional passage of the Consumer Communications Reform Act in 1976. But AT&T's Chairman deButts approached the lobbying effort with a heavy hand and an insistence that almost all terminal equipment competition be eliminated. As a result, the effort backfired, and created more antagonism in Congress than support. The press apparently had little desire to be associated with what was clearly a lost cause. There was no outpouring of editorials supporting the Act.Before the Bell System was broken up, The New York Times ran a poll that revealed 80 percent of consumers were satisfied with their phone service. No other business received such a high satisfaction rating. But despite liking the service received from the Bell System, there was no outcry against divestiture. If as little as one percent of the public had protested with letters to the editor or to their lawmakers, they could not have been ignored.
But there was no such protest. Obviously the public had no idea what divestiture was sure to bring—poorer and more costly service. What has happened could not have been perpetrated without a conspiracy of silence by the press that was supported actively or passively by the FCC, the Justice Department, state regulatory commissions, and indirectly even by AT&T.
Not that everyone was silent. There were individuals, author Constantine Kraus included, who tried over the years to alert the public to what was happening. Articles were submitted to leading publications, columnists, and government leaders. But nothing came of them. One exception was an article, "Social Consciousness in Communications Engineering," that did see the light of day in the Institute of Electrical and Electronic Engineers Communications magazine, in May, 1976. The article correctly predicted the outcome of the emerging telecommunications policies of the government and accurately forecast how the public would be affected. It explained why long distance competition amounts to stealing from the poor to benefit the rich, and why competition in public utility operations forces the consumer to pay for the sum of the costs of all competitors.
If our esteemed government representatives read the article, they disregarded it, just as they disregarded the economic truths revealed in it.
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