3
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The Assault Begins
The Beginnings
The beginnings of the massive breakup of the Bell system in 1984 can be traced to the creation of the Federal Communications Commission (F.C.C.) in the early New Deal. The Communications Act of 1934 consolidated the radio functions of the Federal Radio Commission and the telephone functions of the Interstate Commerce Commission (ICC) into a new independent regulatory commission that was to regulate interstate and foreign communications by wire and radio in the public interest. Like other independent regulatory commissions, the F.C.C. could act both like a court in adjudicatory proceedings and like a legislature in rule-making proceedings. The F.C.C.’s work in foreign and interstate communications was to be complemented by the regulatory jurisdiction of the various state and local public utility commissions. One should recall that in 1934-and for many years afterward—the bulk of telephone traffic was local, not long distance, and therefore largely supervised by the state and local agencies.
The F.C.C.’s powers over interstate and foreign telecommunications under the 1934 statute were broad. The agency’s fundamental goals were enumerated in Section 1: “To make available, so far as possible, to all the people of the United States a rapid, efficient, nation-wide and world-wide wire and radio communication service with adequate facilities at reasonable charges.”1 While the framers of the legislation accepted the regulated network manager system and AT&T’s leadership of it, they were nevertheless hostile to the company, suspicious that its rates and rate base were excessively high. This was in keeping with the New Dealers’ public philosophy, which was sharply critical of big business. The bigger the firm was, the more antagonistic the New Dealers were. Their public philosophy blamed the alleged greed of big business for the Great Depression that began in 1929. Indeed, the failure of the New Deal to lift the nation out of the Great Depression only confirmed in their minds that the predatory behavior of big business was responsible for sabotaging the recovery.2
A persistent theme in congressional debates on telecommunications was that the new agency should investigate AT&T’s structure, rates, and practices. Between 1934 and 1939 the F.C.C. conducted a telephone investigation that, after findings and a report, was expected to be the basis for additional legislation. The staff investigation is important in that its influence and the hostility it generated toward AT&T persisted after the end of World War II. More than any other factor, it led to the 1949 suit against AT&T—the United States v. Western Electric case—which was in large part based on the findings of the investigation, especially those relating to the suspicion of excess profits resulting from the ties between Western Electric, on the one hand, and AT&T and the operating companies on the other. The evidence that Western Electric’s profits were reasonable for an industrial corporation and that it operated efficiently was beside the point to the investigators.3
The driving force behind the F.C.C.’s hostility toward AT&T was Commissioner Paul A. Walker, described in Business Week as a person who “cherishes some private hate against the Bell System.”4 Ironically, the company’s extraordinary technological advances in radio, telephotography, television transmission, stereophonic sound, and talking motion pictures only confirmed the fear of Walker and other New Dealers that AT&T would expand its telephone monopoly to many other areas. AT&T’s political response to new markets during this era was to back away from all fields other than its basic telephone business.
Prelude to the Western Electric Case
While World War II did not entirely suspend partisan politics, most administrative actions were postponed until after the Allied victory. Nevertheless, even during the war, planners fashioned a new public philosophy to deal with the postwar situation. The underlying assumption of most thoughtful persons was that a boom based on pent up wartime savings would be followed by a new depression, much like the 1929–39 episode; few thoughtful people expected the extraordinary sustained growth that characterized the post-World War II era. Accordingly, much theorizing was expended on how to prevent or, at least, moderate the inevitable downturn. Many policymakers looked to Keynesian fiscal policy in the macroeconomic area joined with antitrust policy at the industrial level. Belief in the public philosophy that dominated the Harry Truman presidency was shaped by the sharp economic downturn of 1937. Many observers close to the administration sought to place paramount blame for that recession on big business. Essentially they theorized that big business, exercising monopoly power, had instituted arbitrary price increases. When consumers were unable to purchase goods at these excessively high prices, big business did not lower prices; rather, it laid off workers, reduced output, and postponed investments.5 Thus, the key to preventing another depression in the postwar era was vigorous antitrust action.
Notwithstanding some Republican opposition, to be against monopolies in the immediate post—World War II era was not only politically popular but economically popular as well, in that the theory addressed some of the major economic problems facing the nation at the time. President Truman, an advocate of vigorous antitrust action, vetoed the Reed-Bulwinkle Act in 1948, which granted antitrust exemption to railroad common carriers for jointly formulating rate and other agreements. (Congress overrode the veto.) Truman also vetoed a 1950 bill, this time successfully, that would have allowed certain basing point pricing practices on the ground that the bill would encourage industrywide uniform prices. In both cases, Truman stated his strong support for the antitrust laws. However, antitrust is not primarily a matter of enacting statutes or of vetoing them. The Sherman Act is sufficiently broad to allow the Antitrust Division of the Justice Department to challenge a wide variety of practices. In short, antitrust is primarily a matter of executive-branch enforcement. Therefore, it is in the activities of the Justice Department and the Federal Trade Commission, which is also responsible for antitrust enforcement, that we must look to ascertain the administration’s principles on antitrust.
The Truman Antitrust Division was one of the most vigorous since the enactment of the Sherman law in 1890. Aside from bringing the Western Electric case, consider its other activities in 1949 alone. The Truman administration pursued old and new cases vigorously, largely eschewing compromise in the form of negotiated settlements. A New Jersey court upheld the Antitrust Division’s contention that General Electric unlawfully monopolized basic tungsten filament incandescent lamp patents. A suit was filed to break up the Great Atlantic and Pacific Tea Company, then the nation’s largest food retailer. A major monopoly case was brought against the large tobacco companies, and another was brought to sever the stock and management relationships among Du Pont, General Motors, and U.S. Rubber. American Can Company, the nation’s largest manufacturer of tin cans, was charged with monopolizing. Other major pending cases, in some of which the government sought drastic restructuring remedies, involved Bausch and Lomb Optical Company, the four largest meat packers, major dairies, the three largest farm machinery manufacturers, seventeen investment banking firms, Eastman Kodak, Timken Roller Bearing Company, United Shoe Machinery Corporation, U.S. Alkali Export Association, and the Yellow Cab Company. Meanwhile, the Federal Trade Commission was prosecuting some of the biggest cases it had ever undertaken—its targets included major steel manufacturers and cement producers. Thus, AT&T was in good company when the Antitrust Division brought its action, the major purpose of which was to divorce Western Electric from AT&T and to create three separate corporations from Western.
Large size alone is insufficient to bring an antitrust case; there had to be other factors present before action could be taken. One of the most important factors involved the extension of market power from one market into others. The Supreme Court’s favorable disposition in the 1948 Paramount decision to the divorces of motion picture production and distribution from exhibition constituted an open invitation to attack vertical integration when associated with substantial market power. But from the perspective of antitrust law, the case that provided the closest parallels to the AT&T—Western Electric situation involved the Pullman Company. When a district court decided the United States v. Pullman Company case in 1943, and it was upheld by the Supreme Court, the decision was viewed as a major breakthrough.6 Pullman had provided sleeping car service to the railroads since 1900, achieving dominance of such service through long-term contracts. It used the leverage of its service business to achieve an almost complete monopoly of sleeping car manufacture for a subsidiary that made the cars, effectively preventing others from any sales in the industry. The district court held that it was not necessary for the government to show abusive conduct or intent; benevolent monopoly is monopoly nonetheless. The monopolistic effects of Pullman’s arrangements with the railroads were sufficient to prove a violation of the Sherman Act, even though all the defendant’s customers were satisfied and Pullman’s business was run in an efficient, even exemplary, manner. As a result of the violation, the court ordered the separation of the two components of Pullman’s business. The resemblance between the Pullman and Western Electric situations was readily apparent and might result in AT&T divesting Western Electric even if vertical integration was efficient and reasonable.7
The United States v. Western Electric Case
Why did the Justice Department bring its 1949 antitrust suit against AT&T and the Bell system? Unlike the 1974 case, it was not triggered by the complaints of competitors; there were no complaints about AT&T’s performance. Indeed, the company’s wartime effort was uniformly viewed as exemplary, and its peacetime plans were visionary.8 Rather, the suit stemmed from the Truman administration’s public philosophy and complemented the many other antitrust cases brought during that era. The first media mention of the pending case occurred in mid-December 1948 when Business Week reported that the Antitrust Division was preparing a “Pullman case” against AT&T to divorce Western Electric from the parent company.9 Less than one month later the Justice Department brought its antitrust suit against the company. In contrast to most large-scale antitrust matters, the FBI had not conducted a wide-ranging investigation prior to the suit. The reason was that the case was based almost entirely on the F.C.C.’s hostile investigation in the 1930s. The complaint, consisting of seventy-three pages, described events in AT&T’s history that went back to the turn of the century, and it proposed a divorce of Western Electric from AT&T and a division of Western’s plants into three competing, independent equipment manufacturers. In a statement accompanying the complaint, Attorney General Tom Clark stated that the purpose of the suit was to
restore competition in the manufacture and sale of telephone equipment…. This in turn will lower the cost of such equipment and create a situation under which state and federal regulatory commissions will be afforded an opportunity to reduce telephone rates to subscribers. Absence of competition in the manufacture and sale of telephone equipment has tended to defeat effective public regulation of rates charged subscribers for telephone service.10
The complaint was, of course, not prepared by the attorney general but by Holmes Baldridge, an Antitrust Division attorney who had been a leading staff participant in the F.C.C.’s investigation and later a lead attorney in the Pullman case. The government’s prayer for relief called for not only the divestiture of Western Electric but also for (1) AT&T to acquire all of its equipment by competitive bidding, (2) Western Electric to sell its 50 percent share in Bell Labs to AT&T, and (3) AT&T and Western Electric’s successors to license all patents to all applicants on a nondiscriminatory and reasonable royalty basis11 (even though AT&T had already voluntarily instituted an extremely liberal patent-licensing policy).
AT&T’s April 24, 1949, answer to the complaint consisted of a general denial of the Justice Department’s allegations, several technical legal arguments, and a recitation of the advantages of an integrated telephone system carefully regulated by government agencies. The heart of the defense to the government’s call for drastic relief claimed that the costs of a vertically integrated system were lower than they would be with arm’s-length market transactions between independent manufacturers and the operating companies. “Since all the operating units of the System have common problems there are many things that can be done better and more economically in their behalf by a central organization. The American Company has undertaken to do these things either directly or through its subsidiaries.”12 These included (1) developing and recommending technical standards and operating methods and (2) providing the research and development results of Bell Labs and the manufacturing and supply facilities of Western Electric. Some installations for operating companies were custom-made with considerable give and take among AT&T, Western Electric, and the local operating companies. The lawsuit was, thus, fundamentally about the relative benefits and costs of vertical integration.
The Settlement of 1956
On January 24, 1956, about seven years after the antitrust suit was filed, AT&T and the Justice Department entered into a consent decree and final judgment in the Western Electric case. Although a long lapse of time between the filing of a complaint and its resolution is not unusual in complex antitrust cases, the Western Electric case was unusual in that so few formal proceedings had transpired in the interim. While one view holds that the Republican administration that came to power in 1953 capitulated to AT&T, it does not explain the lack of action between 1949 and 1953 when the Democratic Truman administration that brought the case was in power.
While trial courts play a major role in handling cases before them, it is nevertheless clear that an important shift in public philosophy was taking place. The postwar return to depression did not occur; to the contrary, the American economy had embarked on a sharp upward trend from 1948 to 1956. Gross national product increased an annual average of 4.7 percent (in constant dollars) during those years, while personal disposable income (in constant dollars) increased at an annual average of 4.6 percent, notwithstanding two minor recessions. The unemployment rate averaged only 4.3 percent—a sharp decline from the 1938 rate of 19 percent.13 Events had severely undermined the argument in favor of the antitrust philosophy. At the same time, the United States had become locked in a cold war with the Soviet Union, its most formidable rival since the war of independence. Firms with important research and production facilities were now not just large companies but also national resources, so that any drastic restructuring would weaken not only the companies but would undermine national survival as well. The new public philosophy based on rising affluence and national survival was on the ascendant in 1956, while the older antitrust one—although far from dormant—was in decline. For these reasons the Eisenhower administration was anxious to terminate its major cases against IBM and AT&T.
When we combine these changes with the showing that AT&T made to Justice Department attorneys undermining the foundations of the case, and the support given to AT&T by the Department of Defense, we can readily understand the consent decree of January 1956. The most important aspects of the settlement concerned what it did not do; that is, it did not require AT&T to divest Western Electric and it did not impair the relationship of Bell Labs and the other components of the Bell system. In short, the settlement left the structure of AT&T largely unchanged, except that Western Electric was required to sell the Westrex Corporation, a subsidiary that manufactured sound recording equipment for the movie industry. However, it had become clear as early as 1950, when AT&T announced that Western Electric would no longer manufacture radio broadcasting transmitting equipment or television station apparatus, that the company would withdraw from businesses unrelated to point-to-point telecommunications. Although Western Electric’s endeavors in these fields were promising in the 1950s, AT&T had learned through experience that any activity in non-telephonic fields would be politically troublesome. Thus, AT&T agreed in the settlement that Western Electric would not manufacture products not required by the operating companies and AT&T, except for certain products like the artificial larynx and those manufactured for the United States government, most importantly the Department of Defense. Further, AT&T and its operating subsidiaries agreed not to engage in unregulated, non-public-service activities with the exceptions of working for the federal government, doing experimental work, providing circuits, giving advice and assistance to other communications common carriers, and directory advertising. In summary, AT&T and its component parts agreed to limit themselves to communications activities, defense-related work, and the network manager role.
One of the most important elements in the 1956 settlement was that all past and future Bell system patents were made subject to compulsory license at reasonable royalty rates to all applicants not controlled by foreign interests without regard to prospective use. When one considers that Bell Labs had invented the junction transistor—the basis of all modem electronics—and much else, one can begin to appreciate the value to other firms of this crucial provision. Nevertheless, the settlement was viewed with deep suspicion by adherents of the old antitrust philosophy, many of whom held positions of influence in the Democratic Party. One of the most important of these people was Representative Emmanuel Celler, chairman of the House antitrust subcommittee. In 1958, Celler began searching for evidence that would support charges of a “sellout.” The subsequent hearings would be useful as an attack on the Republican administration as well as a vindication of Celler’s view that only a venal conspiracy consisting of AT&T, top administration officials, and the Department of Defense could have led to such a weak settlement. The Celler committee’s report does not reflect a careful evaluation of the testimony and documents collected in the hearings.14 Nevertheless, suspicion lingered, and AT&T’s later opponents would use the Celler report to argue that the 1956 agreement insufficiently constrained AT&T and that other remedies against the company were necessary. There is a thread, then, that goes from the F.C.C.’s 1930s investigation through the 1956 settlement to the later government actions restructuring American telecommunications.
The Assault in Telecommunications: Interconnection
While the Western Electric episode constituted an assault on the basic structure of AT&T, the F.C.C. and the state public utility commissions were also quietly confronting issues concerning the company and its place in postwar telecommunications. Most of the challenges have their roots in technological changes that began to occur even before World War II but that were accelerated during the war. These changes generated entrepreneurial activity as old and new firms sought to seize opportunities to use telecommunications in novel ways. This, in turn, raised three new issues: (1) what interconnection rights into the Bell network should be granted to the entrepreneurs, (2) how the newly available portions of the expanded radio spectrum should be allocated (spectrum, like land, is a scarce resource), and (3) how regulators could solve the problem of drawing the boundary between regulated public service activity and unregulated competitive activity. AT&T’s reactions to these issues and the responses of federal and state regulators constituted a major controversy in the 1974 suit. During the first postwar decade, the regulatory agencies, most importantly the F.C.C., attempted to resolve the new problems within a traditional public service context. But even then, there were those who advocated a new framework that would grant a larger role to competition. The early postwar events concerning answering and recording devices in the customer premises equipment (CPE) market and intercity television transmission in long-distance transmission constitute the first phase of the erosion of the public service conception. The second phase, culminating in a direct attack on interconnection restrictions, began in 1956.
The most important initial contentions concerned the Bell system’s longstanding interconnection restrictions that prohibited customer-provided interconnection (with few exceptions) into the AT&T-dominated network. AT&T provided CPE and switching and transmission gear, usually of its own manufacture, as well as long-distance transmission. Although its operating companies were joined by many independent local companies, the interfaces between local loops and the national network were controlled or supervised by AT&T. Such controls were exercised over all communications products, including voice, video, data, facsimile, and so forth. AT&T’s interconnection policy was embodied in the company’s related tariffs and had deep historic roots. The interconnection restrictions were uniformly upheld from their beginnings and applied both to instruments that were substituted for Bell equipment as well as those that were added on, such as answering machines.
At a superficial level these interconnection restrictions can be viewed as a naked attempt by AT&T to enlarge its monopoly from those segments of telecommunications in which monopoly was lawfully granted to other product markets in which monopoly was not lawfully granted. Under most circumstances, such tie-in arrangements of a lawful monopoly product or service with another product or service constitutes a violation of the Sherman Antitrust Act.15 Nevertheless, sound justifications can overcome the presumption of illegality. The AT&T argument began by observing that almost from its beginnings the telephone industry has had inventors who developed what are called foreign attachments that supplement or substitute for the components supplied by telephone companies. As early as 1884 the Bell system adopted a policy rejecting such interconnection on the ground that they were injurious to transmitters.
As telephone use grew in the early 1890s and the expiration of the Bell patents neared, the number of foreign attachments that could be made easily and attached to the basic instruments proliferated.16 Some of these devices were found to impair the intelligibility of communications or the quality of the signal, such as an “ear pad for Telephone Receivers.”17 Still other devices during the late nineteenth and early twentieth centuries preyed on public fears, implying that the telephone mouthpiece was a health hazard. For example, a flyer for the Improved Antiseptic Nickel Mouthpiece Attachment claimed that “the scrapings from many telephone mouthpieces were subjected to the microscope by Prof. Kauffman of the Board of Health and great numbers of bacteria germs were found … which shows that great danger actually exists in inhaling these germs in the mouth and nostrils.”18 Still another advertisement for a mouthpiece warned that telephones “may be infected with the most dreadful contagious diseases” because people touched the mouthpiece with sore lips.19 Such flagrant claims, needless to say, angered Bell officials.20 Other attachments sold to consumers did not work, and in almost all cases there was some degree of transmission loss that resulted from interconnecting the device into the telephone network.21
Because of the interactive nature of the telephone network, telephone companies and regulators responsible for the overall quality of the network could not adopt a casual attitude toward such devices. Those adversely affected by foreign attachments that malfunctioned or reduced the quality of conversation included not only those using them but parties to conversations and other subscribers using Bell equipment as well. The proliferation of foreign attachments and the difficulty of locating and testing them before their introduction into the network might cause such engineering and technical problems as hazardous voltages, line imbalance, attenuation, other forms of quality deterioration, and substantial costs. Bell licensees and the telephone companies incurred high transaction and information costs resulting from (1) discovering such attachments, preferably before harm might occur, (2) testing the devices, (3) negotiating with their manufacturers and sellers, (4) proposing modifications and policing the manufacturers’ adherence to the new standards, (5) retesting the devices, (6) installing them or supervising their installation, (7) instructing subscribers in the correct use and maintenance of devices so that the network would not be impaired, and (8) repairing them.
For these reasons the Bell system adopted a policy uniformly approved by the state public service commissions known as end-to-end responsibility. Taking responsibility for the entire network made sound economic sense not only for the telephone company but for the subscribers as well, since it assured lower telephone company costs. For these same reasons, independent companies that were not integrated backward like AT&T also imposed interconnection restrictions. The ICC, PUCs, and the F.C.C. uniformly upheld these provisions as reasonable restrictions.22 Indeed, they often compelled telephone companies to adopt the provisions. However, the tariffs did not bar all interconnection; rather, customer interconnection was prohibited unless a good reason to override the prohibition could be provided. Hence, information and transaction costs were largely shifted to the customer seeking the exception and were not imposed on other subscribers. Those granted exceptions tended to be reliable customers who could be trusted not to impair the network. For example, the United States Army had well-trained telephone personnel and for security reasons maintained control over CPE. Mining and railroad companies also were permitted to provide and maintain certain CPE because of the hazards telephone company employees would face in maintaining the equipment.23
AT&T’s interconnection policies were, then, clearly defined and settled as the postwar era began in 1946. But several factors conspired in the policy’s undermining, among which, ironically, was AT&T’s business and technological successes. From 1946 to 1970, per capita GNP in constant dollars more than doubled, but the number of telephones almost quadrupled. In that period the percentage of households with telephone service increased from 51.4 percent to 90.5 percent. At the same time, telephone rate increases consistently trailed the rate of inflation. To a considerable extent, AT&T achieved these results because of its technological prowess. Coaxial cable, microwave transmission, the transistor and electronic switching, for all of which AT&T was significantly responsible, revolutionized telecommunications technology within a very short time. Increased capacity, lower costs, increased demand, and the general economic boom stimulated telecommunications in this period. No one firm—not even one as large as AT&T—could possibly seize all of the opportunities as rapidly as they could be realized. At the same time, prospective lucrative markets inevitably attracted entrepreneurs seeking to plug into the network through new CPE or private systems that could become more valuable through interconnecting into the public switched network.24
AT&T’s initial postwar responses to the first proceedings, involving recording or answering machines, was to either bar interconnection or to permit interconnection under conditions it carefully controlled, and, in general, the F.C.C. and state regulatory bodies upheld AT&T’s responses with some modification.25 But in a major proceeding known as the Hush-A-Phone case, things began to change. Like so many events that lead to the establishment of important principles, the Hush-A-Phone case had its origins in a relatively small and simple matter. The Hush-A-Phone device, consisting of a simple cuplike attachment that could be snapped onto the telephone handset, was intended to assure relative privacy. It was entirely acoustic and did not involve any electrical or inductive connection into the network. As such, the Hush-A-Phone—unlike most prior interconnection devices—did not raise the issues of physical harm, network safety, or technical compatibility.26
AT&T and its affiliates objected to the Hush-A-Phone principally because it reduced the intelligibility of communication. Because the quality of telephone conversations between users and other parties was lessened by the Hush-A-Phone attachment, the Bell system determined that the device degraded the network. In keeping with its tariff provisions generally prohibiting interconnection, the Bell system notified several Hush-A-Phone customers (most of them department stores) that the attachment was illegal and should be removed. As a result, the Hush-A-Phone company brought action against the Bell system in 1948, requesting the F.C.C. to change the interconnection provisions of AT&T’s tariffs to permit the use of the device. In response, the Bell system claimed that the Hush-A-Phone was ineffective in that it impaired the intelligibility of telephone service and did not afford any significant increase in privacy. Telephone engineers, including some not employed by telephone companies, also complained that the Hush-A-Phone raised the transmitters of certain telephones above their cradles when the instruments were hung up, which tied up central-office lines and delayed incoming calls. It was also noted that the California PUC’s policy was to deny interconnection rights if a device might impair the network because the administrative costs of policing such devices would be too high.27
In February 1951, in an initial decision, the F.C.C. unanimously agreed to dismiss Hush-A-Phone’s complaint, but stated that each foreign attachment must be considered separately based upon potential impairment or quality reduction of the network. In 1955 an almost entirely different group of commissioners upheld the initial decision, 6–0, ruling that the device impaired intelligibility, naturalness, and voice recognition.28 Hush-A-Phone Corporation was not about to give up, notwithstanding the long line of precedent against its position, and appealed the F.C.C.’s decision to the Court of Appeals for the District of Columbia Circuit. To the surprise of most observers, the court’s November 1956 decision reversed the F.C.C, upholding Hush-A-Phone’s contentions.29 Since there was no federal judicial precedent in the area of interconnection, the court was relatively free to vent its views on the subject without constraint. Accordingly, it ignored the network concept and every reason that the PUCs and F.C.C. had provided to support interconnection restrictions. The court disregarded the facts that regulatory agencies have an interest in the quality of transmission and that statutes (including the 1934 Communications Act) direct them to consider quality and promote improvements in the network. In effect, the court held that if an interconnecting device does not physically impair any of the facilities of the telephone company, any commission restriction on interconnection is an “unwarranted interference with the telephone subscriber’s right reasonably to use his telephone in ways which are privately beneficial without being publicly detrimental” (emphasis added).30
Notwithstanding the surprising result in the Hush-A-Phone appeal, it is important to appreciate what the court’s decision did not do. Although the court’s comment, “privately beneficial without being publicly detrimental,” would open the door to the introduction of more such devices, the court did not command the F.C.C. to deregulate CPE interconnection or to promote competition, and it certainly did not warrant any substitution for Bell-provided equipment. Accordingly, the F.C.C, upon remand, directed AT&T to amend its tariffs so as to distinguish between harmful and harmless interconnecting devices. Thus, at this juncture, the company could not prohibit devices that did not injure or impair the system or its operation. The amended AT&T tariffs were filed in April 1957, in accordance with the decisions, but in an accompanying statement AT&T made it clear that liberalized interconnection did not apply to electrical devices because these did create a safety hazard.
Control over Television Transmission
During the early post—World War II period, in which AT&T’s position on interconnection was being undermined, an equally important threat was mounted in the realm of spectrum allocation. We noted in Chapter 1 that entry, industry structure, and allocation issues have been crucial in telecommunications policy. Theoretically, a monopolist should fight against technological innovations that enlarge market capacity beyond its ability to dominate it. AT&T’s response to the most important new transmission technologies with enormous potential to enlarge markets was far more complex than the simple theoretical model would have predicted. The television boom that was promised before World War II, but postponed until after the Allied victory, illustrates the complex response.
In order to understand the issues, a short technical digression is necessary. After World War II the dominant medium for distributing television programs was not yet clear. What was known from the outset of experimental telecasting was that the twisted pair of wires used to carry telephonic transmission was inadequate to carry television signals over long distances. The range of frequencies to be carried in video transmission was simply too broad for both ordinary copper wires and cable. The two principal contenders for the lucrative television transmission market were microwave relay and coaxial cable. While coaxial cable bore a clear resemblance to ordinary copper wire or cable, we cannot assume that AT&T necessarily favored coaxial cable to microwave relay. That AT&T had a strong historical commitment to coaxial cable is evident, as it was in large part developed by AT&T precisely to transmit television signals. During the 1930s, AT&T had been encouraged in this endeavor by RCA, which would become the largest customer of television program distribution. Coaxial cable, consisting of a special cable in which one conductor is completely surrounded by a second one, greatly reduced attenuation and distortion and dramatically reduced power losses at high frequencies. Additionally, the increase in transmission paths compared with traditional two-way voice channels was dramatic. Thus, coaxial cable would permit AT&T to experience a great increase in telephone capacity and at the same time allow it to accommodate the anticipated television boom.
However, at the end of World War II, microwave relay loomed as an alternative for both long-distance voice and television transmission, although it was not necessarily conceived of as a competitor to coaxial cable. While it was entirely possible that one of the two technologies might be the sole survivor for economic or technological reasons, AT&T then contemplated that each would serve its purpose in the television and telephone long-distance markets, and that distance, terrain, and other variables would determine which would be the most economic between any two points. In AT&T’s view, both technologies had to be considered in transmission of voice and television, and as such they were within the jurisdiction of regulators and public service companies.
Nevertheless, in that period, coaxial cable was a more reliable technology. In microwave relay, the microwaves travel only slightly above the horizon and are subject to fading because of atmospheric conditions, and must be retransmitted at towers approximately twenty-five to thirty-five miles apart. A comprehensive microwave system requires the design of (1) repeater circuits; (2) antennae with high gain, good directional qualities, and a low capacity for distortion; (3) filters that can connect a number of different radio channels to a common antenna (thus reducing the quantity of antennae otherwise needed); and (4) repeater amplifiers to compensate for transmission loss in the previous path.31 But the complete microwave system is more than a sum of its parts; indeed, the larger the system became, the greater were the questions of transmission quality, flexibility, dependability, and economy.
A conflict was virtually inevitable between AT&T and the television networks over who would dominate the nationwide transmission of television programming. By February 1948 the television networks’ plans were greater than AT&T’s combined coaxial-microwave system could handle. Accordingly, the Television Broadcasters Association (TBA) urged the F.C.C. to provide frequency space for a private intercity television microwave operation because AT&T and other common carriers could not adequately meet the needs of the television networks. The controversy heated up considerably when AT&T refused to transmit an NBC video program between New York and Boston because the program had been transmitted previously from Philadelphia to New York over the lines of a television network, rather than AT&T’s.32 The controversy, which the F.C.C. ultimately resolved, further undermined AT&T’s transmission monopoly by allowing other firms to distribute intercity video traffic where AT&T and the other telephone and telegraph companies were unable to do so. The agency also rejected any AT&T tariff that refused to transmit television transmission at reasonable rates.33
Spectrum as a Scarce Resource
The controversy between AT&T and the television networks was only the first of several interconnection and spectrum allocation battles that erupted between the telecommunications giants and large users in the postwar era. In contrast to the prewar era in which corporate users saw telecommunications as an incidental cost of doing business, important users began to see telecommunications as a crucial resource in transacting business. In particular, the petroleum industry—an important actor in both the Above 890 Mc and the Carterfone proceedings—typified the burgeoning interest of many industrial and commercial sectors in the enormous possibilities of telecommunications. In October 1947, the American Petroleum Institute (API) created its Central Committee on Radio Facilities; oceangoing-vessel-to-shore communications, petroleum pipelines, and geophysical exploration were only the beginnings of its newfound interests in telecommunications. The head of the API committee projected that “Practically every division or branch of the petroleum industry can well be served by one or more adaptations of radio to effect economies in operation, increase safety or raise efficiency. Radio may, perhaps, provide new methods of processing oil to supplement or even replace the present catalytic refining processes.”34
Many other industries gradually discovered what the petroleum industry did early in the postwar era—telecommunications was a valuable resource. This realization raised for industry representatives a host of issues, including whether they should have the choice of a private system or telephone-company-provided service, interconnection rights, and, of course, frequency allocation. The crosscutting conflicts meant that industrial and commercial microwave users could have interests in conflict not only with telephone companies but with each other as well. For example, API and the theater television interests clashed in 1952 over the allocation of certain microwave frequencies. The political battle over microwave frequencies came to resemble a barroom brawl, but with one difference: virtually every interest took a position in conflict with AT&T’s. In 1953, the Radio-Electronics Television Manufacturers Association (RETMA), desiring a degree of predictability on how to plan the manufacture of sets in the future, requested that the F.C.C. conduct an overall study and promulgate microwave rules in accordance with current and future requirements.35 As the F.C.C. prepared to act, a dozen user organizations, including railroads, motor carriers, and forest industries, banded together in 1954 as the Microwave Users Council.
In May 1957 the F.C.C. began its protracted Above 890 Mc hearings to decide the fate of the microwave portion of the radio frequency spectrum. For the first time in an F.C.C. proceeding, virtually all big business—led by the petroleum industry—contended that it needed privately provided microwave to serve its unique requirements, thus potentially foreclosing AT&T and other common carriers from a large volume of communications traffic. The F.C.C.’s 1959 decision went much further in weakening AT&T’s control over telecommunications than it had in the 1949 television matter, in which the agency conceived non-common-carrier transmission of television as a temporary and supplementary phenomenon. In Above 890 Mc, it found that a frequency shortage did not then exist and that a shortage was not likely to develop in the future. Second, the F.C.C. projected that there would be few private microwave users. Therefore, the intense demand of a few private-line users (demonstrated by their vigorous participation in the hearings) and a projected small overall private-line demand were the key reasons the F.C.C. agreed to permit private microwave. Because the agency viewed private microwave as an exception to common-carrier control of intercity communications, the issue was treated much like a military or police service, for which there is little or no need to discuss boundary questions between public and nonpublic services.36
Thus, AT&T and the other public service companies suffered a major defeat. Clearly the agency was impressed by the intensity expressed by large users of private microwave and felt obligated to accommodate their interests. Of course, the petroleum industry was pleased with the outcome. And, not surprisingly, when the commission reconsidered Above 890 Mc in 1960, it upheld its original decision, largely on the grounds initially set forth.37 Although the door for competition was not yet opened wide, it certainly opened considerably more as a result of the Above 890 Mc case. Nevertheless, if the F.C.C. presumed that the new competition between private and common carriage would reduce its supervisory role, the decision had precisely the opposite effect. AT&T’s tariff responses (usually called TELPAK) were invariably challenged before the agency, which became more deeply involved in AT&T’s corporate affairs than ever before.38 The challenges to AT&T, however, were just beginning.
Space Communications
The unique history of the American space program was responsible for the distinctive economic structure of the communications-satellite industry as well as for AT&T’s strong, but not dominant, position within it. While the story of satellites began before the Soviet Union’s launch of Sputnik I on October 4, 1957, certainly that event had great impact on the structure of the industry. The United States suffered a serious blow to its prestige in science and technology, which, in turn, led to a strong American commitment under government guidance to space technology. Thus, communications satellites became not just a business; they became intertwined with national prestige and a substantial commitment of government resources. At the very least, patents developed under the government’s auspices as well as its exclusive control over satellite launching would inevitably lead to cries of blatant favoritism if only existing common carriers were allowed to deploy communications satellites. Nevertheless, the Eisenhower administration made it clear that it had “achieved communications facilities second to none among the nations of the world. Accordingly, the Government should encourage private enterprise in the establishment and operation of satellite relays for revenue producing purposes.”39 Yet the government’s commitment to “private enterprise,” a policy endorsed by the Kennedy administration over the objection of several liberals in Congress, did not specify the future structure of the satellite communications industry. It did not address such issues as whether the industry would be dominated by AT&T, whether a number of common carriers would jointly operate satellites, or the roles of the aerospace companies and television networks. Moreover, even if government operation of the industry was ruled out, the government could still play a major role by participating in joint ventures.
AT&T’s plan for satellite communications was based in part on the argument that public service principles should prevail in telecommunications regardless of the transmission means—satellites, wire, or microwave. Because AT&T anticipated the charge that it sought to monopolize satellite communications, its plan specified that all U.S. international common carriers should have full access to the satellite system and to ownership participation. The corporation that was finally formed represented a compromise among the various interests and was far from the type of structure that AT&T sought. The 1962 Communications Satellite Act established the Communications Satellite Corporation (Comsat), which would operate satellites for international communication. Although communications common carriers could hold stock in the new corporation, their ownership and voting participation was sharply limited; only six of the fifteen directors could be chosen by the carriers and no single carrier could vote for more than three directors. In short, the statute established a structure in which Comsat would be free of dominance by the existing international common carriers. And, since the suppliers of telecommunications equipment now included aerospace companies, a new carrier’s entry into international satellite communications would, in turn, raise the hopes of those seeking to enter domestic satellite communications when that became technologically feasible.
The successful launch of Hughes Aircraft’s Early Bird satellite in 1965 led the ABC television network to request the F.C.C. to allow it a private satellite that would link its network. This precipitated the F.C.C. to institute its domestic satellite inquiry to investigate general domestic satellite problems. By 1966, the battle had grown as AT&T opposed privately operated satellites on technical grounds (for instance, interference with microwave facilities) and argued that prohibitive costs limited the system’s usefulness. The networks, with the support of the Ford Foundation, argued that a satellite system could relay programs for considerably less cost than what was paid to the public service companies. Since the Ford Foundation expressed no interest in operating a domestic satellite system, AT&T was in the unenviable position of attacking the proposals of an organization that had no financial interest in the outcome. By 1969, AT&T announced that it would end its opposition to the television networks’ operation of private satellite systems40—but by then, the company was in full-scale retreat on many fronts. The Carterfone case would be crucial in undermining AT&T’s position.
Carterfone
As early as 1966, the House Small Business Subcommittee on Regulatory Agencies heard testimony from antique telephone dealers complaining of the CPE interconnection restrictions, even though the Bell system and other telephone companies had gone far in accommodating customer demand for antique and decorator telephone housing. However, the problem extended beyond antique and decorator telephones as numerous business interests sought interconnection rights. For example, the large National Retail Merchants Association stated that its inability to interconnect privately owned systems into the public switched network was a major impediment to its full use of private microwave systems. But AT&T and the other telephone companies felt justified in maintaining interconnection restrictions. Yet the difficulty of supervising CPE worsened because of the postwar proliferation of such devices. Moreover, the F.C.C.’s final word on the issue in the Above 890 Mc decision (1959) approved tariff regulations that limited interconnection, while Hush-A-Phone was treated as a narrow exception to the general rule.41 Finally, during the period immediately preceding the F.C.C.’s 1968 Carterfone decision, state commissions largely upheld the interconnection restrictions.42 Thus, prior to the Carterfone decision, AT&T and the other telephone companies were provided with a clear decision rule: the interconnection restriction in tariffs would be upheld against devices that might harm any component of the network, except if there was widespread public demand for a device and a simple telephone company adjustment could alleviate the safety or quality problem.
The Carterfone, the device that changed telecommunications regulation, was invented by Thomas F. Carter in 1959. Carter, who had been involved in two-way radio, office intercoms, and other communications systems since 1946, discovered in the mid-1950s that his customers with two-way-radio-equipped vehicles sought to connect with telephone users for various reasons. Reminiscing in 1985, Carter said, “The men in the field decided they wanted to talk directly to the supply house to eliminate third party errors. I started designing a little item that would allow these people to do that.” The Carterfone device, an equivalent of which was not offered by the Bell system, permitted direct voice communication between persons using the telephone network and those located at remote mobile radio terminals. When attached to a telephone, the Carterfone allowed communication to take place between the mobile radio user and those using the telephone network without the need for a base station operator to relay messages manually. The instrument worked by having the mobile station base operator place the telephone receiver on a cradle in the Carterfone to effect an inductive and acoustic connection between the telephone line and the mobile radio channel. Not surprisingly, then, the Carterfone met with considerable demand. Carter Electronics’s Texas location probably helped bring the device to the attention of oil companies. Although not the only customers of Carter’s corporation, they were among the most important and provided strong support during the F.C.C. hearings. Because offshore drilling became an important activity of the petroleum industry during the 1960s, the American Petroleum Institute strongly endorsed the Carterfone’s value in this area at the F.C.C. hearings. Yet offshore drilling was only one of many uses that petroleum companies found for the device. Other endorsements for the Carterfone and Carter’s position came from utilities, the United States Air Force, the National Aeronautics and Space Agency, the Antitrust Division, the National Retail Merchants Association, and, within the F.C.C, the Common Carrier Bureau. Thus, the Carterfone benefited from much support.43
In a March 1965 letter to F.C.C. chairman E. William Henry, Carter requested legal clarification of how the interconnection restriction applied to the Carterfone instrument. Told that the restrictions prohibit interconnection “except as specifically provided in the tariffs” and of his right to lodge a formal complaint with the F.C.C, Carter instead filed a private antitrust suit against AT&T, Southwestern Bell, and General Telephone of the Southwest, charging violations of the Sherman Act. The district court then referred the case to the F.C.C. on the ground that the agency had primary jurisdiction. In the fall of 1966, the F.C.C. began its action on the interconnection issues, and on August 30, 1967, the hearing examiner issued an initial decision, finding against AT&T, Southwestern Bell, and General Telephone of the Southwest in almost every particular. He found that (1) users (notably, oil companies) were satisfied with the Carterfone, (2) a substantial unfilled demand existed for the device, and (3) it did not impair the safety or quality of the network.44
The F.C.C., in its decision, went much further than the hearing examiner, using its Carterfone decision as a vehicle to establish new equipment-interconnection principles. The F.C.C. held that there was “no material distinction between a foreign attachment such as the Hush-A-Phone and an interconnection device such as the Carterfone so far as the present problem is concerned.”45 The new rule advanced by the agency held “that a customer desiring to use an interconnecting device to improve the utility to him of both the telephone system and a private radio system should be able to do so, so long as the interconnection does not adversely affect the telephone company’s operations or the telephone system’s utility for others.”46
After telephone company legal maneuvers had failed to move the F.C.C. to change its position, the companies revised their interconnection tariffs in August 1968. The new, liberal provisions permitted the direct electrical connection and interface of customer-provided CPE, other terminal equipment (such as computers), and customer-provided microwave systems into the network, subject to several restrictions. The most important restriction specified that some devices (such as computers) would be connected into the telephone network through a telephone-company-provided control device. The provision was, of course, an invitation to raise the issue of why only telephone companies could provide these devices.
After Carterfone, AT&T was clearly on the defensive in the equipment area, and a new era had been ushered in. The revival of the microwave battle, as we will see in the next chapter, reshaped the long-distance component of the industry as well.