4
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MCI and the Long-Distance Challenge
Little Strokes Fell Great Oaks
“Little strokes fell great oaks” was the aphorism Benjamin Franklin devised to describe the way in which gradual changes lead to dramatic transformations. His aphorism accurately portrays the way in which Microwave Communications Inc. (MCI), a small upstart firm, helped to transform the telecommunications landscape, leading to the breakup of AT&T in 1984, and moved the old public philosophy to a new one in which a form of competition would play a significant role. MCI’s gradually unfolding strategy is instructive. It did not all at once batter the old public service philosophy in which AT&T acted as the dominating network manager dedicated to fulfilling the goal of universal access at reasonable rates. Rather, MCI’s strategy was to carve out exception after exception to the old public philosophy over the opposition of AT&T. Eventually the old public philosophy became untenable and a new one, based on carefully controlled competition and the breakup of AT&T, came to prevail.
How MCI gradually changed public policy in American telecommunications by portraying its self-interest as the public interest is, thus, a critical part of this story. As in the case of CPE, a demand for immediate full-scale competition in long distance would have been rebuffed by the F.C.C. and PUCs. The political dynamic in the case of long distance was similar to and complementary to that in CPE. MCI and others did not at first challenge AT&T’s monopoly of long-distance service; rather, they initially made the reasonable request to be allowed to serve markets not being served by the Bell system. Although peripheral competition with AT&T might exist, the main thrust of the new entrants would be to enter new markets. In the 1960s, the extraordinary potential of the computer, particularly in data transmission, provided the principal arguments for the new firms seeking entry. That is, neither AT&T nor any other single firm could be reasonably expected to serve fully the enormous markets that would be opened up by data transmission. Consequently, the public interest demanded that new specialized firms be permitted to enter carefully delineated segments of the new markets.
Once MCI and other new firms successfully portrayed themselves as representing the public interest, the F.C.C. was virtually committed to their survival. Because it usually takes time for firms in new services and industries to become profitable, the F.C.C. adopted a protective stance toward the young firms. In fact, MCI used a political strategy to exploit the F.C.C.’s commitment: be aggressive toward AT&T and the independent telephone companies. Demand and litigate. In this way, the F.C.C. and the courts would be further encouraged to preserve MCI. Forgotten in the particular battles between MCI and other new entrants, on the one hand, and AT&T on the other, would be the original reason for MCFs license—to develop new markets innovatively, especially in data communications. They never did.
It is important to appreciate that the transformation that MCFs moves ushered in did not come about because AT&T’s record was a bad one; the newcomer simply promised to serve markets left unattended. Indeed, as the following summary shows, AT&T’s record was exemplary. In 1965, an already high 85 percent of households had telephone service; by 1975, the figure had risen to 93 percent. During the same period, the total number of telephones in use (including company, service, and private) had risen from 82 million to 130 million. The Bell system accounted for most of the totals as well as the increases,1 and it achieved these results at high levels of productivity. According to a study conducted by the Department of Labor, in the period between 1972 and 1977 the Bell system’s labor productivity growth exceeded that of all industries but one (hosiery). AT&T’s price performance was also found to be exemplary—from 1947 to 1977, the telephone service industry’s average price increases were about half that of all other industries combined. Whereas the CPI between 1960 and 1973 increased by 44.4 percent, the residential telephone component of the index increased by only 14.6 percent.2 Further, from December 1964 to May 1974, the CPI rose 55.6 percent, food prices increased 72.1 percent, housing 56.5 percent, and medical care 67.3 percent, whereas rates for telephone service rose only 18.5 percent.3 Thus, AT&T’s overall economic performance was undoubtedly high. Its technological and scientific progress between 1969 and 1973 were equally impressive, laying the groundwork for future improvement. For example, in 1969 alone Bell Labs developed the UNIX operating system for minicomputers, the spin-flip RAMAN laser (the first tunable high-power laser in the infrared region), superconducting alloys, and a computer program that produced artificial speech from printed English words and sentences. In the realm of customer services during these years, AT&T had unveiled a telephone that allowed customers to dial emergency numbers (such as 911) without initially depositing a coin, major breakthroughs in dataphone service, the Touch-tone dial, conference telephones, higher capacity PBXs,* and the 698A Code Com set, which provided communication capability for the deaf and blind through combinations of flashing lamps, vibrating finger pads, and sending keys. Comparable progress was made in central-office equipment, especially in the realm of data switching. During the same period, great improvements were made even in such traditional components as cable and connectors.4 Moreover, AT&T’s plans for the future were not limited to short-term goals. The 1971 Bell Labs Annual Report described research in areas that would not be fully developed for some time. For example, the report devoted considerable space to the development of fiber optics—a technology that would not begin to come on line until the late 1970s and early 1980s.5 In addition, the report described scientific work in such diverse areas as superconductivity, lasers and holograms, glassy metals, radio astronomy, and econometrics.6
The Rise of MCI
MCI, or more accurately one of the companies called MCI, began its regulatory life on the last day of 1963 when it filed a Communications Act Section 214 application with the F.C.C. for authorization to construct and operate a point-to-point microwave common-carrier system from Chicago to St. Louis and intermediate points. Its proposed service would be both intrastate and interstate. Section 214 requires interstate carriers to obtain from the F.C.C. a certificate that present or future public convenience and necessity will require the construction and operation of the line. Further, the F.C.C. is required to notify the governor or designated agency of the states in which the construction will take place and to hear complaints about the application, which, in turn, entails a state hearing (usually conducted by the PUC). Section 214 was “designed to prevent useless duplication of facilities with consequent higher charges upon the users of the service (emphasis added).7
Thus, to set the stage for one of the most protracted and complex series of events in the history of telecommunications policy, the burden of proving the necessity for a new or supplemental service was clearly on MCI. Although the statute presumed that monopoly service was desirable, the presumption was rebuttable. Moreover, MCI had to satisfy not only the F.C.C. but also the Illinois regulators in regard to the intrastate traffic it proposed to carry. A 1968 Illinois Supreme Court decision succinctly restated the state’s long-standing principle on public utility competition:
The method of regulating public utilities in Illinois is based upon the theory of regulated monopoly rather than competition. Before one utility is permitted to take the business of another already in the field, it must be shown that the existing one is rendering unsatisfactory service and is unable or unwilling to provide adequate facilities…. Where additional or extended service is required in the interest of the public and a utility in the field makes known its willingness and ability to furnish the required service, the commerce commission is not justified in granting a certificate of convenience and necessity to a competing utility until the utility in the field has had an opportunity to demonstrate its ability to give the required service.8
Accordingly, MCI argued that its new service was unique and not offered by the Bell system. Its principal selling point was flexibility. MCI’s amended application stated that it proposed a microwave system that would provide users with “the bandwidth they wanted and [that they could] increase or decrease these bandwidths at any time to handle any changes in their communication load, or type of equipment.”9 MCI claimed that for the first time small-demand users would have private-line service available through a common carrier and that the rates along the Chicago-St. Louis route would be substantially lower than those offered by Bell.
In February 1964, AT&T and Illinois Bell petitioned the F.C.C. to deny MCI’s application. AT&T claimed that (1) it and the other common carriers had fulfilled every public need for which MCI had applied, and (2) MCI’s proposal was an attempt to attract only a more profitable segment of the total communications market—a cream-skimming arrangement that would impose an economic burden on other Bell customers. Cream-skimming, as the term implies, consists in taking away customers who can be served at a profit, leaving to AT&T and the other utilities the customers who are far more costly to serve or can only be served at a loss. According to AT&T’s view, MCI could undercut its rates because MCI did not incur AT&T’s universal service obligations. A statement prepared for AT&T by Alfred Kahn, William Baumol, and Otto Eckstein—three of the nation’s most distinguished economists—argued that “nationwide rate uniformity and the entry of substantial numbers of competitors are incompatible…. The greater the degree of competition, the less the likelihood of Bell’s being able to continue uniformity, supplying their sparse routes at their present prices which are relatively low in relation to costs. It will be unable to make up its losses among the denser routes because competition will render that impossible.”10 Thus, only AT&T’s rate averaging allowed MCI to cream-skim.
Complex procedural battles and filing errors committed by MCI delayed the F.C.C. hearing examiner’s initial decision until October 1967. In essence, the hearing examiner was sympathetic to MCI’s claim, and the decision came down to nothing more than a plea to give the newcomers a chance, even though he conceded that MCI’s offerings were not novel or unavailable from AT&T and Illinois Bell.11 The appeal to the full commission occurred in 1968, shortly after the F.C.C. heard the Carterfone case. During this period, William McGowan joined MCI, even though he had no previous experience in telecommunications. However, he was an expert in finance, an area in which MCI needed help. Like most experts in financial deals, McGowan had to work closely with lawyers, and it was from one of his lawyer contacts that McGowan met MCI’s John Goeken. In August 1968, while the F.C.C. was deciding the MCI case, McGowan and colleagues established a new company—Microwave Communications of America (Micom)—that would function to sponsor prospective MCI operating companies in other markets. Further, McGowan, Goeken, and Micom would each receive 25 percent of the shares of each operating company and the remaining shares would be divided among private investors.12
It thus became clear that MCI’s Illinois venture was the prelude to many others in which it would compete with AT&T. AT&T’s initial competitive response was the Series 11000 tariff offering for private-line users. Series 11000 tariffs were for discrete high-capacity channels dedicated to single customers or joint users. Instead of directly combating AT&T’s competition in the marketplace, MCI began what became a consistent strategy from that time forward of using administrative, political, and judicial processes to prevent AT&T from offering its service. MCI’s consistent strategy and its acceptance by the F.C.C. is why observers have labeled the competitive process in telecommunications as “contrived competition.”13 Or as Peter Huber, Michael Kellogg, and John Thorne, three prominent telecommunications analysts, succinctly put it in 1992: “AT&T, MCI and Sprint all recognize that gloves-off competition would quickly produce two bankruptcies, one re-regulated monopoly and then a deluge of antitrust suits by the bankrupts against the monopolist.”14 Characteristically, AT&T had greater regulatory burdens than its competitors, and its responses had been delayed in protracted proceedings while competitors were free to make flexible and rapid changes. For these reasons the response to Series 11000 tariffs typified the nature of long-distance “competition” from MCI’s beginnings.
Although Series 11000 was discontinued in 1972 because it did not meet sales projections, its anticipated introduction while the commission’s MCI decision was pending made clear MCI’s peculiar views on competition. MCI sought outright rejection or suspension of the tariff (even though it was priced well above cost) on the ground that telephone companies should not be allowed to depart from rate-averaging principles in individual competitive services. In spite of detailed Bell data that showed Series 11000 rates were priced about 20 percent above costs, MCI also charged that AT&T’s offering was based on noncompensatory rates.15 Thus, MCI’s views on competition as well as a major component of its strategy were revealed in the Series 11000 episode; that is, competition meant that AT&T should not be permitted to provide offerings that conflicted with MCI’s, even if AT&T’s rates were fully compensatory. MCI claimed that it could provide its “unique” private-line service if AT&T did not offer competitive services. To achieve this result, MCI had to persuade the F.C.C. that the Communications Act should be interpreted as adopting this version of competition. Under McGowan’s leadership, MCI adopted a political-legal strategy; as an admirer of McGowan’s admitted, “McGowan spent the summer and fall of 1968 lobbying the government to grant MCI’s license for Chicago to St. Louis. That consisted mainly of talking with people at the F.C.C. and Congress.”16 This strategy would consist first of gaining legislative sympathy and publicity through congressional hearings aimed at AT&T. Since this was a time characterized by anti-big-business sentiment, it was not difficult for MCI to find influential legislators who were sympathetic to small companies seeking to compete against the world’s largest firm. The other important MCI political strategy was to persist in litigation. As the Series 11000 matter indicated, MCI would intervene in all possible F.C.C. proceedings against AT&T.
The F.C.C.’s MCI Decision and the Specialized Common Carriers (SCC) Investigation
On August 13, 1969, in a 4–3 decision, the F.C.C. granted MCI’s Chicago-St. Louis application. The agency limited service to “transmissions between MCI’s microwave sites making it incumbent upon each subscriber to supply his own communications link between MCI’s sites and his place of business (loop service).”17 The F.C.C. claimed that MCI’s principal market would consist of subscribers willing to sacrifice quality for cost saving: “while no new technology is involved in MCI’s proposal, it does present a concept of common carrier microwave offerings which differs from those of the established carriers.”18 Commissioner Nicholas Johnson interpreted the MCI decision in a more general way: “I am still looking, at this juncture, for ways to add a little salt and pepper of competition to the rather tasteless stew of regulatory protection that this Commission and Bell have cooked up.”19 The dissenting opinion of Chairman Rosel H. Hyde focused more on the principles involved than on the particular facts of the MCI Chicago-St. Louis application. Hyde pointed out that the public interest, not competition, was the F.C.C.’s standard, and that the Supreme Court explicitly directed the agency to avoid a standard of competition.20 In this view, if a new innovation such as domestic satellites best serves the public interest through competition, it should be favored, but if competition is unnecessary, redundant, unproved, or inefficient, it should be avoided.
Predictably, MO’s success before the F.C.C. encouraged others to seek entrance into different forms of long-distance transmission, particularly in the most lucrative markets. By the mid-1970s, the applicants included, among others, seventeen other companies affiliated with MCI, several miscellaneous common carriers, and the Southern Pacific Communications Corporation, a subsidiary of Southern Pacific Company (primarily a railroad holding company), which owned a large private microwave system. AT&T, GTE Corporation, and other common carriers routinely opposed the applications, contending that they were better able to provide higher capacity and lower-cost facilities. Most importantly, they pointed to the underlying rationale of Section 214 of the Communications Act, which sought to prevent useless duplication of facilities with consequent higher charges. At the very least, they argued, the F.C.C. should have sought to determine whether the existing carriers or newcomers could more efficiently bring novel services to consumers.
By June 1970 it was apparent that the F.C.C.’s 1969 Microwave Communications decision had opened a can of worms and that general principles were necessary. On July 17, 1970, the F.C.C, accordingly, instituted Docket no. 18920—the Specialized Common Carrier (SCC) inquiry. The issues to be considered included (1) whether as a general policy SCCs should be permitted, (2) whether comparative hearings among the applicants are necessary, (3) technical problems, (4) service quality and reliability, and (5) the appropriate means of local distribution of the SCC service. The F.C.C.’s Common Carrier Bureau argued that competition directed toward the development of new communications services, markets, and technologies was in order. It urged that the new firms would expand the size of the communications market, not draw customers from the established carriers.
MCI conceded that its market was not the public switched network, claiming that there is “a distinct difference between a public telephone service which is a natural monopoly and a customized communications service offered on a private point-to-point basis.” This distinction was critical in the F.C.C.’s approval of MCI’s offering. In other words, if MCI had advanced a proposal to construct and operate a rival long-distance network (which it conceded to be a natural monopoly), the proposal would have been flatly rejected by the F.C.C. Instead, it delineated a market that was private “point-to-point.” MCI’s conception of point-to-point communications was taken from the way in which railroads employed private communications along their lines. A railroad could only communicate with certain points along its designated path and only the railroad was involved in using those facilities, which were not in the public switched network. And just as the private point-to-point service would be largely excluded from the public switched network, so also would the public switched network be excluded from the private point-to-point service.21 However, there were exceptions in which a private point-to-point service could interconnect into the public switched network. As the F.C.C. undertook the SCC decision, the railroad private-line services provided the model for exceptions. Private lines, with AT&T’s permission, could interconnect into the public switched network for designated reasons, such as emergencies involving safety.
In late May 1971 the F.C.C. issued its “First Report and Order” in the SCC inquiry. The commission, without dissent, opted for free entry in the services that the SCCs would provide. The lengthy decision accepted the Common Carrier Bureau’s analysis and added much to it. Those who had expected a strict party vote (which had occurred in the MCI matter) were surprised at the unanimity in favor of competition. But the Nixon administration had made its predisposition toward open competition known in the prior year in its comments on domestic satellites. In brief, the regulated network manager system was left with few defenders within the community of those who influenced communications policy. As is made evident in the decision, the F.C.C. became favorably disposed to SCC licensing because it believed AT&T and the other common carriers would not be able to handle the enormously expanding market in data communications. In view of this conclusion, which stemmed primarily from the F.C.C.’s computer inquiry, the F.C.C. had no difficulty in its decision to allow new carriers to operate in that market. Because the voice market—Bell’s dominant source of income—was also expected to grow at a rapid rate, the new entrants in the data-communications market would not engage in cream-skimming. One cannot emphasize enough how important it was to the SCC decision that the SCCs were viewed as market expanders and not principally as competitors of AT&T’s long-distance, local-loop, or other services. The necessary tenor of the entire decision was that if the SCCs competed with AT&T in the Bell system’s major markets, they would not be needed.22 At this stage, then, the older public philosophy embracing the regulated network manager system had not been overturned, but it was clearly under stress.
The Dispute Intensifies
One of the principal themes that characterizes F.C.C. decisions from this period forward is that the agency, instead of clarifying issues and providing lucid rules, did the opposite. A straightforward public philosophy had been supplanted, not by another such philosophy, but by confusion. The principal evidence in support of this conclusion is the large number of hotly contested judicial cases and administrative proceedings that followed the agency’s SCC decision. Yet at the time the SCC decision was handed down, neither the F.C.C. nor AT&T thought that any great variation from the old public utility principle had occurred.
In summary, the F.C.C.’s conception of competition in the SCC decision was narrow. The SCCs were not expected to compete directly against AT&T in the principal markets in which AT&T was engaged; rather, they were expected to enlarge the market by developing submarkets that AT&T had either not or insufficiently exploited. The SCC decision further emphasized that these markets were principally in the data field. Thus, at the time of the decision, a reasonable observer could assume several rules: that (1) the SCCs could not compete with AT&T in a public switched network; (2) the SCCs could not compete against AT&T in private-line or other services in which AT&T had an established position at the time of the SCC decision; (3) the SCCs could compete in private point-to-point or private-network service if AT&T either did not occupy the submarket or did so only marginally; and (4) AT&T could compete with the SCCs (which, in turn, could compete with each other) within the new submarkets. Based on this reasonable understanding of the SCC decision, AT&T was not displeased and saw no need to appeal, stressing that it might depart from rate averaging and instead price directly competitive services.
The difficulty with this understanding from MCI’s perspective was that the submarkets carved out were small at the time. Accordingly, MCI soon sought to expand into AT&T’s older, more traditional markets. And once the F.C.C. had made its substantial commitment to the SCCs, it was predictable that the agency would enlarge the decision far beyond its close bounds, rather than allow SCCs to fail. Contrary to the myth that large, successful companies dominate regulatory agencies, the MCI episodes that we will detail show that agencies will more likely use their powers to support weak firms in order to justify the “wisdom” of risky decisions. The large, powerful firms, like AT&T, can take care of themselves. Accordingly, the agency can impose costs on them—within reasonable limits—to benefit the newer or weaker firms. The next set of issues concerning services whose acronyms are FX and CCSA illustrate this. The context in which the dispute should be considered is the increasing value of special services that began in the early 1960s. For example, WATS (wide area telephone service) was born in 1961. AT&T’s WATS revenues grew from $18 million in 1961 to more than $1 billion in 1976. The same exponential growth might occur in the cases of other special services.
Foreign exchange (FX) allows a customer to make or receive local telephone calls through a distant switching center. FX effectively provides a long extension cord in the form of a dedicated line between the customer’s location and a telephone company switching center at the distant location. As such, FX was especially popular among airlines and hotels because they could centralize their reservation systems. A person seeking to make a reservation calls a local rather than a long-distance number, which is routed to the foreign exchange. The FX customer receives two bills—one for the private line that connects the customer to the foreign exchange and another for the telephone service that the customer used through the foreign exchange. Although it had certain private-line features, FX service was also integrally tied to the public switched network. Conceivably, FX could be used as an internal private system, but its principal and customary use was to link calls originating in the public switched network to a dedicated line. Thus, under any reasonable construction, FX was neither a private-line nor a private-network service under the SCC decision.
The other service at issue between MCI and AT&T—common control switching arrangement (CCSA)—granted a customer with large communications needs (primarily voice grade) among many points access to the telephone company’s central-office switch, which routed calls to the customer’s dedicated lines. CCSA, which originated in 1963, was an established AT&T service by the time of the SCC decision and, therefore, could not then be considered a unique or innovative service that AT&T was failing to provide. The public switch was used for many economic and technological reasons stemming from the fact that large users’ PBXs and other equipment could not handle the volume of message traffic desired. Accordingly, additional hardware programming in a sophisticated switch, such as the Number 5 Crossbar, allowed a portion of the switch to be dedicated to a single customer. For instance, the large-user customer (such as the United States government) would dial an access code (usually “8”) followed by a telephone number; the common control equipment in the Number 5 Crossbar switch would then translate this information into a route and destination, advance the call to an alternate route, forward the call to other switches, and so forth. A notable feature offered with CCSA was automatic off-net dialing, which enabled the customer to place a call to a telephone not on the CCSA network. Government systems established under CCSA during the early 1960s included the Federal Telephone System (FTS) for civilian use and the Switched Circuit Automatic Network (SCAN) for use by the U.S. Army. By 1971, more than twenty-five CCSA networks had been established for commercial customers. Thus, at the time of the SCC decision, CCSA was an AT&T commercially viable service offering. Further, it was much more than the novel private-line service contemplated by the SCC decision.
MCI’s success in enlarging its service offerings to FX and CCSA—and beyond—stemmed in large part from its political stratagems, certainly not from any technological prowess. MCI employed negotiations with AT&T to establish a record of AT&T recalcitrance that it could use before the courts, Congress, and the F.C.C. Notably, former F.C.C. commissioner Kenneth Cox, who had sided with MCI in its authorization proceeding before the F.C.C., joined the company on September 30, 1970 (only one day after leaving the F.C.C.). MCI already had excellent legal representation before Cox joined the company,23 but Cox would be expected to employ his political expertise. The company’s political strategy was to put AT&T on the defensive and to expand MCI offerings into services already provided by AT&T. As noted at a July 13, 1971, AT&T-MCI meeting, MCI, in addition to an interconnection contract, “wanted to have the freedom to offer its customers every service available from either long lines or Western Union.”24 Clearly, this posture went far beyond the limits of the SCC decision. And if MCI failed in this strategy, it intended to take the issue to the F.C.C. for resolution, knowing full well the agency’s commitment to making the SCC experiment successful. In view of this, AT&T sought to reduce the negotiating tensions between itself and MCI rather than face F.C.C. pressure. Thus, Illinois Bell agreed to provide more costly dial access to the network instead of manual interconnection, even though the Bell system could have resisted doing so in light of the SCC decision’s ambiguity on the point.25
Notwithstanding their differences, MCI and AT&T reached an agreement in late September 1971, which was approved by the Illinois Commerce Commission. AT&T, however, made most of the concessions and MCI began its operations in January 1972. But controversy over rate issues erupted almost immediately. These issues paled, however, before the FX and CCSA disputes that are considered in the context of the general tariff changes called for in the Carterfone decision. Although the 1968 Carterfone decision, which dealt with terminal devices, did not discuss FX or CCSA, it did require the Bell system to revise the interconnection provisions of its tariffs. AT&T thus drafted its new tariff revisions and, in October 1968, it filed further revisions together with an explanation of its new private-line interconnection arrangement: “Connection is made on a voice grade basis at a customer’s service point.”26 The phrase “service point” (later defined as “customer premises”) was sufficiently clear to be limited to “the point on the customer’s premises where such channels or facilities are terminated in switching equipment used for communications with stations or customer provided terminal equipment located on the premises” (emphasis added).27 That is, connections at premises other than the customer’s were not contemplated by the tariff revision. Among the considerations that contributed to the AT&T Tariff Review Committee’s hostility toward looser interconnection restrictions, quality and maintenance were the most influential. Bell argued that divided maintenance responsibility can lead to service deterioration and, hence, cost increases. The need to test all proposed interconnection arrangements would impose high information costs on AT&T and its subscribers.
Within the month, MCI petitioned the F.C.C. to reject AT&T’s post-Carterfone tariff revisions on the ground that they were overly restrictive. The F.C.C. rejected MCI’s arguments, specifically holding that AT&T could bar the use of customer-provided, network-control signaling units and that the Carterfone decision applied to interconnection, not substitution for AT&T facilities28 Among the categories covered by the tariff revisions and the F.C.C.’s rules was private-line service, which the agency defined as “a separate service that does not use the switched telephone network (emphasis added).29 Because MCI-provided FX or CCSA would use the switched network and would directly compete with AT&T in the provision of such services, one cannot conclude that MCI was entitled to provide these services at the time it demanded them. Nevertheless, the defeats that AT&T had sustained encouraged MCI to continue pressing its demands. Thus, following a 1971 F.C.C. decision in the SCC matter, MCI again demanded FX-type interconnection, which AT&T rejected. The novel twist that MCI conceived to overcome the F.C.C.’s objections was to lease space in MCI’s premises to its customers who would then demand interconnection at their “business premises”—MCI’s offices—instead of the customer’s regular business facilities.
On April 18, 1972, Cone Mills Corporation, an important MCI customer, wrote a letter to Illinois Bell (sending a copy to MCI) demanding FX service. In essence, Cone Mills demanded a local telephone at its “offices” on the ninety-seventh floor of the John Hancock Building in Chicago, which happened also to be MCI’s Chicago office. Further, Cone Mills’s contact person was an MCI employee, and the telephone number it provided to Illinois Bell was assigned to MCI. The purpose of the demand was to enable MCI to connect an MCI interexchange channel to the Cone Mills local telephone line—that is, to provide an FX-type service. Illinois Bell refused the request on the ground that MCI was not entitled to FX service.
The stakes were high because FX and CCSA were larger than the conventional private-line market, and during this period MCI was under considerable financial pressure. MCI desperately sought to enlarge its market in 1972 and 1973 because its original private-line projections were inflated and its financial position was distressing. MCI needed FX and CCSA badly. For example, in June 1972, MCI contemplated a 165-city network at a cost of $80 million, yet a September 1972 internal memorandum estimated that a sharply curtailed 34-to 41-city network would cost $100 million.30 On April 11, 1973, MCI’s strategy of using government to meet its objectives was employed when Cone Mills complained to the F.C.C. about Illinois Bell’s refusal (the complaint was prepared with MCI’s “assistance”). During the same period, MCI began its series of complaints to the F.C.C. and the Common Carrier Bureau about AT&T’s alleged high-handedness. Portraying itself as a victim of AT&T, MCI was able to gain the support of those regulators who had put so much effort into the SCC decision and the new policies favoring competition in novel services and equipment; MCI’s failure would undermine their hard work. In a variation of the then popular theme “what is good for General Motors is good for the country,” MCI attempted to show that what was good for MCI was also good for the F.C.C. and its new policies.
The Bell of Pennsylvania Case
During this period MCI launched another attack against AT&T using a second front—the courts. The event that triggered the first court contest between MCI and AT&T began on October 23, 1973, when MCI learned that Bell of Pennsylvania would not provide a loop to serve MCI customer Keystone Tubular in Butler, Pennsylvania. Bell of Pennsylvania denied the request on the ground that AT&T’s obligation was to provide local interconnection only and that Butler was outside the Pittsburgh local distribution area—a concept AT&T employed to delineate the area in which it could provide interconnection to Western Union, MCI, and the other SCCs. Butler was approximately thirty-six miles from the MCI terminal and was located within an area served by an independent telephone company. The incident was only one of many in which MCI made demands for connections far outside the local distribution areas, including demands for areas considerably greater than one microwave hop as well as areas outside the state in which the principal city (such as Chicago) was located. Perhaps most importantly, while one could have questioned AT&T’s definition of a local distribution area, MCI did not offer an alternative one but instead chose to forcefully demand and to involve the F.C.C. and others. Ambiguity was a way to challenge AT&T’s FX and CCSA policy. Late in 1973 was clearly an opportune time for MCI to strike hard, as AT&T was on the defensive on many fronts. It was besieged with equipment-connection requests stemming from Carterfone; the F.C.C.’s restrictions on AT&T in satellite services; and a senatorial investigation led by Senator Philip A. Hart on alleged abuses of monopoly and oligopoly power in several industries, including telecommunications. In Hart’s hostile investigation, former F.C.C. commissioner Kenneth Cox, then a top MCI official, was an important witness.31
MCI brought suit against AT&T in the fall of 1973, challenging Bell of Pennsylvania’s Keystone Tubular action in particular and AT&T’s interconnection policies under the SCC decision in general. During the same period, the F.C.C. instituted Docket no. 19866 to clarify the complaints concerning local distribution areas and other matters arising under the SCC decision. Meanwhile, AT&T had announced its proposed HI/LO tariff offering, which departed from the concept of rate averaging to compete with MCI and other SCCs in their markets and services. MCI’s own study, conducted by the highly reputable Arthur D. Little Company, concluded that private microwave was able to undercut Bell only because AT&T scrupulously followed the principle of rate averaging. MCI’s concept of competition sought to preclude AT&T’s ability to respond as it used the government to defeat AT&T at most every turn. In this respect, it had a valuable ally in Bernard Strassburg, the chief of the Common Carrier Bureau, a principal architect of the F.C.C.’s limited competition policy. The F.C.C. conceded that its SCC policy was not meeting the expectations that services were to be novel and innovative. But, it claimed that experience was yet too limited for the agency to accede in AT&T’s favor.
On the last day of December 1973, the federal district court for the Eastern District of Pennsylvania upheld MCI’s position on the local distribution area issue. Moreover, the court required AT&T to provide FX and CCSA connections, to enlarge the local service areas, and to provide “such other interconnection facilities as are necessary to enable plaintiffs to furnish the interstate services they are authorized by the F.C.C. to perform.32 MCI won in large part because it relied on an October 19, 1973, letter from Common Carrier Bureau chief Strassburg, which stated that MCI was entitled to everything it sought from the court. That the letter was advisory, from an F.C.C. staff person, and that the F.C.C. was in the process of deciding the very issues under consideration did not give pause to the district court. The judge did not come to terms with the rationale behind the basic SCC decision or of the December 1973 reconsideration, did not understand the concept of a private line or how it differed from FX and CCSA, and did not consider rate averaging and other matters in his decision. Instead, Judge Clarence Newcomer relied on such lesser matters as that because Bell included FX and CCSA in its private-line sales literature, they must be private-line offerings.
However, in April 1974, the Court of Appeals for the Third Circuit vacated the district court injunction. In keeping with established principles of administrative law, the court of appeals unanimously held that the district court should have deferred to the appropriate administrative agency in the complex technical issues of FX, CCSA, and local distribution facilities. Moreover, the F.C.C. was then considering the issues that Judge Newcomer had failed to consider. In keeping with its views on the proper role of the courts in such matters, the court of appeals stated: “An examination of these two Commission pronouncements reveals that the existence and scope of any such obligation on the part of AT&T is so unclear that deferral to the expertise of the F.C.C. is both desirable and appropriate.”33 Noting that none of the SCC decisions had mentioned FX, CCSA, or local distribution areas specifically or by implication, the court of appeals decided that it would be presumptuous for it to decide the issues in MCI’s favor, in that such a decision would inappropriately substitute the court for the F.C.C. as the body responsible for deciding competition issues in telecommunications.
AT&T’s victory was, however, short-lived. Spurred by Common Carrier Bureau chief Strassburg, the F.C.C. was strongly committed to preserving—indeed, encouraging—the SCCs. In its important 1974 Bell System Tariff Offerings decision, the agency, in a classic understatement, conceded that “its prior orders may not have been perfectly clear.”34 Reaffirming its belief in the SCCs’ ability to serve the public interest, the commission declared that FX and CCSA were private-line services on the same ground that Judge Newcomer chose—because they were so described in AT&T’s written materials. Neglected was the previously held idea that SCCs were to provide innovative and unique services, principally in the data field, as FX and CCSA clearly would not fit into the older concept. The F.C.C. thus became further committed to the survival of the SCCs, and its concept of competition had changed—the SCCs would be allowed to expand their service offerings in order to survive. For the same reason, AT&T was severely restrained in how it could compete. Thus, AT&T’s executive policy committee authorized the filing of the HI/LO tariff in January 1973 in order to compete with the SCCs. In January 1976, after numerous proceedings and delays largely caused by AT&T’s rivals, the commission ruled the tariff unlawful.
MCI’s Renewed Attack
MCI was not to be satisfied with its FX and CCSA victories. Sensing that its claims were in the vanguard of a shift in public philosophy, MCI continued to press the attack. During this time, large firms were once again under attack. For example, the Federal Trade Commission in 1973 attacked the four largest breakfast cereal manufacturers in one case and the eight largest integrated oil companies in another on the novel view that these firms “shared” monopolies. Impetus for restructuring and deregulating American industry stemmed from the changing structure of the world economy and the fear that without drastic changes American firms would not be able to compete effectively. Although President Jimmy Carter’s statement in signing a key rail deregulation statute was uttered in 1980, it captures the sentiment that was already ascendant in 1973. The president expected that the statute would be “a major boost for the revitalization of the American economy, a revitalization that I intend will restore America’s competitive edge and make possible full employment, and, at the same time, stable prices.”35 Traditional regulatory principles were clearly on the defensive. Although regulation would continue to exist, the agencies would have to show what areas within their domains should continue to be regulated and why. To defend their domains against the deregulation onslaught, they would have to develop coherent theories showing why competitive behavior should not prevail in certain activities. Of course, the competition concept that now applied would mean protecting new competitors, not the fierce rivalry that believers in laissez-faire envision. MCI correctly appraised the shift in public philosophy.
On August 24, 1974, MCI’s vice president, Bert C. Roberts, Jr., sent a confidential memorandum to William McGowan outlining the company’s need to act on a new service called Execunet. The company’s original plan—to rely on private-line offerings largely in the data field—had not met expectations. Consequently, the company devised Execunet, which, as we shall see, was tantamount to WATS and MTS (ordinary long-distance service). Roberts commented in his August 24 memorandum to McGowan that many at MCI doubted that Execunet was a private-line offering (although he did not), and that “each day that goes by will tend to put MCI into a negative cash flow position on the start up of the project.”36 Generally, MCI was in a cash-negative situation in the fall of 1973 and sought to use government policies to reverse the problem. MCI admitted that it could not compete with Bell’s TELPAK offerings in the private-line market. Even earlier, MCI had drastically miscalculated the cost of constructing a private network. In June 1972, it estimated that $80 million would build a 165-city network, but Stanley Scheinman, MCI’s chief financial officer, prepared an analysis in September 1972 that concluded $100 million would be required to build only a 41-city network. Scheinman further calculated that at the end of 1973, MCI would be in a deficit cash position of $15–$20 million. Further, a 1974 internal audit report prepared at the behest of MCI management concluded that the company was itself largely responsible for its difficulties. The report stated that the major cause of circuit installation delay was “poor coordination between and among salesmen, customers, one or both terminating branches in telco personnel. In many instances, this poor coordination has materialized as a general lack of direction and aggressiveness on the part of MCI to solve problems, or to obtain and communicate vital information in a timely manner.”37
With an understanding of MCI’s financial background, it is clear why it sought to expand its offerings far beyond private line. But to do so successfully, it would have to put AT&T even further on the defensive through a private antitrust suit. As early as January 9, 1973, MCI’s top command decided to prepare a private antitrust suit against AT&T and the operating companies. At the same time, MCI officials agreed to prod the Antitrust Division into a major action against AT&T as well as to spur sympathetic F.C.C. staff into action against AT&T in the administrative arena. McGowan mentioned the possibility of a private antitrust suit in a March 2 meeting with AT&T’s John de Butts. Then, on September 28, 1973 (and at other times), MCI officials met with Antitrust Division officials, including chief Donald Baker, in an attempt to convince the Justice Department to bring a major action against AT&T. Obviously, a multipronged attack would be more effective, of which the private antitrust suit would be the first step.
MCI filed its private antitrust suit against AT&T on March 6, 1974, in the federal district court in Chicago. The complaint contained four separate counts: monopolization, attempt to monopolize, conspiracy to monopolize under Section 2 of the Sherman Act, and conspiracy in restraint of trade under Section 1 of the Sherman Act. MCI alleged that AT&T had committed twenty-two different types of misconduct that could be grouped into several categories held by the courts as antitrust violations—predatory pricing, monopolistic refusal to deal through denial of interconnections, bad-faith negotiations, and unlawful tying. MCI requested a jury trial and stated that the full amount of damages sustained would be determined after discovery and proof during the trial. Under Section 4 of the Clayton Act, a successful plaintiff in an antitrust action is entitled to threefold the damages sustained and the cost of suit, including reasonable attorneys’ fees. The case was assigned to Judge John Grady, who began pretrial proceedings and decided a series of preliminary issues, including a denial of AT&T’s motion to dismiss the complaint, on October 6, 1978. The trial eventually began on February 5, 1980, and was submitted to the jury on June 11 after the taking of 11,514 pages of testimony and the submission of about one thousand documents into evidence. Two days after it began its deliberations, the jury rendered its special verdict in the amount of $600 million, which was tripled in accordance with Section 4 of the Clayton Act to $1.8 billion—the largest antitrust damage award in history.
MCI had grand plans to finance expansion from the proceeds of its antitrust award. Considering that MCI’s earnings in the fiscal year prior to the verdict were approximately $13.3 million, a $1.8 billion award was quite substantial. Even Judge Grady was reported as saying that the total judgment “seems unseemly, maybe even obscene.” Half the jurors did not know the damage award would be trebled. One juror said she knew about treble damages from having typed a report for a college student the year before.38 Unfortunately for MCI, the Court of Appeals for the Seventh Circuit overturned the verdict. On January 12, 1983, the Seventh Circuit court rendered its 258-typed-page opinion and 40–page appendix, ordering a new trial on the issue of damages.39 The second trial began in early 1985 with Judge Grady again presiding. The verdict finally handed down in May 1985 was in the sum of $37.8 million, which was tripled to $113.3 million. MCI had certainly replenished its coffers at AT&T’s expense, although not to the extent that the first verdict would have. But even this MCI victory paled before its legal triumph in the Execunet case.
Execunet
Each MCI success in enlarging its offerings only whetted the company’s appetite to expand further. A critical breakthrough was in the service MCI called Execunet. In this service, an Execunet customer gained access to an MCI intercity line by calling a particular MCI local telephone number in the originating city from any push-button telephone. When the connection was made and the customer was identified through an identification number, he or she obtained access to MCI intercity circuits. The customer then dialed any telephone in any city where MCI offered Execunet service. The call was transmitted over MCI’s intercity circuits, which were interconnected through the local telephone company’s switching facilities to the local exchange facilities in the distant city. The call then reached the telephone called. A push-button telephone was ordinarily used in the originating city because MCI’s switching equipment responded to the signal tones generated by this equipment. However, a customer could use a dial telephone and generate the appropriate tones through a readily available “Touch-Tone” pad.
With Execunet, MCI abandoned any reasonable pretense to offering only private-line service. It was a service that more closely approximated ordinary long-distance (MTS) or WATS service. Neither MTS nor Execunet dedicated particular intercity circuits to specific customers; rather, both used whatever intercity circuits were available as well as local telephone company switching facilities and circuits. Second, like MTS, any telephone, not only one within a private subscriber’s ambit, could access Execunet. Third, any telephone in a large number of distant cities could be reached. Fourth, the Execunet customer used common local exchange plants at both ends, and, finally, the Execunet customer, like ordinary long-distance customers, was billed for each call, based on time and distance, with no charge added at the distant city.40 Once again MCI did not offer an innovative service as contemplated by the SCC decision, but rather used government processes to gradually encroach on AT&T’s public service monopoly and, with it, the old public philosophy.
MCI began offering the Execunet service in January 1975. AT&T contacted the F.C.C. in May 1975 (with a copy to MCI), claiming that Execunet was long-distance message telephone service and that MCI was not authorized to offer such a service. AT&T’s position was that Execunet threatened the entire structure of telephone service. AT&T’s MTS service was offered at nationwide averaged rates and, therefore, was susceptible to carriers aiming primarily at low-cost, high-density routes that yield high profits. Execunet also threatened the subsidy contribution that long distance made to local service through the separations process. The Execunet service would remove substantial revenues from the separations process, which would result in increased local rates. After MCI responded to AT&T’s letter, the F.C.C., on July 2, 1975, released an order rejecting the Execunet service on the ground that it was a switched public message service and MCI was authorized only to offer private-line service. Latent in the F.C.C.’s response was the anger of its staff and commissioners that MCI had deceived and betrayed them.41
After MCI appealed the F.C.C. order to the court of appeals, the matter was held in abeyance until MCI and other interested parties could file briefs and comments. On July 13, 1976, the F.C.C. released a decision, reaffirming that Execunet was an unlawful tariff and reminding MCI of the original rationale for its specialized service: “MCI asserted that there was distinct difference between a public telephone service which is a natural monopoly and a customized communications service offered on a private line basis.”42 The F.C.C. also reminded MCI that every filing the company had made before the agency and the courts was premised on this distinction.
MCI appealed the F.C.C. decision to the Court of Appeals for the District of Columbia Circuit, the court then at the cutting edge of judicial activism. The focus of the court’s 1978 decision was on Section 214 of the Communications Act of 1934, entitled “Extension Lines,” the only section that dealt with entry into the telephone business. Completely ignoring the legislative history of the act, which showed that Congress intended telephone service to be delivered by monopolies, Judge Skelly Wright ruled that the F.C.C. should have considered whether the Execunet service should be permitted regardless of the limits imposed by the SCC decision and the operating authority to MCI based on it. And in a remarkable leap of faith, the court concluded, without supporting evidence, that MCI intended to compete only “on the fringes of the message telephone market.”43 Again, the F.C.C., on remand, concluded that AT&T did not have to interconnect with Execunet and a similar Sprint service. And again the court of appeals reversed the F.C.C. decision, holding that AT&T must provide local interconnections for Execunet and similar services44
To all intents and purposes competition in long distance had been established through the long road described in this chapter. But it was a strange form of competition in which the F.C.C. would favor the newer entrants at the expense of AT&T, to which the F.C.C. gave a new appellation—the dominant carrier.45 Under that doctrine AT&T would be subjected to regulatory burdens and inflexibilities in rates, services, and facilities from which competitors would be exempt.46 But MCI’s protracted attack would lead to another devastating impact in telecommunications that we will examine in the next chapter—the dismantling of AT&T.
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* A private branch exchange (PBX) is a switching system belonging to a single organization, usually located on the organization’s premises, that provides private telecommunications services within each of the organization’s premises and between its various premises as well as access into the public switched network.