Dial D for Deregulation

The telephone monopoly is coming apart-and just about everyone stands to benefit.


Picture the scene: It's been a long, trying day, and all you need is to have to make a phone call. But there you are, punching away at the Touch-Tones®. Click—click—bzzz—"The number you have reached is not in service at this time. Please check to see…" You break the connection and try again. This time you wait…and wait…and wait; after 90 seconds you realize you've reached limbo and try a third time. Beep—click—bzzz—"This call cannot be placed on your WATS line." Angrily you slam down the receiver. "If only there were another phone company!"

If all this sounds familiar, join the club. Telephone service is deteriorating nationwide, as our monopolistic telephone utilities struggle to keep up with soaring demand and do battle with increasingly unpredictable regulators. But there's light at the end of the tunnel. Portions of the phone industry—long-distance service and terminal equipment—are being deregulated. And even the local service monopoly is under fire. New technology promises a vast array of new products and services, marrying phones with computers, television, copiers, and other devices.

How far will deregulation go? Can we really have all-out competition in telecommunications? To answer these questions we have to understand the present regulatory system and the forces contending to tear it apart.

THE TELEPHONE MONOPOLY In the ancient history of telecommunications, Congress set social goals for much of the telephone industry with the Communications Act of 1934. Section 1 of that act was passed "for the purpose of regulating interstate and foreign commerce in communication by wire and radio so as 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, for the purpose of the national defense, and for the purpose of promoting safety of life and property through the use of wire and radio communication.…"

Universal service was the goal. Regulated monopoly was the means. To implement the congressional will, regulators of the telephone industry have, at least implicitly, relied upon first barring entry to others and then allowing the regulated monopolist (your local phone company or AT&T's Long Lines Division) to develop and implement cross-subsidies to its various divisions, charging higher than would-be competitive prices for some services in order to subsidize money-losing services.

In the long run, these policies have put a damper on technological development within the telephone industry. AT&T's service, especially, has sunk to such relative depths that it has been compared favorably only to the Army mess hall or the Post Office. To many, the Bell system has not been the solution but the problem.

The results of the 1934 Communications Act should have been expected. It was as if the Congress had neatly tucked the mostly willing telephone industry (pronounced "Ma Bell") into the freezer (with all the enticing goodies inside), closed the door, and flipped on the switch. Except for infrequent openings of the door, the telephone industry has remained locked inside—still with its goodies, it is true, but stifled and frozen.

For the past several years, however, various new industries have been raiding the ice box, leaving the door open for increasing periods of time. Ma Bell, thawing out in the warm air of competition, has not only seen her goodies disappearing at close hand but has smelled the fruits of the free market cooking on the stove in the distance. Now she wants out and is rocking the refrigerator to get what she wants: freedom from the restrictions of regulation. And some of the government officials who have been observing all this ruckus from in front of the ice box have just made a dramatic move to dismantle the door.

Why this change on the part of the government? Is it vision, money, good will, power, or a change in philosophy? Perhaps it is a little of each, but most importantly, it has been brought about by technological advances in a field other than telephony. Actually, those hot, savory items sitting on the stove that Ma Bell is eyeing so enviously are computers—or, more properly, profits brought home by the computer industry.

But, you ask, didn't AT&T swear off electronic data processing (EDP) in its 1956 consent decree? Yes, it did. The Justice Department required that it give up something, and back then AT&T didn't think the computer industry looked all that attractive or would even have anything to do with the telephone industry. But now the computer industry, as the attractive chef cooking up a storm at the stove, is said to be the most eligible marriage partner possible for Ma Bell. The prime reason this relationship is natural is the technological advance of digital switching.

THE COMPUTER MATCH To understand telephony, you must first understand the human voice. Speech is a variation of frequencies. Such variation is continuous in form (analog) and can be visualized as a sine wave:


To understand computers, you must first understand that most computers are based upon a series of digital yes-no decisions, or on-off switches, that can be typified as the following distinct, two-level series of signals:


The way in which these two forms of signaling have met and joined hands in the telephone industry can be illustrated by several calls to your favorite publication, located in Santa Barbara, California. In city A, you'll pick up the telephone and dial 805-963-5993. The resulting "clicking" signals will go to your local telephone company office, where they will be deciphered by going through miles and miles of wire, tripping or spinning a number of switches, each the size of a typical light switch, located upon rack after rack of equipment. Physical contact will be made with the wire leading off in the direction of California, and you're on your way.

If you live in a large city, however, you can easily imagine that the size of the switching office system required to handle all such calls would have to be monstrous. Enter the computer…and your second call. This time when you pick up the phone and dial the number, the clicks are transformed into digital form and quickly wend their way through a computer, and you're on your way to California. The switch has been transformed from a mountain of copper wiring into a small box of computer chips, much smaller both in size and cost.

In yet a third city, not only is your dialing signal changed into digital form but, through the wonders of modern technology, so is your voice. In such form, many more conversations can be squeezed onto a wire pair, thus reducing as well the number of expensive wire pairs that are required for all conversations going on between your area and California.

But wait—now a fourth possibility opens up. With even more advances in technology, you sit in front of a funny-looking telephone, and your voice is mediately and doesn't have to wait to get to your local telephone office. The communication path is digital end-to-end. So what, you ask? Well, try plugging your own home computer into it and see what happens. Imagine this:

"Hello, Bob. I noticed it's time for the next issue of REASON. I've got my word-processing computer on line now. Should I set my printer for 68 pages? OK, it's printing. Looks like another great investigative report this issue. Thanks a lot. Call you again next month. Good-bye." (This picture is not science fiction; Better Homes & Gardens and Robotics Age can be sent via home computers. Now you can see how it's only natural that, once Ma Bell gets involved in computers for switching, she would also want to get involved in computers for word and data processing.

COMPETITION A'COOKING Back to the kitchen. While Ma Bell has been locked up in her freezer, she has not been the major force in the development of telephone switching. This development is the child of the free-market "interconnect" industry. Through case-by-case decisions over the last dozen years, the government has allowed entrepreneurs to take back from Ma Bell the right to produce various goods and services. The most often cited of these allowances is the Federal Communications Commission's Carterfone decision of 1968. For the first time a manufacturer was allowed to "interconnect" his own device to a Bell telephone.

Since then, the government has inexorably been led down a logical path to allow bigger and better privately manufactured devices to be added to or substituted for the Bell telephone terminal instrument. Examples of these devices are such small items as the Stromberg-Carlson telephone you can buy at Ward's for about $20.00 or such large items as the Rockwell-Collins automatic call distributor that all major airlines have bought for close to a million dollars each to handle their complex flight reservations requirements.

Presently, what may concern Ma Bell the most is the developing market for digital private automatic exchanges (PABXs). Here, private firms are installing complete telephone systems in business buildings, saving most corporations thousands and thousands of dollars over what they would have to pay Ma Bell for comparable internal telephone calls. Needless to say, AT&T is losing millions in revenues from such competition, which provides customers not only better prices but, in most cases, more desired product features and better service.

It could be said that Bell could live with such an inconvenience, since, after all, it gets most of its revenues from long-haul transmission (the wire that got your call to California). But enter the competing long-haul transmission companies such as MCI and SPC, developers of Execunet and Sprint, respectively (see "Slash Your Phone Bill, REASON, Mar. 1980). Successful as they have been, for the longest time these competitors were held at bay by AT&T's causing them problems when they wanted to hook up their wires to your local telephone switching office. In a recent antitrust suit, however, MCI was awarded $1.8 billion in treble damages for injury AT&T is alleged to have caused it by its previous illegal, anticompetitive activities. MCI and other common carriers are now expected to have a much easier time expanding their services.

Also enter the satellite companies. A number of well-financed firms, with names like IBM, Aetna Life Insurance, Comsat, Xerox, GTE, and the list goes on, are forming consortia to place satellites in orbit. These will retransmit both voice and data signals sent to them from the rooftops of firms whose antennas are connected to their own PABXs, thus bypassing AT&T's system altogether. It would seem that, for all they could care, Ma Bell could sit in her ice box and freeze. But instituting a replacement system is still in its initial phases and looks to cost billions. Wouldn't it be nice to let Ma Bell out of the ice box if only she would cooperate?

In fact, a closer look reveals that the rocking of the refrigerator is due not only to Ma Bell trying to get out but to some competitors trying to help her out in just the right, profitable way. If Ma Bell can thaw out, a warm relationship could also be established with the computer industry, resulting in what just might be the birth of a new industrial revolution.

THE RACE TO DEREGULATE Just how to deregulate AT&T is no simple matter. Would that complete deregulation could happen overnight; however, obstacles abound. What about all the past promises that had been made to AT&T that it could recapture a reasonable profit as a regulated entity—surely a prime reason for its installing telephone exchanges in normally unprofitable, remote little towns? What about all the depreciation on AT&T's equipment that it thought it could amortize over a useful life of 30 years? Deregulation would make it obsolete almost instantly.

Such are only a small sample of the questions that have been considered over the past several years by the House, the Senate, the FCC, the Justice Department, and the courts. Each of these entities had in one way or another been involved in the legalistic, case-by-case series of deregulatory steps previously mentioned. Over the past year, each has also been in a race to radically deregulate the telephone industry. Rather than being a simple contest, however, the race has looked more like a multiple pushball race, with a horde of lobbyists (for example, the Department of Defense, the interconnect industry, IBM, the independent telephone companies, trade associations, outright Bell opponents, and groups concerned about the influx of foreign-controlled multinational telephone companies ganged up on each contender, pushing every which way toward the "right" direction.

What has resulted are various plans for phased deregulation of the telephone industry, most of which provide for the creation of a single unregulated subsidiary for AT&T. Of last session's slightly different House and Senate bills regarding deregulation, Henry Geller, assistant secretary of Commerce and head of the National Telecommunications and Information Administration (NTIA), said on June 23, 1980: "These are both good bills, although we like the House one better.…We need deregulation. We can't continue this administrative minuet of always asking, 'Mother, may I please introduce a new product?'"

Also involved as a dark horse in the deregulation race is the Department of Justice, which has Bell in court on antitrust charges with the intention of breaking it up into smaller operating units to "enhance competition." Favoring this attempt, William B. Saxbe, spokesman for the North American Telephone Association (NATA), warned of problems with phased deregulation such as found in the House bill. Specifically, he was concerned with the fact that AT&T may use the billions in funds it "gouges" from customers in regulated markets (here meaning your telephone hook-up to your local telephone exchange) to unfairly support its activities in unregulated markets. Remember that AT&T has annual revenues close to $40 billion, with total assets exceeding $100 billion and, as such, is not only a dominant market force but potentially the most influential, feared competitor in telecommunications or any related field.

Saxbe said in a recent interview, "If deregulation is desirable, the telephone companies, which have dominant monopoly power within their exchanges, should not be entirely freed of regulation until marketplace conditions exist.…And this proposed legislation does not provide safeguards to assure anyone that it can happen that way. Leaving such matters to the 'telephone fairy' is both naive and irresponsible." One must remember, however, that Mr. Saxbe was the attorney general in 1974 and the person who initiated the latest antitrust action against AT&T. So it is not surprising that, although now acting as spokesman for NATA, he would argue that any deviation from the Department of Justice plans for AT&T would create a competitive subsidiary that would be a clone of a giant monopoly from the moment it goes into business.

The FCC plan, which differs somewhat from the two congressional bills, also contains "safeguards" against cross-subsidization that are judged by some to be inadequate. Much of the discussion about this and the congressional bills centers around the gorilla theory: Where does an 800-pound gorilla sleep? Anywhere it wants. In other words, what is to prevent the unregulated portion of the Bell System, christened by some as "Baby Bell," from growing up with a nasty temper and a predatory disposition?

Which of the previously mentioned contenders was going to win? Many observers felt that putting odds on any one in particular was beyond the calculation of Jimmy the Greek. Most observers, however, also believed that some quick action was needed, not only for their own particular reasons, but for the common fear that, without some action, AT&T—given its needs and the force of technology—would drag more and more of the free market for computers, data processing, and related goods and services under the umbrella of regulation.

THE FCC TAKES THE LEAD Who won the race? In its action in April 1980, the FCC won the race or, as Congressman Lionel Van Deerlin put it, "hit a home run."

In speaking of the FCC action, labeled the "Second Computer Inquiry Decision," FCC Chairman Charles D. Ferris claimed that the decision "removed the barricades from the door to the information age. The supply of communications products and services will be limited only by the ingenuity of businessmen and scientists. Government will no longer be a barrier that prevents or delays the introduction of innovations in technology." And, he said, difficult as it may be to achieve a new kind of environment and a smooth transition, he had absolutely no doubt that it must be accomplished, because information processing and telecommunications functions share one common set of technologies; operate on one kind of commodity—information; and have one common set of user benefits—improved productivity, enhanced ability to manage complexity, and, in many ways, ability to improve the quality of life of the individual.

Howard Anderson of the Yankee Group (telecommunications consultants) has summarized the FCC's ruling somewhat as follows:

1. All carrier-provided network services must be defined either as "Basic" or "Enhanced." "Basic" is defined as simple voice or data transmission capacity. "Enhanced" is to be defined as the use of basic services (individually or in combination), supplemented by some added value, such as computer or communications-processing applications. Enhanced services are to be deregulated; basic services will be subject to regulation.

2. All carrier-provided customer-premise equipment must be "unbundled" (separately charged) from carriers' basic services prices and must be made available for purchase (at customers' option) by March 1, 1982. Customer-premise equipment may be offered through "enhanced services" subsidiaries.

3. All carrier-provided, customer-premise equipment (PABX's telephones, modems) is to be deregulated; technological capabilities will no longer serve as a distinction between customer-premise equipment…which can be offered by any vendor (e.g., Teletype can now offer EDP capability in its terminals), AT&T and GTE must market, install, and maintain any and all customer-premise equipment through a separate subsidiary.

4. The current computer rules requiring maximum separation between a carrier's regulated communications services and unregulated data processing services are to be eliminated, with the exception of AT&T and GTE.

5. AT&T is not barred by the 1956 Consent Decree from providing enhanced services or non-tariffed customer-premise equipment.

THE PRIZES The impact of the Second Computer Inquiry decision is already being felt in both the computer and telephone industries. In the computer industry, IBM stands very much to gain as a result of the decision, AT&T already buys IBM 3270-compatible intelligent terminals. These have the potential to be very powerful small business computers, which AT&T could very easily market through its business unregulated subsidiary ("Baby Bell") for use in the integrated electronic office of the future. (It is presumed that Bell itself will not go into head-to-head competition with IBM by building mainframe computers but will concentrate on developing smaller computer equipment that it can sell at its phone centers, much in the manner of Radio Shack.)

"You can be sure," says Steven Chrust, a research analyst with the Sanford C. Bernstein Co., "that AT&T will be there offering everything you need…. The only limitation is the imagination of the guy who writes the software." And, John Gantz, director of publications for International Data, a market research firm for the information-processing industry, says that eventually the ruling will create more competition in "niche-type services"—special areas too small for the giant but well suited for a smaller company to exploit. Gantz maintains that deregulation will help everyone in the end.

On the other hand, it is the meantime that concerns Datapoint. Datapoint is a computer company that is already concentrating on providing "office of the future" telecommunications equipment, and it expects to be hurt, so much so that it has instigated the formation of a legislative lobbying group—ISCAR (Industry Study of Communications Act Rewrite)—to constrain Bell. "With a monopoly such as AT&T poised to enter our markets," said Harold O'Kelley, president of Datapoint, "the thing that worries us is that, as entrepreneurs, we all know how competition and the free market works. [Datapoint distributed William Simon's A Time for Truth to its stockholders.] Unleashing AT&T to enter our markets must be done on a fair and equitable basis without forcing every Bell telephone user in the land to finance 'Baby Bell's' R&D, factories, marketing, servicing and money sources.…Competition is a tough game, and I don't think a monopoly could be expected to play it fairly. That's why it was regulated in the first place."

In the telephone industry, perhaps the greatest impact of the decision is a state of confusion. No one knows just exactly what will happen. On the one hand, AT&T has just been unfettered from years of regulation and can be expected to put up quite a fight with its competitors. Its inventing geniuses at Bell Labs can dream up new products with much greater certainty than previously that the legal staff at top-management levels will not be so worried about antitrust action or that the financial staff will be concerned that older equipment already in use must be properly depreciated before new equipment can be introduced. As a marketing arm, Baby Bell can pick and choose just exactly which products it wants to sell. If it doesn't like what Bell's Western Electric division is manufacturing, it can purchase from manufacturers elsewhere, with the result that Bell can shake off many of its previous problems stemming from "vertical integration."

On the other hand, AT&T is at a disadvantage, because it has to offer its long-haul transmission facilities to its competitors at the same price it charges Baby Bell. Thus, new competitors of Bell will be on the same footing as its offspring, and current Bell competitors will be free to continue enjoying the advantage of having developed their own long-haul transmission facilities.

In addition, Bell has no long history of competing in a free market. Unlike the top executives of the interconnect telephone and data-processing industries, who tend to rise through the ranks of sales and marketing, AT&T's managers, from Chairman Charles L. Brown on down, have traditionally had engineering and technical backgrounds. It is apparent that Bell will have to purchase top-level marketing expertise.

DEBATING THE RESULTS What do the lawyers have to say about the winner of the race to deregulate? FCC Commissioner Robert E. Lee sounded a note of uncertainty when he anticipated a flurry of litigation over the commission's decision. He rhetorically asked and responded: "Who's going to sue us? Everybody." To which Philip Verveer, Common Carrier Bureau chief replied, "I think that is a fair assumption."

Victor Block of Telephony said, "What is clear at this time is that the decision no doubt will be tested in the courts; and that it will affect the effort of Congress to amend the Communications Act; that it will interplay with the Dept, of Justice (DOJ) antitrust suit against, and consent decree with, the American Telephone and Telegraph Co. (AT&T)."

John M. Lothschuetz, vice-president and general counsel for United Telecommunications, said:

Based on what we've seen and heard so far, the commission certainly has addressed many of the problems the industry has. The biggest problem as I see it is the right to reimpose regulation. Some people in the industry feel [the FCC's decision] is fine. This is what we've been shooting for. But the commission still will be sitting back there watching the industry, and if they feel anyone has gotten out of line—boom, they're right back under regulation. That seems to be the biggest headache at this time. We'd definitely like to see legislation clarify a number of questions—and that's one. Under legislation, once the commission gives up jurisdiction over something, that's it. I just have a sense that the FCC is going to be sitting in the wings, and when you get into a real hot competitive battle they're going to step in again—and of course could engage in market allocation and everything else.…I think it's going to be a dream world for lawyers, and the public doesn't gain by that. You've got to have some decisive decisions.

Lothschuetz is joined by John L. Kirkley, editor of Datamation. In a recent editorial essay, he wrote:

The questions are many, the issues are complex, and the outcome is bound to be clouded no matter what Congress, the FCC, or the courts do. But there is one certainty. One segment of our society will be kept extraordinarily busy by these gyrations, and its members will make potfuls of money.…The lawyers, of course. After all, when all is said and done, it's not whether you win or lose that counts, it's the size of your fee.

With the gradual merging of technology over the years, virtually all of the experts agree that some kind of FCC action was inevitable—and that the litigation, which is expected to take years to resolve, was equally inevitable.

BEYOND THE FINISH LINE Not waiting for the Computer Inquiry II legal dust to settle, AT&T moved in August 1980 to establish domestic and international subsidiaries that would carry the giant company into a variety of new markets. The company's board of directors voted to realign the responsibilities of AT&T's top officers—a move that was seen as the first step toward one of the largest corporate reorganizations in history. FCC chairman Charles D. Ferris, calling AT&T's moves a positive step, said that he thought the company "should be commended."

In December the FCC took a further step toward deregulation by deciding that it does, indeed, have the power not to regulate certain segments of the telecommunications industry—namely, firms that do not possess market dominance (in long-distance, for example, that's everyone except AT&T). And in January it began opening up even the local phone monopoly by voting unanimously to allocate radio frequencies for use by companies that wish to connect local communications users with satellite ground stations, bypassing the local phone system entirely. Enough frequencies will be provided to allow 16 companies to offer the service in each locality; Xerox, for one, plans to have such systems in operation in major cities within a few years.

Notwithstanding court litigations and antitrust suits, the question of AT&T's entrance into the EDP industry is no longer a question of if but rather of how. With the damn-the-torpedoes, full-speed-ahead attitude of Bell and its competitors, the telephone will never again be quite the same. And with AT&T officially in the data-processing market and Xerox and IBM in the communications market, it's a safe bet that awareness and use of futuristic systems will spread rapidly. Before the decade is over, telephones will become the central components in entire home computer systems, programmed to turn household appliances on and off, store family financial records, pay bills, and even scan data banks for shopping bargains at neighborhood stores. Surely a bright, exciting future awaits the industry, its customers, and all free-market participants.. .as they reach out and touch tomorrow.

William Bahr is a manager of product planning in communications systems for a division of Rockwell International. He has an MBA from the University of Kansas.