Hanging Up on Your Phone Company

How technology is digging a grave for local phone monopolies.

On any given day in the United States, some 800 million conversations pass through more than 1 billion miles of telephone lines. Most of these electric link-ups—over 90 percent of them—are local calls. Of these millions of local calls, three-quarters are handled by the 22 operating companies—with names like New York Telephone, Bell of Pennsylvania, and Pacific Bell—that make up the Bell System, a component of American Telephone & Telegraph, the largest company in the world.

From the beginning of next year, however, the Bell System will be no more. Under an agreement hammered out between AT&T and government antitrust regulators, the corporate giant will be split asunder, stripped of more than half of its assets and employees. The 22 local companies that constitute the Bell System will regroup into seven new independent regional companies that will offer only local service, AT&T itself, as a provider of long-distance service, will still be a giant in telephony, but a giant with competitors.

The AT&T breakup has a lot of people worried about what will happen to local phone rates. The issue arises because of the present structure and pricing of phone services.

With few exceptions, local telephone service in the thousands of communities throughout the United States is provided by a single company—most likely a Bell company—that has been granted an exclusive franchise by state regulators to provide service to the particular area. Regulators defend exclusive franchises on the grounds that phone service is a "natural monopoly"—that is, the greater the number of customers over which a phone company's costs are spread, the lower the average cost per customer. So in a city of 100,000, a single phone company can serve all residents at a lower average cost than can two different companies serving only 50,000 each.

Based on this rationale, state regulators, beginning in the early 1900s, took it upon themselves to allow only a single phone company to provide service to a community. And so that the company could not take advantage of its monopoly position to charge high prices, regulators would also control local phone rates.

Then in 1934, Congress passed the Communications Act, setting out "universal telephone service"—telephones everywhere, all interconnected—as the aim of a national telecommunications policy. In pursuit of this goal, federal regulators and AT&T—which by this time had become the country's largest phone company and its only long-distance provider—devised a way to ensure "affordable" local service. Through a system of cross-subsidization, users of long-distance service—primarily businesses—would pay rates in excess of the service's cost, so that ordinary citizens could receive cheap local service.

While the AT&T long-distance monopoly remained intact, cross-subsidization posed no obvious problems and succeeded in supporting universal service. (With about 182 million phones in use in the United States—some 36 percent of all the phones in the world—all but two percent of American households now have phone service.) But as microwave and satellite technology developed in the '70s, competitors began to offer long-distance discount service—at rates 20 to 50 percent lower than AT&T's. The monopoly began to crack.

AT&T's soon-to-be-effected breakup by government regulators allows the pared-down giant to lower its long-distance rates and compete with firms like MCI Telecommunications, General Telephone & Electronics, and Western Union. But the system of subsidizing local service through artificially high long-distance tolls is threatened. And so a swarm of controversy now encircles the issue of your local phone monopoly's rates.

Must your local telephone service remain a monopoly? That's been the conventional wisdom of regulators. Perhaps it presently is the closest thing we have to a "natural monopoly," all those millions of miles of copper cables linking each house on the block to an "exchange" or "central office," where, by dialing, the caller actuates switches that connect him to someone else in the local exchange area or put him through to one network or another out there. All this equipment—the wires, switches, and so forth—is costly to maintain. Without subsidies from high long-distance rates, rates for local service will have to rise. The national average basic rate of $10 per month is projected to double, possibly even triple. And if regulators remain intent on monopoly arrangements, consumers will have no choice but to pay what the local phone company charges or go without the service altogether.

But just as the notion that long-distance service was a natural monopoly evaporated with the advent of new discount services within the last decade, so too this last great "natural monopoly"—local telephone service—is now being challenged. Wondrous advances in solid-state physics have conjured up a profusion of technologies providing new means for circumventing—or "bypassing"—the local phone company.

The engineers are there with the ideas and the equipment, and the entrepreneurs have the money to fund new kinds of local bypass systems. Many are developed. Some are being built now. Some will begin to be advertised before year's end. And they will be in mass use by the end of the 1980s. But the extent to which such systems operate—how diverse the services might be and how low the rates might go—will largely depend on how much freedom entrepreneurs will have to compete among themselves and with the local phone companies.

THE BYPASS BUSINESS

In the business, all systems designed to circumvent the local telephone company are called "telephone bypass." And nowadays, it is a business just talking about ways around the local telephone company. Dr. Jerome Lucas, president of Telestrategies, Inc., a McLean, Virginia, consulting firm, runs several conferences a year just on telephone bypass. Several hundred people pay $250 a day each to attend them. I recently attended two of the conferences to get a close-up perspective of the emerging industry, its personalities and technologies.

The bypass conferences are where the dogs of the business warily gather and sniff one another out. There's a definite canine tension in the air as the different telephone dogs defend their territory, size up competitors, engage in a bit of braggadocio now and then, or just listen intently with ears erect.

Each dog knows he has to do just the right amount of barking, just enough so that pack members or clients are apprised of what he can do if he's on their side, but not so much that he gives away valuable intelligence to competitors.

Everyone's heard of some of the new technologies and seen and become familiar with some. The coaxial cable—that 3/8-inch-thick cable consisting of a core wire surrounded by an outer conducting sheath—is one of the technologies that can be used to bypass the local phone company. It is usually installed to provide that entertainment smorgasbord called "cable TV." But it is not difficult or very expensive to add a telephone signal onto cable. There is, as industry people say, "a mile of bandwidth" available in that coaxial cable. Optic fiber—strands of glass through which impulses of light pass to convey a signal—is another fabulously capacious cable that has the potential to bypass the copper-wire local network.

The other bypass technologies are, to use an excellent old-fashioned word, wireless. They involve the "smart" use of radio signals—that is, the signals' transmission or reception is enhanced by advanced technologies—especially microwaves in several different forms. These technologies include, most prominently at this time, "digital termination systems" and "cellular radio systems."

Though it is convenient to speak separately of each of the emerging technologies, actual bypass systems—many aspects of which are in the research-and-development stage—may tend to include both wireline and wireless components. Phil Freedenberg, director of systems engineering at M/A-COM DCC, a Maryland firm that is developing bypass technologies, has been "living bypass" for several years now. In conjunction with Telestrategies, he has published a telephone-directory-sized report on what has happened so far in bypass and on the technologies for the future. His main conclusion is the not surprising but untidy statement: "No transmission medium will dominate. Each has its advantages and disadvantages. Hybrids will be best."

Brian Thompson, senior vice-president for corporate development at MCI—the company that first challenged AT&T's long-distance monopoly—says much the same. MCI, he says, "wants to have a kitbag of different tools" and to be free to use the most efficient technology to carry a message. Says Thompson in an obviously well-practiced gag line: "If the milkman will take the message, we'll look at him."

CABLE IN COILS

Part of the fascinating maze of pipes beneath our big cities are ducts built for great clusters of different-colored "wire pairs" of plastic-covered copper cables. Underneath all those manholes, from which steam blows and through which cables are drawn from giant spools, is an enlarged ants' nest of passageways; and despite modern digging machinery, it is still very expensive to tamper with.

For all the talk of fiber-optic cable revolutionizing the economics of cable based communications—inexpensive plentiful, and more-efficient glass fiber replacing expensive copper wire—the hard reality is that it doesn't matter much at all in many applications how cheap the cable gets or how efficient. The reason: cable costs themselves are now trivial compared to the costs of breaking ground, placing ducts, and restoring the surface.

According to a study by Phil Freedenberg of M/A-COM DCC, the cost of building underground ducting in city areas is $20 to $25 per foot. So whether cable can be reduced in cost from $5 a foot to $2 is rather immaterial. The cost of hanging cable from existing poles is, of course, much less than ducting—say, $4 or $5 a foot in an average cable system. In between is the cost of underground cabling in open suburban areas, where ducts are not needed and cable can be buried behind mechanical "plows." Even there, the cost—$10 per foot—is above that of fiber-optic cable itself.

According to Freedenberg, cabling costs per subscriber ranges between $180 at best and $540 at worst. Only a lucrative new business, such as video entertainment, therefore, will justify cabling to households—whatever the cable itself costs—and telephony will have to be an "add-on" use to someone else's cable system.

As far as businesses in established city centers are concerned, the issue is whether the competing new technologies of cable, given the vast expense of new ducting, can get into the existing underground ducts. So far, the local telephone companies have had a virtual monopoly over the telephone ducts. In most places, a state utility law requires phone companies to share the use of the ducts on a "reasonable rental" basis. But if the local phone company owns the ducts, getting the courts or public utility commissions to enforce sharing is often difficult.

Old ducts can carry telephone cabling with, due to new technology, much greater capacity. So the local telephone company should need progressively less duct space to house its cabling. It should be able to rent or sell ducts to its competitors. In New York City's Manhattan area, the ducts are owned by the New York Subway Company—nothing to do with the rail subways—and it leases space to all comers. (Actually New York Subway is a subsidiary of New York Telephone, but Manhattan Cable says NYS works at arm's length from its owner and has dealt fairly with the cable company.) That's made possible the development of the country's major central-city business cable system, operated by Manhattan Cable, a subsidiary of Time, Inc. Chase Manhattan, Manufacturers Hanover, Citibank, Morgan Stanley, and the city government itself all lease multiple circuits from Manhattan Cable and are saving hundreds of thousands of dollars a year by bypassing New York Telephone.

Manhattan Cable's coaxial cable is technologically a better medium for such links, and many businesses like the feeling of security that alternative systems provide. Indeed, when Manhattan Cable first started selling its institutional cable service, most clients saw it as a backup to New York Telephone. "Now," says Manhattan Cable president John Gault, "they keep the New York Telephone circuits as backup."

Given that 70 percent of American homes—some 60 million or so—are wired with coaxial cable, with half of these actually subscribing to a cable service, and given that each cable has a great capacity to carry telephone signals, this essentially entertainment medium provides enormous potential for competing local phone service. (In order to convey phone conversations, the cable must be two-way, and most new systems are.)

But to date, a variety of problems have retarded the development of cable telephony. Cable companies are principally entertainment-oriented, and most have not pursued alternative possibilities. Also, cable companies fear being designated "common carriers" if they take telephone traffic, thereby subjecting themselves to rate and service regulation by public utility commissions.

In Omaha, MCI recently made moves to bypass the local phone company by proposing to offer its long-distance telephone subscribers direct connection via their TV cable—and got into a legal battle with the regulators. John Mann, director of corporate development at MCI, said at a Telestrategies conference in June that MCI is nonetheless actively trying to interest equipment manufacturers and cable operators in investing in switching systems and other equipment needed to make telephone service an economical add-on to cable. It even has a name—"cablephone"—for phone service as an add-on to your cable TV.

A firm that's developing both cable and wireless bypass technologies is M/A-COM DCC (it's no more informative spelled out in English), located near Washington, D.C. I'm not sure whether the national capital deserves to be titled the communications capital of the nation, but a lot of actors in the new telecommunications show are in the Washington, D.C., area.

Take I-270 northwest of the city's Beltway into the rolling farmland of Montgomery County, Maryland, and cruise a while. Well before you reach the battlefields of Gettysburg, at Germantown you'll see a neat set of office buildings off to the right in a grassy field, with the title M/A-COM DCC. It is a subsidiary of the big Boston communications equipment manufacturer M/A-COM, and out here in Maryland they specialize in "last mile," or bypass, equipment.

As you circle around off I-270 and proceed down country lanes designed for the occasional traffic of rural life, and as your eyes search between new developments across bits of farmland trying to find the M/A-COM DCC buildings again, you ponder the frustrations of the last mile. But then you identify the buildings again by their cluster of large satellite dish antennas.

Manufactured inside that complex is equipment that carries a satellite signal the "last mile" to the end user. Because huge satellite dishes like those at the M/A-COM complex are extremely expensive, costing tens of thousands of dollars, few businesses or individuals can invest in on-their-own-premises dishes that receive microwave signals directly from a satellite. Last-mile signaling equipment—in the manufacture of which M/A-COM DCC is perhaps the world leader—is the way around having your own satellite dish while benefiting from satellite communications.

But last-mile technology is much more than that. It is also an alternative local telephone company, for any technology that can receive and send communications on a major trunk, like a satellite, and distribute it to a variety of local users is in the business of bypass.

M/A-COM DCC has two major product lines, each aimed squarely at the bypass of the local phone company. One, called CAPAC, uses coaxial cable as its transmission medium. The other, called RAPAC, uses microwave to bypass the local phone company. RAPAC is specified in some 20 licensed bypass systems now being built in major US cities.

Both RAPAC and CAPAC have been demonstrated in a major experiment that linked the financial districts of New York City and San Francisco. At the New York end, Manhattan Cable provided the "last-mile" links to brokerage houses via coaxial cables. To convert microwave satellite signals to cable signals, and vice versa, M/A-COM DCC provided a CAPAC processor and switch, which hooked into a satellite network via rooftop dishes. In San Francisco, RAPAC and CAPAC were each used for the "last-mile" bypass of the local phone company.

DIGITAL DELIVERY

Among the radio-based bypass technologies, "digital termination systems" (DTS) are developing rapidly. These have been launched with a lot of marketing ballyhoo as "total business communications systems," since they can carry computer data, facsimile images, and video teleconferencing, as well as conventional "voice."

Traditionally, telephone signals have been "analog"—or a continuously variable wave—rather than the simple and much faster "on-off" language of "digital" systems. These make use of rapidly traveling streams of electrical pulses, or digital "bits." Telephones will be about the last communications device to "go digital," but the advantages of digital—primarily the high-speed transmission of any sort of data—are such that the move toward telephones compatible with the rest of telecommunications seems almost inevitable.

In a local digital termination system, each subscriber is equipped with a two-foot-diameter transceiver dish—either affixed to the building or installed indoors behind a window—which points toward a central transceiver "node." When subscribers send messages to other subscribers, the central node receives the microwave signals and retransmits them in an arc throughout the system's service area. (Hence this technology is called "point-to-multipoint.")

Because each message is "addressed" to a specific subscriber's station, only that subscriber will receive the message intended for him. By addressing messages, assigning frequencies, and intermixing—or "multiplexing"—signals, a radio-based DTS efficiently uses scarce frequency and expensive equipment.

DTS microwave is up in the frequency levels used in communications satellites. The general trend in radio technology, especially in America because of congested radio-frequency fields, is the development of new systems using signals of ever-higher frequencies and—the technical corollary—of ever-tinier wavelength. Smaller wavelengths have some drawbacks; they are intensely directional and more easily interrupted by rain. But a great advantage is that many components, especially antennas, can be smaller.

Radio-based digital termination systems will experience their first big year in 1984, but will be used primarily for long-distance communication at first. Bedecking office buildings all around American cities will be two-foot-diameter dish antennas. A whole stack of big-name communications firms and many lesser-known contenders that may make their names in radio-based DTS are presently building systems throughout the nation. The Federal Communications Commission (FCC), which regulates the use of the radio spectrum nationwide, only allocated the necessary microwave frequency to such systems in 1981 and only began to accept license applications last year.

Much simpler than DTS—and with great potential in many places for bypassing the local phone company—are systems based on the older "point-to-point" microwave technology. Now being introduced are some amazingly simple, light, and quite inexpensive point-to-point systems using very-high-signal frequencies. A point-to-point system provides a private channel of communication, via microwave transmission, between two points, each of which transmits and receives signals directly to and from the other point.

A leader in point-to-point is Gemlink, a General Electric system. It uses a pair of 10-pound dish transceivers that look disconcertingly like car headlights and can be bolted onto a water pipe. Good anywhere you can get a line of sight between two points up to six miles apart (depending on rainfall patterns), Gemlink connections cost half the amount of leasing Bell lines and will cost perhaps a tenth or less in capital and installation costs. Old-fashioned, low-frequency microwave was simply uncompetitive in such applications and, anyway, the FCC hadn't allocated the necessary radio spectrum for it.

THE CELLULAR SENSATION

The market for the new technologies has to be proven. The market for personal mobile communications, for example, will most likely be tested stage by stage, as established technologies are stretched and combined. Hence, we now have the "cordless" telephone, a radiophone that allows you to wander around your house, by the pool, or in the garden. But this device depends on a fixed transceiver plugged into a power outlet in the house. The market for cordless phones may be quite quickly throttled off by increasing congestion and interference and the phones' lack of privacy. Cordless phones may overcrowd their available frequencies so quickly, we may see a repeat of the CB (citizens' band) boom and bust of the 1970s—unless some very "smart" new technologies can be brought to the rescue.

To get beyond the range of cordless phones you have to go to higher radio frequencies where there are plenty of channels available. At the higher frequencies not only is there the spectrum needed, but signals become more directional—that is, less dispersed or broadcast around—as well. This enables similar frequencies to be used in many different places, for different signals and conversations.

This quite-localized range of higher-frequency radio is utilized in the new "cellular" radio mobile-telephone systems. The service area of a cellular system is divided—and can be constantly subdivided—into hexagonal cells, each cell being served by a "nodal" transceiver with a range of 1–12 miles, depending on the size of the cell. Each nodal transceiver uses the full menu of frequencies—666 in all—to carry separate conversations.

The key to mobility lies in a sophisticated, computerized "hand-off" system in which the base "node" keeps a constant check on the signal strength of each talking mobile phone in its cell. When that mobile unit moves too far away for the cell's base node to maintain a high-quality signal, the node hands the conversation off, automatically and unknown to the talker, to the base node station of an adjacent cell. Hence the caller can move from cell to cell, his conversation uninterrupted.

Transceiver nodes in the system are all interconnected via phone lines, with devices to convert radio signals to phone signals and vice versa. In this way, mobile radiophones and standard stationary telephones can communicate through the cellular system. (In the future, systems with other means of interconnection—microwave, perhaps, or coaxial cable—may be developed. But for the present, phone-line interconnection is the norm.) Thus, cellular phones will not be a boom-and-bust fad like CB radio, a system through which CB operators can talk only with other CB operators.

The United States has been slow to get into cellular, though AT&T developed the technology in the late '60s and applied to the FCC in 1969 for a license to build cellular systems. The FCC dragged its feet for 15 years, however, with studies, hearings, and other excuses for inaction. It wasn't until June 1982 that the commission finally started to accept applications for cellular systems. Though it has not yet granted a single operating license, the FCC has given about 25 permits to companies to start building systems in various cities, including Chicago and New York.

The FCC is allowing two competing cellular operators in each market (one of which will be the local telephone company). Each operator will get half of the total 666 frequencies allocated for cellular use and will vie for customers (though the equipment will allow subscribers of one system to communicate with the other system's subscribers). Because of the diversity of the technology, cellular represents one of the major opportunities for bypassing the local phone company.

There are two fairly distinct kinds of cellular phone. One's really a car phone. The other is a hand-held, self-contained portable unit, able to fit in a purse or briefcase. We've had car phones for years—at least posh guys have. The cellular ones won't look much different from the old ones, but they give far-superior signal quality—less whistle, crackle, and pop.

Most important, cellular mobile phones won't have to be for a tiny elite. The old car phones operated on congested lower frequencies, and their transmissions were omnidirectional and relatively high-powered, so the 25 frequencies allotted to the old car phones could not be reused for many miles around. With only a couple of dozen simultaneous conversations possible within a 10- to 20-mile radius, car phones were inherently an elitist technology.

By contrast, cellular's 666 channels can be reused almost infinitely as cells are subdivided into smaller cells and as signal power is brought down. Whereas there have been only 160,000 car phones nationwide, with high-frequency cellular there could be tens of millions of mobile and portable phones on the system. Industry estimates put the number of initial cellular users at 1.5 million, with that figure doubling by the end of this decade. Such is the confidence in the future of cellular that when the FCC in June 1982 started to accept license applications for the top 30 markets, more than 200 were received.

Most industry observers think most cellular action, to start with, will be in car phones. It is much less demanding to manufacture a phone that works in a car than to make one you can carry around. In a car, a unit can draw on the car's power supply and can use the roof as an antenna. In a truly portable phone, the phone has to have its own power and antenna. It is being done, however, and an American company is the leader.

Motorola, Inc., of Chicago, is planning to mass-produce the world's first truly portable phone, called, rather clumsily, Dyna TAC. Weighing 1.8 pounds, it measures 8 by 3 by 2 inches. Jim Caile, head of cellular marketing at Motorola, claims the device will fit in his pocket—a pretty large pocket, perhaps, but it is clearly a fairly portable phone. It is good for 12 three-minute phone calls on a battery charge. Caile says Motorola hasn't set a price for Dyna TAC units yet, but they may retail somewhere between $2,400 and $4,000.

A small New York-based company, Millicom, has a similar-sized portable telephone, which Chief Financial Officer Brian McAuley told me should sell for $1,000 and rent for $28 a month. Most in the industry consider these prices "a little way off"—on the low side, of course—but quite possible with quantity sales. If such a price can be achieved, the future of cellular portable phones looks brilliant.

Where will they work? Nearly everywhere—in the home, in the street, in cars, but not so well in the interiors of office buildings. Probably not at all in elevators or subways, certainly not in planes. (Although, in planes, there will soon be a satellite-based radio system, courtesy of Western Union, through which airplane passengers will be able to communicate with earthbound humans.) So cellular won't be quite the ubiquitous means of communication conjured up in Star Trek–like scenes, but it will be a massive advance on the wireline fixed phone we now know.

There have been small-scale experimental cellular systems operating in the United States for a couple of years, including AT&T's pioneer system in Chicago, as well as two others (in the Washington-Baltimore and Raleigh-Durham areas). Full-scale systems have been operating—some since 1974—in the Scandinavian countries, the larger cities of Japan, Saudi Arabia, Singapore, and Australia.

William Newport, president of AT&T's Advanced Mobile Phone Service (AMPS), says he hopes to have a full-scale cellular system in Chicago by November this year. AMPS is working to have cellular available in California before the June 1984 Olympic Games. By 1984 and 1985, AMPS and other cellular developers hope to mass-market systems to most American cities. Cellular will be generally available throughout America by about 1987 or 1988.

How ubiquitous is the mobile phone going to become? No one can say. So much depends on its cost and how well it works in the hands of ordinary, nontechnical people. Herschel Shosteck, of HS Associates in Silver Spring, Maryland, has surveyed various people's interest in cellular phones at different prices. Shosteck finds price the key. For example, less than 10 percent of businesses, Shosteck has found, are interested in cellular at total costs of $100 a month or more per phone. At $50 a month, a quarter of businesses are interested. At $75 a month, Shosteck could find no measurable demand from householders, but substantial demand developed at $50.

No one knows how quickly cellular prices will go down. But we do know the baseline service prices operators will initially charge, from their startup filings with the FCC. AMPS in Chicago, for instance, is asking a monthly access charge of between $40 and $50, the precise amount depending on numbers of units in use. Its calls will be a basic 39.3 cents per minute in peak hours and 23.5 cents off-peak. On top of that, you have the mobile phone itself to purchase, and for the moment that's the most expensive part of the system. A $3,000 unit financed at 14 percent per year is about $100 a month. It's clear that for now the AMPS system is for the limo set! That's certainly the way the big-government monopolies overseas have sold cellular. In my native Australia, for example, the system was launched at a monthly charge equal to $170, with calls extra. As a result, in three years of operation, the system's got a mere 6,000 subscribers.

That kind of high-priced system, it seems clear, won't become an item of mass use. After all, cellular is competing with standard phones that have a basic monthly cost of $10—which, due to the AT&T breakup, may double or triple over the next several years—with pagers that cost $100 to buy and $5 per month to operate, and with pay phones that cost mere coins. Yet, if Millicom can really market a good portable phone for $1,000, you're up for less than $30 a month, and that's a completely different ballgame.

POLITICAL BYPASS

Just as affordability of the various bypass technologies will in large part determine their growth and success, so too will the regulatory environment in which they exist. In fact, taking a leaf from the recent history of long-distance phone service, it is likely that the political obstacles will be the most formidable. MCI's success in cracking AT&T's long-distance monopoly in the '70s, opening up the field to a host of later competitors, was largely a matter of pursuing deregulation through Washington's political, bureaucratic, and legal snakes and ladders.

A former railroad-union official from a coal-mining area of Pennsylvania—but also a graduate of the Harvard Business School—MCI's chief executive officer, William McGowan, should be one of the great heroes of contemporary free enterprisers. A visionary 54-year-old bachelor, McGowan is a determined and hardworking entrepreneur. He saw an economic opportunity in the accumulated fat of AT&T's phone system and said that there must be a political way to break into its monopoly. MCI originally stood for Microwave Communications, Inc., though it might better have been styled LTF—Lobbyists for Telecommunications Freedom. For the first half of its life, the Washington-based firm employed more lawyers and lobbyists than engineers.

In the early 1970s, MCI had first tried operating private telephone links via microwave for big telephone users, but ordinary dial-up phone service was where the real action was—AT&T's business. McGowan knew the technologies were there to compete with AT&T and develop a good business, even with a relatively modest share of the telephone market, for people would leap at lower-priced service. The great obstacle he had to overcome was government protection of AT&T's monopoly.

McGowan recalls the hours he spent in the FCC reading room and how he discovered that, while local telephone franchises were monopolies, there was nothing specific in any statute or regulation that spelled out an AT&T monopoly in long-distance service.

"Everybody thought there was a legal monopoly, even the FCC," says McGowan. "But no one could give me chapter and verse, so I went and tested it in the courts." Some test! AT&T fought him every inch of the way. And most of the time, the FCC was against him, too. But after almost 10 years of litigation and lobbying, in 1977 a federal appeals court ruled in favor of MCI, saying there was no legal basis for the FCC-AT&T obstruction of MCI's "Execunet" dial-up long-distance service.

MCI had started up Execunet back in 1975. By cleverly exploiting the bureaucrats' rules, the company had hustled the FCC into giving it a permit. Almost as soon as the regulators realized what they'd done, they tried to backtrack. But MCI was off and running. The FCC was trying to slam the stable door after the proverbial horse had bolted. It was a brilliant race through the Washington maze.

Following MCI's lead in the mad dash in long-distance competition have been a number of contenders, including General Telephone & Electronics, International Telephone & Telegraph, Satellite Business Systems, and Western Union. And as the competition has heated up, long-distance rates have cooled down.

In the case of local phone competition, then, much is going to depend on the regulatory environment of this traditionally overregulated area. For example, the question often is raised now whether restrictions preventing local telephone companies from offering coaxial cable services will be justifiable if cable companies get into telephony. One observer, Eli Noam, writing in the Federal Communications Law Journal, suggests that in places where an established cable company is allowed to use part of its capacity for phone service, authorities should then permit local phone companies to go into cable: "By pitting large carrier systems against each other, one encourages a dynamic development of technology and applications, and at the same time reduces the need for regulation."

Unfortunately, however, telephone companies and cable operators alike have developed a monopoly mentality. Recently, for example, in New York, some of the cable franchisees selected to provide service in uncabled boroughs threatened to pull out of New York, because Merrill Lynch and other developers were planning to install cable through the franchisees' areas to link a proposed Staten Island "teleport"—a collection of satellite earth stations—with the developers' customers. The cable-TV operators seemed to think they were getting some monopoly right to laying cable in these boroughs and that the city would protect them from any competition. After much discussion and negotiation, the issue, at this writing, has not yet been fully settled.

For their part, cities have shown too little interest in competition, probably on the instinctive understanding that where there's competition, there's less monopoly profit for the government to skim off and less of a case for regulation. As an illustration of this governmental bent, all around the country there are little skirmishes between city regulators and apartment owners over satellite master antenna television (SMATV), or minicable networks.

In an SMATV system, a large dish antenna receives a television signal directly from a satellite, then conveys the signal to end users' TV sets via a cable. Such systems mostly serve large apartment or condominium complexes. It makes economic sense for an apartment owner or condo association, if it has a master antenna, to sell its signal to residents in other nearby apartment blocks, as well. It appears one can legally do this if public property is avoided. But if the cable has to go over or under even the tiniest public alleyway, regulators and cable-TV franchisees, with their monopoly mentality, will charge breach of franchise regulations. Those who step on the local phone company's turf, then, will most likely encounter the same monopoly mentality.

A bill that passed the US Senate in June, concerning local cable-TV regulation, may indicate what's in store for local phone regulation. The bill asserts new federal powers over cable TV. It is too early to say whether this development is an improvement, though there may be some grounds for optimism.

The Senate bill is a mixed bag. If Congress passed the bill in its present state, it would go far in deregulating cable rates and would limit the fees and services a local government could require of a cable operator in return for a franchise. (As documented in REASON in a July 1982 article by Tom Hazlett, City Hall has done a pretty awful job with cable, entrenching monopoly and extracting for itself all kinds of goodies from cable companies as the price of a franchise.) The Senate bill, too, would allow cable to offer a wide array of telecommunications services—such as computer-data transmission—in an unregulated environment.

On the other hand, the bill would give local authorities the power to restrict or regulate the provision of basic phone service—that is, two-way voice communication—via cable. And that does not bode well for competition between coaxial cable and the local phone company, at least in voice transmission.

Moreover, the prospect of sharply rising local phone charges following the AT&T breakup creates a constituency for politicians and other regulation-minded persons to obstruct the workings of the marketplace through new controls. And indeed, in July Sen. Robert Packwood (R–Ore.) introduced a bill into Congress to "help maintain the country's nationwide telephone service at reasonable rates" (shades of 1934). Packwood's bill calls for surcharges on long-distance carriers and on "any companies that bypass the local telephone company," the revenues from which will go into a "universal service fund." This fund would then subsidize local phone service for residential customers. Not an especially encouraging sign for bypass and the benefits for consumers of vigorous competition.

It is said again and again that telephone competition favors the rich, because the average individual can't afford the investment of switching over to a bypass system. At first, that will be true. It is going to be business and the rich who will be the first big users of the new telecommunications, partly because they are big users of communications. (Something like 4 percent of the Bell System's users now account for more than 60 percent of its revenues.)

It was the rich who first got electricity in their homes, first got washing machines, and first bought automobiles. All these gadgets and technologies took time and development to become generally affordable items.

A large part of the reason America has benefited by new and productive technology has been the extent of competition—how it constantly forces providers and manufacturers to change, economize, and improve. And the lower business costs that competition forces mean lower prices for consumers. Communications is particularly in need of competition and entrepreneurship, having been especially ill-served by the dead hand of bureaucracy and government regulations.

Under the AT&T-FCC telephone trust, Americans have paid a high price for universal service as it was engineered by the government-enforced monopoly. High rates, for example, have discouraged long-distance use. Indeed, distance has been more of a communications cost than it should have. Economic activity, communications, and transport decisions have been distorted as a result.

There are enormous benefits and changes to be wrought by lower, more-realistic telephone charges and new services. Consider the impact of just one innovation, the "800" toll-free system, which is already a major factor in the deurbanization of America. "Mail order"—or "800-order" business, it should be called—is growing at twice the rate of retail sales generally, in large part because of lower rates in the context of a modern nationwide telephone system. Factories in "the boondocks" can now advertise nationally and take orders by 800-number phone calls.

"Telecommuting" is another phenomenon that modern telephony can make possible. With portable terminals hooked via telephone to remote computers and data bases, people can draw information from their offices down the phone line and feed their work back down it again, with the flick of a little switch—one marked "ANS/ORIG" (answer/originate) in the case of the Radio Shack 100 on which I am typing this article.

CALLING UP THE PAST

It has been in periods of untidy, tumultuous competition that products have been democratized and gone through their most rapid rate of growth and innovation. The history of the telephone itself is instructive.

For most of its history, phone service has existed in a near-monopoly situation under strong government regulation. From 1876 to 1894, Alexander Graham Bell's company held the patent for the telephone and thus had a monopoly on phone service. By the end of the period of Bell's patent monopoly, there was barely one telephone to each 250 US residents. Yet it was such an inherently powerful piece of technology that its rate of growth was quite good—16 percent per year.

But the telephone business really took off in 1894, when the Bell patent expired and independents were allowed to compete with Bell. For 13 years of open competition, 1894 to 1907, the number of telephones grew annually by 27 percent. By the end of that period, there was a telephone for every 14 Americans.

In their 1978 book, The Evolution of the American Economy, historians Sidney Ratner, James Soltow, and Richard Sylla describe the flowering of telephone competition:

The effects of competition in telephony were striking. Between 1893 and 1907, when the independent [telephone] movement reached its peak in relative terms, the number of phones in the US increased from 266,000 to 6.1 million. Of these, 3.0 million were independent and 3.1 million were Bell phones; Bell's market share had fallen from 100 percent to 51 percent. Although its market share had been cut in half, Bell did react vigorously to the new competition by cutting its charges to its subscribers and by adding more than ten times as many phones during 1893–1907 as it had put into service in the era of its monopoly from 1876 to 1893.

But AT&T (the Bell company formally became American Telephone & Telegraph in 1900) did not like competition. It had been making profits of 40 percent on investment during its patent monopoly period; after 1900, hectic competition from the independents reduced its rate of return to around 8 percent. The corporation saw an easier and more profitable life through a restoration of monopoly. Government regulation was the key.

By 1907, AT&T began a massive buy-up of independent telephone companies and initiated a propaganda drive against the supposed wastefulness of competition. That bore fruit in 1910, when a law put telephony under the regulatory control of the Interstate Commerce Commission—transferred to FCC jurisdiction in 1934—and competition was effectively ended. From 1908 to 1913, the growth of telephones dropped from 27 percent annually to 8 percent. From 1914 onward, under the ICC, and from 1934, under FCC control, annual growth dropped to between 4 and 5 percent.

During America's competitive telephone period, between 1894 and 1907, there developed quite a bit of service duplication. That is, people had lines and telephones from a second telephone company. On a small scale, that is starting to happen again. In some downtown areas, for example, some long-distance companies lease lines from their own exchange or central office to the subscriber. If he's a small business with "key" style telephones—each phone having buttons for each outside line—one or two keys may pick up, say, GTE's Sprint long-distance lines, and the others will be linked to the regular local telephone company. A slightly larger company with a PBX (private branch exchange) might have a least-cost routing system built into its switch. This routes long-distance calls to the cheaper carrier's lines and local ones automatically to the local company.

There's no reason this couldn't happen in people's homes, too, especially as "telecommuting," or working from home via computer, increases and people hook more devices into phone lines. Those independent lines coming into the business or home are a long-overdue revival of competition that saw the democratization of telephony in America.

Early on, "bypass" of the telephone monopoly undermined its monopoly powers, and it can do so again. During the competitive years of American telephony, AT&T's revenues per phone were halved by competition—down from $76.41 in 1894 to $35.71 in 1909. Which suggests that those who now assert so dogmatically that competition must raise costs to the householder are just way out. There is a new era on line—if we will just laisser faire.

Peter Samuel is a Washington-based feature writer for the Murdoch newspaper chain and a frequent REASON contributor. This article is a project of the Reason Foundation Investigative Journalism Fund.