For The Last Time: The Bell System Monopoly Is Not Being Rebuilt

by on April 22, 2011 · 6 comments

Believe it or not, this argument is being trotted out as part of the pressure from consumer activist groups against AT&T’s proposed acquisition of T-Mobile. The subject of a Senate Judiciary Hearing on the merger, scheduled for May 11, even asks, “Is Humpty Dumpty Being Put Back Together Again?”

It seems because the deal would leave AT&T and Verizon as the country’s two leading wireless service providers, the blogosphere is aflutter with worries that we are returning to the bad old days when AT&T pretty much owned all of the country’s telecom infrastructure.

It is true that AT&T and Verizon trace their history back to the six-year antitrust case brought by the Nixon Justice Department, which ended in the 1984 divestiture of then-AT&T’s 22 local telephone operating companies, which were regrouped into seven regional holding companies.

Over the last 28 years, there has been gradual consolidation, each time accompanied by an uproar that the Bell monopoly days were returning. But those claims miss the essential goal of the Bell break-up, and why, even though those seven “Baby Bell” companies have been integrated into three, there’s no going back to the pre-divestiture AT&T.

The Bell System monopoly was vertically integrated. Not only did it have a monopoly on local services, it operated the only long-distance company, it handled all incoming and outgoing international calls, and, most important, its wholly-owned subsidiaries, Bell Labs and Western Electric, developed, manufactured and sold all network equipment from the switches and cable to the phone in your home and office.

The claim that that AT&T and T-Mobile merger will remake the Bell System is undone by recalling why AT&T was broken up in the first place. It had little to do with it being a monopoly provider of residential telephone service. Remember, in the final judgment, the seven spin-off companies retained their local monopolies.

The problem was that AT&T was its own supply chain. As such, in the 1960s and 70s, as the computer industry was going through massive upheaval because of rapid and disruptive strides being made by semiconductor companies, AT&T remained insulated in a bubble. Since AT&T only bought from AT&T, AT&T could dictate the pace of telecom technology evolution, say from mechanical switches, to electronic to digital. This was virtually opposite the situation that was happening with computers and data networking, where central mainframe-based architectures were disintermediated by distributed computing. IBM and Sperry were giving way to Digital Equipment Corp. and Wang, and ultimately Microsoft and Apple.

It’s arguable, at least, that the demand for faster data networking, driven by the trend toward distributed intelligence, created the policy pressure for the Bell break-up and competitive telecom in general. MCI, which provided the first long distance alternative for businesses, appeared on the scene in the late 70s. At the same time, spurred by the 1968 Carterfone decision that permitted end-users to attach their own terminal equipment to AT&T network, intense competition broke out for office phone systems, especially those that could integrate data networking. More and more, it seemed as if AT&T’s ironclad grip on the U.S. public network was an obstacle to innovation, not the enabler it had purported itself to be for decades (and one of the legs on which it rested its whole “natural monopoly” argument).

In fact, conventional wisdom at the time was that the government was going to force AT&T to divest Western Electric and Bell Labs in order to create a competitive market for network infrastructure. Divestiture accomplished this somewhat, because it separated local exchange infrastructure from AT&T’s control. Ironically, it was market forces that accomplished what regulators had hoped to, when, in 1996, AT&T divested Western Electric, because by then, AT&T itself was the Bell companies’ biggest competitor, and that was straining its ability to sell into that segment.

So while the divested Bell companies have re-merged, even to the point of consuming their former parent, they have no control over the supply chain, and therefore, cannot control prices or product development the way AT&T did pre-break-up.

Keeping things in the context of wireless for now, as that’s what’s driving the AT&T and T-Mobile deal, it’s clear consumers are impatient for the latest smartphone models. Even as merged unit, AT&T and T-Mobile cannot arbitrarily choose when and where to release new technology like the Bell System once could. Quite the opposite, there continues to be an ongoing race as to which company can deliver the most popular phones on the best terms. Case in point was the hoopla surrounding Verizon’s introduction of the iPhone earlier this spring. That was accompanied by price cuts as well as hints of the new iPhone model expected in the fall. In the meantime, a geek war has broken out over the utility and relative benefits of Apple’s iOS-based iPhone and Google’s Android operating system. Certainly the debate gets confusing, overwrought and tiresome, but that’s because consumers can vote with their pocketbook. In the Bell System days, there were no such dialogues because there was no such choice.

Most other arguments fall apart, too. Size by itself is not an antitrust argument. Nor is duopoly or triopoly. It takes a certain level of capital and heft to operate a nationwide network, and the fact that post-merger, there will still be three national companies competing alongside regional players speaks to the competitiveness of the industry. AT&T and Verizon have similar market share numbers, and although Sprint lags, it has a healthy share of the government sector. It is not as weak as the media suggests.

Market share also is an imprecise measure of competition and consumer harm. A company with 80 percent market share may be doing nothing illegal. It can be holding that level because low prices and innovative products yield loyal customers. Cisco Systems, which makes Internet routers and switches, is a great example. It dominates the segment, yet does through aggressive innovation, quality products and strong customer support.

At the same time, we have seen companies whose market shares pundits have deemed unassailable wilt in the face of a newcomer who can provide more utility or expose a weakness. Witness Firefox against Explorer; Facebook against MySpace, and in wireless devices, Apple against Nokia.

Others have raised the customer service issue–that AT&T consistently ranks low in customer service surveys. This metric itself cannot be used as a “customer harm” because there is no predicting how this might change with the mix of T-Mobile (which has good customer satisfaction ratings). Measurements are also subjective. Everyone complains about the phone company. Yet, in AT&T’s case, the equally measurable popularity of the iPhone seems to offset those complaints. It also undermines the market share argument–begging the question of why a company whose service is reportedly so inferior poses such a threat to competition. But just to be skanky, if antitrust approval hinged on customer service, United Airlines would never been allowed to merge with Continental.

A valid antitrust case must show the merger will allow AT&T to illegally or unfairly limit options for consumers. In U.S. antitrust law, this usually means determining whether a dominant company can it use its size to undermine or drive out otherwise healthy competitors by controlling access to other parts of the supply chain—such as manufacturing, transportation or distribution. In modern antitrust jurisprudence, leveraging size to speed innovation, respond to market needs, or lure investment dollars is not seen as unfair or illegal. This distinction guards against the use of courts to protect or prop up uncompetitive companies. (European antitrust, however, is a different animal).

The AT&T/T-Mobile merger is a sign of maturing market, not the reconstitution of a monopoly that existed 30 years ago in an environment very different from today. Bottom line, economies of scale could not sustain seven regional telecommunications companies. Far from “unthinkable,” as one-time FCC Chairman Reed Hundt once declared, their consolidation was inevitable. A few prescient analysts, including Victor Schnee and Allan Tumolillo in the landmark study “Taking Over Telephone Companies,” predicted this very thing as far back as 1990.

Broadly speaking, we are entering a new phase of service provision, where wireless stands to be a much more competitive “last mile” technology for broadband. This will shuffle the players and the stakes again. The former AT&T companies dominate wireless, to be sure, but on the wireline side, cable companies have the competitive advantage. The right approach to this merger would be to view it in the context of the evolving broadband market. With this perspective, AT&T and T-Mobile won’t be one wireless company among three, but one national broadband player among six or seven.

Let the competition grow.

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