CHAPTER 2
The telecommunications industry in the USA up to 2000
‘What use could this company make of an electrical toy?’
– William Orton, president of Western Union, 1876
In the first decade of the 20th century, AT&T was losing the battle against its independent rivals, which owned over half the exchange lines in the USA and were offering rates that were well below those AT&T would have preferred to charge. The company’s balance sheet was showing increasing levels of debt.
The financier JP Morgan was very quick to spot an opportunity, and in 1903 he began to acquire AT&T’s publicly traded bonds. By 1907 he and his associates in New York and London had taken control of the business; and within a decade the debt had been brought under control, service quality had improved, and a secure path to the future was being established through an emphasis on technological research, an effort that resulted in the creation of the world-renowned industrial research and development outfit Bell Telephone Laboratories (Bell Labs) in 1925.
In 1910 AT&T acquired a 30% interest in its former rival, Western Union, and for the first time telegrams could be sent over telephone lines, creating a second revenue stream from the same set of assets. At the same time AT&T continued to acquire as many independents as it could. Complaints that AT&T was anti-competitive led, in 1913, to the company’s opening up its long-distance network to its local-exchange competitors.
Technology continued to improve. New electrical components were invented that enhanced sound quality and the range of the signal, reducing the need for expensive amplifiers and the complex task of error correction.
New milestones were passed at an accelerating rate: the first transcontinental call was made in January 1915, when Alexander Graham Bell in New York successfully called his former collaborator Thomas Watson in San Francisco. By October that year, the Atlantic had been crossed by the first wireless call.
Efforts to improve on automatic-exchange design continued throughout this period. The first automatic exchange, the Strowger, had been invented in the late 1880s by Kansas City undertaker Almon Strowger, after he realised that he was losing business to his main competitor because the latter was married to the woman who operated the local telephone exchange. Strowger began experimenting with brass collar studs, metal pins, and created a machine that would bypass his competitor’s interfering wife. He was awarded a patent for the device (also known as a step-by-step or SXS switch) in the same year and, together with a few relatives, he founded the Strowger Automatic Telephone Exchange Company and began marketing the new invention to the various telephone companies scattered across the USA.
In 1915 Western Electric designed a ‘coordinate selector’, which was to form the basis for the first ‘crossbar’ switching, allowing any input to be connected to any output. The design was subsequently improved and enhanced, and in the years after the Second World War, crossbar exchanges replaced Strowgers in many markets around the world.
The First World War saw huge growth in the use of the telephone, both at home and near the front line. By 1920 over two thirds of all lines were still in the USA, where the total had risen to over 16.5 million; and by the end of the 1920s the US accounted for over 20 million lines, still some two thirds of the total.
International Telephone and Telegraph (ITT) was formed around this time, by the brothers Sosthenes and Hernand Behn, with the aim of building a global telephone network. Their first major move on to the global stage came in 1924, when ITT took a controlling stake in Compañía Telefónica Nacional de España (CTNE), a company that had been formed to consolidate several regional operators in Spain. (Today, this company is known as Telefónica.) The ambitious Behn brothers followed this a year later with an even bigger deal: to keep the antitrust hounds at bay, AT&T had agreed that its Western Electric manufacturing subsidiary should divest itself of its international assets. ITT bought them, including British International Western Electric, which was renamed Standard Telephones and Cables (STC).
Then the Wall Street crash of ‘Black Monday’ in late October 1929 changed everything. The growth of phone connections stopped altogether and the industry began to go into reverse. By 1934, the number of lines in the US had been reduced to just under 16.9 million, a 16.5% drop from the 1930 peak. In just four years, the US lost more telephone lines than there were in the whole of Germany, the world’s second-largest market. (It would be another five years before the US got back above 20 million, just in time for another world war.)
AT&T suffered as the largest provider, but the crash almost eliminated some of its smaller rivals.
In the post-war period great strides were made in several key technologies that are central to today’s telecommunications industry. The first took place in June 1946, when the Southwestern Bell (SBC) division of AT&T launched the first car-phone service.
This early manifestation of the mobile telephone had several disadvantages: it weighed about 35 kilograms and took up most of the space in a car’s boot; it cost a lot, with the monthly subscription set at $15 and call charges of 30–40c for a local call (about $205 and $4.15–$5.50, respectively, in present-day values); and capacity on the network was very limited, as the amount of bandwidth made available for the service was strictly rationed. America’s Federal Communications Commission (FCC) wasn’t inclined to give the new service access to much of the available radio spectrum, which was, after all, a scarce and potentially valuable resource – and might it not be better used to provide TV?
Someone had already thought of a way of improving capacity, however: in 1945 EK Jett, the then-head of the FCC, mentioned the idea of ‘small zone’ (or cellular) systems and noted that by such an arrangement ‘in each zone the … frequencies will provide 70 to 100 different channels, half of which may be used simultaneously in the same area without overlapping’.2
Bell Labs put a lot of thought into the cellular concept, and in 1947 two of its engineers proposed a hexagonal structure for the cells. Bell also considered whether such a system would be a commercial success – and concluded it would not.
On 5 October 1957 the world awoke to the news that the Soviet Union had launched an artificial satellite into orbit. The spacecraft, Sputnik 1, could only broadcast a series of bleeps back down to Earth, having no capability to transmit a received signal. However, its very existence was enough to alarm the US and thus the ‘space race’ began.
The end of the 1950s and early ’60s saw further development efforts from the Americans and their allies, which culminated on 10 July 1962 with the launch of Telstar, the world’s first communications satellite.
Another giant leap into the future took place in the 1960s, when the first commercial integrated circuits arrived. An integrated circuit is an electrical circuit with all of the components integrated on a single common surface, usually silicon. Gordon Moore, one of the early pioneers of integrated circuits, noted that the number of transistors on an integrated circuit of the same size roughly doubles every two years – the famous ‘Moore’s Law’.
On 3 April 1973 Dr Martin Cooper of Motorola in the USA made a call to Dr Joel Engel, his rival at Bell Labs, using the world’s first hand-portable cellular radio telephone. Cooper’s phone weighed just over a kilogram, was 23 centimetres long, 13 centimetres deep and 5 centimetres across – but it worked. (Cooper later confessed that he’d been inspired by 1940s comic-strip detective Dick Tracy, who used a two-way wrist radio – a fictional precursor to not only the mobile phone but the smartwatch too.)
In the USA, the ground had been prepared for competition in telecommunications by a series of decisions taken by the FCC in the late 1960s. Carter Electronics, a small electronics company, had developed a device that allowed someone using a two-way radio (such as those used by delivery companies and taxis) to connect to a third party through the public-telephone system, and the FCC granted permission for the Carterphone to connect to AT&T’s network. As this decision threatened AT&T’s ability to determine what kind of equipment could be connected to its network, it appealed against the FCC ruling in the US Court of Appeals. It lost both the case and at the same time its monopoly on the supply of subscriber equipment.
Then, in 1969 a small company, Microwave Communications Inc. (MCI), was granted licences to build a series of microwave relay stations to provide long-distance connectivity to users of two-way radios. It soon became clear to AT&T that MCI might represent a threat to its monopoly long-distance business, and some of AT&T’s local operating companies started making it difficult for MCI to achieve satisfactory interconnection terms between the local and microwave network. MCI filed an antitrust suit against AT&T in 1974.
MCI’s case was hugely strengthened when later that year the Department of Justice joined in, filing another suit against AT&T that called for the corporation – the world’s largest by value at that time – to be dismembered.
Eventually, in 1982, AT&T announced that the company had voluntarily agreed to break itself up, separating manufacturing and long-distance operations from those of the local exchange companies.
On 1 January 1984, the old ‘Bell System’ re-emerged as the new Bell System consisting of eight separate companies, a long-distance company and seven so-called ‘Baby Bells’. These were all about the same size but had very distinct geographic and economic characteristics: NYNEX (the New York and New England Exchange Company), Bell Atlantic (which served the eastern seaboard), BellSouth (most of the southern states), American Information Technologies Corp. (Ameritech, the midwest), Southwestern Bell (Texas and the rest of the south), US West (14 states from the Dakotas across to the west coast) and Pacific Telesis (PacTel, California and Nevada).
These regional companies were given the right to apply for the new cellular licences. According to some sources, AT&T had been offered the mobile business, but turned it down on the grounds that ‘it’ll never be more than a marginal thing’. This was something of a misjudgement, but AT&T wasn’t alone in drawing this conclusion.
This first licensing process in the USA wasn’t a straightforward process. The FCC set a common technology standard that all operators were required to use: AT&T’s Advanced Mobile Phone System (AMPS), an analogue or ‘first-generation’ cellular design. Next, it divided the country into 306 separate regions. Within each of these, the available spectrum was divided into two equal blocks, ‘A’ and ‘B’. The B block was to be given to the local phone company, the ‘wireline operator’, while the A block would be awarded after an auction to a so-called ‘non-wireline operator’ – a new entrant into the telephone market.
Awarding the B-block licences was a comparatively straightforward process, as this usually meant giving the licence to the local Bell company. In those instances where there was more than one operator in the franchise area, the wireline companies generally came to some kind of joint-venture arrangement, with proportionate equity stakes – not a matter to concern the FCC.
The A-block licences were quite another matter, and with each successive tranche of licences, 50 or even 100 bids for the same franchise weren’t uncommon. In the end, the FCC gave up, and in 1984 it called on an obscure piece of legislation that allowed it to offer the licences by way of a lottery. It took the best part of a decade for some of the smaller licences to be awarded, by which time the B-block operators had been up and running for quite a while – and had secured all the most attractive customers.
As the dust began to settle after the initial US licence awards, eight large mobile-telephone operators emerged – one was owned by General Telephone and Electric (GTE), the largest US independent operator, while the seven others were the mobile subsidiaries of the ‘Baby Bells’.
With the launch of the US cellular network in 1983, the total number of countries with functioning mobile networks worldwide amounted to six (or seven, if you count the private NMT network launched in Saudi Arabia to keep the royal family in touch with each other). More followed in 1984, as the technology spread across the world. AMPS was preferred in most markets.
The FCC awarded the first A-block licences in 1983; a young entrepreneur called Craig McCaw won several of them. By 1986 McCaw had only 14,800 subscribers across 12 markets, who together generated revenues of less than $300,000. The young man still had the firm conviction that mobile was the coming thing, however. That year he bought MCI Airsignal, which had been awarded several key non-wireline licences, giving his company six further markets and minority interests in another five. This established McCaw Cellular as by far the largest of the non-wireline operators and it was well on its way to becoming the largest cellular operator in the country.
In 1984 BellSouth took its first tentative steps down the cellular path, bolstering its presence in one of its home states with the creation of new cellular joint ventures with other local-exchange operators. In 1986 BellSouth bought a 15% stake in the ambitiously named Mobile Communications Corporation of America, which had interests in cellular properties in several key markets outside the BellSouth footprint. It bought the remaining 85% of the business in 1988.
PacTel struck next, in early 1986, with the acquisition of Communications Industries, which would eventually become a joint venture between PacTel (subsequently AirTouch) and McCaw. SBC jumped on the bandwagon in early 1987. Later the same year, PacTel was back in action again, acquiring stakes in several large midwest franchises.
McCaw Cellular went public in 1987. The shares were ‘speculative and involve[d] a high degree of risk’3 but this failed to deter investors. The issue was oversubscribed and traded up from $21.75 to $24.50 on day one.
On 19 January 1989 British Telecom (BT) surprised everyone when it announced that it had formed a partnership with McCaw, acquiring a 22% stake in the business. Bringing BT on board gave McCaw much-needed additional resources. As the company’s presence in the US expanded, McCaw began developing plans to offer a complete national roaming service, such that any of its subscribers in any of the company’s many markets could use their phone anywhere in the country.
In 1989 McCaw’s acquisition of the controlling interest in LIN Broadcasting made McCaw the clear number one in the new mobile market, with an enlarged business a footprint that contained over 100 million potential customers – but the company was saddled with debts of more than $5 billion.
In 1990 GTE bought Continental Telephone, propelling it into second place in the market, behind McCaw. And in late 1991 Bell Atlantic announced the acquisition of Metro Mobile CTS, the second-largest independent cellular business in the US, in a deal that gave Bell Atlantic a further 180,000 cellular subscribers to add to its existing 283,000.
In 1994, belatedly realising that its decision to ignore mobile had been a bad one, AT&T bought McCaw Cellular for $12 billion.
In October 1993, a decade after the first cellular launch in the US, the FCC announced that it intended to increase competition in the market by auctioning additional licences. These licences weren’t for plain old cellular, they were for an entirely new service – the so-called personal communication service (PCS).
Once again, the FCC divided the country into numerous regions. The spectrum reserved for the new service was in the 1.9GHz band and had been divided into six separate blocks, designated A to F.
These auctions were problematic for several reasons, including that the A, B and C blocks contained three times more spectrum than the D, E and F blocks, with 30MHz of available bandwidth against just 10MHz; and that there was no obligation to use any particular technology – each operator could decide which of several competing standards they preferred. Further, the C and F blocks were reserved for ‘designated entities’ (new entrants, owned by minority groups).
To reduce the number of possible competitive bidders and improve their chances of achieving national coverage, four of the largest cellular companies agreed to pool their resources. AirTouch joined up with Bell Atlantic; NYNEX and US West to form a consortium called Prime PCS; and Sprint created Wireless Co. out of a new Sprint subdivision, Sprint PCS, together with three large cable companies that included Comcast. The auction generated over $23 billion in fees for the US Treasury.
Other parts of the industry were also changing. By the start of the 1990s, three giant transatlantic alliances had been formed to address the needs of the corporate market: AT&T had allied itself with Unisource, a consortium of four European companies (KPN of the Netherlands, Swisscom, Telia from Sweden and Spain’s Telefónica); France Telecom and Deutsche Telekom had created Global One in partnership with Sprint, the third-largest US long-distance operator; and BT had teamed up with MCI to form Concert.
Then, as the decade progressed, telecoms operators became increasingly aware that they needed to become larger if they were to cope with the challenges of a competitive market. Size did matter! Bell System began to reassemble itself. In 1995 Bell Atlantic and NYNEX merged their cellular interests to create a business with a single unified network, and the following year the two parent companies merged in a deal that created an organisation with over 40 million phone lines, well over a quarter of the national total.
SBC completed an acquisition of PacTel in 1997, the third largest in US corporate history, which created the second-largest telecoms company in the US, behind AT&T. Then, in 1999, SBC merged with Ameritech to create the country’s largest phone company, with some 57 million phone lines and a market value of $62 billion.
An aggressive newcomer was also being disruptive. WorldCom, which began life in 1983, had become the fourth-largest long-distance company in the country by 1997, behind AT&T, MCI and Sprint. In October that year it acquired MCI. (In 2002 WorldCom admitted that it had misrepresented its earnings, inflating them by $3.8 billion – the largest such fraud in history. Verizon bought the business in 2005, after it had emerged from bankruptcy protection.)
In 1999, Vodafone merged the US cellular interests it had acquired when it bought AirTouch with Bell Atlantic’s mobile business, taking a 45% stake in the enlarged business. The new company was initially called Bell GTE but subsequently Verizon Wireless. It was more than twice as large as the next-largest operator, AT&T Wireless, with a presence in 49 of the top 50 markets; it covered over 250 million of the country’s 280-million population, including a significant proportion of those living in rural areas.