Telephone Industry

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From 1877 to 1984, the public switched telephone network (PSTN) in the United States was operated as a virtual monopoly by American Telephone & Telegraph (AT&T). Since 1984, the industry has experienced tremendous change as technology and government policy have combined to introduce competition and to expand the scope of the industry beyond the provision of local and long-distance telephone service. During its second century, the telephone industry will continue to evolve into a full-service information utility, capable of delivering telephone, data, and interactive video among other services—part of what David Goff (2000, p. 242) characterizes as "a massive transformation of global information and communication facilities."

The First Telephone Century

Alexander Graham Bell launched the first Bell Telephone Company in 1877, and the firm quickly established local telephone exchanges on the East Coast from Washington, D.C., northward. In order to connect the growing number of local exchanges, a system of "long lines" was established under a subsidiary called the American Telephone & Telegraph Company. Throughout most of the twentieth century, the Bell System built the national telephone network by creating a system of local-exchange carriers operated by twenty-two Bell operating companies and interconnected by AT&T's long-distance service. At first, independent (non-AT&T) local telephone operations were denied access to AT&T's long lines, and the company used its powerful position to acquire attractive independents to become new regional Bell operating companies. David Atkin (1998) notes that the U.S. Department of Justice threatened antitrust action against AT&T in 1913, resulting in the Kingsberry Commitment (named for the company vice-president who drafted it), whereby AT&T pledged to interconnect independent telephone companies.

The 1920s saw the emergence of radio broadcasting, and AT&T entered this new communications industry for a time. However, a series of legal disputes with other broadcasting firms distracted AT&T from its core business and once again attracted unwanted government scrutiny. As a result, AT&T sold its broadcasting properties, but continued to serve the new industry profitably by providing leased lines from the Long Lines Division for networking. The Communications Act of 1934 placed regulation of the common-carrier telephone industry and broadcasting under the same agency, the Federal Communications Commission (FCC). The administration of President Franklin D. Roosevelt set the goal of providing universal telephone service in the United States and promised AT&T immunity from antitrust action in order to achieve this goal.

AT&T was able to provide near-universal telephone service through a system of cross-subsidies. Business and long-distance customers were charged at a rate higher than the cost of service, while residential customers were generally charged at rates lower than the cost of service. In addition, urban customers were overcharged for their service, while rural customers were undercharged. Government seemed to view these cross-subsidies as a fair exchange for universal service and considered AT&T to be a "natural monopoly." Nonetheless, the U.S. Department of Justice sought to break up the company in the 1940s, but the effort was ended with a negotiated final judgment in 1956. AT&T aggressively resisted the attachment to its network of any device not approved (manufactured) by AT&T. Between 1956 and 1969, AT&T lost several legal battles against firms with new or competing technologies, including a 1969 case that gave upstart long-distance service MCI the authority to connect to the AT&T network.

The Breakup of AT&T

By the mid-1970s, AT&T, the largest company in the world, was increasingly regarded as inefficient and anticompetitive, and its once-protected monopoly status was seen as a detriment to the future of the telephone network. In 1974, the U.S. Department of Justice determined to break apart this corporate giant. In 1982, AT&T and the Department of Justice reached a negotiated settlement, technically a modification of final judgment (MFJ) from the 1956 proceeding.

Under the terms of the MFJ, the twenty-two Bell operating companies were reorganized into seven regional Bell operating companies (RBOCs): Bell Atlantic, NYNEX, BellSouth, Ameritech, US West, Pacific Telesis, and Southwestern Bell. These RBOCs, or "Baby Bells," were authorized to operate local-exchange carriers, but they could not provide long-distance service beyond the markets within each firm's territory. In addition, the RBOCs were prohibited from offering video (cable) or information services. AT&T retained its long-distance franchise, subject to competition, and was forbidden to enter the local services market.

In the aftermath of the AT&T divestiture, the cost of long-distance service has declined, initially due to the ending of cross-subsidies, and later due to aggressive competition in this sector. Generally, the cost of local service increased immediately after the divestiture, with the largest increases experienced by rural customers. Competition in local telephone service remains limited.

Convergence, the Internet, and the Telecommunications Act of 1996

By the 1990s, a shift from analog to digital communication technologies was well under way within the telephone industry. With digital technology, all information takes the same form, a code composed of bits or binary digits (0 or 1). Nicolas Negroponte (1995, p. 18) describes this phenomenon elegantly with the phrase "bits are bits." Any technology that can process or transfer digital data can handle digital representations of text, graphics, sounds, video, or other computer data. "Convergence" is the term used to describe the digital-era erosion of the technical boundaries that used to define and separate communications and media technologies and industries.

Digital signals are considered to be technically superior because they are less subject to electrical interference and signal loss than the analog variety. Both AT&T and the Baby Bells developed and employed digital technology from the 1950s onward. However, the legacy that PSTN built during AT&T's first century remains a substantially analog network designed to optimize voice traffic. In the digital era, the telephone industry has found it both necessary and profitable to adapt its vast national and global infrastructure to carry both digital data and analog voice signals. This process of change is both a cause and effect of a large-scale restructuring of the telephone industry.

The euphoric vision of an "information super-highway" emerged in the United States in the early 1990s as politicians and others began to consider the potential of digital information technologies. The emergence and growth of the public Internet after 1994 gave substance to the vision. The desire of government to enable the development of advanced information technologies and the skill of corporate and industry lobbyists combined to create the Telecommunications Act of 1996. As Wilson Dizard (1997, p. 132) describes it, "the law drastically reduced, and in many cases eliminated, the regulatory barriers between telephony, cable TV, satellites, and broadcasting in ways that permitted open competition among all digitally based services." For the telephone industry, the net effect of convergence, the Internet, and the Telecommunications Act of 1996 has been a major transformation, as firms attempt to become full-service information utilities and as new competitors enter the fray.

In the aftermath of the AT&T divestiture and the Telecommunications Act of 1996, wireline telephone services are currently provided by firms from two sectors of the telephone industry: the incumbent local-exchange carriers (ILECs) and the competitive local-exchange carriers (CLECs).

The Telephone Industry Transformed

In Trends in Telephone Service, the Federal Communications Commission (1999) reported $246 billion in U.S. telephone industry revenue for 1998. Local service generated $104.6 billion plus another $10.6 billion for toll (long-distance) calls handled within local-service areas. Long-distance services generated $94 billion, and wireless had grown to $36.8 billion. In the United States, 104.8 million households (94%) subscribe to telephone service, with each household spending an average of $809 annually (in 1997).

The ILECs, generally the RBOCs, remain a dominant force in the telephone industry. Atkin (1998) reports that the Baby Bells control 98 percent of local telephone service in the United States. A hands-off regulatory approach by the government since 1996 allowed mergers and acquisitions to reduce the number of RBOCs to four: Bell Atlantic, SBC Communications, Bell-South, and US West. In 1999, Bell Atlantic acquired the largest non-Bell local carrier, GTE, and renamed the company Verizon. US West was acquired by Qwest Communications in 2000. Despite the intent of the Telecommunications Act of 1996 to open all telephone markets to competition, the ILECs have maintained control over their core businesses, creating what both competitors and regulators call "the last mile bottleneck."

Within their local strongholds, the ILECs operate with a mixture of digital and analog technology. The consolidation that reduced the number of major ILECs has contributed to economies of scale and scope that facilitate the rebuilding of networks with optical fiber and other advanced technologies that these firms will require to become full-service information utilities, offering telephone, Internet, business data services, and video to subscribers. Sequential digital improvements in the local loop have generated new revenues for local-service providers from such services as caller ID, call waiting, three-way calling, call return, and repeat dialing. However, much of the local loop is composed of twisted-pair copper wire, an analog transmission medium that dates back to the beginning of the industry.

Prior to the 1990s, the incumbents were the only option available to businesses needing data networking services. The ILECs initiated integrated services digital network (ISDN) service for smaller businesses, and faster (and more expensive) T-1 lines to meet the needs of larger institutions. However, the data needs of businesses grew exponentially during the 1990s, and the emergence and growth of the Internet meant that a growing number of residential and small-business subscribers would need digital data connections as well. Goff (2000) reports that the existing network of the ILECs represents a $250 billion investment. Rebuilding this infrastructure to digital standards will take years. As a result, a new, second-generation type of telephone company, the CLEC, has emerged.

While most indeed offer local (and long-distance) telephone services, CLECs emerged in the digital era to provide modern data services at competitive prices. As Goff (2000, p. 248) describes them, "CLECs are free to pursue markets opportunistically and typically target businesses (the traditional cash cows of the ILECs) in high-tech markets and larger cities where faster return on investment can be found." Firms such as World-Com, Nextlink, Qwest, Williams, and ICG are building new, broadband, high-speed, packet-switched fiber networks, the "fat pipes" that are capable of carrying the growing volume of data traffic generated by businesses. These firms are also developing and operating the fiber backbone networks that speed huge volumes of digital data (including Internet data) between domestic and international business capitals.

Because the business market is so lucrative, the large-data CLECs have shown very little interest in residential telephone services. However, the tight control of the residential market by the ILECs is being challenged by competing technologies.

The cable television industry has strong potential to develop competitive telephone services and to play a role as a CLEC. Cable systems are wired with coaxial cable, a transmission medium with a large signal-carrying capacity, and cable "passes" 97 percent of U.S. households. However, cable systems were built to send signals in only one direction, and like the ILECs, the cable industry must replace analog technology with digital. Still, the per-household cost of rebuilding cable systems to function as full-service information utilities is substantially less than the cost of rebuilding the PSTN to an equivalent level of technology. Many of the leading cable firms (including Cox Communications, MediaOne, and Time-Warner) offer telephone services in selected markets. AT&T, the nation's largest long-distance company, purchased Tele-Communications Inc., the nation's largest cable multiple system owner, in 1998. This acquisition will enable AT&T to offer local telephone service in many parts of the United States and reduce its payment of access fees to local telephone companies for their role in completing long-distance calls.

The greatest challenge to the dominance of local wireline telephone service is posed by the wireless telephone industry. This new service began as (analog) cellular telephone service in 1984. Initially, two cellular franchises were awarded in each market area with one reserved for the local wireline company. Digital wireless service was initiated in 1994 with the introduction of personal communications services (PCS), a higher frequency variant of cellular technology. By late 1999, there were eighty-three million wireless subscribers in the United States, and wireless revenue was near the $50 billion level.

Portability helped this technology catch on quickly in the business community, particularly among business people on the move. Many also recognized the value of a wireless telephone as an emergency link from the car, briefcase, purse, or backpack. As the price of wireless service declined and wireless telephones became smaller, they began to appear everywhere. Despite the rapid growth of wireless services in United States, America still lags behind European countries in the percentage of wireless users. One major reason is that in the United States, wireless subscribers pay to both send and receive calls, whereas in Europe the cost of a wireless call is borne by the sender. In addition, roaming charges, additional fees that are assessed when wireless subscribers venture outside of their service provider's territory, represent a cost that is not incurred with wireline service.

In many U.S. markets, wireless telephony is very competitive, with two cellular and as many as six PCS firms vying for market share. Some of the nation's largest wireless operators, major long-distance services (e.g., AT&T, Sprint, Nextel), offer flat-rate pricing plans for local and long-distance service without roaming fees. In this way, wireless services escape franchise territories and become national in scope. In the competitive wireless market, flat-rate pricing and the elimination of roaming charges are practices that are expected to spread.

The introduction of digital PCS technology had a positive effect on the older, analog cellular services. Rather than fading away, the cellular systems converted to digital technology and developed the ability to offer basically the same range of services as digital PCS, including advanced telephone services, paging, fax, and data (even Internet) services. Increasingly, additional devices such as laptop computers and personal digital assistants (PDAs) are being interfaced with wireless technology. As the range of wireless services continues to improve and the cost continues to become more competitive with wireline rates, it is expected that a growing number of telephone users will disconnect from wire-line systems and use wireless to meet all of their telephone service needs.

As the twenty-first century began, the often-chaotic transformation of the telephone industry was continuing. Several trends were clear, however. First, the packet-switching technology of the Internet will increasingly become the preferred switching technology of the industry. The CLECs have exploited this technology, and the ILECs must continue to integrate packet switching within networks designed for a different approach (circuit switching). Second, an increasing share of telephone-related services will migrate to wireless technologies and wireless will challenge wireline businesses for market share. Residential consumers should have more choices of both technologies and providers. The predicted information utility, a single two-way connection carrying telephone, video, and data, will become a reality, but the likely provider is yet to be determined, with telephone companies, cable firms, wireless providers, satellite systems, and even electric utilities competing in this sector.

See also:Bell, Alexander Graham; Cable Television; Communications Act of 1934; Digital Communication; Federal Communications Commission; Internet and the World Wide Web; Telecommunications, Wireless; Telecommunications Act of 1996; Telephone Industry, History of; Telephone Industry, Regulation of; Telephone Industry, Technology of.


Atkin, David. (1998) "Local and Long Distance Telephony." In Communication Technology Update, 6th edition, eds. August E. Grant and Jennifer H. Meadows. Boston: Focal Press.

Baldwin, Thomas F.; McVoy, D. Stevens; and Steinfeld, Charles. (1996). Convergence: Integrating Media, Information & Communication. Thousand Oaks, CA: Sage Publications.

Bittner, John R. (1991). Broadcasting and Telecommunication: An Introduction, 3rd edition. Englewood Cliffs, NJ: Prentice-Hall.

Dizard, Wilson P., Jr. (1989). The Coming Information Age: An Overview of Technology, Economics, and Politics, 3rd edition. New York: Longman.

Dizard, Wilson P., Jr. (1997). Meganet: How the Global Communications Network Will Connect Everyone on Earth. Boulder, CO: Westview Press.

Federal Communications Commission. (1999). Trends in Telephone Service. Washington, DC: U.S. Government Printing Office.

Goff, David H. (2000). "Issues of Internet Infrastructure." In Understanding the Web: Social, Political, and Economic Dimensions of the Internet, eds. Alan B. Albarran and David H. Goff. Ames: Iowa State University Press.

Negroponte, Nicholas. (1995). Being Digital. New York: Vintage Books.

David H. Goff