The Telecommunications Industry

Once upon a time, the telecommunications was offered up by most regulatory economists as the classic example of natural monopoly. The telephone industry seemed to have the structural features that made it a perfect candidate for public regulation, including:

	Economies of scale and scope (economies of scope between local telephone service and long distance service).
	High fixed costs. Long distance transmission can be done via copper or fiber optic cable, microwave, or satellite transmission--all three methods entail high fixed costs. The cost of constructing an infrastructure for the delivery of local phone service is staggering.
	Common costs: Costs identifiable with supplying a product set.
	Inelastic demand (particularly for local telephone service).
	Externalities.
	Demand is subject to time-of-day and time-of-year variability.

Structure of the industry prior to the 1982 consent decree (known as the Modified Final Judgment)

	American Telephone and Telegraph (AT&T) was formed as a subsidiary of American Bell . Western Electric, the Denver-based telecommunications equipment manufacturer, was an affiliate of American Bell. AT&T subsequently became a telecommunications behemoth, dominating markets for telecommunications equipment, long distance and local telephone service.
	Click here to view the Structure of AT&T

The regulatory environment prior to 1982

	There are two principal (and opposing) views about the history of telecom regulation: (1) It was a rational response to the structural characteristics of the industry; or alternatively (2) It was a case of AT&T dominating what should have been a competitive industry by means of "capture" of regulatory power.
	The Mann Elkins Act of 1910 to regulate the intercity communications market. The ICC had the power to regulate entry and exit of carriers in the long distance market. It also regulated long distance rates.
	Regulatory authority was transferred to the Federal Communications Commission with the Communication Act of 1934.
	State public service commissions regulated local telephone rates. Most often they employed average cost pricing.

	Since overhead or fixed costs represent a large proportion of total cost, long distance an local telephone rate were determined to a large degree by the FCC allocation of common costs between the respective services.
	FCC officials decided early on that the agency should emphasize the universal service objective. AT&T, through its Bell Operating Companies (BOCs) should provide service to nearly everyone at "affordable rates."
	To meet the universal service objective, FCC used value of service pricing in the long distance segment to "compensate" AT&T for slim (and sometimes nonexistent) margins on local telephone service.
	Disproportionate share of common costs allocated to long distance service.
	Long distance service become AT&T's cash cow that in effect cross-subsidized local telephone calls.

The 1956 consent decree

	The DOJ filed a § 2 (Sherman Act) suit against AT&T in 1949. The DOJ claimed that AT&T leveraged its monopoly position in telephone service to create a "captive market" for telecoms equipment affiliates (Western Electric and GTE). Captive market for handsets was especially lucrative
	Justice pushed hard for spin-off of Western Electric in negotiations with AT&T.
	Final terms: AT&T retained equipment affiliates but prohibited from entering the computer industry.
	Depending on your point of view, the 1956 consent decree was either a humiliation for DOJ or a disaster for AT&T, since it was prohibited from entering the computer industry on the front end of an explosive growth phase. [Some say the big winner in the 1956 consent decree was IBM].

The FCCs "Above 890" decision

	FCC terminated AT&T's exclusive rights the frequencies above 890 megacycles in 1959. The Above 890 decision created an opening for MCI.
	Prevailing rate levels left AT&T vulnerable to cream-skimming in the long distance segment.
	AT&T attempted to block MCI's entry with a 2 pronged strategy

BOCs set entry-deterring rates for local interconnection privileges.
Intense lobbying effort stressing the universal service objective.

	MCI sought relief through FCC administrative hearings, then filed suit against AT&T in 1974.
	The DOJ filed suit the same year, beginning a protracted legal battle that culminated in the 1982 consent decree.
	MacAvoy and Robinson note that "in essence AT&T had illegally manipulated its dominant position in three sets of telecommunications markets--equipment, local exchange, and long distance--in order to monopolize the entire domestic telecoms industry. The [DOJ] accused AT&T of illegally refusing to provide competitors with local interconnections service and of setting entry-inhibiting prices in potentially competitive parts of its business" [Winning by Losing, p. 14]

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