A brief history of competition in telephony 1880-1900

Back in 2017, Jonathan Taplin, made his case in the New York Times for breaking up Google by relating the early history of telephony:

Consider a historical analogy: the early days of telecommunications.

In 1895 a photograph of the business district of a large city might have shown 20 phone wires attached to most buildings. Each wire was owned by a different phone company, and none of them worked with the others. Without network effects, the networks themselves were almost useless.

The solution was for a single company, American Telephone and Telegraph, to consolidate the industry by buying up all the small operators and creating a single network — a natural monopoly. The government permitted it, but then regulated this monopoly through the Federal Communications Commission.

But, as Aswath Rao pointed out, the buildings of Boston were connected with a nest of wires in 1881 as well. Why is this specific picture important? Bell’s patents on the telephone expired in 1893, which sparked the independent revolution, so it was impossible for any competitor to exist before then. Why then were buildings inundated with lines in 1881 as well? At the time, lines were single use. So if you had 20 telephone lines in your building, you had 20 lines on the outside. Around 1910 multiplexing was introduced, which allowed for multiple messages to be transmitted along a single line.

The history of early competition in the telephone is more nuanced than retrospective stories stifled by the constraints of newspapers allow. And if we are to look to the past to gain some insight about our present situation we need to be careful not to commit the historian’s fallacy of presentism, anachronistically interpreting the past through present-day ideas and perspectives.

Of course, there’s no malice to be heaped on any historical interpretation. As Richard Gabel, a leader within the Office of Telecommunication at U.S. Department of Transportation noted in 1969, “There is no general theory of public utility regulation. What often passes for theory is a reconstruction of historical events woven into a pattern of generalization to meet contemporary issues.” The rest of this piece is my effort to understand how competition developed in the early telephone era. It is an ongoing effort, so pardon the dust. But like all analytic works of this type, it uses the lens of today to understand the past.

While there are important predecessors like Antonio Meucci and controversies involving Elisa Gray, the beginning of the AT&T story starts with a series of patents by Alexander Graham Bell in 1876. Within a year, Bell had set up an exchange in Connecticut.

As his company, the American Bell Telephone Company of Boston, grew throughout the 1880s and 1890s, the company was like other nascent industries, capital constrained and loosely organized. The multidivisional form that we are used to, where a company has clearly defined departments organized around financial targets, simply didn’t exist. Even the precursor corporate form, known as the unitary form, didn’t really apply to the Bell system at the time. Instead, local agents or entrepreneurs in a region would establish a company and then contract with Bell in Boston to lease the technology. Bell owned a large share in the largest exchanges, like those in New York and Chicago, but these were special cases at the beginning.

Historian Robert MacDougall explained,

The so-called Bell System was thus not a single entity before the 1910s, but rather an association of affiliated operating companies, each with considerable autonomy. Before the turn of the century, executives at American Bell and the local operating companies rarely spoke of a single “Bell System.” Only their competitors and enemies, who accused Bell of being a monolithic and monopolistic trust, used that sort of language. Bell executives spoke instead about “American Bell and its associated companies,” carefully emphasizing the independence of the regional operating firms.

Early in the history of the company, the problem of sourcing capital became apparent. What was effectively franchising was preferred because the Boston company didn’t have the capital to bring the technology into homes across the United States. In a similar fashion, Bell of Boston also didn’t have the ability to build long distance lines, which required massive investment. It was the development of these lines by the American Telephone & Telegraph company, a Bell subsidiary in New York City that changed the industry and the company. Since New York had a more permissive set of laws for corporations, AT&T came to acquire Bell in the late 1880s, thus becoming the holding company.

Theodore Vail, who would become famous as the consolidator of the telephone company, was tasked to head this new company. But right out of the gates, one of the first projects to connect New York and Philadelphia was a bust, since neither of the local companies made the adjustments necessary to actually allow for long distance service. Vail left AT&T in 1887, just as the patents were to run out and when he was back at the helm of AT&T twenty years later, much had changed.

In Vail’s absence from 1894 to 1907, the independents grew rapidly. Where the Bell system had generally served businesses, the entrants diversified into residentials service, introduced innovations like the handset and the automatic switch, and began to compete on price. Early AT&T was singularly focused on a single market, that of businesses. It was a monopoly and, “Monopoly pricing had its counterpart in restricted growth.”

As they grew, they contacted with each other to exchange traffic. Milton Meuller noted,

A typical independent operating company owned exchanges in ten to thirty key cities and signed long-term, exclusive connecting contracts with independent exchanges they did not own. On the borders of their territories, they entered into agreements with the neighboring independent regionals for the interchange of traffic.

In most cities, there weren’t 20 competing companies that didn’t interconnect, as Taplin notes. With the exception of isolated systems in Dallas, Atlanta, Mobile, and Shreveport, the regional independents were all physically connected. In more sparsely populated regions, telephones would be owned like a coop. The Census wrote about this group in 1922, admiring “the large number of farmer or rural lines.” The report continued, explaining the importance of interconnection:

Although practically always connected with exchanges, these lines are, in many cases, owned jointly by the individuals who have telephones connected with them and not by the companies owning the exchanges. Lack of a central ownership, and sometimes even a definite name, makes it difficult to secure information in regard to lines of this character.

Telecommunication networks are often assumed to have economies of scale, but actual data from the period clearly show this isn’t the case. As Douglas Galbi details, the average operating expense per telephone rises with the logarithm of the number of telephones served. So, the average operating expense per telephone for a million-unit network was about double that of a telephone network serving a thousand telephones.

The natural monopoly story needs revision. As industry historian Richard Vietor detailed, “Vail chose at this time to put AT&T squarely behind government regulation, as the quid pro quo for avoiding competition.” He continued, “This was the only politically acceptable way for AT&T to monopolize telephony.”

In future, I will be exploring this topic in more detail.