The Master Switch

by Tim Wu

  That kind of language from the White House was a shock to AT&T, the longtime friend of the federal government; and yet by the late 1960s, with everything in flux, the Nixon White House and FCC began to question the continuing benefits of the Bell monopoly. In fact, the FCC had begun to entertain the radical belief that a bit of competition was not only feasible (technically and politically) but indeed might just help the cause of efficiency in the telephone system (a line of reasoning paralleling that about the cable industry). It was a paradigm shift and an ideological reordering in process: bit by bit, Theodore Vail’s faith in centralized monopoly was giving way to a new belief in the value of decentralization. And by the 1970s, both the White House and the FCC’s official rhetoric began to use terms like “competition” and “deregulation” instead of “regulated monopoly.”

  To say AT&T wasn’t receptive to the new paradigm of the 1970s would be an understatement. AT&T’s new chairman, John deButts, responded with a speech that would not have been out of place in 1916. “There may be sectors of the economy,” he said, “where the nation is better served by modes of cooperation than by modes of competition … the time has come, then, for a moratorium on further experiments in economics.” He would spend the 1970s doing everything within AT&T’s power to try to turn the river around, toward more monopoly and less competition, against all odds. He was a true Bell man, almost stereotypically so. People magazine called him “a one-company man and proud of it” and a man who “remembers the days when saying Ma Bell was a monopoly was an expression of pride.” “The sacred public mission of the Bell System not only had been drilled into his mind,” writes Steve Coll, “but had seeped into his soul.” The collision between AT&T and the tides of history are what led to the second great communications breakup of the twentieth century.2

  THE FCC TURNS ON AT&T

  The trouble began when the FCC, increasingly convinced that competition had some place in the telephone system, began to think it would be a good idea to create a few little pools, as it were, of competition, here and there, while leaving the main Bell monopoly intact. That might sound moderate, but the reaction of AT&T at the time was resistant in the extreme. It had the mentality that to give an inch was to give the whole yardstick, and so it stuck stubbornly to the conviction that it, and it alone, needed to retain total control of every element of telephony. Echoing Theodore Vail’s old condemnation of “wasteful competition,” Bell argued that any degree of it, however minor, would create chaos. Judge Richard Posner, a consultant for AT&T in the 1970s, describes their rigid belief “that nobody should be permitted to interconnect with the network.…” In particular there must be no interconnection by MCI, AT&T’s bête noire, and no attachment of terminal equipment by customers (that is, no “foreign attachments”). That was AT&T’s absolute line of defense: “not one step backwards,” as Stalin said when the Germans were approaching Stalingrad. In a 1968 submission to the FCC, Bell made the same point, if less colorfully: “Since the telephone companies have the responsibility to establish, operate and improve the telephone system,” argued Bell, “they must have absolute control over the quality, installation, and maintenance of all parts of the system in order effectively to carry out that responsibility.”3

  The FCC went ahead with creating three main “pools” of competition with the Bell system: long distance services, attachments (or “consumer premises equipment”), and “data processing” services. Let us look at each in turn.

  The company known as AT&T was born in 1885 as a long distance company, only later to become a holding company for the whole Bell Empire. AT&T had long regarded its long lines as the crown jewels of its kingdom. Indeed, long distance was the key to its power, and also central to Bell’s whole idea of “universal service”: the firm used inflated prices on long distance calls to subsidize phone service to rural communities, making good on its pledge of universality without suffering a financial loss.

  So important were the long lines, you may remember, that in the early 1900s J. P. Morgan had used his financial muscle to prevent financing of any would-be alternative network. Denying access to the long lines, meanwhile, proved an instrument of terror in the campaign against the Independents in the 1910s. By the late 1960s there had still only ever been one national long distance network, and it was the hallmark of Bell’s identity.

  Suddenly, and unexpectedly, the FCC, AT&T’s old ally in the suppression of competition, was a friend to competitors. An upstart known as Microwave Communications Inc. (MCI), founded in 1963, proposed to use microwave towers to sell cheaper private line service for businesses between Chicago and St. Louis. AT&T, of course, regarded MCI’s service as inferior, redundant, and a challenge to the universal service system. In the Bell company vernacular, MCI was engaged in mere “cream skimming” of the most profitable services (long distance for business customers) without taking any responsibility for basic services. Remember, faith in its public duty was as much encoded in AT&T’s DNA as its right to monopoly. Nonetheless, much to AT&T’s outrage, the FCC let MCI go ahead, making the microwave company for a generation thereafter the chief thorn in AT&T’s side.4

  The second pool of competition was in devices that attached to the phone lines (“foreign attachments” or “consumer premises equipment”).

  In functionality, these devices made the Hush-A-Phone that Bell had fended off in the 1950s seem a mere doodad. In a seminal case in 1968, the FCC ordered Bell to allow the connection of the “Carterfone,” a device designed to connect a mobile radio to a Bell telephone.* Based on the Carterfone advance, the FCC went further and specified something simple but absolutely essential: the familiar RJ-45 telephone jack. You have probably used the phone jack hundreds of times without realizing the hard-fought battle behind it. The modular phone jack made it unnecessary for a Bell technician to come and attach one’s phone to the phone line. More crucial, with the phone jack in place, any innovator—any person at all—was suddenly free to invent things that could be usefully attached to the phone line.5

  That phone jack and the Carterfone decision made it possible to sell to the public devices like fax machines and competitively priced (non-Bell) telephones. They also made possible the career of Dennis Hayes, a computer hobbyist (“geek” is the term of art) who, in 1977, built the first modulator/demodulator (modem) designed and priced for consumers, the so-called Hayes Modem. He built, that is, the first consumer device that allowed personal computers to talk to each other, and with that you can spy the first causal relation between the federal deregulation of the 1970s and the birth of a mass Internet.6

  The third pool of competition that the FCC created is the most obscure, but no less important. In 1971, the FCC issued a rule banning AT&T from directly entering the market for “data processing” or “online services.” These were the earliest precursors of what we now call Internet services, though in those days it usually meant accessing a more powerful remote computer to help with number crunching. The FCC decided it would reserve this market for companies other than AT&T, though it did allow AT&T to participate at arm’s length via a subsidiary. The reasoning was that if AT&T were allowed direct access to the market, it would immediately destroy any competitors and colonize the market for itself. And so, just as predatory fish are sometimes kept in separate tanks, AT&T was specifically banned from the burgeoning online services or data processing industry.7

  In short, with strange and unprecedented foresight, the FCC watered, fertilized, and cultivated online computer services as a special, protected industry, and, over the years, ordained a set of rules called the Computer Inquiries, a complex regime designed both to prevent AT&T from destroying any budding firm and also to ensure that online computer services flourished unregulated. What matters so much for the fate of telecommunications and our narrative is that the infant industry the FCC protected in the 1970s would grow to be constituted of firms like America Online, Compuserve, and other online network companies (ISPs). While those names may no longer possess
the luster they once had, in the 1990s they were the very firms that brought networking and the Internet to the American masses. In short, in these obscure and largely forgotten regimes, the new FCC played surrogate parent to the Internet firms that would later tear apart the traditional media industries and information empires, transforming the nation.

  TO THE BREAKUP

  Whereas in the 1970s the FCC saw itself as cultivating a garden of new and promising firms, AT&T saw a pestilent swamp in need of draining. AT&T was more than displeased with the government’s promotion of competition; it was enraged and, as before in its history, willing to go to nearly any length to stop it. Dipping into a vast war chest, Chairman deButts in 1976 sent his lobbyists to Congress with a bill that would reverse all that the FCC was trying to do—with provisions, for instance, that simply outlawed MCI as a threat to universal service, and reversed Carterfone and even Hush-A-Phone. When that failed, AT&T returned to its most tried-and-true modus operandi: a campaign of industrial warfare designed to exterminate its competitors.8

  Substantively, AT&T’s campaign in the late 1970s might be described with the euphemism of “civil disobedience.” Even as the FCC was encouraging firms to enter the telecommunications market, AT&T was laying traps for them that would make them regret that decision forever. But it would be Bell’s course of retaliation, not the existence of their monopoly, that ultimately would put the Justice Department to the test and move them to seek a judgment against the firm for abusing its privileged power. In this sense, Bell’s competitors served the FCC as a cape serves the bullfighter, goading the angry beast to action that led ultimately to the sword.

  The full legal story of the breakup is complex, a major historical event to which no chronicler could do justice in brief. For our purposes, let the following lineaments suffice: Through the 1970s, AT&T came up with one scheme after another to nullify the effect of the FCC’s orders and destroy the companies battening on them. For example, in the case of any foreign attachment (say, a fax machine), Bell would file a tariff requiring the competitor to establish something called a “protective connective arrangement.” Supposedly a means to “protect” the network, the scheme was a thinly veiled way of imposing additional costs and regulatory burdens. The economist and Bell veteran Gerald R. Faulhaber contends that the scheme effectively bought AT&T eight more years of monopoly in this area.9

  Meanwhile, AT&T’s greatest wrath was saved for MCI, an upstart deemed beneath contempt, deserving of the nastiest tactics from the early Bell company’s repertoire. The campaign against MCI was complex, subtle, and hard to summarize. In areas of MCI strength, AT&T took up the trusty lance of predatory pricing, trying to bleed MCI and any similar firms out of business. When enjoined by court order to allow MCI to connect their switches to its local circuits, Bell occasionally resorted to sabotage. According to one account from the other side: “on a Friday afternoon, AT&T pulled the plug on MCI’s circuits between New York and Washington. Without warning, the data line at a major Washington department store went dead, and other corporate customers were similarly disconnected.” Such conduct discouraged MCI’s customers, but unfortunately for Bell, they also gave the antitrust lawyers at Justice plenty of proof to support a claim that Bell was abusing its monopoly.10

  Although the business would be concluded under President Reagan, the will to break up Bell originated in the Nixon administration, as we’ve seen, in both the Justice Department and the White House Office of Technology Policy, headed by Clay Whitehead. Whitehead and others believed that the telephone system no longer needed to be a monopoly and that the nation would benefit from dividing AT&T into smaller parts. We do not know what President Nixon thought about breaking up AT&T—though perhaps, as the tragic outsider, he considered it yet another part of the establishment that he hated.

  Like all antitrust lawsuits, the Bell case had gone on seemingly without end by the time Judge Harold H. Greene inherited it in 1978. At first, most knowledgeable observers considered it unthinkable the proceedings could end with AT&T broken up. It might, the smart money reckoned, be more aggressively forced into compliance with FCC regulations, or forced to sell Bell Labs. But an outright breakup of the nation’s telephone company, which since 1921 had provided the world’s best service? AT&T chairman deButts in 1974 made it clear that a breakup was unthinkable; he expressed disbelief that “Justice would take an action that could lead to dismemberment of the Bell System, with the inevitable result that costs would go up and service would suffer.”

  But unfortunately for deButts and AT&T, the enthusiasm in the age of Reagan for “competition” and “deregulation” exceeded even that of the Nixon era, and Bell’s continuing opposition to anything other than monopoly was, in that environment, a blasphemy. As the years carried America farther into the new decade, and as more and more evidence was presented, the arguments of AT&T’s defense counsel, virtually reconstituting Vail’s speech of 1916—competition is bad, monopoly good; rivals are just “cream skimmers”; AT&T needs total control over telephony for the good of the nation—steadily lost their cogency.

  True, the FCC had once agreed with all of these ideas. But times change, and so do regulatory regimes. As Harold Greene, the district judge who presided over the breakup, put it, “AT&T had an obligation to follow the more recent FCC policy rather than the Commission’s previous policies which may have suited it better.”11

  At some point, and it’s hard to say exactly when, AT&T finally began to recognize the existential peril it was in. Some say it happened after Judge Greene’s incisive rejection of the firm’s 500-page motion for dismissal.* It might have been earlier: John deButts, the most Bellheaded chairman in the firm’s history, resigned in 1979, by some accounts because he realized that a breakup was inevitable and he wanted no part of a Bell divided. DeButts died two years after the breakup, which he never stopped referring to as a great tragedy. “Up until his death,” read his obituary in The New York Times, he “fervently believed in the Bell telephone system.”

  Whatever the trigger, what remains so fascinating is how much Bell, under its new chairman, Charlie Brown, conceded, and how quickly, once it took on board the likelihood of defeat.12 In a compromise worked out with Justice, the greatest firm in communications history agreed to be divided into eight pieces—not slapped on the wrist, or even chipped away at, but virtually sliced and diced. The firm held on to its long distance services, Bell Labs, and Western Electric, its equipment manufacturer. But seven separate regional operating companies would be carved from the corporate carcass, the local monopolists now released as independent companies. Since each of the so-called Baby Bells would continue to have an effective monopoly over local services, however, each was placed in a newly designed regulatory cage of reinforced and toughened FCC rules. Each would be obliged to accept connections from any long distance company (not just their former parent), and all were explicitly shut out of new markets such as online service and cable.

  AT&T did make a final attempt at challenging its own agreement in court. Yet Judge Greene was by now wholly unsympathetic; indeed, his decision affirming the breakup could easily have been written by Thurman Arnold, the antitrust fundamentalist. “It is antithetical to our political and economic system,” wrote Greene, “for this key industry to be within the control of one company.” The United States had tolerated, even encouraged, a monopoly of its most important industry for nearly seventy years. But it would no longer.

  It fell to Charlie Brown, the last chairman of a united AT&T, to announce to the world in 1984 the breakup of the world’s greatest communications monopoly. Trying to put a hopeful face on what was in effect a corporate funeral, Brown chose to introduce on the same day a new AT&T logo, a globe graphically girded by lines, replacing the old bell that had long signified corporate liberty virtually without limits as well as the founder’s name. “Today signals the end of an institution … the 107-year-old Bell System,” announced Brown, “and the start of a new era in telecommunication
s in this nation.” With that assertion no Bell antagonist could argue.13

  The Empire, divided

  DeButts and the old Bellheads were right about the immediate effects of the breakup. An American public wearied and bewildered by the years its government had spent hounding the nation’s most reliable corporation* would very shortly face a rude awakening to inflated and complicated phone bills, including all sorts of mystifying connection fees and surcharges. (The degree to which the long lines had been subsidizing loss-leading markets throughout the country was greater than even Bell itself knew!) It would be some years before these inconveniences were offset by the fruits of innovation. On the other hand, when the innovation pent up by the Bell system came out, it was not a trickle but a tidal wave, in computing, telephony, networking, and everything else that has defined the information economy of the last thirty years.

  It is always to be preferred that the Cycle proceed of its own accord. The examples of the Paramount decree and the Bell divestiture are both tales of much that is bad and ugly arising before the eventual good of an open industry. There is an undeniable efficiency that attends a monopoly’s doing what it has been perfected to do, whether that be to turn out a certain kind of film or provide a universal phone service. What such well-oiled machines do not do so well, however, is initiate the sort of creative destruction that revolutionizes industries and ultimately multiplies productivity and value. And where information is the ultimate commodity, the multiplier effect is incalculably great. It is too much to ask of any corporate entity—pace Theodore Vail—to be the guardian of the general economic good. That interest will always be served by disruptive innovators, however much inconvenience they may visit upon us.

  * Today, in telecom jargon, a “Carterfone rule” is one that allows consumers to attach whatever they want to a network, physical or wireless.