The Telecommunications Industry Essay, Research Paper
The Telecommunications Industry
There are many changes that occurred in the industrial organization of interexchange
telecommunication services in the United States during the 1985-1995 period. Let?s look at the
general idea of Telecommunications. It is the two-way exchange of info in the form of voice or
data messages between tow users at distinct geographic locations? (5, 7). The two-way exchange
is now a numerous way exchange through the use of computers and the Internet. There are four
important areas of the telecommunication industry in the United States. Technology plays a
major role in telecommunications. Before technology, there was no such thing as
telecommunications. During the ten year period there are some key advances in
telecommunications due to technology. With growing technology, more companies want a piece
of the action. There is a significant increase in long distance carriers and an increase in the size
of these carriers. There is also a large influx in pricing and competition during this period.
Another key factor in the success of the telecommunication industry is the regulations
established for individual carriers and the industry as a whole. With the increasing size of the
industry and the major technological advances, stricter regulations must be present to keep the
structure of the industry. Lastly, there are some differences between local and long distance
carriers that must be looked at to fully understand the industry. There is also a fifth major aspect
that defines Telecommunications, that is the American Telephone &Telegraph Company
(AT&T) and the history behind it.
Technology is a key aspect in the growth of telecommunications. If one had to point to the single
most important reason for the new competition in local telephone markets. It is the advance of
technology. Digitalization has reduced barriers between voice telephone, data, and media
services (9, 29). Microprocessors are the principal component of digital switches. So as their
performance increases and their price falls, switching costs fall and scale and scope economies
increase (9, 13). Scope economies mean that a few companies produce many services. The
adoption of digital technology in all aspects of the network has improved performance and
lowered costs. Digital transmission, whether over copper of fiber cables or over the airwaves, is
cleaner and more secure due to more durable cables(9, 16). Technological advances such as fiber
optics and wireless transmission have paved the way for competition in the local exchange. But,
new technology alone could not bring competition to the local exchange (9, 10). It takes
innovations in communications technology and new service offerings pressure both suppliers and
industry regulators to change (9, 2).
In 1984, there was a large growth in the size of the industry and of its respective business.
Teleport offered competitive local business services in New York City (9, 9). Competition is met
with aggressive responses, including price cuts and improved service offerings. The new
competitiveness effected rates and offerings of local exchange carriers in years to come. In
particular, the integration of local, long distance, cellular and cable services establishes the
groundwork for offering innovative service packages at Bundled Rates (9, 11). Two factors are
most important for the relative advantages of the various new competitors: The incremental costs
of building local telephone networks and the pre-existing goodwill with potential subscribers (9,
37).
There were gains and mistakes made by several competitive firms during this period. Instead of
divesting itself, Ameritech proposed to interconnect with competitors and unbundled its network
services selling services at nondiscriminatory cost-based rates (9, 11). They were trying to be
competitive in a world of monopoly. In 1994, MCI decided on a strategy to build its own local
networks in selected cities for selected customers. Problems struck when they could not reach
households. It proved to be very expensive and MCI quietly scaled back its plans. MCI then
decided to grow internally by creating its MCImetro division (9, 11). These firms were trying
different approaches to compete with AT&T after the divesture.
The cost wars during the period also had an affect on companies entering the market. Since
average costs are everywhere declining, strong scale economies prevail. Scope economies occur
when a single firm can provide an entire array of services more cheaply than a collection of firms
who specialize in just a few of those services. Scope economies stem from the joint use of
facilities by several services without substantial congestion problems. Costs of local exchange
service is ?sub additive? which requires the cost of a given level of local services when supplied
by a single firm is less than when parceled out to two or more firms. If production experiences
scale economies, then costs are sub additive (9, 14). In 1985, the traditional common carriers
recorded about 106.2 billion dollars in operating revenues from domestic and international
telephone and telegraph services. Operating revenues increased to 113.6 billion dollars in 1986.
This does not include specialized common carriers, domestic satellite companies, or interconnect
companies (2, 132).
In 1991 AT&T produced 34,384 million dollars in operating revenues and 38,069 million dollars
in 1995. MCI produced 8,266 million dollars in 1991 and 14,617 million dollars in 1995. Sprint
produced 5,378 million dollars in 1991 and 7,277 million dollars in 1995. ( 7 )
Rate regulation reforms began in the late 1980?s. At that time, all states and the FCC regulated
telephone rates to ensure the firm did not earn more than its allowed rate of return on invested
capital. In 1990, the FCC adopted the new regulatory scheme of ?price caps? with profit sharing
for the Local Exchange Carrier?s (LEC?s). A price- cap scheme places a ceiling on the average
revenue a firm can charge on all services, with appropriate adjustments over time for inflation
and the rate of productivity improvement that comes form technical change (9, 44). Price-caps
are increasingly replacing rate-of-return as the form of regulation in the telecommunications
industry. Profit sharing mechanisms could also be implicit in the FCC form of price-cap
regulation. High profits could induce the FCC to set lower price caps, thus allowing consumers
to ?share? what was formerly profit (10, 8).
With time and the pressure form courts and lawmakers, regulators have gradually opened
communication markets to competition and realized the benefits of lower prices and improved
service (9, 3). Between the AT&T divesture in 1984 and the passage of the Telecom Act in 1996,
more and more states started to allow and encourage competition in interexchange markets (9,
46). The interest in local competition really began in the late 1980?s, through proceedings on
?Open Network Architecture? (ONA) that were intended to give service providers access to
unbundled parts of the ILEC networks (9, 39). Procompetitive collaboration between carriers
was initiated by FCC decisions on interstate access by information services providers and
Interexchange Carrier?s (IXC?s) (9, 47).
States regulate prices for intrastate services, and the FCC regulates interstate services (10, 8). In
order to keep local residential rates low, regulators allowed business and long-distance access
rates to increase (9, 39). Today, rate-of-return regulation and price-cap regulation are commonly
used in seeking to protect telephone customers from excessively high prices resulting from the
carrier?s exercise of market power (4, 58). In 1996, Congress passes the Telecom Act which
seeks to open local exchange to competition through facilities-based entry (9, 9).
There are differences in local and long-distance carriers that show the structure of the industry.
There are advantages and disadvantages for each type of carrier. The advantage of the IXC?s
over LEC?s is that their brand-name recognition is nation-wide, while the LEC?s only command
regional brand-name recognition. But, it appears harder for IXC?s to enter local markets than it
is LEC?s to enter long distance markets (9, 36). Local exchange rates are under state control
except for access provided for interstate services. Scope economies dictate that local and long
distance share the same local loops and switching (9, 41). This lowers the overhead costs of both
the LEC?s and the IXC?s. Local exchange service comes highly bundled and highly inelastic
while the long-distance exchange is more elastic and less bundled.
Since local calling areas seem to be growing, the size of local exchange markets would be
growing too(9, 25). 85% of outgoing calls are local. In 1995, households spent $19.49 per month
on basic service (9, 18). Local switching charges re levied because a long distance telephone call
must be switched through the local network, thus tying up switching capacity that has alternative
uses. The carrier common line charge is levied specifically to defray the costs of the local
telephone distribution plant, and not the costs of completing long distance calls (10, 5).
Long distance companies also purchase a different form of carrier access, special access, from
local telephone companies. Special access lines are leased by the month at rates corresponding to
their capacity and distance. Actual usage is not metered. Special access, which is supplied by
local telephone companies, competes with third party firms. These third party firms, called
Competitive Access Providers or CAPs, build small networks in downtown business area that
connect users to long distance companies without the use of local telephone networks. This is an
example of a volume discount rate (10, 7).
American Telephone and Telegraph has had quite the history of ups and downs. At one time,
they were relatively the only long-distance telephone company in existence. In the past twenty
years or so, AT&T?s dominance has been reversed by legal decisions, legislative developments,
and competitive forces (9, 2). ?Modification of Final Judgment? called for the divestiture of the
Bell Operating Companies on January 1, 1984 (9, 8). Although AT&T was able to take
advantage of the brand loyalty to the Bell system, from which it continued to benefit after the
breakup (9, 28). AT&T was broken up into smaller local firms.
At first, the non-AT&T long distance companies, known as the Other Common Carriers
(OCC?s), had inferior connections to the local telephone companies. This sort of access is called
?non-premium access?. The FCC has since made new regulations(10, 6). As part of the
settlement, the divested local telephone companies were obligated to install switching equipment
that allowed for ?equal access? by any long distance company. This allowed AT&T?s
competitors to introduce services that were comparable to AT&T?s. AT&T?s market share
dropped from 95% to 80% between the years, 1982-1987. By 1991, MCI?s and Sprint?s revenue
market shares had climbed to 17% and 10%. Suprisingly though, since the divestiture; industry
output measured by the number of calling minutes, had nearly tripled (10, 4). While the FCC
regulates AT&T prices directly, the OCC?s and the third party-access providers are not regulated
directly.
The FCC decided to move to price-cap regulation for AT&T in May 1989 (10, 8). The specific
form of price-cap regulation adopted for AT&T divided services into three ?baskets?. ?Basket 1?
includes residential and small business services, international services and operator assisted and
calling card services. ?Basket 2? is limited to 800 number services. And, ?Basket 3? contains all
remaining services, principally those offered to large businesses. Each basket has its own pricecap. As services have been shown to be competitive, they have been removed from price-cap
regulation. In October 1991, the FCC permitted AT&T to negotiate contracts with large business
customers as an alternative to using the tariffed prices (10, 9).
A simple rate rebalancing could be held up for several months. These delays hampered AT&T?s
ability to respond rapidly to increasingly aggressive competition from the other interexchange
carriers. Commercial customers were demanding a host of new digital and other advanced
telecommunication and data services. AT&T?s incentives to efficiently invest a new technology
were silenced by rate-of-return regulation. Since divestiture in 1984, the FCC has continued to
regulate AT&T as a dominant interstate carrier in the market for long distance telephone
services. In the spring of 1989, price-cap regulation of AT&T replaced traditional rate-of-return
regulation. The change was designed to proved AT&T with improved incentives and greater
pricing flexibility in increasingly competitive long distance markets while protecting against
cross-subsidization, monopoly and predatory pricing (5, 167).
The telecommunications industry has come a long way through out the past two centuries. It all
began with the invention of the telephone by Alexander Graham Bell. This took place in 1874
and is said to be the beginning of an era. There have been thousands of advances since then. We
can see this through the period discussed in this essay. It is a small but significant time in the
development of the telecommunications industry. We have seen changes in technology, sizes and
competitiveness of companies, and regulations. We have also looked at the important differences
between LEC and IXC carriers. Lastly we learned about one of the most prestigious telephone
companies ever, AT&T. I feel that I have learned a lot while researching for and writing this
paper. I think that I have a good understanding of price discrimination, natural monopolies and
competitive industry. It is truly amazing to think about the importance of the telecommunications
industry to the world today.
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