Telephone Communications, Except Radiotelephone

Industry Snapshot

Since the invention of the telephone in 1877, the demand for telecommunication services has steadily expanded. Even when competition from wireless systems increased during the 1980s, wireline service sales grew at a rate of more than 5 percent annually, and long distance calling volume expanded 12 percent.

The Telecommunications Reform Act of 1996 made the most sweeping changes in the industry in 62 years. Aimed at reducing segmentation between local phone service, long distance service, wireless service, and cable television, the act sought to lower prices, improve services, drive greater technological innovation, and create new business and jobs for the United States. By the early 2000s, one of the most obvious results of the reform was the rapid pace of mergers and acquisitions in the industry. For example, by 2008, only two of the seven regional Bell holding companies created by the breakup of AT&T in 1984 remained: Verizon Communications Inc. and Qwest Communications International Inc.

Organization and Structure

The wireline telecommunication services industry includes firms that provide electronic communications using wire networks or fiber optic lines. The massive U.S. wireline infrastructure incorporates 750,000 miles of aerial wire, 3.5 million miles of cable, and, following massive infrastructure build-outs during the 1990s, about 90 million miles of optical fiber. The Federal Communications Commission (FCC) reported that by the mid-1990s all the telephone companies together served nearly 94 percent of U.S. households.

Although the Telecommunications Act of 1996 removed legal barriers in general, the industry is still largely divided into long distance carriers and local telephone companies (telcos). Local telcos provide basic telephone services. They bring telephone access lines into homes, hook up new customers, and service local lines and equipment. Telcos also connect customers to long distance carriers, and sometimes handle intrastate toll calls that are considered long distance.

In addition to basic services, many local telcos publish phone directories, offer operator assistance, and provide numerous add-on services. Examples of such services are voice mail, caller identification, call-waiting, touch-tone dialing, wide area telephone service (WATS), separate digital lines, 1-900 billing services, and video conferencing.

By far, the majority of local telephone lines were serviced by the Bell Operating Companies (BOCs), called "Baby Bells," because they were the offspring of the 1984 American Telephone and Telegraph Company (AT&T) divestiture. At the time of the breakup there already were a few established independent local phone companies, notably GTE. Together these companies and the BOCs are referred to as Incumbent Local Exchange Carriers (ILECs), as opposed to new local carriers, called Competitive Local Exchange Carriers (CLECs).

In addition to the BOCs and independents, competitive access providers (CAPs) offer local telephone services. Started in 1992, CAPs typically furnish dedicated fiber optic telephone lines that connect corporations and long distance carriers. Because CAPs are not subject to the same pricing regulations with which the BOCs must comply, they can often deliver service to high-volume corporate customers at reduced rates. Some observers feared that these early companies would siphon off debilitating amounts of high margin business, but the telcos have not suffered greatly from their presence. The terms CAP and CLEC are now often used interchangeably.

Long distance carriers, the other division of the wireline telecommunication services industry, provide national and international services via wire and fiber optic lines. Their services often utilize satellite and microwave systems as well. Long distance carriers typically pay a hefty fee to have local carriers route long distance calls to their lines, although the rates have steadily declined since 1997.

Since 1984, when its virtual monopoly of the telephone industry was ended by the federal courts, AT&T had steadily lost market share in the long distance segment. The FCC reported that in 2000, AT&T held a 39 percent share of long distance revenue. At that time, Worldcom held about a 22 percent share, while Sprint had about 9 percent. By 2007, however, the market had changed. While long distance services no longer remained the industry leaders' focus, wireless, broadband, and digital television services were the new future for those companies that remained after mergers in the mid-2000s.

AT&T, Worldcom, Sprint, and some other large services were referred to as "facilities-based" carriers because they maintain the infrastructure necessary to connect calls. In addition to facilities-based carriers are "resellers," companies that complete customer calls using a transmission facility leased from a large carrier.

Digital Communications.
Most telephone networks transmit voice and data communications using analog technology, which sends a type of sound wave over the phone line. A digital system sends bits of numeric data, making it much faster, less expensive, and more reliable than analog transmission. In addition to the data communication options offered by the standard carriers and the CAPs, a new breed of wireline service companies provides data communication services. Value-added network (VAN) providers furnish contract services such as electronic mail, credit card verification, and electronic data interchange. These companies typically lease lines, which they use to set up data communications networks for their customers, from carriers at bulk rates. Many VANs are able to efficiently link a company's global computer networks. By contracting with a VAN, a company also can avoid incompatible national regulatory and technical communications standards and receive consolidated billing.

Background and Development

The first attempts at an electrical telegraphing system occurred in the mid-1700s in Europe. One experimental system used 26 wires, one for each letter of the alphabet. Numerous telegraph models were developed with limited success during the late 1700s and early 1800s. American Samuel F.B. Morse introduced the first commercially successful telegraph in 1844. "What hath God wrought?" were the first words to be transmitted on the 37-mile pole line between Baltimore, Maryland, and Washington, D.C. Under Morse licenses, open-wire pole lines were soon erected all over the United States and Canada.

Alexander Graham Bell is credited with inventing the telephone in 1876, although fellow American Elisha Gray's work closely paralleled Bell's efforts up to that time. The technology was immediately put to use in sophisticated telephone systems by the National Bell Telephone Company (originally the Bell Telephone Company). Western Union Telegraph Company also began offering phone service, using technology developed partly by Gray and Thomas Edison. As a result of an out-of-court settlement regarding a patent dispute, Western Union sold its phone operations to Bell in 1879.

The public immediately embraced Bell's phone service. By March 1880, there were more than 30,000 U.S. telephone subscribers and 138 telephone exchanges. By 1887, just 10 years after the commercial introduction of the telephone, there were more than 150,000 subscribers and about 146,000 miles of wire. In addition, nearly 100,000 people had phone service in Europe and Russia.

As telephone services expanded, a demand for long distance services arose. Bell established the American Telephone and Telegraph Company in 1885 as its long distance subsidiary. Important equipment and wire advances allowed commercial service to be implemented between Boston, Massachusetts, and Providence, Rhode Island, by the 1890s. Distances gradually increased with the introduction of new equipment, such as relays, loading coils, amplifiers, and repeaters. Although microwave systems allowed limited telephone communications with overseas telephone users in the 1940s, large-scale wireline telecommunication was not available until the 1950s.

Bell Telephone and AT&T.
Broad patent rights enabled the National Bell Telephone Company, which became the American Bell Telephone Company in 1878, to completely dominate the telephone service and equipment industry throughout the late 1880s and early 1900s. Bell built a nationwide network by licensing local operating companies to deliver service for 5 to 10 years. Bell received $20 per phone each year and reserved the right to buy the local network at contract expiration. Although Bell's patent rights terminated in 1894, only a few independent companies emerged as competitors. By 1899, Bell maintained a network of 800,000 lines.

AT&T became the parent company of the Bell system in 1899. The number of subscribers increased to 3.12 million by 1907, boosted by an overwhelming demand for phone service from isolated rural Americans. Moreover, new management during the 1910s was able to drastically improve the company's performance. AT&T adopted a strategy of expansion, centralized management, and increased research and development. AT&T management also followed a monopolistic course, believing that competition had no place in the telephone industry.

AT&T began buying up independent operators in the 1910s and 1920s. It also started delivering telegrams over phone lines. In 1915, AT&T completed the first telephone line that connected the east and west coasts of the United States. By 1921, AT&T served 64 percent of the 21 million phones installed in the United States and owned many of the networks used by almost all of its independent competitors. By 1929, the company was generating annual revenues of more than $1 billion. Despite setbacks during the Great Depression, AT&T service continued to expand at a rate of more than 1 million new customers every year during the late 1930s and 1940s. In 1955, it laid the first transatlantic cable, linking its customers to Europe.

AT&T grew quickly during the 1950s and 1960s, meeting surging demand with an influx of new products, services, and technological breakthroughs. By 1966, the company had more than 1 million employees and served about 85 percent of the households in the areas in which it operated. Despite pressure by antitrust regulators to cede its market dominance, AT&T continued to grow during the 1960s and 1970s, becoming the largest company in the world. By the early 1970s, AT&T was serving roughly 80 percent of the phone users in the United States and providing 90 percent of all long distance service. Antitrust suits filed separately by MCI and the Justice Department in 1974 signaled an end to the company's unfettered reign.

The Communications Act of 1934 established telecommunications as a regulated industry under the jurisdiction of the FCC. The act directed the FCC to regulate the industry based on "public interest" rather than free market competition. For most of the twentieth century, the FCC believed that a regulated monopoly that could establish a standard nationwide telephone network was in the best interest of the public. The FCC and state regulatory bodies set the rates that AT&T could charge for its services, allowing the company to cover its costs but not generate excess profits. In addition, the Justice Department kept an eye on AT&T to make sure that it did not illegally compete in other industries.

In the 1970s, antitrust pressures began to change regulator's attitudes toward AT&T. Many people believed AT&T and its Bell companies did not have enough of an incentive to install new technology and improve efficiency. Furthermore, potential industry competitors were pressing for permission to compete with AT&T using proprietary technologies. For example, MCI wanted to compete using its microwave long distance technology. Although MCI received permission to offer limited service during the early 1970s, its 1974 suit was the regulatory turning point.

In 1982, after a lengthy court battle, AT&T agreed to divest its operations. The monopoly was broken in 1984, when AT&T was divided into eight small companies. Under the Modification of Final Judgment (MFJ), AT&T became a regulated long distance carrier and its 22 BOCs were organized into seven regional holding companies. Among other results of industry deregulation, competitors were allowed to enter the long distance service industry. Federal and state regulators planned to slowly remove restrictions on AT&T as competitors became established. When AT&T was divided in 1984, it had sales of $36 billion from long distance services. This represented 88 percent of U.S. wireline long distance services sales. By 1998, its share was down to 43.1 percent.

Regulators began to loosen restrictions on AT&T and the Baby Bells in the late 1980s. In 1989, they removed profits caps on AT&T, and in 1991, they reduced pricing constraints. In 1995, the FCC ended its classification of AT&T as a "dominant carrier." The Baby Bells, though still hampered by state price and profit regulations, enjoyed greater flexibility and competing in some new markets in the mid-1990s. For example, U.S. West formed partnerships with several CAPs outside of its local service region to offer data-transport services.

The Telecommunications Act of 1996, signed into law February 8, 1996, eliminated 62 years of regulation of the telecommunications industry. The legislation was intended to promote competition across the industry, resulting in the development of new technology, the creation of new business and new jobs, and ultimately lower prices. Local telcos, long distance providers, wireless companies, and cable television operators would be free to offer any and all telecommunications services.

A major provision held that the Baby Bells and any new local telephone network developers must allow competition for local service using their local networks. They are also required to allow the resale of their services, much like long distance service is resold by a great number of small long distance companies. Finally, they must provide the customers of these resellers the same type and quality of service that they provide their own customers.

The major benefit of the new regulations for the Baby Bells was freedom to enter the long distance market after demonstrating that they had opened local networks to viable competition. Having done so, they were able to join with other companies, local or long distance, to form subsidiaries to offer long distance service jointly. The goal was to provide "one-stop shopping" for all telephone services.

One of the goals of federal regulation continued to be universal service. Companies that provide service in a region must make it available to everyone at an affordable price, even in areas where the costs of providing the service are much higher. Companies that offer such service receive subsidies from a fund supported by all interstate telecommunications providers.

Other provisions of the act allowed BOCs to manufacture telecommunications equipment. It further allowed telephone companies to offer video programming and other utility companies to offer telecommunications services through subsidiaries set up for that purpose.

A defining characteristic of the telecommunications industry throughout the 1990s and continuing in the 2000s was the large number of mergers, acquisitions, and joint ventures. In anticipation of deregulation, many companies joined with companies in other segments of the industry. In 1994, for example, AT&T acquired McCaw Cellular Communications, the largest cellular provider in the United States at the time. Altogether, 746 such transactions were announced in the industry between January 1994 and June 1996, with a value estimated at $110.7 billion. Nearly 73 percent were mergers of service providers for wireline, wireless, and cable TV operators. The rest involved equipment and software providers.

In 1998, mergers and acquisitions in the U.S. telecommunications industry were valued at $234.8 billion, four times the figure for 1997. Among these were the mergers of MCI and WorldCom, Ameritech and SBC Communications, AT&T and TCI, and Bell Atlantic and GTE. Early in 1999, the trend continued as AT&T made a deal for MediaOne Group, a major cable company, MCI Worldcom made a bid for Sprint and Sprint PCS, and Vodafone AirTouch announced a merger with Bell Atlantic, the largest U.S. local phone company. A relative newcomer, Qwest Communications International, primarily a long distance provider to business, closed a deal for U.S West, the Denver-based BOC. Industry analysts expected the trend toward consolidation to continue into the new century, including more international ventures as the European market moved toward deregulation beginning in January 1998.

The industry continued its steady growth. The FCC reported that local service revenue in 1998 was $101.9 billion, an increase of 5.6 percent. Competition, however, had not developed to any great extent, as the ILECs accounted for more than 96 percent of revenue. Nonetheless, there was some improvement, as in 1993 they accounted for 99.7 percent. The long distance segment of the market showed similar growth, with an increase of 6.1 percent in long distance conversation minutes. Long distance showed somewhat more competition than local service, with AT&T holding only 43.1 percent of the market. MCI Worldcom garnered 25.6 percent, and Sprint captured 10.5 percent. All other long distance carriers together held the remaining 20.8 percent.

The growth in popularity of the Internet as a business tool as well as a medium for nonbusiness consumers affected the strategy of industry players. AT&T's bid for MediaOne, the leading cable company, as well as other cable carriers, concerned cable's potential for carrying large amounts of digital data, as well as local telephone traffic. Other wireline industry powers acquired wireless cable companies and other new companies developed Local Multipoint Distribution Systems (LMDS) and Multichannel Multipoint Distribution Systems (MMDS) for their potential to provide a way to bypass the local telephone company and for their potential to provide the broadband delivery of data necessary for the Internet.

During the mid- to late 1990s, telecommunications service providers engaged in massive infrastructure build-outs in anticipation of the coming convergence of voice and data communications via a single network. However, by the early 2000s, a capacity glut and high levels of debt developed when expected demand did not materialize. This led to falling profits and stock values for industry players. In its assessment of the overall telecommunications services industry, which also includes wireless providers, Value Line reported that while industry revenues increased, net profits fell drastically. Revenues rose from $289 billion in 2000 to $291.2 billion in 2001. However, net profits fell from $24.5 billion to $10.2 billion during the same time. Value Line estimated revenue at $285.5 billion in 2002 and $288.5 billion in 2003. Profits also fell, and so did capital investment levels. Coupled with an already weak economic climate, this created to challenging times for the industry.

By the early 2000s, the Telecommunications Act of 1996 had not achieved the intended effect of getting Baby Bells to open their markets to competition. These firms successfully limited competition in a variety of ways. The Baby Bells were expected to control 74 percent of local and long distance wireline revenue by the year 2005. By early 2002, Verizon had already obtained FCC approval to provide long distance service in Connecticut, Massachusetts, New York, Pennsylvania, Rhode Island, and Vermont. SBC had obtained long distance rights in Arkansas, Kansas, Missouri, Oklahoma, and Texas.

Current Conditions

The outlook was relatively positive in the mid-2000s for the Baby Bells. In addition to their solid position in the local telephone service market, three of these companies--BellSouth, AT&T, and Verizon (Verizon Wireless)--benefited from ownership stakes in the nation's two leading wireless telephone companies. However, long distance providers faced a more competitive landscape as they lost market share to wireless telephone companies offering free nationwide long distance plans, and to Baby Bells entering their markets. The rising use of e-mail, chat, and Internet telephony offered additional competition for long distance players.

At the end of the decade, Verizon and AT&T were the top industry leaders. They recognized that in order to remain competitive, they would have to transform with the changing times and depend less on revenue from the traditional telephone business and more on the newer areas of wireless and broadband. According to the FCC, 94.6 percent of all U.S. households had telephone service in 2007, just a 1.8 percent increase over the previous year.

The trend for industry leaders in the mid- to late 2000s was to increase their bundled offerings, presenting customers with discounted billing for a group of services, such as phone, wireless, Internet, television programming, and more. By 2007, many customers in large markets could have their home telephones, in-home office telephones, wireless phone, broadband Internet, and digital television services from the same provider at significantly discounted rates.

Industry Leaders

Verizon Communications was formed in 2000 when Bell Atlantic purchased GTE. It boasts 45 million wireline access lines serving 28 states and Washington, D.C. Verizon's Telecom service's fiber optic network served 12.7 million homes and businesses in the U.S. in 2008. The company reported consolidated revenues of $97.4 billion in 2008. Verizon acquired MCI, Inc., in a merger that closed in January 2006, expanding Verizon's global and business reach. After the merger, Verizon employed more than 240,000 and served customers in over 140 countries with its three segments: Verizon Wireless, Verizon Telecom, and Verizon Business.

AT&T steadily lost market share in the highly competitive long distance market after 1984. In 2002, AT&T reported revenue of $37.8 billion. Since 1984, its toll revenues rarely declined from quarter to quarter and dropped only twice from one year to the next. As of 2003, AT&T claimed to serve about 50 million consumers, as well as 4 million business customers. The company agreed to be acquired by SBC Communications in a cash and stock deal valued at $16 billion, although the name of the company's many business segments remained AT&T. In 2006, AT&T purchased BellSouth for $86 billion in the largest telecommunications takeover in history. The company continued its growth and reinvention, and by 2007, with the acquisition of Cingular Wireless, it was the leading wireless carrier. AT&T boasted 66.5 million access lines and revenues of $124 billion in 2008, as well as 301,000 employees worldwide.

Other industry leaders included Qwest Communications, with 2008 revenue of approximately $13.5 billion, 15 million access lines serving customers in 14 states, and nearly 33,000 employees. Embarq Corp., a Sprint spinoff, had 6.9 million access lines at the end of 2006 and offered local and long distance service in addition to wireless, Internet and other services in 18 states. Embarq reported revenues in 2008 of $6.1 billion and approximately 16,000 employees. CenturyTel offered services to customers in 25 states, primarily in the South and Midwest. The company posted revenues in 2008 of $2.6 billion with a workforce numbering 6,500. Windstream, which was spun off from ALLTEL, offered telecommunications and information services with 3.2 million access lines in 16 states and posted revenue of $3.2 billion in 2008 and 7,350 employees.

Research and Technology

The industry invested capital on labor-saving automation and targeted investments at several emerging technologies in the late twentieth century. During the mid-1990s, the most important area of research and development was digital transmission. Both long distance and local carriers raced to develop and integrate new digital technology that would increase line capacity and speed and allow the efficient transmission of data, voice, and video. ISDN deployment was slowed by the lack of agreed standards in the United States. Telcos also invested in other data transmission technologies, such as Switched Multimegabit Data Service (SMDS), frame relay, and asymmetric digital subscriber line (ASDL). These technologies, combined with advancing fiber optic and ISDN efforts, resulted in vast data transmission improvements. Technologies not traditionally associated with wireline networks were also attracting attention from the industry, including fixed wireless systems and cable modems.

An important element of the move to digital transmission was the development of a fiber optic network, the basis of the much-touted "information superhighway." Fiber optic networks can carry a lot more traffic than copper, making them much more suitable for the transport of large volumes of data and video. In 1998, local carriers increased their deployment of fiber 21.5 percent, with ILECs deploying 2.1 million miles of fiber and CLECs deploying 1.3 million. The effort by the CLECs represented an increase of 73 percent over the previous year. By the early 2000s, about 90 million miles of fiber optic cable had been deployed. However, some analysts considered this aggressive deployment overkill, estimating that less than 10 percent of this capacity is actually used.