IT Industry Essay

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.

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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 price-cap. 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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Institution: Washington D.C., 1989 423 pgs. 2. Economic Commision for Europe,
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Regulatory Reform. Oxford University Press: Oxford, New York, 1989 412 pgs. 4.

Johnson, Leland L. Common Carrier Video Delivery by Telephone Companies. Rand
Publishers: 1992 77 pgs. 5. Mitchell, Bridger M. and Ingo Vogesang.

Telecommunications Pricing: Theory and Practice. Cambridge University Press:
Cambridge, New York. Rand Publishers, 1991 305 pgs. 6. Olves III, Dick W. The
Making of Telecommunications Policy. Lynne Rienner Publishers: Boulder, London,
1999. 7. Table 11-2. Total Operating Revenues of Long Distance Service
Providers. 1985-1999. 8. Telecommunications Type Approval: Policies and
Procedures for Market Access. Organization for Economic Co-Operation and
Development (OECD) : 1992 161 pgs. 9. Volelsang, Ingo and Glenn Woroch. Local
Telephone Service: A Complex Dance of Technology, Regulation, and Competition.

Edited by Larry Duetsh, 1998. 51 pgs. 10. *** Essay on the Breakup of American,
Telephone and Telegraph.


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