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 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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