IT Industry Essay, Research Paper

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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