ENTRY RESTRAINT S IN THE COMMUNICATION EQUIPMENT INDUSTRY Thesis fat the Degree of HI. I). MICHIGAN STATE UNIVERSITY Manley R. Irwin E963 THESIS NW! | [HIM l l WWI This is to certify that the " ““" ' ~ -- thesis entitled ENTRY RESTRAINTS IN THE COMMUNICATION EQUIPMENT INDUSTRY presented by Manley R. Irwin has been accepted towards fulfillment of the requirements for Ph.D. degree in Economics (1% MW; Major professor Date_June ll}: 1963 LIBRARY Michigan State University i‘ h) u’ RESEARaI tun 18 figs 3 ‘61 ABSTRACT ENTRY RESTRAINTS IN THE COMMUNICATION EQUIPMENT INDUSTRY by Manley R. Irwin This study seeks to evaluate the factors contributing toenfiry restraints in both the domestic and international segmnns of the communication equipment industry. The problem of market entry assumes two levels. First, vertical integration exists as the predominant market structure in bofiidomestic and international aspects of the industry; and thepnoblem of entry is centered around the attempt by the nonhnegrated supplier to gain market access. A second facun‘is concerned with two competing modes of rendering commnfication service, metallic circuits and microwave radio cdrmfits. In general, the nonintegrated firms have a vested interest associated with the latter, while the integrated manufacturers and their common carriers have substantial investments in the former. Given the problem of entry, this study cites three facuns that historically have tended to inhibit market awry. Ifirst, the legal and technical factors of patented humdedge, capital requirements, and the frequency spectrum; Seunmq the market structural traits associated with the priCj-ngand interconnection policies of the common carrier; and third, policy decisions within the public sector. “I ‘1 "-I Manley R. Irwin This classification of restraints is applied to both Hm domestic and international equipment markets. The study suggests that while most of the legal and technical deterrants have eroded with time, the structural barrier of vertical integration remains as a formidable restraint to market entry and hence competition. The study concludes that public policy must address itself to this issue and require vertical disintegration as a means of re- stcuhing a competitive environment to the communication equip- ment industry. Much of the research for this study was obtained direzctly while working with the Senate Small Business Com- mittxee during the summer of 1961. In addition, the author has (:onducted interviews with the Department of Justice, the staf]? of the Federal Communications Commission, and the_ Natixonal Aeronautics and Space Administration. Non- govezmnment sources include interviews with American Tele- Phonca and Telegraph Company, Bell Laboratories and Western Elec1:ric, Western Union, Motorola, General Electric, Radio COIPHDIation of America, and Chrysler Corporation. In addi- tiorl, conversations with private utility consultants, priVTite microwave consultants, and the Washington law firm, Smitll and Pepper, have been most useful. The direct interview has supplemented such sources as congressional hearings, FCC dockets, and a host of books, perjJDdicals, journal articles, etc. relating to the problem uncle r consideration . ENTRY RESTRAINTS IN THE COMMUNICATION EQUIPMENT I NDUSTRY BY Manley R. Irwin A THESIS Submitted to Michigan State University in partial fulfillment of the requirements for the degree of DOCTOR OF PHILOSOPHY Department of Economics 1963 ACKNOWLEDGMENTS This study originated as a result of an internship pro- gram with the Senate Small Business Committee in 1961. The program is part of the Industrial Organization Workshop of the Department of Economics Sponsored by Professor Walter Adams. This study would be nonexistent but for the oppor- tunity and encouragement provided by Professor Adams, and the author is deeply indebted. In addition, the author is particularly grateful to Professor Joel Dirlam for his substantive criticisms and suggestions, to Professor Anthony Koo for his helpful com- ments as well as the observations of Professors Robert Lanzillotti, Boris Pesek, and Carl Brehm. Appreciation is also due to the members in the indus- trial organization workshop for their contributions and criticisms, to the staff of Senator Long and the Small Business Committee, much credit is due for permitting me to gain experience into the formulation of public policy decisions, as well as to members of the Department of Justice, the Federal Communications Commission, and the National Aero- nautics and Space Administration. The author extends his thanks to the American Telephone and Telegraph Company, Western Electric, Bell Laboratories, Michigan Bell, RCA, Motorola, General Electric, Western Union, Chrysler, and the ii Washington law firm Finally, this granted by the Ford opinions, and other are not necessarily of Smith and Pepper. study was made possible by a fellowship Foundation. However, the conclusions, statements are those of the author and those of the Ford Foundation. iii Chapter I. II. III. IV. V. TABLE OF CONTENTS INTRODUCTION . . . . . . . . . . . mE PROBLm O O O O O O O O O O O 0 Domestic Market . . . . . . . . . Conventional Technology . . . . New Technology . . . . . . . . International Market . . . . . . Conventional Technology . . . . New Technology . . . . . . . . DGIESTICMARKET.......... Legal and Technological Restraints The Patent 0 o o o o o o a Government Research and DevelOpment Innovation of Radio Relay . . . Diffusion Effects . . . . . . . Frequency Allocation . . . . . . Capital Requirements . . . . . . Market Structure . . . . . . . . Interconnection . . . . . . . . Pricing . . . . . . . . . . . . Telpak Original . . . . . . . . Appendix to Telpak . . . . . . . Policy Decisions . . . . . . . . INTERNATIONAL MARKET . . . . . . . Legal and Technological Restraint Frequency . . . . . . . . . . . . Capital Requirements . . . . . . Market Structure . . . . . . . POI-icy O O O O O C O O O O O 0 POLICY ALTERNATIVES . . . . . . . . Domestic Market . . . . . . . . . International Market . . . . . . BIBLIOGRAPHY . . . . . . . . . . . . . . . . iii Page 15 16 16 47 67 67 82 100 100 100 111 119 126 140 160 183 183 213 217 246 251 261 261 266 269 273 273 299 299 311 316 Table 10 11 12 13 14 15 16 LIST OF TABLES Band Widths Required for Various Radio- Communication Services . . . . . . . . . . . American Telephone and Telegraph Company Investments in Subsidiaries and in Other Companies . . . . . . . . . . . . . . . . . Bell System Operating Revenues . . . . . . . Private Line Services Revenues . . . . Demand Components of Bulk Communication Market . . . . . . . . . . . . . . . . . . . Channel Revenue Projections of Bulk Communication Market . . . . . . . . . . . U. S. Communication Equipment Sales . . . . Average Annual Sales of Telephone Apparatus and Equipment and Percentages of Total, Western Electric Company and Five Leading Independent Producers . . . . . . . . . . . Western Electric Company, Inc. Investments . Western Electric Company, Inc. Sales . . . . Division of Other Income Between Bell and Non-Bell BuSiness o o o o o o o o o o o o 0 Radio Frequency Classification . . . . . . . Classification of Functional Types of Signals O O O O O C O O O O O O O O O O O O The Market for Communication Equipment . . . Approximation of Sales Volume in Microwave Point-to-Point Communications Systems of Leading Manufacturers . . . . . . . . . . . Summary of Private Microwave Information Based on Construction Permit Applications . iv Page 17 23 26 32 35 36 37 38 41 43 44 50 56 57 59 60 Table 17 18 19 20 21 22 23 24 25 26 27 28 29 3O 31 32 33 34 35 Motorola Customers . . . . . . . . . . . . . FCC Microwave License Applications . . . . . Microwave Equipment Markets . . . . . . . . Number of Microwave Stations . . . . . High CapacityfiDeepsea Telephone Type Submarine Cable Systems Owned Wholly or Partly by United States Companies . . U.S. International Carriers Revenues . . . . Revenues from Overseas Communications Services Reported by Telephone Carriers for the Years 1951 to 1960, Inclusive . . . . . Revenue Distribution of Overseas Record carriers 0 O O C O O O O O C C O O C O O O 0 Revenue Distribution of Major International Carriers . . . . . . . . . . . . . . . . . . International Telegraph Carriers Combined Growth of Operating Revenues . . . . . . . . U.S. Government Purchases of Overseas Communication Services . . . . . . . . . . . Comparison of National Research and Development Expenditures, 1930-1945 . . . . World War II Communication Procurement . . . Estimate of Funding and Conduct of Research and Development, 1960 . . . . . . . . . . . The Market for Electronic Equipment, 1954-1965 c a o o o o o o o o o o o o o o o Spectrum Allocation Before "Above 890 Docket” . . . . . . . . . . . . . Microwave Equipment Study . . . . . . . . . Telpak Classification . . . . . . . . . . . AT&T Toll Line Facilities . . . . Page 62 63 63 64 7O 72 75 77 77 79 80 112 115 116 118 142 175 218 235 Table 38 Comparison of Telpak Charges, Micro- wave Costs and Telephone Company Private Costs . . . . . . . . . . . . . . . . . Cost/Channel—Mile for Cable vs. Satellites . . . . . . . . . . . . . . . Satellite Cost Ranges . . . . . . . vi Page Figure 10 ll 12 13 14 15 l6 17 LIST OF FIGURES The frequency bands used in the Bell System's wire communication system . . . The Bell telephone system . . . . . . . . . Territorial divisions of the Bell System and location of Western Electric distributing houses I 9 O O O O O O O O O O O O O O O 0 Total revenues Western Union—Bell System- Independents . . . . . . . . . . . . . . . Domestic public telegraph message services, Western Union-Bell System . . . . . . . . . Total private line market-—AT&T and Western Union . . . . . . . . . . . . . . . . . . . Domestic telegraph private wire revenues, Western Union-Bell System . . . . . . . . . Relationship of bulk communications market to Bell System‘s toll business . . . . . . Western Electric Co., Inc. and principal subsidiaries . . . . . . . . . . . . . . . Western Electric sales . . . . . a . . . . Radiation Spectrum . . . . . . . . . . . Anterior view of a microwave antenna . . Terrestrial microwave link . . . . . . . . Multiple channel capacity of a microwave Signal . g g o o o o o o a a o o I o o o 0 Components of a microwave repeater station . I . C C C O C C O O O O O O C C 0 Domestic market-—entry . . . . . . . . . . Conventional transoceanic means of communication . . . . . . . . . . . . . . vii Page 19 21 22 31 33 34 4O 45 48 51 52 53 55 66 68 Figure Page 18 U. S. overseas telephone messages . . . . . . . 73 19 U.S. international telephone message volume (1930-1959) . . . . . . . . . . . . . . 74 20 Satellite as a microwave repeater . . . . . . . 83 21 The satellite in a communications system . . . 84 22 Anterior view of a low orbit satellite SyStem O O I O O O O O O O O O O O O O O O O O 87 23 High altitude communications system . . . . . . 89 24 Synchronous relays . . . . . . . . . . . . . . 89 25 WOrld-wide telecommunication revenue potentially available to Telecomsat . . . . . . 91 26 Projected world wide intercontinental tele- communications demand versus estimated capacity of existing, planned, and proposed telephone cables, 1960—1980 . . . . . . . . . . 92 27 Projected transatlantic telecommunications channel demand versus capacity of existing planned and proposed cables, 1960-1980 . . . . 93 28 Market access--internationa1 equipment firms . . . . . . . . . . . . . . . . . . . . . 96 29 GE4Lockheed common carriers‘ common carrier concept . . . . . . . . . . . . . . . . . . . . 97 30 Summary——entry problem of nonintegrated equipment firms . . . . . . . . . . . . . . . . 99 31 Research and development expenditures in the United States, 1930—45 . . . . . . . . . . 113 32 Percentage distribution of funds for per- formance of research and development, by industry and source, 1961 . . . . . . . . . . . 117 33 Decline of patent ratio . . . . . . . . . . . . 130 34 Safety and Special radio service—- developmental basis . . . . . . . . . . . . . . 155 35 The Bell System coaxial cable program . . . . . 162 viii Figure Page 36 Coaxial cable . . . . . . . . . . . . . . . . . 165 37 Proposed Western Union radio relay system with supplementary trunk facilities . . . . . . 166 38 Western Union income . . . . . . . . . . . . . 167 39 Raytheon income series . . . . . . . . . . . . 169 40 AT&T coaxial and radio relay channel miles . . . . . . . . . . . . . . . . . . . . . 171 41 Map of new transcontinental microwave net- work and planned southern extension . . . . . . 173 42 Cost studies . . . . . . . . . . . . . . . . . 176 43 Microwave cost figures . . . . . . . . . . . . 180 44 Bell-non-Bell interconnection . . . . . . . . . 187 45 Bell vs. Western Union video relay systems . . 194 46 Railroad pole lines vs. private microwave . . . 201 47 Charges for 12 voice channels and 24 terminals . . . . . . . . . . . . . . . . . . . 220 48 Charges for 240 voice channels and 480 terminals . . . . . . . . . . . . . . . . . . . 221 49 Discrete vs. derived channels . . . . . . . . . 223 50 Motorola's concept of Telpak pricing . . . . . 229 51 Leverage of vertical integration . . . . . . . 242 52 Marginal cost pricing . . . . ... . . . . . . . 250 53 Spacemground interference potential . . . . . . 268 54 Compromise satellite bill . . . . . . . . . . . 293 ix CHAPTER I INTRODUCTION This study is concerned with the communication equip- ment industry. The Specific problem under analysis is the problem of market entry. An assessment of the entry problem will be organized under the following topics. First, what is the nature of market entry; second, what are the poten- tial or actual deterrants to market entry; and finally, what policy recommendations emerged from this study. The second topic, the deterrants to market entry, will receive the major emphasis in this study. Specifically, these barriers are classified as: 1. Legal and technological barrierS—-including patents, absolute capital cost, and the nature of the frequency Spectrum. 2. Market structural barriers-~including the interconnection policy and the pricing policy of the common carriers. 3. Finally, government policy-~including an assessment of decisions undertaken by the Federal Communications Commission, the Justice Department, and the National Aero- nautics and Space Administration. The markets under consideration will be segregated into the domestic equipment and the international equipment market. The specific purpose of this chapter is to segregate market structure as a potential deterrant to entry. The salient structural trait of the communication equipment in- dustry is that of vertical integration--a characteristic that appears to be common to both domestic and international markets. Furthermore, vertical integration exists between common carriers as suppliers of communication service and equipment manufacturers as suppliers of communication appa- ratus. Thus, a survey of previous thinking on the subject of vertical integration will serve as a convenient prelude to the general discussion of market entry. Market integration assumes three general forms: horizontal, vertical, and conglomerate integration. Hori- zontal integration is said to occur when like products are subject to common ownership; conglomerate integration exists when unlike or unrelated products are subject to common ownership; and vertical integration occurs when successive stages of production and/or distribution are subject to common ownership. Typically, vertical integration occurs when the raw material-final product sequence is absorbed into one operation; and sometimes the classification is further refined into forward or backward integration, depend- ing upon whether the source of the movement originated in the product or factor market. Although these definitions are general, the essence of vertical integration is that the market as a criteria of performance is diSplaced by the internal decision of the firm.1 Most commentators appear to agree that vertical inte- gration in and of itself is a neutral term and its existence in varying degrees is almost universal.2 This attempt to survey the literature will examine the relationship between vertical integration and market efficiency, market power, market entry, and finally, policy alternatives. The problem of efficiency arises when vertical inte- gration induces either a fall or a rise in the firm's per unit production costs. The former would result from econo- mies of integration, the latter from diseconomies. Several factors can contribute to economies of vertical combinations. A new technology may shift and redefine the technological process in which several independent steps are combined into one.3 1Arthur R. Burns, The Decline of Competition (New York: McGraw Hill Book Co., 1936), pp. 431-2, 461; also: M. A. Adelman, "Integration and Antitrust Policy," Harvard Law Review, Vol. 63, 1949, pp. 27, 33. 2Corwin Edwards, "Vertical Integration and the Mono- poly Problem," Journal of Marketing, Vol. 17 (July 1952— April 1953), pp. 404-5. 3See E. A. G. Robinson, Structure of Industry, pp. 25- 6. New technology can also result in what Robinson terms technical disintegration "where some given process requires a scale of production considerably greater than the Smaller firms in an industry can achieve, this process tends to be Separated off from the main stream. . . . Thus the indus- try becomes broken up into two or more industries and each is enabled to work at its most convenient scale of produc- tion." See George Stigler, "The Extent and Basis of Mono- poly," American Economic Review, 32:2 (1942), p. 22. A second economy may be induced by the eliminationzof 1 transactions or savings in the ”cost of transfer.” Such economies may include the avoidance of selling costs, the elimination of advertising, and perhaps greater economies of scale. Research laboratories are often justified as a result of scale economies.2 Other economies may result from a continuous flow of resources as a consequence of greater vertical control.3 Designated as a "rationalization" of the production process lower costs may be the result of the elimination of plant shut downs, the elimination of unnecessary inventories, and a dampening of wide output fluctuations.4 The importance of the last factor may rest upon the nature of the average cost curve, i.e., if it is,f1at-over a large span of the firm's output, fluctuations may not exact a high cost. Nevertheless, the coordination of resource input and produc- tion appears to have some importance in reduCing operating costs-~as Wallacenotes in the ease of the aluminum induStry.5 A . 1M- A. Adelman, PIntegrationIand the Antitrust Laws," 02. cit., p. 29' - , 2G. E. Hale, "Vertical Integration: Impact of the Anti- trust Laws upon Combinations of Successive Stages o'f_ Pro- duction and Distribution, "'Columbia Law Review, XLIX (1949), vpp. 950- l. '3Edwards, o . cit., pp. 405—6; also Maintaining; Competition (New EDIE McGraw Hill Book Co., 1949), p. 98. . 4Donald H. Wallace, Market -Control in the Alumihpm Industry (Cambridge: Harvard'Univer51tyPreSS, 1932) p.182. 51bid., p. 174. 5 Firms that integrate forward into the product market may induce lower coStS as a result of better diStributiOn, more coordinated merchandising, greater quality control, etc. In addition, Wallace cites other factors as important cost advantages accruing to integrated firms: 1. Closer and less wasteful coordination of re- quirements between successive stages. 2. The location of plants at points which are, for the particular industry, more favorable (because of tranSportation or production ad- vantages) than the locations already used or likely to be used in the given economic con- .juncture. , 3. The imposition at one or more stages of a more effective scale of investment, or more efficient tethnique. 4. The promotion of rationalization at one or more stages. 5.‘ The initial extension of able business man- agement of the control of more than one stage, or the imposition of more able manage- ment than:that already in control. Several observers have suggested that vertiCal intee gration possesses the virtue of permitting the firm to circumvent certain market imperfections. Spengler, for ex- ample, points out that a firm facing a monopolist supplier and confronted with menopoly prices can avoid monopoly rent by integrating-backward.and:supplying;itself.2 The 4‘ A. V . 1 11bid., p. 182. .zJoseph J. Spengler, “Vertical Integration and Anti- trust Policy," Journal of Politica1.Economy, Vol. 58 (1950), p. 351. "For our vertically-integrated.producer_has been enabled, through vertica1_integration, to evade the rent- 7’1 1;! ”.1 u~.‘ lower cost of production as a consequence of this circum- vmnion will ultimately benefit the consumer in the form of lower prices. Arthur Burns cites an example of this phe— inmenon when farm machinery producers were able to boycott. the steel and iron monopolies by providing their own steel Immds.1 However, Dirlam and Kahn have cautioned that if a firm is granted the power to remove monopoly profits, no assurance exists that the integrated firm will resist the temptation to insert monopoly profits itself.2 Spengler's thesis of the cost advantages attendant vertical integration extends beyond mere market imperfec- tions, however. He asserts that an integrated firm can avoid a host of Federal and state taxes that accompany all market transactions as well as permit the firm to dodge fair trade. pricing and farm supported prices.3 These are cost advant- ages that the nonintegrated firm cannot avail itself of. In Short, as a source of functional efficiency, verti- cal integration can result in advantages if, by combining' like 'monopolistic' surcharges being imposed by sellers situ- ated in earlier stages of production.” Also Burns, op. cit., p. 439. 1Burns, op. cit., p. 422. ' 2JeeliB. Dirlam and Alfred E. Kahn, Fair Competition: The Law and Economics of Antitrust Policy (Ithaca: CorneIl University Press, 1959), p. 148. SSpengler, op. cit., p. 351. \J (unrations, the firm finds that its costs are lower than if .fluzoperations are performed independently. Just as the efficiency of a plant has limits imposed turdiseconomies associated with size, the same diseconomics axfiront vertical combinations. That is, a point is reached “mere the cost advantages associated with vertical inte- guation are cancelled by cost disadvantages. The first is associated with the limitations of management. AS a plant includes more successive operations under its jurisdiction, it is possible that the technical optimum size may be greater or lesser than managerial optimum.1 Thus, even with the computer, managerial efficiency has its limits and . . there is no reason to suppose that all the dif- ferent functions of management and of manufacture will reach their optimum size at one and the same total output of the product.2 There is further the problem of synchronizing various 3 Burns has observed: plant scales in a production chain. The most economical scale of production at some stages of production is larger than at others; the longer the chain of processes integrated the greater the probability that it will include one which will induce large-scale organization of that process and, therefore, also in the preceding and succeeding processes. ’ 1E. A. G. Robinson, The Structure of Industry (Nisbet and Co., Ltd., Cambridge at the University Press, 1947), pp. 108, 112. 2Ibid., p. 108. 3George W. Stocking and Myron W. Watkins, Monopoly and Free Enterprise (New York: The Twentieth Century Fund, 1951), p. 65. 4Burns, gp. cit., p. 432. Thus, it becomes increasingly difficult for each stage to operate at optimum output. Again, the diseconomies of vertical integration may tend to elicit a bias.toward managerial inflexibility. Vertical integration may diminish the responsiveness of the firm to changes in knowledge of methods of production. In addition to the insulation effects of excessive vertical combination, a firm may be so committed to an investment inherent in a given process or product that it will resist alternative means of reducing costs. The vertically integrated firm is tempted to con- tinue using the former raw material in order to secure as great a return as possible from invest- ment in prior prgcesses which have now become partly obsolete. ' In sum, vertical integration induces market efficiency' if the cost advantages of combination outweight the cost disadvantages. However, there exists the problem that market size-may blur the area where diseconomies supersede cost economies and this leads to the second problem-~therelation- ship of market power to vertical integration. A .1 _ 11bid., p. 432. Also, p. 42, "The integration of the manufacture of automobile parts with the assembly of auto- 'mobiles, probably delayed the abandonment of the 'Model T Ford. I" . 2 . - . . . . Ibid. Also: Stocking and Watkins, o . cit., pp. 341-3; aIso Edwards, cit. pp 98, 171-3. See Carl , Kayser and Donald F. Turner, Anti Trust Policy-—An Economic and Le a1 Anal sis (Cambridge: Harvard University Press, I9595, I22. For an opposite view see: G. E. Hale, "Im- pact ofp the Antitrust Laws upon Combinations of Successive Stages of Production and Distribution, " 49 Columbia Law Review (1949),. 952. Corwin Edwards suggests that the problem of market Imwer arises when a firm assumes a diSproportionate share cf the industry's total output. Given the absolute size of the firm: the fact that a single business unit extends over several successive levels becomes the source of Special opportunities for the exercise of business power. This power or market "leverage” becomes apparent if the non- integrated firm resides in the product market or in the factor market. The nonintegrated firm, facing high factor costs from the integrated firfis manufacturing subsidiary and confronted with low product prices imposed by the integrated firm's re— tail subsidiary may be subjected to low profit margins which dampened the nonintegrated firm's ability to invest and ex- pand. The aluminum industry experienced the ”double squeeze" from integrated Alcoa.2 Under conditions where demand increases in the product market putting pressure on the supply of factor resources, it is conceivable that under conditions of supply inelastic- ity, the integrated supplier will favor its own retail out- let at the expense of the nonintegrated firm. On occasion, some nonintegrated firms have been ”starved” into bankruptcy. 1Edwards, "Vertical Integration and the Monopoly Prob- lem,” op. cit., pp. 405—6; also Maintaining Competition, p. 98. 2Dirlam and Kahn, op. cit., p. 167. r ‘E 10 A second problem of market control occurs when the nonintegrated firm resides in the factor market. The firm that operates in both retail and manufacturing market is able to enjoy the Option of make or buy on the manufacturing level. Again, this option can be employed to exact price discounts (discounts not accorded nonintegrated buyers) by threatening to undertake in-house manufacturing. If the integrated firm purchases supplies in sufficient quantities, then the exercise of the make or buy option becomes an ef- fective strategic device. Thus, A & P, in threatening to undertake the manufac- ture of certain products, obtained price discounts from some of its Suppliers. Adelman argues that such price con- cessions ultimately benefited the consumer in this parti- cular instance.1 I The A & P case is also illustrative of the strategic advantages associated with diSproportionate combinations. The government Charged that the company was subsidizing its low prices on the retail level from the high profits in the manufacturing level, and cases exist where a multi-market firm has ”bought into” a market by underwriting the losses from other markets. Furthermore, Corwin Edwards observes \lM. A. Adelman, ”The A & P Case: A Study in Applied Economic Theory,” Quarterly Journal of Economics,l949, p. 255. ”However, it may be that some of the abuses condemned by the government and the courts are not clearly an exercise of coercive bargaining power but are rather policies that vertic- ally integrated concerns should be encouraged to follow. Should not a vertically integrated grocery store be en- couraged to bargain with its suppliers for lower prices on the basis of what its own manufacturing costs would be?” 11 that the nonintegrated supplier may be forced to absorb in- dustry outputgfluctuations.1 As a hypothetical example, if a firm's vertical subsidiary operates at an optimum level,in supplying 80 per cent of the firm's manufactured product, the remaining 20 per cent is supplemented by independent sub- contractors. During a contraction in demand, the 20 per cent is cut off while the firm's own subsidiary continues to Oper- ate at optimum levels. A practice that appears common in the automobile industry, the nonintegrated supplier virtually assumes the risk of demand fluctuations.2 Vertical integration raises some problems of market entry. The problem arises when the existence of vertical integration prompts nonintegrated firms to integrate in self- defense. Chamberlin' remarks that this phenomenon of parallel integration . . . erects barriers in the way of competitors securing distribution except by integrating them- selves. Another apprehension leading to compulsive integration is the fear of high factor prices. Frequently, a potential entrant to an industry in which the major established firms are integrated 1Edwards, 0. "Vertical Integration and the Monopoly Problem," op, cit., p. 408. 2Donald A" Moore, The Automobile Industr in the Structure of American Industr , WaIter Adams, ed. {New York: flachIIan, I934), p. 293. The automobile practice was called "tapered vertical integration." 3Edward H. Chamberlin The Theor of Mono olistic ConEetltlon (Cambridge: Hariar n vers y ress,, , , saga nqs‘ I. : ..- :-.-: ...- I a... yr Vvh 'l N‘s. _ _— ‘L‘ n. .-‘I.-- 12 through several production stages will find that if it enters in nonintegrated status for production in some later stages it will have to purchase materials from established integrated firms and thus perhaps pay premium material prices. Together, the potential of high factor prices and the possi- bility of inadequate access to resources prompt the enter- ing firm to match integration for integration (witness the aluminum industry). The result is that in the presence of verticalintegrati01variable costs to the firm are converted into fixed costs.2 This, in turn, raises the capital re- quirements for entry into the industry, as well as increases the scale of plant necessitated by the greater fixed invest- ment. Chamberlin asserts that parallel integration pro- motes duplication of plant and equipment, leading to under- capacity and possible redundant plant. But the crucial impact of parallel integration is its effect on potential competition. As Kaysen and Turner summarized: In general, entry into a vertically integrated in- dustry is more difficult than would be entry into one of its component horizontal stages, gt least by the amount of the extra capital cost. l Joe S. Bain, Barriers to New Competition (Cambridge: Harvard University Press, 15525, p. 133. 2Carl Kaysen and Donald P. Turner, Anti Trust Policy-- An Economic and Le al Anal sis (Cambridge: Harvard Univer- sity Press, 15355, p. III. 3 0 0 Ibid. p. 120. See: Bain o . Cit. p. 145; also: B. A. G. Robinson, Mono ol , p. 6A, "But quite obviously, the larger the capi a requirement, and the larger the addition of output in relation to the existing output of the industry the less likely is any competitor to think it profitable to attempt to force his way into the industry and the more enduring is the quasi-monopoly likely to be." Robert Bork, "Vertical Integration and the Sherman Act: The 13 Finally, what policy suggestions have been advanced in deal- ing with the market control aspects of vertical integration? Much of the answer to this question is dependent upon what is regarded as the source of market power. Spengler and others have suggested that vertical integration per se is not at fault.1 The real cause exists in horizontal concen- tration and to this problem all policy considerations should be directed. Others insist that diSproportionate market power associated with vertical integration should be subject to divestiture action if such action is consistent with market 2 efficiencies. Still others advocated a market performance criteria Legal History of an Economic Misconception,” 22 University of Chicago Law Review, pp. 195-6. Thus, monopoly power de- pends upon the percentage of the market occupied by the firm, and the ease of entry into that market. Vertical integration does not increase the percentage of the market controlled by a firm. It should be equally apparent that such integration does not impede entry into a market. 1Spengler, op. cit., p. 352. "It follows that vertic- al integration if unaccompanied by a competition-suppressing amount of horizontal integration and if conducive to cost and price reductions, should be looked upon with favor by a court interested in lower prices and a better allocation of resources. " Further, if restraint of trade exists, ". . it is the horizontal elements that need be singled out for remedial treatment. See also: E. A. G. Robinson, The Structure of Competitive Industry, pp. 132- 3; and Erich schneider, ”Real EConomies of Integration and Large- scale Production Versus Advantages of Domination" in Monopoly and Competition and Their Regulations, Edward H. Chamberlain, editor, p. 212. Also: G. E.’Ha1e, op. cit., p. 952. 2Walter Adams, "Public Policy in a Free Enterprise Economy," Structure of American Industry (New York: Mac- millan Co., 1961), p. 557. Also: Edwards, ”Vertical Inte- gration and the Monopoly Problem," p. 407. 14 in evaluating vertical combinations in a case by case basis.1 In its concern with competitive entry, this study will at- tempt to evaluate the relevance of the Spengler thesis against the existence of vertical integration in the communication equipment industry. 1Adelman, o . cit., p. 49. "What we need, therefore, is a painstaking examination of the economic facts of the indiv1dua1 case." CHAPTER II THE PROBLEM Given this brief survey of the literature on vertical integration, the discussion will now concentrate on the first of the three broad issues cited in Chapter I, namely, what is the nature of the market entry problem. It is the thesis of this study that market entry in the communications hardware industry assumes three levels. Its technological level takes the form of competing altern- ative means of conveying information, metallic circuits vs. radio or microwave circuits. Its market level assumes the form of nonintegrated suppliers seeking entry into a market previously regarded as the province of captive suppliers of common carriers, i.e., integrated equipment suppliers. Finally, while somewhat oversimplified, it is fair to ob- serve that the integrated firms tend to represent a vested interest in metallic circuits, while the nonintegrated firms tend to represent a vested interest in microwave radio relay. In short, the integrated equipment firms are being challenged by nonintegrated firms who, in the main, repre- sent a competitive technical alternative to the conventional means and equipment used in rendering communication services. 15 an a a 16 We turn first to the domestic market, to be followed by the international market. The problem of entry in the domestic equipment market will include first, a survey of conventional communication technology and its attendant market structure; second, a survey of new communication technology and its market struc- ture; and finally, the problem of market entry as a conse- quence of competing technologies. Domestic Market Conventional Technology The raw material in the transmission of intelligence, be it record, voice, or data, is the electromagnetic signal. Information is relayed by a process of pressing an intelli- gence signal on a carrier signal and removing it at its destination--a process known as modulation and demodulation. Each signal, depending upon the information carried, exhibits the property of oscillating so many cycles per second. The number of oscillations or range of frequencies required by a Specific signal is known as bandwidth, and the bands of frequencies required vary from small to increasingly large requirements as illustrated in Table 1. For example, the band of frequencies required to convey one television signal is equivalent to 600 telephone voice signals or channels. In general, the amount of information carried by a signal is proportional to its frequency of oscillation. 17 TABLE I BAND WIDTHS REQUIRED FOR VARIOUS RADIO-COMMUNICATION SERVICES fl . Typical Band Kind of Service Widths, cps Keyed telegraphy--manual (25 wds/min) 0-100 Frequency shift telegraphy O-l,800 Tone-modulated telegraphy (25 wds/min, 1,000 cps tone) 0-2,100 Telephony, commercial (ssb) 0-3,000 Facsimile, 8 x 10 in., 100 lines/in. trans- mitted with 1,000 cps tone 0-4,000 Telephony, commercial (DSB) 0-6,000 Telephony, high quality 858 0-5,000 FM Facsimile, 8 x 10 in. pix, transmitted with 1,000 cps tone O-l4,000 Telephony, exceptionally high quality 558 0-20,000 Telephony, frequency modulated O-36,000 Telephone broadcasting, FM, high quality O-200,000 Television, commercial (525 lines, 30 g frames/sec) 30-4,350,000 High-definition television (1,029 lines, 30 frames/sec) ' 30-16,650,000 Source: The Electronic Spectrum, Electronic Industries, Chilton Company, 1962, Philadelphia; also Philco, Lansdale Division, Lansdale, Pennsylvania. Frequencies are usually measured as either kilocycles or megacycles. A kilocycle is a thousand oscillations or cycles per second, a megacycle is equivalent to a 1000 kilocycles. The communications industry is erected upon the pro- perty of electromagnetic signals. Sending equipment or station equipment converts sound waves into electric impulses, the impulses carried via metallic circuits, the electro- magnetic signal is then reconverted to sound waves by receiving 18 apparatus. The signal could be a voice message (telephone) or a record message (telegraph). In either case, subscribers are interconnected to each other by central exchanges known 'as switchboards and the whole complex laced together with . wires and cables. Reference to technology as conventional by no means minimizes the complexity of a modern communications network, but rather the description is directed to the traditional medium through which.intelligence is transmitted in the domestic market, namely, metallic circuits. I Originating as open cepper wires, lines were strung on glass insulators mounted on pole—crossarms. As the state of the art progressed and as an interference known as crosstalk was diagnosed and solved, wires were strung closer together in the form of cables, enabling the trans- mission of more messages. The epitome of the metallic circuit was the coaxial cable developed by the Bell Tele- phone Company. The capacity of the coaxial cable permitted the rendition of signals of wide bandwidth, such as fre- quencymodulation radio (FM) and television, as well as hundreds of telephone channels (not simultaneous with video, -however. The technique of multiplexing and the development of carrier systems expanded the capacity of metallic circuits. Carrier systems, by generating a wider frequency band, ex-. panded and permitted simultaneous relaying of voice mess- ages, in some cases doubling capacity of cables. n F‘Lh 19 Figure 1 illustrates the adaptation of carrier systems to open wire conductors, conductors in paired and quadded cable, and coaxial cable. § § 3 g g 9‘ 3‘ i 9. 1 IHCewievl . f |.flhwbv| as ,L Van Primeij L can» ] Owwmanww .c. [ Vme ~an DC F Vauniqvm‘gj } ------" 1:333:22: ::':::‘_‘:‘_r W... I Antwan SI ....... T -.._____‘T _____ , - , __1'1034 ________ ____[ “6mm L J ..... -..J_------_I___-_-r l . _ . _ - ___ _ {of 31:; .............. [ 6m' 1 Figure l. The frequency bands used in the Bell System's - wire communication system. Source: Charles Mapes, "Carrier is King," Bell Telephone Magazine, XXVIII:4 (Winter, 1949-30), p. 198. Firms engaged in rendering domestic communication services are known as common carriers. Subject to regu- lation under the Communication Act of 1934, these public utilities are granted licenses to engage in the rendition of interstate communication service. A certificate of convenience and necessity represents a monopoly grant by the government to the common carrier, and in return for this grant, the tariffs, service, and profits are under 20 surveillance by the FCC. The carriers must grant service to all consumers and are assured of reasonable rates of return. Message record service is provided by Western Union and message voice service rendered by some 3,000 plus tele- phone companies. However, in both markets, record and voice, the American Telephone and Telegraph Company is of central influence. Hence, the Bell System will be described in closer detail. The organizational structure of the Bell System is depicted in Figure 2. Supporting the Bell System are twenty-two operating subsidiaries. Nineteen operating companies are almost wholly owned by the parent firm, American Telephone and Telegraph Company, and two subsidiaries partially or sub— stantially owned. The operating companies are divided into regional territories or states and provide local exchange telephone service. Long distance service is provided by the Long Lines Department of AT&T, whose lines and facili- ties interconnect each of the operating companies. Table 2 and Figure 3 depict the Bell Telephone associated com— panies and the territories in which service is conducted. In addition to the Long Lines Department, AT&T's General Department performs much of the administrative work of the whole system by financing the operating companies, supplying them construction funds, and providing cash for day-to-day Operations. 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IL seed 1: «J O 3 5:32:82 . l/f'if .8 .9 .83» 2328...... .. ..... .. 1.. . 23 TABLE 2 AMERICAN TELEPHONE AND TELEGRAPH COMPANY INVESEMENTS IN SUBSIDIARIES AND December 31, IN OTHER COMPANIES 1960 Capital Stocks owned by AT&T Co. PRINCIPAL TELEPHONE Per cent SUBSIDIARIES owned New England Tel.&Tel. Co. 69.33 New York Tel. Co. 100.00 New Jersey Bell Tel. Co. 100.00 Bell Tel. Co. of Pa. 100.00 Diamond State Tel. Co. 100.00 Chesapeake & Potomac Tel. Co. 100.00 Chesapeake & Potomac Tel. Co. of Md. 100.00 Chesapeake & Potomac Tel. Co. of Va. 100.00 Chesapeake & Potomac Tel. Co. of West Va. 100.00 Southern Bell Tel. & Tel. Co. 100.00 Ohio Bell Tel. Co. 100.00 Michigan Bell Tel. Co. 99.00 Indiana Bell Tel. Co., Inc. 100.00 Wisconsin Tel. Co. 100.00 Illinois Bell Tel. Co. 99.32 Northwestern Bell Tel. Co. 100.00 Southwestern Bell Tel. Co. 99.99 Mountain States Tel.& Tel. Co. 86.75 Pacific Tel. & Tel. Co. 89.62 Total OTHER SUBSIDIARIES Bell Telephone Laboratories 50.00 Western Electric Co., Inc. 99.82 195 Broadway Corporation 100.00 Other -- Total OTHER CCMPANI ES Southern New England Tel. 19.06 Cincinati & Suburban Bell Tel. Co. 29.83 Bell Tel. Co. of Canada 3.51 Miscellaneous Investments Total Cost (thous. of $) $310,641 1,424,280 523,667 666,316 41,700 101,000 226,468 250,000 97,000 1,266,817 532,042 409,399 206,587 218,224 671,422 411,040 1,243,243 439,195 1,402,360 $10,441,301 $27,500 739,361 26,015 31,068 $823,944 $36,990 21,065 18,855 28,304 $105,214 Advances from AT&T C0. (thous. of $) $84,000 18,400 15,500 4,175 22,200 28,800 28,000 7,700 29,000 17,500 18,000 6,200 5,900 39,000 17,900 25,000 18,200 134 000 $519,473 $4,600 3 650 wt— ,250 $4,600 8,100 ’3T27799 ‘S-oAurce: AfIf&fIf Apnpal Report, 1960, p. 21. 24 reSpective areas; in return, AT&T receives stock dividends and a 1 per cent management assessment on the subsidiaries' gross revenue. Western Electric, the manufacturing and supply arm of the system, is owned wholly by AT&T, In addition, Western Electric and AT&T each own 50 per cent of the stock in Bell Telephone Laboratories, Inc, the non-profit research facil- ity of the system. The Bell Laboratory conducts fundamental research and determines equipment Specifications of tele- phone apparatus. It bills both Western Electric and AT&T, depending on the ratio of work performed for each. Finally, the 195 Broadway Corporation performs the real estate functions in New York. Figure 2, then, depicts what has be- come known as the Bell System. In a sense, the System ex- hibits trilevel vertical integration in that Bell Labora- tories designs communication equipment and apparatus; Western Electric manufactures the equipment; and the operating com- panies purchase the equipment in order to render service to the end user, the consumer. Overseeing these activities stands AT&T. Its Long Lines Department functions as oper— ator of the long distance facilities, and its General Depart- ment functions as a holding company--controlling the stock and operations of the Bell subsidiary companies, Bell Laboratory and Western Electric. Although no written contract exists between Western Electric and the Bell operating companies, the fact that each is subject to common ownership means that the Bell 25 subsidiaries purchase practically all of their equipment from Western Electric. Western Electric, in turn, procures some 35 per cent of its equipment means from outside suppliers.l Total Operating revenues for the communication industry are shown in Table 3. Figure 4 includes the revenue break- down between Western Union, the independent telephone com- panies, as well as the Bell System. The preeminence of Bell's 8 billion dollar receipts is amplified by the fact that the 2 billion dollar receipts of the independents is shared by some 3,000 separate independent companies. The market for communication services can be separated into the public message market and the private line market. The former includes service rendered to the general consumer including voice and record service. The latter includes equipment and channel leased to private business for Specific purposes and exclusive connections. Table 3 contrasts the percentage share of local message and toll exchange service rendered by the Bell System and the independents. The Bell System accounts for some 85 per cent of local exchange service and 98 per cent of toll exchange (long distance) service. While Bell's predominance in telephone message service is generally recognized, perhaps less well known are the mar- ket Shares in the public message record field--the Telegraph and Teletypewriter Exchange Service (TWX). Figure 5 illus- trates this market with about a 50-50 Split between Western Union and Bell's TWX service. 1Letter from AT&T to author, May 6, 1963 26 TABLE 3 BELL SYSTEM OPERATING REVENUES Bell System Operating Revenues (before Uncollectibles) (In Thousands) Local Toll Year Service Service Miscellaneous Total 1951 $2,146,439 $1,342,914 $159,605 $3,648,958 1952 2,397,552 1,470,267 182,900 4,050,719 1953 2,642,905 1,571,088 214,956 4,428,949 1954 2,836,958 1,720,742 241,677 4,799,377 1955 3,086,455 1,959,667 264,967 5,311,089 1956 3,368,608 2,176,241 297,243 5,842,092 1957 3,647,596 2,357,650 331,375 6,336,621 1958 3,944,443 2,490,649 360,590 6,795,682 1959 4,250,778 2,786,144 381,033 7,417,955 1960 4,547,409 2,996,436 414,280 7,958,125 1961 4,797,528 3,217,300 440,101 8,454,929 Reporting Companies of U. S. Independent Telephone Association Operating Revenues (before Uncollectibles) (In Thousands) Local Toll Year Service Service Miscellaneous Total 1957 $411,704 $198,618 $26,626 $636,948 1958 459,906 217,470 30,336 707,712 1959 519,394 254,147 31,855 805,396 1960 585,004 289,400 36,398 910,802 1961 640,202 320,193 39,370 999,765 Source: FCC letter to author, January 23, 27 .uoo>:m >onwuaou >D coaum :fioomm< moonooaoe pooocoooooH mopmum oopflcb .oEoHo> Hoofiumflpmwm Hoacm< NOQH come no oeoenueoo< .Hamnmuez .1 noose; «nonsmoui an .4864 .6 noumflw :0 00m on“ ouomoo ooNflooesom mo ammo» moan: snowmoz mo 3ofl>ou < nouuoom .mpcoocoaoooHIEopm>m Haomncoacs nuopmoz mosco>od HmpoH .v ousmfim , OQOH wmoa onoa VmOH Nmoa OWOH wvoa ovoa O _ . _ A u L a F a O AOSOHV oohaamz Rama fiance come: ecoomoz III-Ill. Y\\\.\\ \\\\\. mofioodeoo omonmoaoh pcoooomoooH 1\\\\ m \\\\\ 1 111 \\\\ N \\ \\ \\ \ \\ \\\ \ \\ \x 8 .xx‘\\ \\\\ \ \\ \\\,Anmmumoaofi boo odonaoaoev \\\ Hooch soomam 446m \\ T\ o \\\ \\ \\ \ ex. \\ \ \. \\\ A.pmm.lllL.\ oooflw cowaaom ma QMNmHHOD Ho maceaawm 28 .Eoum>m HammIGOwGD : .uuo .mo sowmoz .m .>moofi moan: assume: no 3om>od < ”mouaom ouw>uum ommmmoa snowmoaoa umanan umumoaoa .m ussmwm oooa wmoa omoa vnou mmod omoa wood coda o _ A A . , o .111. sl‘ \.‘\ f \Lr\\.|||\ on L on x\ \ \LI‘I|\ \\\:\\\ Apo;maaumov :aoumsm drum \\ . as \\ MK\ SET: moi, \ ooa A.om6.oooai newfiawz NHH on”! ona :0wmp :soumoz .ll oom%fiflmmo: mo madmaamx 29 As opposed to the public message market, the private line market varies in importance to the Bell System and Western Union--accounting for some 2 per cent of Bell's total revenues, but 20 per cent of Western Union's total revenues.1 As noted earlier, circuits in this market are leased to business firms, at a flat monthly fee, for rendering service to specific points. The services include the following: a. Telephone service consists of furniShing channels terminating at customer locations in telephone instru- ments or PBX (private branch exchange) board furnished by telephone companies. The service is furnished by the Bell System companies and their connecting carriers. b. Telegraph service consists of furnishing both channe s and station equipment, or the channels only with the customer providing his own station equip- ment. This service includes what is termed teletype- writer service by AT&T and teleprinter service by Western Union. c. Telephoto raph (facsimile) service consists of telephone gra e channeIs Specially adapted for trans- mission of picture material. AT&T furnishes the channels only and the customer provides the station equipment. In Western Union's service, station equip- ment may be furnished either by the customer or the carrier. d. Data transmission service consists of telephone and telegraph grade channeIS for the transmission of signals generated by customer-provided data process- ing equipment. # lInitial Decision, adopted July 6, 1961. Before the Federal Communications Commission, in the matter of American Telephone and Telegraph Company charges, classification, regulations, and practices for and in connection with Private Line Services and Channels, Docket No. 11645. In the matter of the Western Union Telegraph Company changes, classific- ations, regulations and practices for and in connection with Domestic Leased Facility Service, Docket No. 11646. (Here- after cited as the Private Line Docket.) 30 e. Remote metering, supervisory control and miscelIaneousISigpaling services. TeTephone and tele- graph grade channels are furnished for such purposes as indicating readings of customers' meters at distant locations and remote control of customer-provided switches and signals. f. Multiple channel service consists of certain group- ings of telephone grade channels and of telegraph grade channels for charging purposes. A customer leasing a requisite amount of Such Service iS afforded a discount increasing with the quantum of channels between desig- nated points. g. Government extension Service consists of the fur- nishifig of facilities to customers for interconnection with a private line telephone, telegraph or telephoto- graph service furnished to an agency of the United States Government for the collection and dissemination of information relating to matters of public interest Such as weather conditions and aircraft flight inform- ation. The facilities furnished such customers by the carriers are channels with or without station eqnip- ment, subject to the variations described above. Total revenues (Figure 6) are shared between AT&T and Western Union with Bell accounting for nearly all private line telephone (recently Western Union was permitted to render private line voice). Private line telegraphy is Split between Bell and Western Union in a 2:1 ratio (Table 4 and Figure 7). 2 has Recently, one-third of the private line market been further segregated into the bulk communications market (Figure 8). Equivalent to about 1 per cent of the Bell lIbid., p. 60. 2Before the Federal Communications Commission in the rnatter of American Telephone and Telegraph Company Regula- tions and charges for Telpak services and channels (Docket ,No. 14251, testimony of Curtiss M. Bushnell, Motorola Ex- hibit No. 13, p. 7 (herein cited as the Telpak Docket)). 31 Millions 4.5 AT&T 1-0" Western Union O l I l l 1 l l 1955 1956 1957 1958 1959 1960 1961 Figure 6. Total private line market--AT&T and Western Union. Source: FCC letter to author, January 23, 1963. 32 TABLE 4 PRIVATE LINE SERVICE REVENUES AT&T and Western Union (In Thousands) _ Revenues Private Line AT&T Telegraph Private Line Program Year W.U. AT&T Telephone and Other 1951 $15,202 $35,920 $43,526 $30,228 1952 17,679 40,254 52,801 35,802 1953 19,924 44,034 60,581 41,138 1954 22,347 48,138 63,388 55,030 1955 26,486 54,664 82,576 58,558 1956 31,700 65,154 101,822 63,170 1957 36,131 76,627 119,906 65,951 1958 40,757 84,651 141,031 70,315 1959 51,423 107,389 170,185 75,656 1960 56,578 116,479 201,225 86,158 1961 61,140 121,071 210,591 93,364 1962 56,444a 115,617b 186,934b 95,583b TELPAK Service not included above: 1961 $17,315 1962 58,459b all months estimated 11 months actual Source: FCC letter to author, January 23, 1963. 33 .Hamnmso: .m .3 poooflmoum >n .deH «o mono: mo muonOmewafiou MUOp down: snowmoz mo 3ofl>ou m .Eopm>m Haomucofinb :uopmoz .mooco>ou mow: opm>fium namumoHoH owpmoeoa 00m may ouowon oouwumeeam mm ”ouuaom .b whamwm 0H OOOH wmoa OMOH emoa mmoa 0 0H we H co 0 ‘1 _ d a J _ \I‘II\‘IIIs \\\\\\YcOM:D :uoumoz \\\\\\ \\ \\\x \ \\\ \ i \ \\\\ om \ \\\ 239$ 36m 8863 .833: 8.83 \\ .\ \. ms \ .\ \ \ \ OOH V\ _\ \. A.omo aoofiv condos: o.saam seen 90 ww084~wz Billions of Dollars 34 7 - . 6 . ; 5‘. \ O O O 4 _ o ; o o a o 't o " oo «o “O as 0 “ O " 00 OM OF 8:; \ 0.; \ of: 3 —-‘ “ N N 0 ~ N " l‘ " ‘0'“ H-P Na 49;: 69G *fi'G Q) Q) 0) «E 0.8 \ «a 4» HG 49:: 2 _ n$4 . c H a u U” QJQ) 00) a:> E > I g > GO GO 0 a? a? a? >.: > c 1970 > g 00 00 OO 1_ oz wz 0‘2 .5 . ___] <1 1—» v ‘ lh‘ ‘A B C A B C A B C A Bell System's total toll business B Bell System's toll private line business C Total bulk communications market ‘Figure 8. Relationship of bulk communications market to Bell System's toll business. Source: Jlglpgg_g§g;igg§, proposed findings and conclusions of Motorola, Inc., p. 67. 35 System's total operating revenue, this market is generated by the growth of automatic data processing techniques (hence the need for broadband channels) and the trend toward business decentralization of operations while centralizing administrative locations. The bulk market has been defined by Bell as those users whose demand exceeds six voice. channels—-a market consisting of government agencies and very large firms (Western Union estimates that 55 per cent of its revenue comes from 5 per cent of its customers).1 As op- posed to an 8 per cent growth rate in public message service, the private line market is growing at 20 per cent. Table 5 projects the growth of this market relative to Bell System's total toll business and toll private line business; the dollar and channel equivalents are shown in Table 6. TABLE 5 DEMAND COMPONENTS OF BULK COMMUNICATION MARKET Millions of Dollars Annually Calendar Years 1965 1970 Total Government $128 $192 TranSportation Industries 11 34 Other Industries ‘ 26 46 Total $165 $272 1Western Union Presentation, op. cit., p. 44. 36 TABLE 6 CHANNEL REVENUE PROJECTIONS OF BULK COMMUNICATION.MARKET Millions of Dollars Annually Calendar Years 1965 1970 6-12 voice channels or equivalent $80 $123 13-24 voice channels or equivalent 28 47 25-60 voice channels or equivalent 21 37 61-240 voice channels or equivalent 36 65 Total $165 $272 Source: Telpak Hearings, testimony of John F. Magee, Bell System, Exhibit No. 1, p. 5. Reference to Table 4, column 4, captioned “Program and others" reveals Bell's revenues from transmitting video and AM programs through its facilities. 0f the total broadcast and video transmission channels furnished, Bell Supplies some 93,660 channel miles, whereas, the independents account for some 150 channel miles.1 Thus, AT&T's position in the public message voice, public message record, the private line market, its rendition of program channels is attested by the following statistics; the Bell System ac- counts for 85 per cent of local exchange service, 98 per cent of long distance facilities, 50 per cent of message record service, about 70 per cent of the private line lFCC letter to author, September 17, 1962. 37 telegraph field, almost 100 per cent of private line tele- phone and intercity program channels, and approximately 85 per cent of the total private.line market. The communication equipment market includes an array of equipment ranging from telephone sets to cable terminals. Some indication of the magnitude of the market is recorded in Table 7, showing sales from 1953 to 1962. TABLE 7 U. S. COMMUNICATION EQUIPMENT SALES W Total sales GNP (billion dollars, (billion dollars, P0pu1ation Year constant 1958) constant 1958) (millions)- 1953 1.77 $408.7 $159.64 1954 1.78 402.1 162.42 1955. 2.16 434.9 165.27 1956 2.70 443.6 168.17 1¢57 2.73 452.0 171.23 1958 2.48 441.7 174.171 1959 2.65 475.1 177.14 1960 2.93 487.8 180.13 1961 est. 3.20 -- -- 1962 est. 3.33 -- -- k Source: United States Department of Commerce, Communication Industries Division, Business and Defense Services Administration, December 21,1961. The Bell System's manufacturing subsidiary, Western - Electric, is the central factor in the equipment market ac- counting for 73 per cent of all telephone apparatus and equipment, insulating~wire and cable in the country in 1954, and some 60 per cent.in 1961.1 In relative terms Westenn _- 1Private-Line Docket, Initial Decision, op. cit., p. 37. 38 Electric ranks sixteenth in size among all U. S. corpor- ations, and in terms of sales, ranks ninth.1 Over a period of twenty-five years, Western Electric's sales to the Bell companies have amounted to 95 per cent of its total sales. Necessarily, this has meant that Western Electric's share of the total equipment has averaged around 90 per cent. Some concept of Western's historical market predominance is revealed in the annual sales for an eight- year period beginning in 1926 (Table 8). TABLE 8 AVERAGE ANNUAL SALES OF TELEPHONE APPARATUS AND EQUIPMENT AND PERCENTAGES OF TOTAL, WESTERN ELECTRIC COMPANY AND FIVE LEADING INDEPENDENT PRODUCERS, 1926-1934 Average Per Cent Annual of Company Sales Total Western Electric $115,079,000 87.6 Automatic Electric 8,637,898 6.6 Kellogg Switchboard and Supply 4,471,670 3.4 Stromberg-Carlson 2,626,498 2.0 North Electric 443,536 .3 Leich Electric 173,920 .1 Source: John B. Sheahan, "Competition vs. Regulation as a Policy Aim for the Telephone Equipment Industry.” Unpublished Ph.D. thesis, Harvard University, August 1951, p. 55. 1H. R. Bickett and T. W. Spicer, ”Indirect Regulation of Western Electric" (notes from which informal talk was given December 20, 1962, to Amherst group, American Telephone and Telegraph Company), p. 1. 39 Over 90 per cent of the Bell System's communication apparatus and equipment is secured from Western Electric. This investment in plant and equipment influences the cost of telephone service since as one component in the rate base the Bell operating companies are entitled to earn a reason— able rate of return. In 1957, for example, about 50 to 60 per cent of Bell's gross investment in telephone plant1 (18 billion) was Western Electric equipment. Remaining investment includes property (buildings and land), instal- lation costs, and local supply purchases. Figure 9 outlines the corporate structure of Western Electric: The Teletype Corporation manufacturers and sells printing telegraph equipment, not only to Bell System companies, but also to Western Union. Some indication as to the investments of Western Electric is depicted in Table 9. Table 10 outlines the breakdown of Western's cus— tomers, and Table 11 her income. Figure 10 depicts the general distribution of Western's output over time. Most of the government contracts involve defense work. The domestic equipment market also includes the sub- sidiaries of the General Telephone and Electronic Company (Sylvania, Automatic Electric, etc.). On a smaller scale, the General System represents a market structure integrat- ing manufacturing units with the operating companies. 1Private Line Docket, op. cit., p. 37. 40 100% owned by Western. Manufactures & sells print- ing telegraph equipment. Teletype Corporation A Nassau Smelt 100% owned by Western. & Refining Reclaims & sells non- Co., Inc. ferrous metals. Western Fanufacturers 99.9% owned by Western. Electric COI’ unction Rail Serves principally the Inc. [Lay Company Hawthorne Plant of 7 - Western. 82.% owned by Western. Owns & operates building in New York City used principally as distri- buting house of Western. 395 Hudson St ’ Corporation 100% owned by Western. W980 . Holds Western's invest- Corporation ments not directly re- lated to the Bell business (including Westrex Corp. which sells sound equip. abroad). Figure 9. Western Electric Co., Inc. and principal sub- sidiaries. Source: NARgg-Egc 1948 Study, p. 13. 41 we we HmpoH OH NH cofipmsam>om mm mm moucm>p< I u .Amoumnm OOH u usaw> you H mv EUOpm Hmufimmo prczo Roofiv Aconcoqv .qu .>cwmeoo ofluuomam cuoummz omm omm Hmpofi Aaumv AHSNV msoufi >cmmsounopCfl How m>uomom co mo coaumoam>om sou woe Amuueem meu.m - usau> uea ooawv xuouu Huuumeo Apoczo &o.oov >cmaeoo waHflmm coauocSW .muouawomwscmz moo_m mHo_v HopoH Awaev Aomav msopfl >28QEOU~6¢Cfi now o>nomom mam.a mme.H coauuuae>um omH.H o memos nausea one.m one.m Amuueem ooo.ma - uaae> use 023 necem Heuuauo Abmczo $ooav .ucH .>chEoo wCMCAMom new wcfimeEm smmmmz new we mum we HmHOH Aomvuov Aommucv mauve >CMQEOUHopcfl How m>ummmm eam.e wme acupunau>um ooo.mew oom.omw Amuueem ooo.omm.s . usau> Hen ozv locum Henuaeo Apoczo fiooapwcofipmuoauoo masuoaoH unam> hafisvm pm moficmmeoo xuwfibfimnsm oooa Hooa .Hm nonsmomm .Hm Honsmuoo AmpcmmsocH Ca mumaaoov Heed new oeoa .Hm uuhEuuuo nu m< mezmzwmm>zH .ozH .>zcmnsoo snowmoaoh new oaozmoamh :muanms< >9 poczo ounmamm Acfi maoocmaaoumflz Hoe.» mmo.w meeue6m6>em shamed “moo BoHom no um manospmo>cH guano co .2 pphwwwlu com e 000 ma memoa panama oom.emw oom.uma Amuueem ooo.mem - uea ooawo eu0um Heuwmeo Aumficfimnsm HopoH pl- _ i p ..I: HmuoH AomV AemV eoenusae>um om om mmucm>p< OH OH Amuuenm ooa - usae> use oonov xuonm Hunaauo Apmczo gooav Ampmcwov .Uuq .xcmasoo ofluuuoam snowmoz a a Amoumcm 00H n msam> moo ozv xoovm Hmpfiamo Acmczo gooav coaumuomuoo mfipcmm oooa Hooa .Hm nonsmuoa .Hm monsoomo Avoscflwcouv o mqm<8 43 TABLE 10 WESTERN ELECTRIC COMPANY, INC. SALES Years 1960 and 1961 (Dollars in Thousands) 1961 1960 By Customer Classes 8611 Telephone Companies $1,916,805 $1,850,248 Non-Bell customers: United States Government 608,950 702,669 Subsidiary and associated companies 12,001 7,560 Graybar Electric Company, Inc. 17,018 17,399 Other customers 8,365 19,539 Total non-Bell customers 646,334 747,167 Grand Total 2,573,139 2,597,415 By Product Classes Apparatus and equipment: Switchboards 1,023,312 929,706 Station apparatus 160,045 148,144 Protection and outside plant 56,762 58,935 Repairs and services 112,930 102,648 Non-telephone products 580,936 683,375 Total apparatus and equipment 1,933,985 1,922,808 Cable and wire: Exchange and toll cable 176,079 219,980 Rubber covered wire 27,519 31,391 Total cable and wire 203,598 251,371 Supplies 425,556 423,236 Grand total $2,563,139 $2,597,415 Source: NARUC—FCC, 1962, p. 20. 44 A.m:0fipu:Umu ouocob momonpcoummv .Hm .a .meoa .oom-o:m¢z H3.28m .mcofiumuomo Seuw my amen :H poonaocfi we noes; .mucosumm> use ammo >umuoasop Scum mEoucfi >Mwmmfiucfium wnfiucmmmu on oooa GM wao.mw bum 00H CM oem.Hw mooaauxoummomcomxo Honpo wanmofla a uo>o mumflooou meow omcoofia new sceammco ou .mofiuam>ou mo mmouxo may now voodoo“ we omcmaxo mcfiumocamum poueaou one unoEQOHo>oU muonooum oconmoaou noes: >n «noose mopsaucfln ”mnemoua >cmaeouumpcfi How o>ummou :M mmnanu mo uuowmo mopnaocH . m Hom.em mmo.ew mem.omy who.mw unme.eaw ome OH oee oefi eoe uueno a emuuueeH .meeuee>eo nmee.e mee.e muum uueuueo one cofiwmmnwmsoo .mmfipaw>om Hme.m, meo.e emo.m one ooe.o fleece m m m Aconcoqv.pug.oo oaupumam quoumvz m 0H mm m mm .00 .Sm cowwucah .mumH396wwocmz oem Aewv emu ma eon .oo weeeeuum e meeuauEm summez mwe.mw omo.mw mua.mw Heew eee.ow :oeneuoauoo easemauh dumUMHNMUMmDSW EOHM UEOUGH oeon ome.emt eeu.mw oem.ofiw mau.mw usmo.eaw cue en eme omfi mmm uueno a emuuuneH .meeuue>eo nema.m ema.m moom encoded . one cowwomcoasoo .mofiuam>om oeo.e- mme.m mmm.o oom emm.oa Hence m m m Aeoueonv.oun .oo oeuuuuam euuuuuz ma mm 00 N No .00 .>m newuuczh .muousyumwacmz was Hoe eee em om» .oo meeeemum a meeuauEm nemuez www.mw Noa.mm 000.0% mmew oam.ow nowpmuomuoo ma>uoaob mnmowummofimnam scum osoocH Heed Haomnnoz Haom Hauoh mome oEOUGH mmouo Hmuonom .HU:M momcmaxm Ambnmmsonfi cw mHmHHoov ail Hooa new oooa whom» mmmszDm QAMmIZOz Qz< qqmm ZMNZHmm mZOOzH mmmfio m0 ZOHmH>HD HA m4m<fi III ‘1'. -\IV 2,700 2,400 2,100 45 1 GovernmenJand O:her 1,800 1,500 1,200 900 600 300 19 \ \ ig//V lags. .,‘\\\N Bell 52 1953 1954 1955 1956 1957 1958 1959 1960 1961 Figure 10. Western Electric sales (in millions of dollars). - Source: Western Electric 1961 Annual Report, p. 5. _ The non-affiliated or non-integrated equipment firms supply the independent telephone market. The latter market, however, has been declining proportionately since 1920 from 15,000 to 3,000 companies,1 particularly under the impetus of mergers, General Telephone, in particular, has grown largely by merger, thus providing a market for its manufacturing 1U. S. Congress, Senate, Space Satellite Communic- ations, Hearings before the Subcommittee on Monopoly of the SeIect Committee on Small Business, 87th Congress, lst Session, 1961, p. 318 (hereafter cited as Senate Small Business Hearings). IIV\ 46 subsidiary1 (60 per cent of General's revenues come from its manufacturing activities). Together, the Bell System and GT&E account for 92 per cent of the U. S. telephone operating companies.2 A general summation of the communications industry re- veals that the Bell System is paramount, both in the render- ing of communication services and in the supplying of communication equipment. More important is the salient feature of vertical integration--a market pattern that assures Western Electric of virtually a captive market for its goods and services. The Bell operating companies as monopsonists, and Western Electric as monopolist approximates the bi- lateral monopoly model in economic theory. Furthermore, competition in both service market and equipment market is further diluted by Western Union's de- pendence upon Bell's circuits. In the early 1950's, for example, Western Union leased some 70 per cent of its circuits from the Bell System3--a situation in which Western Union is attempting to alleviate. Furthermore, as noted earlier, Western Union's teleprinter equipment is supplied to no small 1Ibid., p. 171. Statement by General Telephone and Electronic Corporation. 2Senate Small Business Hearings, testimony of North Electric Company, op. cit., p. 318. 3"Electronics Puts Young Blood in Old Company," Business Week (August 27, 1960), p. 90. [A Ill 5:- III 47 extent by Western Electric's teletype subsidiary.1 New Technology The preceding discussion of both product (communication services) and factor (communication equipment) markets rests upon the assumption of conventional technology. That is, the industry owes much of its origin and subsequent growth to the metallic circuits of wire and cable. We have seen that this technology requires poles, rights-ofeway, certific- ates of convenience and necessity and, as a public utilities, are subject to regulation by both federal and state commis- sions. We turn now to radio circuits as opposed to metallic circuits, and will examine the nature of this new technology. and the market structure associated with it. As a Carrier signal, radio waves exist as an altern- ative media to metallic circuits in the transmission of intelligence. The physical properties of various radio signals are determined by their position in what physicists label the electromagnetic Spectrum. First postulated by Maxwell and verified by Hertz, the electromagnetic Spectrum is a continuum of signals possessing the common property of similar velocity--the velocity of light (Figure 11). The continuum ranges signals from very low to increas- ingly higher frequencies, or alternately from long wave lengths to increasingly shorter wave lengths. lRichard Elliott, Jr., "A New Era in Data Communic- ation is Opening Up," Barrons, XLI:16 (April 17, 1961), p. 21. ~«.:.ulu .-.. ....|.|... ...}. ...... ..... . .03... . I 11‘I in: oI-nl. I'lvlt (ii I I07 0-.v‘iI.-.v v b.9luinl. Can-r l—RADIATION Srecnuu, WoaLn Was 11 Speed constant at 106,0“) miles (300,000,000 meters) per second. Frequency (relative rates 01 radiation per second) diminishing toward the lelt, increasing toward the tifll. Wave length (relative length at radiated units, i. e., oi waves or at rays) diminishing toward the right, increasing toward the left. 1 quadrillion megacycles 1 trillion megacycles 1 billion megacycles (.333 microns 1 million megacycles (3 3 3 microns) 300,000 megacycles (1 millimeter) 30 000 megacycles (1 centimeter) 3,000 megacycles (1 O centimeters) 300 megacycles. (1 meter) .30 megacycles (10 meters) ' A 3,000 Irilocycles 3 megacyc es) 100 meters) 300 kilocycles (1,000 meters) 30 lrilocycles (10,000 meters) 20 kilocycles 10 kilocycles (30,000 meters) 956 cycles 16 cycles cosmic rays gamma rays X-rays ultraviolet rays (0.4 microns) violet light rays green yellow arange (0.7 microns) red infrared rays ' V-band, 50,000 mc extremely high hequencies (EHF) -band 0, mc X'-band, 10,000 mc superhigh frequencies (SHF) nd, 3,000 inc L-band, 1,000 mt: ultrahith gagencies (UHF) - n , me very high trequencies (VHF) high frequencies (HF) (short waves) medium lr‘equencies (MF) (medium length waves) low Irequencies (LF) (long waves) usual high limit at audibility u\ very low frequencies (VLF) (very long waves) middle C. lowest limit 01 audibility (above 1 ,000 megacycles) h—Slry waves FJ g—--hAicroumves —’ LGtound waves J Nuclear J k— Molecular and domic radiation-J;- radiation _— Radio frequencies Audio Irequergcies—JP THERA- NUCLEAR FISSION PEUIICS SUNLIGHI, ARTIFICIAL LIGHT INFRARED RADAR, TELEVISION Special channels 50-1 W lisilocycles) Cammercial channels RADIO COMMUNICATION Special channels MUSIC spercrr , TELEPHONE COMMUNICATION Dulany Territt, U. 5. Army in World War II, The Technical , The Signal Corps: The Emergency (to December 1941), Office of—MiIitary History, Department of‘the Army, Washington, D.C., 1956, Radiation spectrum. bOUI’CC cw Figure 11. Service 7. p. 49 The spectrum is divided into the radio Spectrum and the quantum or molecular and atomic radiation Spectrum. The latter includes infrared rays, light rays, ultraviolet, x-rays, gamma rays, and cosmic rays. The radio Spectrum is bound on the bottom level by oscillations of less than 30 kilocycles per second (very low frequencies) to frequencies oscillating as high as 3,000 megacycles. The Spectrum is ranged and classified into bands classified below as to frequency range and wave length (Table 12). At any given point in time, the spectrum utilization is limited by equipment that transmits and receives the radio signals. Thus, the state of the art imposes a limit to the availability of the Spectrum, and since the demand for Spectrum use generally exceeds its availability, the spectrum is a scarce resource subject to rationing and allocation. Radio signals are classified as ground waves, Sky waves, and direct waves. Ground waves include the frequency bands from UP (less than 30 Kc/s) to medium frequencies (MP, 300 Kc/s). The ground wave exhibits the property of follow- ing the curvature of the earth. Long distance transmission via this signal is rather expensive because of the power needed to generate the Signal. The sky wave includes the high frequencies (HP) to very high frequencies (VHF). The sky wave travels in straight lines, but is reflected from a ceiling of ionized particles 300 miles above the atmosphere, called the iorosphere. High frequency use of the sky wave 50 .mama .Q .AHOOH .aoflumuomuoo mamofluoe .mcmofiuoe< meowmoHo>ocm 65H :.cofiww0fl::esoo Oflnmm mo mHDHeriofionm: ”mouaom .20 H.ora ooo.oom-ooo.om .. sueusouum some sauEuuoxm ...... arm .eu arcs ooo.om-ooo.m .. sueusouum emu: uuazm ...... mmm Ase ooHV .e H ooo.mroom .. aueuseuum ewes «and: ...... am: .5 area oomiom .. aueusousm ewe: suu> ...... mm> .e oarooa om-m -- sueeaouum ewes ....... a: .e coarooo.a o.m-m. ooo.m-oom sueusuuum ensue: ....... a: e ooo.arooo.oa .. cemrom aueuseuuw zoo ....... an .E ooo.oa uw>o rr om cusp mmuq >ocosomuw 30H >uo> ...... mq> Annapoeflpaoo ocouum non oaouom Ham osmz coop one muopos Gav moao>unmuz moao>uoHfix rwfi>ounn< sumaoam>mz amend >ucmsomum aofiuoofiMMmmmHo >uaoavoum II III oneeoHaHmmeoo sozmsommm oHaem ma money 51 permits long distance radio communication since the signals are transmitted by ricocheting between the earth and the ionOSphere. Beginning at the UHF band and continuing to the top of the radio Spectrum at EHF is the direct wave. AS higher frequencies are generated and as the position on the electromagnetic Spectrum approaches light, the radio waves of very short wavelength (microwaves) assume quasi optical properties, that is, they tend to travel in straight lines. Figure 12 illustrates the optical qualities of micro- wave Signals. The figure is an anterior view of a typical microwave antennae shaped as a paraboloid. The waves are reflected, focused, and beamed to adjacent towers. Parasitic Element Half Wave Antenna at Focus of Paraboloid Coaxial Cablejy from Transmitter or Receiver Figure 12. Anterior view of a microwave antenna. - Source: Andrew R. Boone, “The Army's Radio Relay Equipment," Radio News, 35:1 (January, 1946), p. 152. Distinguished from the sky wave by the property of traveling in straight lines and penetrating the ionOSphere, the microwave or direct wave is relayed by constructing a series of towers in tandem Spaced at intervals of twenty to thirty miles apart within line—of-sight of each other. In this manner the Signal is caught by repeater stations before it leaves the earth and is redirected to another repeater station. Thus, the signal is received and ”bent” around the earth‘s curvature, permitting long distance terrestrial com- munication (Figure 13). Figure 13. Terrestrial microwave link. Source: Adapted from “A Report in the First Relay Communications Satellite," NASA Facts (January 14, 1963), p. 3 Microwave confers advantages not available in metallic circuits. First, it possesses greater channel capacity. As higher frequencies are generated, the Spectrum size needed to convey a voice signal becomes a smaller percentage of 53 total SpeCtrum available; hence, more channels can be sent over one microwave beam. In this sense, microwave has been described as a wide-band multi-channel Signal. A microwave beam can simultaneously transmit voice channels, channels for data, telegraph, as well as the wide band frequencies of television (Figure 14). // Video \X /{ Voice ‘3 y Teletype y 1 Computer Data A \L Telegraph J] \ / Figure 14. Multiple channel capacity of a microwave Signal. Source: Adapted from Telpak Hearings, FCC, Docket No. 14251, Bell System Exhibit No. 3, At- tachment E, p. 36. Certain cost advantages are associated with radio relay as opposed to metallic circuits. In addition to its existing capacity, a microwave system can increase its capacity by additional equipment capacity in metallic tional wires must be The Spacing of at each relay station. Increased channel circuits is more expensive since addi- strung. microwave towers eliminates wire, poles, and right-of-way, and the concommitant maintenance costs 54 thereof. Since towers are less susceptible to acts of nature, microwave systems tend to be a more reliable means of conveying voice and record data. The blow-up of a typical microwave repeater station and its components is shown in Figure 15. At the receiving station the information Signal (tele- phone, telegraph, video, etc.) is impressed (modulated) on the microwave carrier signal. The signal is transmitted to an adjacent station and demodulated. The dotted line con- necting the transmitting and receiving equipment is usually a wave guide-~a tube that directs the Signal flow to the antenna. Multiplex equipment derives from the wide Spectrum of frequency lesser channels used in conveying voice or record messages. As in metallic circuits, carrier equipment permits the Simultaneous transmission of many channels. The capacity of the system_is increased by the addition of more radio equipment and emergencyequipment is useful in case of a power failure. The versatility of microwave systems is evidenced by the variety of signals it can handle. The Electronics Industry Association has classified the functional types of signals as the following (Table 13): The Size and potential of the microwave communication equipment market varies as to the source of data. The Small Business Administration in one survey included land mobile radio equipment--a component which tends to inflate the natural market size. Nevertheless, some indication ‘ / // \ \ ‘ \ 4’ \~ To west To east Antenna Antenna .: ,\/ 7...... Radio Radio Transmitter I Receiver Radio #1 + Radio , Receiver I i Transmitter Standby . Radio L IL‘ Radio gultiple: Equipment #- : Equipment quipmen l [I Additional I I I: I I Additional ' ' . . . R ' P“ 1 gadIO nt I V01ce Circuits Eagioment L. quipme : To Telephone q p I ......... Switching System —------ __- From Normal AC , L I Power Source Figure 15. Rectifier and Battery Maintenance A1ar8i& Talk- ing rcuit Generator I [Emergency AC 1 Test Equip- Ben & Spare ar 5 Components of a microwave repeater station. Source: H. E. Weppler, ”The Use of Microwave Radio for Telecommunications,” Communications, Science Technology and Development, United States Papers, prepared for the United Nations Conference on the Application of Science and Technology for the benefit of the Less Developed Areas, p. 108. im...‘\tu t.,r !‘ 56 TABLE 13 CLASSIFICATION OF FUNCTIONAL TYPES OF SIGNALS *Band- Functional Description width Comments TELETYPE for printed or .05 Only high Speed tele- memorized pulsed type type requires more than intelligence the .05 bandwidth which is normal for most equipment today. TELEMETERING for remote .05 Pulse type telemetering instrumentation can time Space multiple functions within this Small band Space. SUPERVISORY CONTROL for .05 Same as Comment 2. performing remote oper- ations DATA PROCESS for trans- .05-l Normal intelligence mitting pulsed type com- transferred similar to puter intelligence teletype but some high speed circuits require full voice channel bandwidth. PROTECTIVE RELAYING for .05-l Speed of relaying oper- electric power trans- ation will determine mission line protection bandwidth requirement. VOICE COMMUNICATION 1 This is the basic channel bandwidth. REMOTEVVHF l Essentially same as Com- ment 6, usually patched between systems at audio. FACSIMILE for remote re- 1-4 Depends on Speed. Most production of pictoral popular requirement to- diSplays day is for narrow band equipment. REMOTE RADAR 1-150 Depends on definition and number frames per second, ll TABLE 13 (continued) 57 Functional Description *Band- width Comments REMOTE ITV 1-300 Same as Comment 9. *Bandwidth is expressed in equivalent voice channel multiplex band spacing as normally used today on typical point-to-point radio systems (4KC). Source: Before the Federal Communications Commission, in the matter of allocation of frequencies in the bands above 890 me, Electronics Industries Associ- ation, p. 6. THE MARKET FOR COMMUNICATION EQUIPMENT TABLE 14 1954-1965 (Millions of Dollars) + ..7 1954 1955 1956 1957 1958 1959 1960 Land Mobile Radio Broadcast Equip- ment Microwave Communic- ation Equipment $90 $95 $120 $150 $155 $175 $190 Aviation/Marine Communication and Navigation Equip- ment -— -- 100 130 140 175 200 Commercial Sound . Equipment -- -- 110 135 140 150 160 Total $250 $270 $330 $415 $435 $500 $550 Source: "A Study of Small Business in the Electronics In- dustry," Small Business Administration, Washington, 25, D. C., p. 32. 58 of market growth is revealed in their study. Recently Motorola estimated that the 1961 industrial and commercial microwave market approached some 60 million dollars.1 Given the wide range of market estimates, the equip- ment suppliers include both common carrier subsidiaries as well as the non-integrated equipment firms. Some estimates suggest that Western Electric accounts for some 60 per cent of all equipment2 manufactured and sold, with some eight to ten firms sharing the remaining 40 per cent. A rough tabulation of the market distribution of these nonintegrated manufacturers is shown in Table 15. An indirect assessment of non-common carrier subsidi- aries is revealed in the private microwave license applic- ations and the construction permit applications of the FCC (Table 16). Another stab at assessing market shares was made by the Small Business Administration. They concluded that, excluding the common carriers' manufacturing sub- sidiaries of AT&T and GT&E, 75 per cent of the microwave equipment was manufactured by Motorola, Collins, RCA, and General Electric.3 The market demand for microwave communication Systems include common carrier and non-common carrier segments-~with 1, . . . Microwave Market Research,” Military and Electronics, Inc., Motorola, 1962, p. 3. 2Ibid., p. 8. 3Small Business Administration, 0 . cit., p. 33. 59 TABLE 15 APPROXIMATION OF SALES VOLUME IN MICROWAVE POINT-TO- POINT COMMUNICATIONS SYSTEMS OF LEADING MANUFACTURERS W ; Company Market 1960 Volume Budelman Corp. (C) (P) $300,000 - $500,000 Collins (P) est. $2,000,000 General Electric (P) est. $2,000,000 Int. Tel. & Tel. (P) (T) $4,000,000 Lenkurt Electric (P) est. $6,000,000 Motorola (P) $6-8,000,000 Radio Corp. of America (P) (T) $10,000,000 Market Symbols: P - Private sales C - Common carrier sales T - Total world sales Source: C. A. Tyson, et al., ”Microwave Communications: Commercial P0551bilities in the 60's," Micron Association,l96l. 60 TABLE 16 SUMMARY OF PRIVATE MICROWAVE INFORMATION BASED ON CONSTRUCTION PERMIT APPLICATIONS AS of AS of 12-31-55 9-30-60 Transmitters 1,846 4,525 Transmitter miles 44,678.2 105,176.1 Companies applying for construction permits 117 236 Transmitters by Manufacturer: Collins 84 317 Federal 309 358 General Electric 186 638 Motorola 680 1,771 Philco 15 39 RCA 337 897 Westinghouse 128 323 All other, including combinations 107 182 Total 1,846 4,525 Source: Telpak Hearings, FCC Docket No. 14251, Bell System Exhibit No. 10, Attachment B, p. 7. the former existing as the dominant Share. The Bell System uses heavy duty microwave systems (600 voice channels plus), such as TD-2 and TH, in the rendition of video and long distance telephone service. In fact, some 60 per cent of today's video programs are relayed through the air, and 40 per cent of the toll exchange channels are relayed via micro- wave link.1 The Bell operating companies adhere to the 1H. E. Weppler, "The Use of Microwave Radio for Tele- communications Communications,"_SpALQEIEthQLQEE.ing.2£1§122r ment, United States papers prepared for the United Nations Conference on the application of Science and Technology for the Benefit of the Less Developed Areas, Vol. 12, p. 106. 61 policy of procuring the bulk of their equipment needs from Western Electric. The nonintegrated equipment firms are dependent upon two markets. First, they sell equipment to the common carriers--including the Western Union Company, the independ- ent telephone companies, and the Bell operating companies. Western Electric purchases some 35 per cent of its radio 1 That the latter telephone equipment from outside suppliers. provides the predominant market outlet is attested by a break- down of Motorola's microwave equipment sales to the telephone industry. Of a total of 246 stations, the Bell System ac- counts for almost 50 per cent of Motorola's total. A second market for microwave equipment takes the form of private microwave systems. This market includes the Federal government, public safety organizations, and the general group of right-of-way companies, such as railroad, pipeline companies, and power utilities. An indication of the demand components of this market is revealed in the number of FCC license applications depicted in Table 18. What is the future potential market for private microwave? The answer to this question is becoming increasingly uncertain. One market projection, established by Motorola, indicates an annual growth rate of 13 per cent (Table 19). On the basis of a new frequency eligibility policy of the FCC permitting liberalized licensing for commercial use of private microwave systems, the Electronic Industries 1Letter from AT&T to author, May 3, 1963. . .‘...N....1 .....sfiasxfipe 5.. .. i 1... h i . 62 TABLE 17 MOTOROLA CUSTOMERS _ No. of Company Name Stations American Telephone & Telegraph Company 6 Bell Telephone Company of Nevada Cameron Telephone Company Central California Telephone Company Chesapeake and Potomac Telephone Company Citizens Utilities Company Commonwealth Telephone Company General Telephone of Florida Greenwood Telephone Company Inter-County Telephone and Telegraph Company Kern Mutual Telephone La Fourche Telephone Company Leelanau Telephone Company Linn County Telephone Company Mansfield Telephone Company Michigan Bell Telephone Company Midland Telepfione Company Mountain States Telephone and Telegraph Company New York’Telephone Company North Carolina Telephone Company Northern Ohio Telephone Company Northwest Bell Telephone Company OhioiBell Telephone Company Pacific Power and Light Company Pacific Telephone and Telegraph Company Pennsylvania Bell Telephone Company Pioneer Telephone Cooperative Rochester Telephone Corporation Sierra Telephone Company Southern Bell Telephone Company Southwestern Bell Telephone Company Telephone‘SerVIces*Incorporated Texas Telephone and Telegraph Company West Coast Telephone Company Western Carolina Telephone Company Western Telephone Company l—‘ p... N OUINUION-bwabNNNUtflNflwUlt-‘Nwl-‘bNObNNLACDNUIO‘O H 1.- Bell System Companies 126 Source: Motorola Microwave equipment sales to the telephone industry, Motorola, 1961. ll 63 TABLE 18 FCC MICROWAVE LICENSE APPLICATIONS As of As of Transmitters by Services 12-31-55 9-30—60 Aeronautical 5 38 Business 0 0 Forestry conservation 0 6 Forest products 0 10 Highway Maintenance 2 16 Local government 39 242 Manufacturers 0 0 Marine O 0 Motor carrier 0 5 Petroleum 766 1,813 Police 34 346 Power 272 1,354 Public safety 6 44 Railroads 8 88 Special industrial 12 27 Not classified 1 1 Total 1,145 3,990 Source: Telpak Docket, Bell System Exhibit No. 10, Attach- ment B, p. 9. TABLE 19 MICROWAVE EQUIPMENT‘MARKETS, 1961 - 1971 Growth Rate Millions of Dollars per Year 1961 1971 (per cent) Military Radar Systems 800 1100 3.5 Military Communications & Navigation 300 450 4.0 Military Countermeasure 150 300 7.0 Industrial & Commercial Communications 60 200 13.0 Nonmilitary Radar 50 150 11.5 Test Equipment 75 300 15.0 Miscellaneous: Military 50 200 15.0 Nonmilitary 15 100 21.0 1500 2800 6.5 SOurce: Microwave Market Research, Military and Electronics, Inc., Motorola, 1962, p. 8. 64 Association (EIA) projected demand in the following table: TABLE 20 NUMBER OF MICROWAVE STATIONS Present Eligibility Expanded Eligibility Year High Low Avg. High Low Avg. 1966 9,800 3,600 7,600 12,000 6,000 10,000 1976 15,000 600 12,000 21,000 11,000 18,000 Source: The Above 890 Docket, Electronic Industries Associ- ation. As we shall see, these projections are highly Specu- lativesince they do not take into account such market vari- ables as the pricing policy of the American Telephone and Telegraph System. However, the impact of microwave technology is not as striking in the public message market as it is in the private line market. It will be recalled that in this latter market, the common carriers lease their circuits for private com- merical use. Now private microwave has introduced a new element in this market. Translating the virtues of greater capacity, lower cost, greater reliability, and less main- tenance, plus the ability to handle simultaneously record and voice Signals, private microwave systems have conferred to the end-user of bulk communication an additional option. In addi- tion to exercising the alternative of leasing his communic- ation needs from the common carriers, the end-user may elect 65 to pwn his own radio relay system. It is the exercise of this latter option that has provided the entre for the non- integrated supplier vis-a-vis Western Electric. Thus, if the end-user elects to lease his needs from the Bell System, then Western Electric "wins"; if the consumer chooses private microwave, then the nonintegrated manufacturer "wins." Figure 16 contrasts the options confronting the con- sumer and illustrates the relevance of this additional choice of owning to the problem of market entry. The additional choice granted the consumer because of microwave technology, enables the nonintegrated supplier to circumvent the integrated complex of the Bell System. As such, it creates a provocative set of market relationships. The nonintegrated supplier now competes directly with the Bell operating companies who lease service in their private line markets. And since Western Electric manufactures and supplies the system's equipment, the nonintegrated manu- facturer competes indirectly with AT&T'S manufacturing subsidiary. Yet, there remains a second market for the non- integrated supplier reminiscent of the independent equipment suppliers of the 1930's; namely, they supply equipment to the Bell System via Western Electric. In this second market relationship, the nonintegrated Suppliers act as subcon- tractors to Western Electric. In our review of the literature, vertical integration was classed by one of two characteristics: the nonintegrated firm resided pniy in the product market or resided pnly in the factor market. Ills-ell! Ilse‘ rIIIAiv I‘Uiz ....-e .o ..07 ‘ IhIiIn 1‘ rinelli Iii-II I. 66 .Suuao J washes oeumosom .oH unawam uofiamnsm powwow. runawaoz I... uofiammsm UmannwounH Headmasm nouns Iii. uoflammsm rouafiaoz payoummucH _ _ _ _ _ _ _ _ _ _ muofluumo _ aoseoo _/ / / a, / b 9 S ten/7 s / umESmGOU mcofipao 038 Eye: oopaoumcoo nossmaoo muufluuao aoesoo asvaw 2N wasdmaoo waxed: HOponm meunz posooum :ofiwao 0:0 now; ooaaouwaoo nusamaoo 5 . Ill 67 In the communication industry, microwave technology has pro- duceda Specie that does not fit into the conventional format of vertical combinations. The nonintegrated supplier under consideration sells in 221E product and factor markets. His good in the factor market is microwave equipment, and his good in the product market is raw bandwidth. In sum, market entry elicits two traits. Microwave circuits compete with metallic circuits, and nonintegrated suppliers seek entry into the communication industry by selling bandwidth ”wholesale.” International Market Conventional Technology The conventional techniques employed for overseas transmission of communications includes high frequency radio and submarine cable systems. Both systems provide a total of 491 telephone circuits of which 226 are radio and 256 are cable (9 are open wire land lines) (Figure 17). 1 . Radio transmission by high frequency (HF) techniques or short wave radio utilizes the frequency bands between three and thirty megacycles. As a sky wave, HF radio Signals are dependent upon ionOSpheric reflection for their transmission. Since the ionOSphere is subject to changes dependent upon the hour of the day and the time of the year, in addition to being susceptible to magnetic disturbances, this type of service is of poor quality and subject to prolonged 1R. Kestenbaum, "Global Communications, State of the Art," Electro-Technology (November, 1961), 68:5, p. 63. 68 a,” “M W / ,1,- onOSphere \ \ Figure 17. Conventional transoceanic means of communication. Source: Telesat, Business Planning Study for a Commercial Telecommunication Satellite, Part I, Lockheed Aircraft Corporation, Missiles and Space Division, pp. 5-7. interruptions. In fact, ionOSpheric disturbances and solar flares result in only a 70 to 80 per cent availability of HF radio circuits.1 Within the next fifteen years it is expected the usable bandwidth of HF radio telephone will decline be- cause of the Sun-Spot cycle. Radio service is assuming the position of a backup to submarine cable service. Superior in quality and reliability, the first sub- marine cable system capable of voice transmission across the Telecomgat Study, Final Report Missile and Space Vehicle Department, General Electric, p. II-A-6, 1960. o 69 Atlantic was laid in 1956. The cable transmits voice Signals by amplifying the Signal with repeaters Spaced at adjacent intervals. Because of the expense of raising the cable for repair and maintenance, the vacuum tubes in the repeaters are designed with a twenty-year life. The submarine cable has a limited capacity of voice channels since the emphasis has been directed to cable reliability andlxngevity. Thus, the cable's bandwidth is .14 Kc/s or about 1/50 of the band- width provided by a terrestrial coaxial cable. (A land microwave system has a 24 mc. capacity.) AS the state of the art has progressed, capacity has been increased. One method, called TASI, uses switching techniques which permits the doubling of capacity by taking advantage of the Silent inter- vals in a conversation. The difference in the bandwidth capacity available for overseas communication and those available for domestic service is such that a north—south bisection through the continental United States would sever over 100 mc of cables and microwave systems; while the same bisection in the mid- Atlantic would cut only one megacycle.1 Thus, submarine cable capacity is limited in that it possesses no broadband capabilities such as are needed to transmit a video Signal. The important cable Systems interconnecting the U. S. with the rest of the world are owned by AT&T outright or 1Before the Federal Communications Commission in the matter of Allocation of Frequencies of the Bands above 890 mc, Docket No. 11866, American Telephone and Telegraph Company, Testimony of John R. Pierce, p. 3 (hereafter cited as the Above 890 Docket). owned as a joint venture with foreign 70 which are foreign governments. Table existing and pending cable systems. HIGH CAPACITY DEEP-SEA TELEPHONE TYPE OWNED WHOLLY OR PARTLY BY UNITED TABLE 21 April 1, 1962 agencies, most of 21 includes a list of SUBMARINE CABLE SYSTEMS STATES COMPANIES Present Capacity- Primary Voice Communic- Date Open Channels Name of ation for (Without Cable Terminals Service TASI) Owners Trans- New York 9-25-56 48 AT&T atlantic-l Montreal Canada (TAT-l) London England Alaska Seattle 12—11-56 51 AT&T Ketchikan Hawaii Oakland 10-8-57 47 AT&T Honolulu Hawaiian Tel. Trans- New York 9-22-59 48 AT&T atlantic-2 Paris France (TAT-2) Frankfurt Germany Puerto Miami 1-26-1960 48 AT&T Rico San Juan Radio Corp. of P.R. Bermuda New York 1-8—62 80 AT&T Bermuda Cable & Wireless P.R.- San Juan EXpected 84 AT&T Antigua Antigua 1963 Cable & Wireless Jamaica Miami Expected 128 AT&T Jamaica late 1962 Cable & Wireless 71 TABLE 21 (continued) Present Capacity— Primary Voice Communic— Date Open Channels Name of ation for (Without Cable Terminals Service TASI) Owners Trans- New York Expected 128 AT&T atlantic—3 London late 1936 England (TAT-3) Japan Honolulu Expected 128 AT&T Midway July 1964 K.D.D. * Wake Hawaiian Guam Tel. Tokyo *K,D,D, - Kokusai Denshin Denwa Co., Ltd., a Japanese Corporation Source: Federal Communications Commission, Common Carrier Bureau, International Division. Since a voice Signal requires some twenty times the bandwidth capacity of a telegraph signal, on the basis of cable channel capacity, some 90 per cent is devoted to voice service. The total revenues associated with U. S. overseas com— munication is Small relative to the U.S. domestic market. Table 22 depicts the total annual revenue for 1960 and its voice and record components. On a revenue basis, revenues from record services ac- count for about two-thirds of the market, the remaining is voice. 72 TABLE 22 U.S. INTERNATIONAL CARRIERS REVENUES Telegraph Cable $36,169,000 Radio 50,806,000 Telephone 48,096,000 $135,071,000 Source: Federal Communications Commission, Statistics of Communications Common Carrier, 1960. Figures 18 and 19 view over time the relative growth of voice and record message volume. A closer look at the international voice market (Table 23) reveals the relative importance of AT&T, Cuban American Telephone and Telegraph (nationalized), Radio Corporation of Puerto Rico, and the Hawaiian Telephone Company. Again, AT&T is of central importance, controlling over 90 per cent of the voice market. The overseas record market differs from its voice counterpart in that competition exists between some seven companies as illustrated in Table 24. Table 25 indicates the relative distribution of all international common carriers. Clearly, American Telephone and Telegraph, International Telephone and Telegraph, Radio Corporation of America Communications, and Western Union ac- count for 94 per cent of the market. AT&T'S revenue includes 1 some $850,000 representing rentals received from leasing 1U.S. Congress, House, Antitrust Consent Decrees and the Television Broadcasting Industgy, Hearings before the Antitrust Subcommittee No. 5 of the Committee of the Judici- ary, 87th Congress, lst session, 1961, p. 6. 73 500,000,000 100,000,000 50,000,000 10,000,000 5,000,000 1,000,000 Messages 500,000 100,000 50,000 73 74/ 10,0001 57009920 1930 1940 1950 1960 Figure 18. U. S. overseas telephone messages. Source: Telecomsat Study, Final Report, Missile and Space Vehicle Department, Lockheed, p. II-B—6 (adapted). 74 50 40 Source: Statistics of Common Carriers, FCC (1958), Table 20 30 20 \X 10_ 1930 1935 1940 1945 1950 1955 1960 Figure 19. U. S. internationaltelegraph message volume (1930-1959). Source: The Rand Corporation Communications Satellites and Public Policy: An_lntroductory Report by B. H. Klein, et al., September 15, 1960. Prepared for National Aeronautics and Space Administration (adapted). 75 90990309 90 00990>09 0999 090>999 909 90 9099093 00990990000 9009 909 009 99 .om09 .mN 90990990m 009>90m 99 000099 003 09900 099000009099 90999 0980 .8009 .m9 .990m 009>90m 99 000099 003 0990 090 .m.D 099 9003909 90990 90 .9900 09009 9 .00 898< >9 >9999Om 009300 E090>m 09009 0>030909s :90N9909r099r90>o: 099 9093 0009 0990E0m9m990 w9990 r9090 99 0009090 >9 00900990 0903 .00 9909m0908 9 090990908 900990s< 90990 90 00990>09 0980 .00990>09 9090 0099099 .00 090990908 .09099900 090990909 9090990990999 099 09 000009 9099 00990>09 90 09090 099 0099099 909 00 0099 099099 90 90990909900 09009 90 00990>09 0999 090>99m .9099 >9 0090990 m009>90m 099 909 0000009 099 >9 0009 09099090 09099009999900 000090>0 90 909909 099 909 09099900 9909w0909 9090990990999 9099 00>90009 ooo.omww 009099900 90 0099099 0009 909 .00 898< mo 00990>09 0999 090>999 0980 .0099990 09 09900 90990 90 09090 9090 omr9m09 m900> 099 909 9099 9900x0 ..m.D 099 99 9909 09990909 099 09 099099999990 m0m9090 009>90w 000090>0 099 90 09090 0.9099900 099 000990999 .9099099909 0999 99 00099099 909 090 0090909 99099> 099 99 .099 .09009 090 009900 00990E< 99< 90 090 Asm09 .0 9090900 09 90999 .990303 0900 9090 99 .099 .09099009999 1800 <09 90 0909909000 090990909 9099 0009900 .m.D 909m 00990>09 90 0999090 90999 >90>99090ma ess.0 mm0.me se0 00m.m 9 0s00.m 909 00e u0s0.0 000.s0 0009 0m0.0 099.00 mmm 900.9 9 e00.9 m09 9ms 0m9.0 ee0.0m 0009 000.9 9e0.sm 0990 eme.9 m 000 ss9 sms 000.9 0es.em 0009 0s0 0s0.mm -r 9ssm0 -- 000 m09 000 s9s 0es.0m s009 090 000.09 .. r- -- 000 909 e00 009 0009.09 0009 0em 00s.09 .. r- -- 0e0 00 e0s 0e9 00e.m9 0009 0mm 000.m9 .. -r e 0ee 00 000 0m9 900.09 e009 00m 000.99 -- -- 9 000 009 s90 m09 9m0.09 0009 e90 000.09 -- r- 9 000 00 090 09m 090.09 m009 0000 e9s.090 .. r- 90 s0m0 000 0000 mem0 900.00 9009 0999 0wmmm02 9000999 0m00002 9000999 0mmmm0z 0999 900 A00 0999 A90 9008 090>m99 090>99m . 090>m9m 090>9901 0mnmm0z 090>99m 000000 90908 .00 0099 099099 mo .00 9909m0908 .00 9909 0908 090990908 .9900 09009 9 090990908 9 090990908 9099030: 900990s< 909:0 900990s< Inf“ «0909900 0 0090090980 em>9009029 0009 09 009 00099 909 000 00990000 mZOImMQM8 >m Dm8mommm mm09>mmm mZOHH0 20mm mszm>mm mm mqm<8 .\ hvrhueen 76 .0s9 .0 .0009 09.090330 908800 09099009998800 90 0099099090 .9090098800 09099009998800 9090009 9009900 .0009 .0m >90990h 909909090 99 000099 003 0099 099099 090 .m .3 9003909 09900 090990909 098m .099 .09099009998800 <09 >9 00999990 0903 0099999009 09009 90990309 099 090 09009 09> 003 009>900 .m.:r9099030m 099 0900 9099 09 90999 .0009 .0 9090900 909909090 99 000099 003 .90090999 90 0930 .00 090990908 9099030: 099 90993 99 .09900 9099030: 0989 90099999000 mm m9m<8 77 TABLE 24 REVENUE DISTRIBUTION OF OVERSEAS RECORD CARRIERS IT&T (American Cable and Radio Corporation) All American cables and radio 15,503,769 Commercial cable 6,957,776 Globe Wireless 848.839 Mackay Radio & Telegraph Co. 11,975,874 Radio Corporation of Puerto Rico 2,416,994 Press Wireless 2,050,195 United States Liberia 113,921 RCA Corporation 32,543,226 Tropical Radio 3,274,379 Western Union 13,707,852 South Porto Rico Sugar No data Source: Federal Communications Commission, 1960 Statistics TABLE 25 REVENUE DISTRIBUTION OF MAJOR INTERNATIONAL CARRIERS International Common Carrier Revenue % AT&T 42 32 AC&R (ITT) 34 26 RCAC 33 25 Western Union 14 11 Other 7 6 Source: Federal Communications Commission, 1960 Statistics '78 cable channels to the international telegraph carriers. (IT&T, for example, owns no cables, but conducts its Oper- ations through leased channels.) The remaining 6 per cent of the market is shared by several companies, who, although classified as international common carriers, engage in activity ancillary to the rendition of communication services. Press Wireless, engaged in sending press diSpatches, is owned primarily by the New York Herald Tribune, the New York Times, and Time, Inc. The United States-Liberia Radio Corporation is a subsidiary of Firestone Tire and Rubber Company; Tropical Radio is a subsidiary of the United Fruit Company; and South Porto Rico Radio is a subsidiary of a commercial sugar firm. Both international voice and record carriers offer public message and private line service. Table 25 depicts the proportion of each service supplied by the voice carriers, and Table 26 shows the breakdown of services for the record carriers. It is interesting to observe the significance of government expenditures on the demand side of the market, particularly in the lease channel or private line market. Thus, U. S. government expenditures account for 40 per cent of the demand for the Telegraph carriers leased channel service, and 99 per cent for AT&T's leased channel service (Table 27). Ox 7 l‘ .90909>99 9090990990999 .900999 9099900 909900 .9090099900 09099009999900 9090009 ”009900 .090909090 09 990999900 90 909909 090 .09099090 m9909>900 .0009>900 099990009 090 900000099 00099 0009000 09999999 090990909 9099 00990>09 999099099990 90993 9909003 90 900290 009>900 09099009999900 0090909 9090990990999 9099 00990>09 099 00099099 .00000009 099909 090 99909:09:999o9 990 9099 00990>09 0990009909m 000.00 000.0 000.09 000.0 000.99 000.00 9009 900.00 000.0 009.09 000.0 000.0 000.00 0009 000.00 000.0 000.09 900.0 000.0 000.00 0009 009H00 990.0 900.999 000.0 900.0 000.00 0009 000 00 000.0 000.0 000.0 000.0 000.90 0009 000.00 000.0 000.0 000.0 000.9 000.00 0009 000.000 000.00 000.00 000.00 000.90 000.000 0009 9009009099 990 00990>09 099909090 90 99909< 00990>09 m0009>900 90908 m00990>09 00990>09 00990>09 900» 90908 90990 9099 9099090 x0908 9 0000002 00990>09 000009 009>900 990990909 90909090n09a90909090 900999 9909: mm09 mszm>mm 0298<9M9O 90 383090 09299200 m99999<0 I9<9099NH 9~ ~ . (4) Station Present Methods station Cable Radio J Addressee Telegram C Addressee Facsimile D Figure 21. The satellite in a communications system. Source: Senate Small Business Hearings, RCA, p. 127. 85 cent of the system's total cost.1 The ground equipment in— cludes receivers and transmitter, telemetry equipment, antennaes, etc. Much of the controversy as to the nature of the satellite system centered around the type of system to be established. Although this question was debated on a technical level, it is important to know at least the alleged advantages and disadvantages of various communication systems. Satellites can be active or passive. A passive satellite acts as a mere reflector of the microwave signal. The signal is "bounced" off the reflector without being amplified. The classic example of this type was Project Echo (a high school student sent messages via the Echo balloon). Another example of a passive system was Project Westford or Project Needles. Here bits of tin foil were launched to create a reflecting belt for radio relaying purposes. The advantage of a passive satellite lies in its simplicity. Most of the complexity of such a system resides on the ground in the form of transmitting, receiving, and tracking equipment. The disadvantage of such a system is the high power required to send the signal, since the satel- lite does not boost or amplify it. The attenuation of the signal necessitates rather complex equipment to receive it 1Communications Satellite Act of 1962, Hearings before the Committee on Foreign Relations, United States Senate, 87th Congress, Second Session on H.R. 11040, p. 319. State- ment by John H. Rubel, Assistant Secretary of Defense, Deputy Director of Defense Research and Engineering. Secre- tary R. S. McNamara disputed this ratio. See pp. 319-21. 80 as well. Most of the current effort today is directed to- wards the development of active satellites. As its name implies, the active satellite amplifies the microwave signal between destinations. In this sense, an active satellite is a repeater similar to a microwave tower. The energy for such amplification can come from the sun (solar cells convert light energy into electrical energy) or from a nuclear battery (conversion of a radioactive substance into electrical energy). An example of the former mode of energy is the Telstar satellite; an example of the latter includes the Navy’s Transit satellites. Active satellites have the advantage of decreasing the ground network complexity, but of increasing the complexity of the satellite. Since the signal is amplified, the ground station's sending and receiving equipment is reduced in power and complexity. The satellite, however, operating in the hazardous environment of Space encounters problems of longevity and reliability. A further refinement of active satellites classifies them as low, medium, and high orbit systems. Passive satel- lites can also fall into these categories. Furthermore, the satellites can rotate in a polar orbit or an equatorial orbit. A low orbit satellite is one that revolves at a height of 3,000 to 6,000 miles. The Bell System has Sponsored this satellite system as a first step in the commercial innov- ation of satellite techniques. Since a low orbit system 87 would contain satellites revolving in random fashion and since no one satellite would be in View longer than twenty or twenty-five minutes, communication via such a system would necessitate dual sending and receiving equipment. While one station would ”lock on” a satellite in view, an- other station would be searching for another approaching satellite. Station A Satellite Station B T T l R R T ’29 T R “\xi-‘ ,//” R Satellite Figure 22. Anterior view of a low orbit satellite system. Source: Senate Small Business Hearings, RCA, p. 127. Figure 22 demonstrates the anterior view of how ground stations would phase from one satellite to another. Total coverage of the world would require some forty to sixty satellites. The advantages accorded by such a system are several. Foremost is the availability of launching 88 vehicles capable of pushing up the satellites. The dis- advantages attributed to such a system are the complexity of the ground stations (dual stations plus telemetry equip- ment) and the limited accessibility of the ground stations. Some have asserted that the cost of a world wide, low orbit system would be prohibitive and that the satellites would be living in the Van Allen radiation belt resulting in damage to satellite components. The twenty-four hour or synchronous orbit system exists as one alternative to the low orbit system. Sponsored by ITT, Hughes, Lockheed, RCA, and General Telephone, the essence of this system rests upon its altitude. If a satellite could be thrust to a distance of 23,300 miles above the earth, then the period of its orbit would be the same as or synchronous with the earth's period of rotation. Viewed from the earth, the satellite would look as if it were a fixed star. This fixity would eliminate the complex- ity of ground station equipment since their only function would be to aim at one point. Furthermore, it is contended that three such synchronous satellites would cover 99 per cent of the earth‘s surface (Figure 23). More important, those favoring a synchronous system, is the fact that accessibility is greatly facilitated by the satellite as depicted in Figure 24. The synchronous system of satellites has several dis- advantages. The first is the problem of launching boosters. Although this is expected to erode in time, there is 89 Satellite Satellite Equator ' a ellite 22,300 miles from satellite to Equator Figure 23. High altitude communications system. Source: New York Times, October 8, 1961, "Satel- lite Signals—~Relay Sfations in Space Provide New World of Communications," by David Sarnoff, p. M15, T T A J R R T Fixed T B Satellite I R R T T C H R L_. __ T D T p T G R R R Figure 24. Synchronous relays. - Source: Senate Small Business Hearings, RCA, p. 127. 9O serious doubt that as of today, such a system could be hoisted into a synchronous orbit because of inadequate rocket power. Another complication is keeping the satellites in a fixed position-~the problem of attitude control. A further problem is the problem of delay (six seconds) and echo control. It is generally acknowledged that the ultimate system will be some form of synchronous satellite, but the innov- ation of such a system awaits further advances on several fronts in the state of the art. Assuming that a satellite system will be established (and hence a wide band multi-channel communications system available), what are the market demand prOSpects of its use? General Electric has projected the world~wide tele- communication revenues available in Figure 25. Figure 26 projects cable capacity against the projected demand for voice and record services and Figure 27 focuses on the trans- atlantic market alone. It is apparent that overseas communication demands will soon overload existing and planned capacity. Unless more cables are laid, an alternative means of transoceanic means of communication is inevitable. (AT&T has estimated that by 1980 fifty overseas cables will be needed.)1 lTelesat._Telecommunication Satellite Business Plan- ning Study, Lockheed Aircraft Corporation, Missiles and Space Division, Sunnyside, California. v.- 91 2400, - 2200 2000 Maximum 1800 1600 1400 1200 1000 / 71/ 800 1’ Revenue — Millions of Dollars 600 r /’ / ,/ // ’lMinimum ’ l 400 /’ // /// / ,/ 200 / /’ 0‘ _ 1965 1970 1975 1980 Figure 25. World-wide telecommunication revenue potentially available to Telecomsat. Source: Telecomsat Study. Figgl Report, Missile and Space Vehicle Department, General Electric, p. II-Be32. 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 8,000 / I 7,000 / I / / r 6,000 / / / /£ 5,000 / 1 4,000 ’Total Projected. ./ Demand Voice & / Record / /’ 3,000 / /' / ”£2,000 / 7,17; WM' /’ Hi77V7flr77 Arrf Cab /’ I f Estimated , / W Range 0 1,000 I, j / f C1 Y #‘i / , ,//////// ——"" Projected Record Deman ’, * H1i""”" " I --‘—‘L.J—L +4-— 0 60 61 62 63 64 65 66 67 68 69 .70 71 7273 74 7576 77 78 79 80 Figure 25. PrOjected world wide intercontinental telecom— munications demand versus estimated capacity of existing, planned, and proposed telephone cables, 1960—1980. Source: Telesat, Telecommunication Satellite Business Planning Stugy, Lockheed Aircraft Corp., Missile & Space Division, Sunnyside, California. L.-.JI» 4 .4. n 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 93 J J i l A-TAT-l and TAT-2 with TASI B-TAT-2 and TAT-2 with TASI plus planned TAT-Canada cable a—TAT-l and TAT~2 with TASI plus planned TAT~Canada and TATe3 cables D~All existing & planned cables with TASI -TAT-1,TAT~2 & TATeCanada with TASI plus satellite link in l ieu of TAT~3 Projected Demand 1 — A __l“ B _JT'T' Figure 27. 0 60 61 62 6364 65 66 67 68 697071 7373 74 7576 7 7 7879 80 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 Projected transatlantic telecommunications channel demand versus capacity of existing planned and proposed cables, source: 1960-1980. TelesatL‘Telecommunication Satellite Business Planning Study, Lockheed Aircraft Corp., Missiles and Space Division, Sunnyside, Calif. 04 No definitive eStimate has been made regarding the potential of the equ1pment market for a communication system of satellites. It is evident from the cost ratio of the ”Space" component of such a system that aerOSpace firms seek to participate in the supplying of boosters, satellites, and even the ground station complex of antennas, transmission and relay equipment, tracking apparatus, etc. As subcontractors to other prime contractors, Western Electric, for example, is classified as an aerOSpace firm as well as a communication equipment firm, having participated in such projects as the Nike series, the Titan program, Pro- ject Echo, and Project Mercury.l In addition to the captive equipment subsidiaries of the common carriers, there exist firms in the aerOSpace in- dustry who have participated in major portions of the space program. Although Lockheed and General Electric originally had expressed a desire to participate in the communication satellite equipment program, other companies less articulate but nevertheless appeared very willing to participate (Hughes, Philco, Bendix, North American, etc.). Again, these firms had gained experience and competence as a result of participating in the U. S. Space effort. The real problem confronting the nonintegrated equip- ment supplier in the international market was how to 1The 1961 AerOSpace Year Book, 42nd Annual Edition (AerOSpace Industries Association of America, Inc.), p. 160. 35 participate in supplying his Space knowhow and technology. Since the overseas common carriers, particularly AT&T, were integrated into subsidiaries having some aerOSpace experi- ence, the tendency to funnel all equipment orders to their own equipmentfirms would prove, as in the past, irresistible. Furthermore, the projected capacity of a satellite system, be it low or high orbit, was of such a magnitude that one system only would handle all the traffic. A second system would merely be redundant. Thus, unlike the domestic equip- ment market, the nonintegrated supplier could_gg£ circum— vent the integrated complex of the overseas common carrier and their equipment subsidiaries by establishing a rival system. General Electric and Lockheed expressed apprehension of being "frozen out” of one of the first commercial applic- ations of Space technology. Furthermore, even if Western Electric chose to supple- ment its communication satellite equipment needs from the nonintegrated supplier, the fact remained that the status of the non—Bell equipment firm was reduced to that of a sub- contractor (Figure 28). Hence, it was not surprising that the nonintegrated equipment firms advocated a new organizational entity that would assure them of market entry. This organization, pro- moted by both General Electric and Lockheed, came to be known as a common carriers' common carrier. The function of the organization would be to own ground stations and/or satellites. The common carriers' carrier would purchase the '96 Consumer (Impossible) 1 Product 3 Market 2 L with common carriers , Factor 3 Market l Integrated Nonintegrated hardware aerOSpace Supplier supplier Figure 28. Market access~~international equipment firms. equipment necessitated by a satellite system and then lease channels to the international common carriers who, in turn, would sell services to the endwuser. To insure that non— affiliated equipment suppliers would receive ”equitable” treat- ment, the new entity would reside between the common carriers and the equipment market. In summary, both domestic and overseas markets exhibit several parallel patterns. 4-] Consumer Common Carrier i i 1 Common ' I Carriers' I Common 1 “fig- mu- 1 i l Carrier . —- -.. 4 ‘ .... -a- Integrated Nonintegrated Hardware AerOSpace Supplier Supplier . ... ___... -...J .-.. ..-. Figure 29, GEeLockheed common carriers‘ common carrier concept. First, the existing market structure is an extension of metallic circuitrymecable and Wire in the domestic market, Submarine cables in the overseas market. Second, both domestic and overseas markets are highly integrated into both the service market and the equipment market. Third, a new technical alternative, microwave, challenges the con- ventional technology. In the domestic market microwave takes the form of private micrcwave systems; in the international market, microwave is being prOjected as a communication satellite system. Fourth, nonintegrated equipment firms, in both domestic and international markets, have a vested interest in this competing technology. Fifth, the noninte- grated firm seeks market access for his goods and services; hence the problem of entry. We have attempted to delineate the similarities and the differences of market entry in both domestic and inter- national markets. Figure 30 attempts to portray the general issue of entry confronting the nonintegrated equipment firm vis—a-vis the integrated equipment firm. Domestic Market Consumer 4.: o x S 2: Y 3 \ a \ a \ m \ \ \ Common ‘ Carrier 1 1 l. i .. | G.) x l a m 2 I 8 | +4 u | m m | Integrated Noninte- Supplier .‘.__ grated Supplier Figure 30. 99 International Market Consumer Common Carrier F""' '—"1 lCommon ' 'Carriers' : Common ~‘k Carrier l \\ I \ L——.—- —-—J ‘\ \ Integrated Noninte— Supplier 4_ grated Supplier Summary--entry problem of nonintegrated equipment firms. CHAPTER III DOMESTIC MARKET HaVing attempted to delineate and define the general problem of market access, we turn now to the domestic market with the question, what are the real or potential restraints to market entry? As noted previously these alleged re- straints are classified in the following manner: 1. Legal and technological 2. Market structure 3. Government policy Legal and Technological Restraints This chapter will examine the first category, legal and technological restraints; and will include a consideration of, first, the role of the patent right, second, the size of the frequency Spectrum, and third, capital requirements. The Patent The analysis of the patent right will be discussed under two general headings: first, what is the role of the patent as a barrier to entry; and, second, has this barrier eroded with time. The discussion of patent erosion will indicate an assessment of the impact of the public sector upon the communication industries and an evaluation of the 1956 AT&T consent decree. The role of the patent grant in the evolution of the communications industry is of critical import. In fact, 100 101 it has been observed that the Bell System was constructed on patents. As a legal grant by the state, a patent confers to the recipient certain property rights relating to the possession and use of knowledge. The patent system, in granting this monopoly position exists as an exception to the general theme of the competitive enterprise system. The rationale of the patent system rests upon the hope that a short-run grant of monopoly right will generate the invention and innovation of new products and processes so that in the long-run the total community will benefit in terms of economic growth. Thus, a limit is placed in the patent grant under the assumption that seventeen years should provide adequate incentive to the hazardous and risky occupation of the inventor. Following three years of litigation, the first and crucial patent on the telephone instrument was granted to the Bell Patent Association in 1879. On the basis of this patent, the Bell Association leased patent licenses to oper- ating companies formed to render telephone service. In re- turn for the patent license, the Bell group received an option to purchase 30 to 50 per cent1 of the capital stock in the licensee companies, as well as supervision over the financial development of the companies. By the time the 1U. S. Congress, House, Consent Decree Program of the Department of Justice, Hearing befbre the Antitrust Sub- committee (Subcommittee No. 5) of the Committee on the Judiciary, 85th Congress, 2nd Session, Part 11, Volume 1, American Telephone and Telegraph Co., p. 1750. 102 original Bell patent expired in 1894, Bell owned or controlled, through stock purchases, most of the licensee Operating companies. In addition to consolidating its control of the tele— phone industry, the Bell interests embarked upon an aggressive policy of patent acquiSition. Again, by 1894, the company had acquired some 900 patents associated with the rendition of telephone service. In 1935, the Bell System possessed an inventory of some 9,255 patents in addition to having licenses from 6,000 others.1 Although the patent base of the Bell System included most of the devices in the rendition of voice messages, patent dominance was particularly paramount in the technology of long distance telephony. Substantially, all of these patents originated outside of the Bell System and were purchased from independent inventors by the Bell interests. During the term of the first patent grant, the Bell Association initiated infringement suits against independent telephone groups operating under rival patents. Some 600 infringement suits were initiated, 200 alone directed against the American Cushman Telephone Company. After 1894, with basic patent expiration, Bell initiated suits against both the users and manufacturers of non—Bell Telephone 1Federal Communications Commission, Report on Tele- phone Investigation (pursuant to Public Res. No. 8, 74th Congress), House Document 340, 76th Congress, lst Session, June 14, 1939, p. 267. (Hereafter cited as 1939 Telephone Report.) 103 equipment.1 In additicn, no licenses under Bell patents were granted to others in the telephone field from 1879 to 1912.2 In the evoluticn of the communication industry, long distance telephony appears as a crucial variable in market control. As suggested, Bell's position soon became impregn— able. The firSt deVice, the Pupin loading coil, permitted the extension of voice transmission by reducing the attenu— ation of the voice signal in a ere conductor. .Although it did not energize or amplify the Signal, the early loading coils increased the effiCiency of the metallic medium. Bell's patents on the c011 were purchased from Michael Pupin at the turn of the century and remained in effect until 1921. More important to the long diSIance transmission of veice was the telephcne repeater. The repeater differed from the loading coil in that it amplified the voice signal. The continual boosting of the Signal permitted the first transcontinental line to be established in 1915. The rem peater as an amplifier was dependent upon the triode or the radio vacuum tube. As a result of purchases of the DeForest vacuum tube and the Arnold high vacuum tube, the Bell position in telephone repeaters was again preeminent. l . U. S. Congress, House, ngsent Decree Program of the _1 .01..- .- Department of Justice, op. CitT, 5:71749. 2 , . _ - . Federal Communications CommiSSion, Telephone Investi— ation, 74th Congress pursuant to Public Resolution No. 8 9 1938. Known as the Walker Report, not adopted by the Com_ mission, p. 248. 104 Closely allied to the vacuum tube was the development of carrier systems, devices that permitted the simultaneous transmission of several voices by generating higher bands of frequency. Bell's position in carrier systems became secure and its refusal to license the telegraph industry delayed that industry's innovation of this technique. Another important development in telephone technology was the coaxial cable. A product of Bell Laboratories, a research subsidiary formed in 1925, the cable as a broadband multi—channel circuit permitted the transmission of such wide signals as FM radio and television. An experimental cable was laid in 1936, and in 1941 the cable was innovated for commercial use. Substantially all the patents on the cable were owned by Bell. The formation of Bell Laboratories as the research arm of the Bell System ostensibly removed the dependence of the Bell System research upon external sources and placed re- search in-house. Thus, by the 1930's, of the total patent portfolio of 9,000 odd patents, only 3.5 per cent repre- sented outside purchases.1 Nevertheless, Bell's market position rested heavily on the patents relating to long distance telephony, the most crucial, including the Pupin loading coil, the DeForest vacuum tube, and the repeater circuits of Grissinger. These three devices were regarded 1Floyd L. Vaughan, The United States Patent System-- Legal and Economic Conflicts in American Patent History Norman: Oklahoma Press, 1956), p. 74. u.» . . ,... \ a...\ ..fl. 105 as the most important patents since the original two tele- phone patents granted in 1879. All three were purchased from inventors external to the Bell System. The examination of the Bell System's structure by the Federal Communications Commission in 1938 is perhaps the most extensive probe undertaken by any government agency.1 The investigation revealed that of the total telephone patents owned by Bell, 46.7 per cent were in actual use, 845 patents were not used because of the need for further develop- ment, 2,126 were unused due to the existence of superior alternatives, and 660 were awaiting application.2 Some 1,300 patents were not utilized as no need was determined for their innovation. Bell's licensing policy was restricted to those operating companies within the Bell System and the telephone refused to grant patent licenses to other companies. The denial of patent licenses that AT&T held idle, prompted charges that the system was exercising undue discretion in the innovation of communication techniques (65 per cent of Bell's telephone patents were idle).3 In summary, by the 1930's the Bell patent base encom- passed the entire field of telephones and telephone apparatus 1For a criticism of the FCC investigation, see: John F. Bickley, ”That Two-year Phone Probe--Review of the Pro- posed Report on the FCC Investigation of the Bell S stem," Public Utilities Fortnightly, XXI:13 (June 23, 1938 , particularly p. 781. 21939 Telephone Report, op. cit., p. 234. 3Ibid., p. 235. 106 and with concentrated strength in the fields of long dis- tance transmission--including repeaters, carrier systems, and coaxial systems. The only serious challenge to Bell's position in toll exchange circuits occurred with the advent of an alternative means in the rendition of voice--the radio. Again, however, Bell's patent base served it well. Much of the early experimentation in radio transmission occurred prior to World War I and several firms were engaged in pressing the state of the art. As each firm patented new radio devices and components and refused to license each others'devices, a patent stalemate emerged by the outbreak of the war. In fact, radios were not produced in large quanti- ties since no one company controlled all the essential com- ponents for a complete radio system.1 The stalemate was temporarily alleviated by the first World War when a government guarantee was issued protecting all manufacturers from infringement suits on work performed for the government. By the Armistice, wartime research and development had extended the art to where mass commercial 1The patents situation of radio before World War I: ”There were prior to the entrance of the U.S. into the World War, a number of inventions covered by patents, which could have been utilized in the manufacture of a large portion of the modern radio apparatus, and also numerous inventions covering various systems which could have been employed in rendering a more efficient transoceanic radio communication service. These patents were, however, controlled by oppos- ing interests who refused to license one another.” Federal Trade Commission, Report on the Radio Industry, 1924, p. 14. 107 introduction of radio was impending. However, with the lapse of wartime conditions and the withdrawal of the government's anti-infringement guarantee, the patent barriers were soon erected. Most of the key radio patents were owned by the American Marconi Company (a subsidiary of the British Marconi Company), General Electric, Westinghouse, and AT&T. Not only did each firm have an ownership segment of the radio art, but the government found itself in substantial possession of radio patents acquired through the Alien Property Custodian. Included were German patents on radio circuitry.1 The refusal of rival firms to license one another prompted General Electric to open negotiations with British Marconi with the end of diSposing its patents and clearing out of the radio field.2 The War Department was distressed by these negotiations-—particular1y the Navy. The Navy did lDallas W. Smythe, The Structure and Policy of Electronic Communications (Urbana: UniverSity of Illinois, 1958), p. 50. “The Government, in its own right, acquired a sufficient patent position to dominate the field. These patents came to it through the purchase for 1.6 million from the Federal Telegraph Company and the Poulsen Werden Corporation of 22 patents and the purchase of some 110 German patents (including the Schlol- milch and VonBronken patent) from the Alien Property Custodian." 2N. R. Danielian, AT&T: The Story of Industrial Con- quest (New York: The Vanguard Press, 1939), p. 109. The patent stalemate was as follows: DeForest Vacuum Tube (AT&T), overlapping Fleming Vacuum Tube (Radio Corporation) Arnold High Vacuum (AT&T), interference with Langmuir High Vacuum (General Electric) Colpitts Grid Modulator (AT&T), interference with Alexanderson Alternator (General Electric) Hartley Plate Modulator (AT&T), interference with White Plate Modulator (General Electric) DeForest Oscillator (AT&T), interference with Lang- muir Oscillator (General Electric) Armstrong Oscillator (Westinghouse) HE! - ‘ 108 not want to be dependent upon a foreign supplier for its radio apparatus; thus, in the name of national security the Navy advocated public ownership of the radio industry.1 Under this threat, the triad of American companies initiated the formation of a domestic radio patent pool. The cross— licensing agreement included General Electric, Westinghouse, and AT&T.2 The agreement resulted in the formation of a patent holding corporation, Radio Corporation of America. RCA incorporated the assets of American Marconi as well as acquiring substantially all of the domestic patent rights on radio.3 Subsequently, when the struggle over radio networks en- sued, the Bell System's long distance lines conferred to AT&T the strategic advantage of interconnecting several radio stations into a network. When AT&T refused to permit net- work rivals to have access to the telephone long distance facilities, the broadcasters turned to the two telegraph common carriers. Since RCA, as a result of the patent pool, 1U.S. Navy was the largest consumer of radio apparatus and feared British dominance of key equipment. See: Gleason L. Archer, History of Radio (New York: American Historical Society, 1938), p. 168. 2RCA agreed to purchase radios in the ratio of 40 per cent from Westinghouse and 60 per cent from General Electric. 3A5 a result of these and other agreements, RCA ob- tained rights to over 2,000 patents, including practically all the patents of importance in the radio science of that day. W. Rupert Maclauren, Invention and Innovation in the Radio Industgy (New York: MacMfilan Co., 1949), p. 107. 109 now had access to the telephone patents, it was possible for RCA.to transmit voice messages via transcontinental tele- graph lines.1 The emergence of a discrete parallel long distance telephone system posed a latent threat to the Bell System's toll circuits. This threat, plus RCA'S dissatisfaction with the quality of Speech transmission over telegraph lines, induced a market realignment in 1926. AT&T sold its network to RCA (who formed a subsidiary National Broadcasting Company). In re- turn, RCA agreed to lease its program transmission channels from the Bell System. In short, AT&T sold its broadcasting business in exchange for maintaining the integrity of its long distance telephone circuits. The structure of the equipment market also felt the influence of the patent. In 1882, the Bell interests purchased the largest manu- facturer of telegraph equipment, Western Electric. Incorpor- ated into the system as the exclusive manufacturing subsidi- ary, Western Electric was given the sole right to manufacture telephones, telephone apparatus, and equipment under the Bell patents. Western Electric was committed to sell its equip- ment only to those companies who were licensees of the Bell lDallas W. Smythe, op. cit., p. 51. "This monopoly position rested, to some extent, on the tacit policy of the Navy and the Department of Justice to refrain from enforcing government-owned radio patents against RCA-owned patents when the former appeared to be infringed on by the latter." 110 patents. Since Bell refused to grant patent licenses to non- Western Electric manufacturers—-inc1uding the idle patents of AT&T (60%)--the equipment market was effectively cartellized and controlled. The refusal of Western Electric to sell equipment to non-Bell operating companies prompted the formation of independent equipment firms as suppliers. The emergence of competition prompted a reversal of Western Electric's policy in 1908. Western Electric was permitted to sell to independ- ent operating companies, but the products were restricted to switchboards and telephone equipment. The independents were denied equipment necessary in the rendition of long distance calls, such as loading coils, repeaters, and coaxial cable systems. Thus, in both markets Bell's patent policy effec- tively isolated competition into territorial pockets. By the 1930's Western Electric's preemption of the com- munication equipment market (90%) included not only tele- phone equipment and apparatus, but telegraph and teleprinter equipment as well (Teletype Corporation). The stockpiling of patents, the high ratio of idle patents, refusal to license total patent possessions to non— Bell operating companies, exclusive licenses to Western Electric, denial of equipment to non-Bell telephone companies, refusal to issue licenses to non-Bell equipment firms, denial of patent licenses to the telegraph industry, refusal of facilities to non-Bell broadcasters, swapping patents in obtaining exclusivity in certain markets prompted some lll observers to speculate as to whether the patent system was amenable to abuse. Certainly, the patent existed as one entry restraint in the communication equipment market. Having examined the role of the patent in the evolution and structuring of the communication industry, we proceed to an examination of the factors that have tended to erode the patent as a barrier to entry. The discussion will include first an examination of the impact of the public sector of the economy, emphasizing first the role of government research and development expenditures (R & D); second, the innovation of communication techniques under government auSpices; and, third, the diffusion of technical knowledge attendant govern— ment research and development and procurement contracts. Following the impact of the public sector on the patent barrier, we shall then examine the impact of the 1956 AT&T consent decree with Special reference to the patent pro- visions of the decree. Government Research and Development Table 28 and Figure 24 suggest three trends as a con- sequence of the second World War. In the first place, the absolute aggregate expenditures on research and development expanded from a base of 166 million dollars to a wartime average of 600 million dollars. In the second place, the burden of funding research and development shifted during the war from the private sector of the economy to the public sector. 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Qua. 3?. mmr . GOMflfiUMQ 00w UHOMUQ OUUI ocLOI '53, 5159 00+ ofls 156 In the first place, although private users can obtain frequency allocations without a proof of need or without a case-by-case approach, they may not share the use of a micro- wave system. It will be recalled that right-of-way users and public safety groups could band together and share utilization of a microwave link. To the consumer confronted with the option to lease his facilities from the common carrier versus own his own microwave link, the FCC decision against shared use may tend to favor the leasing option and hence the common carriers. In the second place, frequencies are not necessarily allocated permanently; they may be subject to reallocation as a result of domestic needs or international needs. To cite an example, currently three dockets are pending before the Commission eliminating the sharing of frequencies between the common carriers and private microwave systems. One docket, 14712, reallocates bands 2110 to 2200 MC into four discrete bands.1 Another, No. 14729,2 reallocates bands 6,000 and 10,000 to 12,000 MC, and a third, No. 14722.3 1Before the Federal Communications Commission, Docket No. 14712, in the matter of amendment of Parts 2, 6, 7, 9, 10, ll, 16, and 21 of the Commission's Rules to designate portions of the 2110-2200 MC/s band exclusively for the use of domestic fixed public stations and for the use of oper- ational fixed and international control stations and to re- serve a portion thereof for omnidirectional operations, 1962. 2Before the Federal Communications Commission, Docket No. 14729, in the matter of amendments to Parts 2, 4, 7, 8, 9, 10, ll, 16, and 21 of the Commission's Rules concerning the allocation of the fre uency bands 6425-6575, 10550- 10680, and 11700-12200 MC 5, 1962. 3Before the Federal Communications Commission, Docket 157 suggests reallocation for educational television (ETV). Al- though no overt apprehension has been expressed by microwave users, the Commission's reallocation of the 2,500 to 2,690 bands from Operational fixed to ETV states: Should the Commission eventually reallocate the 2500- 2690 mc band for this new education service, it is further_proposed that existing licensees in this band would be given a reasonable peind of time in which to amortize their investment.1 [EmphaSiS mine.] (The common carriers, in general, are responsible for pro— viding channels for ETV.) Turning to Space communication frequency needs, the problem of reallocation is latent but present. Again quoting the Commission on this issue: Accordingly, if future conditions warrant a re- allocation of frequencies to provide for Space communication needs we will then take whatever action may be necessary. Accordingly, all users in those bands are put on notice that if future developments in Space communications Should war— rant they may be required to shift frequencies or otherwise modify existing authorizations to meet possible requirements for space communic- ations needs. Although the frequency use and allocation situation in the short run may remain fluid, long run advances in the No. 14744, in the matter of amendments oszarts 2 and 4 of the Commission's Rules and Regulations to establish a new class of educational television service for the transmission of instructional and cultural material to multiple receiving locations on channels in the 1990-2110 mc/S or 2500-2690 mc/S frequency band. 1962. 11bid., p. 2. 2Before the Federal Communications Commission, 1960 Above 890 Order, 0 . cit., p. 848. Federal Communications Reports, Vol. 29, E960, p. 848. 158 state of the art hint at breakthroughs indicating that the supply of frequencies may vastly exceed demand. Although largely funded by military research and development, the laser (acronym for light amplification by stimulated emission of radiation) or light beams may relieve some aSpectS of frequency congestion. Using coherent light beams at fre- quencies oscillating at billions per second, the laser potentially can serve as the medium for voice, record, and data signals. A laser generates frequencies at 500 trillion waves per second in contrast to the highest radio wave of 50 billion cycles per second.1 Theoretically, one laser beam could carry as much data as existing radio frequencies. To contrast the laser with microwave, one microwave Signal can carry 1,800 voice channels or one television Signal; a laser beam can carry 100,000 telephone calls or 100 television programs.2 In summary, the "Above 890” decision was of crucial im- port to the non-affiliated firms in microwave equipment in- dustry. We have seen that prior to this decision, the use l"Powerful Laser Light Beams Show Signs of Many Potential Uses; Research Pushed," Wall Street Journal, CLIX: 73 (April 13, 1962), p. 18. 2Jerry E. Bishop, "Communication via Laser,” Wall Street Journal (December 11, 1962), p. 6. "A little calcu- lation shows that the visible region between the wavelengths Of 4,000 and 7,000 angstrom units could contain 80 million television channels." Arthur L. Schawlow, ”Optical Masses," Scientific American, 204:6 (June, 1961), p. 53. ”Lasers Hit the Jackpot," Business Week (November 3, 1962), p. 34. ”IBM and GE said they consider their new lasers a major break- through that will immeaSurably Speed up the use of lasers as communications carriers . . .” 159 of microwave systems was limited to the Federal government, public safety organizations, communicatiOn common carriers, and certain right-of-waycompanies. By expanding the eligi- bility of licensing of private microwave systems, the FCC literally expanded market potential from the public utility class to the manufacturing and commercial class. This decision was prompted by two factors: first, in the opinion of the Commission, the supply of microwave bands was now sufficient to permit free access to all; and, second, liberalized eligibility would "spur" manufacturing competition. Thus, as one potential barrier to entry, the raw material of private microwave systems was,with certain reservations, diminished. Under the classification of legal and technological restraints, we have considered the patent and the avail- gability of microwave frequency band. A third barrier is associated with the capital requirements necessitated in installing wide band multichannel systems. If . . . the ranks of effective potential entrants are Often greatly thinned by capital require- ments . . .1 then, the availability of knowledge and the free abundance of the factor resources may not be sufficient to overcome capital cost barriers. 1Joe S. Bain, Industrial Organization (New York: John Wiley and Sons, Inc., 1959), p. 252. 160 Capital Regyirements Although the data in this sectionare unfortunately meager, an attempt will be made to assess cost barriers in the resource market (common carriers purchasing equipment) and in the product market (end-users purchasing radio relay equipment). Finally, an attempt will be made to evaluate the implications these costs hold for entry into the equip- ment market. We turn first to metallic circuits and then microwave circuits. The coaxial cable, as a multichannel broadband medium, is the product of the research efforts of Bell Laboratory and Western Electric. The coaxial cable originated as a device to handle the heavy traffic routes of the Bell System. Research on the cable preceded by twenty years the first experimental cable in 1936 between New York and Phila- delphia. The cable, containing repeaters every ten miles, supplied a capacity of over 200 two-way voice conversations. In addition, television pictures were relayed over the cable to study the practicability of the cable as a medium for the wideband Signal. Greater experimentation produced a cable of 3 MC/s bandwidth and, in 1941, the cable was innov- ated for commercial use. Work on the cable ceased during the early years of the war. Bell's research and development effort shifted to mili- tary contracts and there was the more urgent need to develop transcontinental long-distance lines as these facilities 161 ‘were jammed.1 AS the war entered the third year, work resumed on the 1941 cable. This resumption was largely dictated by the short- age of lead and copper as a war material. AS Opposed to other telephone media, the cable required less of the strategic material.2 Another factor was the advent of television. On February 24, 1944, NBC'S President, Niles Trammel, wrote AT&T stating: The National Broadcasting Company looks to the Bell System to provide and make available to NBC the neces- sary intgrconnecting facilities for such a television network. Five days later, Mr. Keith S. McHugh, AT&T vice presi- dent, replied that the Bell System planned to construct six to seven thousand miles of coaxial cables within the next five years.4 The cable was to be nationwide and transcontinental, linking New York with Los Angeles. On March 17 of the same year, AT&T announced, in The Wall Street Journal, that it would set up an experimental microwave radio relay System of television capacity between New York and Boston. However, the announcement indicated that AT&T would rely . . . on the concentric cable as the best means for further expansion . . .5 1M. E. Strieby, "Coaxial Cable Systems in the U.S.," Signals (January-February, 1947), 1:3, p. 40, 2M. , p. 40. 3Telecommunication Report, 10:29 (March 2, 1944), p. 6. 4New York Times, 11:5 (March 17, 1944). 5Before the Federal Communications Commission, Above 890 Docket, o . cit., Electronics Industries Association, "Highlights of Raaio Relaying History," p. l. 162 0 sum: 0 WND "m“ museum“: . . MIWIAUK! ‘\ . mavmm 0“ 1‘01"“ . cmcaoo. ON" 0‘ o ucmmo nus“ .’ N mucnco' ”W" n‘ cm .\. at. Low: to: mom: “‘23?“ um: . ' a x O \ mm mu 0 o O ’ MW Jacuon ‘ IL PASO ammo o NIW ORLEANS o O - coma; cam now won communion HOWON oa msmuo =3 COMIM CARI MNNID POI um "WM! MMMmMWMWM WWI-Hothouse.” mmmMumhmhuM MWWWuMMMVM Figure 35. The Bell System coaxial cable program. Source: M. E. Strieby, op. cit., p. 42. As a matter of thoroughness, the Bell System would give radio relay a trial. As noted earlier, the Bell System had received contracts for classified research and production of Signal Corps radio relay systems (AN/TRC-b). The time table of the coaxial cable system included com- pleting the New York-Washington link by 1945; the New York- Boston, Washington-Charlotte, Chicago-Torre Haute-St. Louis, Los Angeles-Phoenix links by 1946. The 1947 schedule included 163 Chicago-ToledO-Cleveland-Buffalo link and part of the Southern Transcontinental route. Between 1948—50, the Southern transcontinental route was to be finished. Establishing a coaxial cable system is a complex oper- ation. After selection of the cable route is made, rights— Of-way have to be negotiated and purchased. In the case of buried cable, the property owner receives a price based on a per linear rod (16—1/2 feet). The legal work in tracing heirs, ownership, property lines, checking title, etc. is handled by the Legal Department of the AT&T'S Long Lines Department.l ‘Construction is relatively slow Since the right-of-way has to be cleared--a process involving cutting trees, pulling stumps, opening fences, etc. After the coaxial cable is delivered to the laying Site, a rooter plow digs a Slot, then a cable-laying plow buries the cable. A cleanup crew follows the cable crew, preceding the legal department which must make settlements for crop losses and other construction damages.2 The cost of a transatlantic coaxial system was of such magnitude that the combination of research expenditures and the capital outlay required to institute a nationwide system apparently eliminated all the common carriers except the 1Harry H. Hoopes, "Right of Way Comes First," Bell Telephone Magazine, XXVII:4 (Winter 1948-49), pp. 241-3. 2Ibid., p. 243. 164 Bell System (neglecting, for this analysis, AT&T(S patent position on the coaxial cable). In 1945, for example, 339 miles were laid at a cost of $7,056,000 or $21,000 a mile.1 The nationwide cable system of 3,287 miles was estimated at $56,356,000 or an average of $17,000 a mile.2 Furthermore, in 1946, AT&T compressed its five-year program into three years, increasing the annual investment burden.3 It was hoped that by 1950 some 12,000 route miles Of this broadband system would be in service. Projecting the lower figure of $17,000 per mile, the capital outlay by Bell for its coaxial system approached a total of one billion dollars within a five—year period (Figure 36).4 As an alternative to broadband metallic circuits, a radio relay system was proposed by Western Union and Raytheon (other proposals are not meant to be Slighted, but these three firms actually started construction). Western Union announced its plan in the Fall of 1944. Employing RCA equipment, the telegraph company constructed and innovated the first commercial radio relay system in 1947. Western Union's plan incorporated a nationwide radio relay system capable of handling all communication service, 1Telecommunication Report, 11:51 (August 9, 1945), p. 6. 21010., p. 6. 3Lawrence G. Woodford, "The Bell System's Progress in ’Esfi eision lNet.works, ” Bell Telephone Magazine, XXVI: 3(Autumn 4Author's estimate ($17,000 x 50,000 miles). 165 9.9.5 § :3 m {i o E § T HCJU $AN DC) \I U. HJ / G 8 )7 Mites .4 / "r9402" 41 4} 44- 45 4t. 41 4s 49 80 5. 52 53 5'4» 5: 66 57 ’60 Figure 36. Coaxial cable. Source: Long Lines Department, Our Company and How It Works, October, 1960, p. 99. including television. The first triangle included Pittsburgh, Washington, and New York with subsequent Sites purchased as far south as Atlanta and as far west as Omaha. Microwave links as opposed to coaxial systems require neither extensive rights-of-way nor the time consumed in the laying of cables. Western Union's system as projected in- cluded the linking of eight major cities, the eastern tri- angle by 1948, and sixteen other links planned by 1949-51. 166 .-..M- . . . O . . u." "f" 5. .. I. m as ' . ma . II .. ' NM / ..-..-..-.. "'"" "'m" \ / mm ,4 ~ .. - , ""9...— L‘ _, A I 5 l \ . ... m m “I Figure 37. PrOposed Western Union radio relay system with supplementary trunk facilities. Source: Julian Z. Millar, "Telegrams on the Beam --A Preview of the Western Union System of Radio Beam Telegraph,” Signals, 1:3 (January0February) p. 27. - . The cost of such a transcontinental relay system was considerably less than a comparable coaxial network. Thus Western Union's costs were projected at $17,100,000 in con- trast to the $56 million coaxial system.1 Although the telegraph company assumed an early lead in the construction of a-nationwide radio relay system, even this $17 million capital requirement proved to be formidable. By 1949, the company had spent only $2-1/2 million on its radio relay network.2 1Hyman A. Golden, The Domestic Tele ra h Industr and the Public Interest (unpuBIisfiea P5.D. tfiesis, Harvard Universify, 19305, p. 246. 2 Ibid., p. 247. 167 The main problem was Western Union's financial situation. During the crucial construction years between 1945-50, the telegraph company incurred a deficit in three of the five years. Among other factors, Western Union's financial posture eliminated any hope Of establishing an immediate nationwide radio relay network. 1,94 2 2013.9 20.3 Gross - . 193.1 INCOME \/'\\ 187.8 \19’6.2 185.1 18 .9 .1... - r, g 4p 1., V V V 9.1 7.3 \\\\&gl N81: r Income \ I \ IT \ / \ I .\ 4.3 4,4 / \ / \ if 11.0 1945 46 47 48 49 50 51 52 Figure 38. Western Union income. Source: Annual Rpport 1955, p. 25. 168 A second nationwide radio relay system was announced by Raytheon in the Fall of 1944: As a result of the experience which it had acquired during the recent war from the use Of microwave fre- quencies in connection with its development of magnetron and radar equipment . . .1 Raytheon intended that its transcontinental system sould handle all communication signals, including FM and video. AS in Western Union's case, Raytheon purchased sites, towers, erected buildings, and by 1946 Six stations were put into Operation on an eXperimental basis between New York and Boston.2 Estimated cost of the link was $1 million. How- ever, rather than a broadband facility, Raytheon constructed a narrow band link and it lacked the capability and the equipment tO transmit television Signals. Early in 1946, the company landed an Air Force research contract for wide television transmission equipment. . . . the construction of which involved the same type of research and development which appeared to be essential for the type of equipment required for relaying TV signals between New York and Boston.3 1Before the Federal Communications Commission, op. cit., in re. Application of Raytheon Manufacturing Company, Docket No. 8756, Federal Communications Repprts, p. 387. 2Ibid., p. 389. 3Ibid., pp. 389-90. "Raytheon believed that the ex- perience which its staff would gain in the work would be helpful in carrying out its plan for a nationwide microwave relay system. Raytheon, therefore, took advantage of this opportunity and became successful bidder as subcontractor to the Bell Aircraft Corporation." 169 Raytheon, in winning the contract developed the equip- ment for the Air Force and subsequently marketed the product commercially. But the company had paid the price of delay- ing development of its radio relay system. As the postwar era began, Raytheon's dependence upon military hardware made it particularly vulnerable to the peacetime transition period. Finding it difficult to raise the necessary capital, the firm attempted to enlist the help of Western Union, IT&T, and others, but to no avail. By 1947, the economic and financial plight of Raytheon forced it to abandon its radio relay plans (Figure 39). 173.0 N?” 4 60.4 53.7 56.3 59.5 A» 05 AA' "“ A *7"— “*—_—JV v: v 9.; 9,4 9,5 3.4 3n \ 11 ‘ 0 NJ, \ I \r '45 '40 '47 '48 '49 '50 Figure 39. Raytheon income series. Source: Raytheon, Annual Report, 1950, p. 30. 170 Although presumably committed to a metallic broadband network, subsequent to World War 11, AT&T continued research and experimentation on radio relay techniques. As noted earlier, the telephone company innovated essentially its AN/TRC-6 equipment for use off the New England and California coasts. However, these were essentially narrow band systems-- incapable of transmitting a wide band television signal. Ap- parently all the elements encompassing Bell's broadband relay system were available except a miniature electron tube that generated the frequency and permitted the relaying of broad- band Signals without the remodulation technique required at each relay station. While construction of Bell's relay network was begun, Dr. Jack Morton of Bell made the breakthrough of this com- ponent known as a closed Space triode.1 Completing the last link in the TD-2 system (as the Bell relay equipment was called), AT&T embarked on a nationwide construction program that soon not only eclipsed Bell's competitors but supplanted its own coaxial system. The estimated cost of the trans- 2 continental extension of TD-2 was $40 million and Bell's lMerton J. Peck, The Weapons Acquisition Process: An Economic Analysis (Boston: DiviSion of Research, Graduate School of Business Administration, Harvard University, 1962), p. 247. "In 1947 the success Of an important and costly American Telephone and Telegraph Company radio relay system development hinged upon the uncertain producibility of a miniature electron table . . ." There was a breakthrough for AT&T only; RCA employed a traveling wave tube with success. 2John R. Pierce, “Hazards of Communication Satellites," Bulletin of the Atomic Scientists: A.Magazine Of Science and ‘Public Affairs, XVII:5-6 (May-June, 1961), p. 183. 171 resources were able to handle this capital expenditure with considerable ease. By 1951, the first coast to coast link was completed (Figure 40). Radio Relay Broadband -—- Channel Miles ‘1 0‘. Coaxial Tube Miles 10" .../(K K 225 200 175 m 150 L) fi 125 j 100 :5 75 50 \ l .1) :73 2 5 Figure 40. 114.034 in '45 '44- '45 '46 '47 '46 ‘41 '50 '54 ‘51. '59 '54 '55 's‘ '57 '5: ‘59 AT&T coaxial and radio relay channel miles. Source: Our Company and How It Operates, Long Lines Department, AT&T, October, 1960. 172 The previous evaluation has centered on the factor or resource market in that it attempts to delineate the capital expenditure alternative confronting common carriers who em- ploy equipment in the rendition of services to the consumer. In this market only one carrier, AT&T, was capable of constructing a nationwide broadband metallic system. When radio relay techniques became available again the commitments of fixed investment were such (even though substantially less than coaxial) that both Western Union's and Raytheon'S efforts proved abortive. Apparently the Bell System possessed suf— ficient financial resources to elect and pursue heavy invest- ments in metallic and radio facilities. In the product market the cost of duplicating common carrier facilities deterred the individual end—user from exercising any Option other than leasing his services from the carriers. Existing evidence suggests that the costs of heavy duty microwave equipment may not be as formidable as they once were in the immediate postwar era. Two factors may ac- count for this erosion in the resource market. The first may be a rise in the financial resources of the firm relative to the Size of capital outlay for microwave and the second factor may be the decline in the cost of the capital equip- ment itself. Western Union is a case in point of the first trend. In 1960 Western Union, using RCA 600 voice channel equip- ment, initiated construction of a nationwide microwave relay 173 system. The system, costing 96.5 million dollars, is to be completed in 1964.1 Figure 41. Map of new transcontinental microwave network and planned southern extension. Source: Western Union AnnualgReport, 1961, p. 3. Western Union's financial picture has reversed since the bleak postwar days, with operating revenues of around $277.5 million, net income around $10 million.2 Western Union's private line market has grown rapidly and the timely award of Air Force contracts for a nationwide data 1W. P. Marshall, A Review of Western Union Today as Summarized before the FCC CommiSSiOnerS on March 9J 1961, p. 23. 2Western Union Annual Report, 1961, p. 10. 174 transmission system, a bomb alarm system, plus contracts from the Weather Bureau and the Federal Aviation Agency have enabled Western Union to construct its relay system--the first nationwide microwave System paralleling the AT&T system. (The Air Force Datacom and Bomb Alert System will generate an additional annual income of $38 million.1 A second factor tending to induce entry is the decline in equipment costs. It is of interest to note that Western Union's relay system employs RCA equipment. This same equip- ment is being utilized by the Canadian Government for a transcontinental system at a cost of $12 million for 3,000 miles.2 Western Union's construction cost of $4,000 per mile represents a substantial decline in equipment costs if the TD-Z costs averaged around $13,000 per mile (3,000 miles at $40 million).3 As a matter of fact, the Bell System's TD-2 radio relay system has declined in cost by 23 per cent Since the end of 1950.4 In any event, the inadequacy of data dictates that any observations on equipment cost erosion be extremely Speculative. 1Ibid., p. 4. 2E. J. Hart, "RCA Microwave Selected for Canadian Com- munications Network,“ Radio Corporation of America, Industrial Electronics Products, CEmden, New Jersey, 19621 3Author's estimate (3,000 miles at $12 million). 4U.S. Congress, Senate, Antitrust Problems of the Space Satellite Communications System, Hearings befOre the Subcom- fmittee on Antitrust and Monopoly, Committee of the Judiciary, 87th Congress, 2nd Session, pursuant to S. Res. 258, Part 2, 1962, p. 686 (letter from H. I. Romnes, Western Electric president to Newton W. Minow, Chairman, FCC). 175 The impact of microwave Systems on the product market is as profound as it is on the factor market. Radio relay has conferred to the consumer an additional option of owning his communication system versus leasing his services from the common carriers. Of course, the equipment needed by end- users is not the heavy duty apparatus utilized by the carrier; rather it tends to be the lighter or skinny route equipment (less channel capaoity). Nevertheless, the attributes of productivity, flexibility, reliability, and maintenance, when translated into costs, make owning a system attractive vis-a—vis monthly leasing rates. Again, the potential users of radio relay systems must be of such a Size that the capital outlay attendant such a system is within their reach. Table 33 depicts the invest- ment range as a function of the system's length and Figure 42 displays the cost component breakdown of repeaters and towers. TABLE 33 MICROWAVE EQUIPMENT STUDY Total Investment Length of System (000) (miIes) - Low High 25 _ $ 29 $ 55 50 62 104 100 119 ' 188 200 233 357 500 576 ' 865 1,000 1,147 1,711 Source: Before the FCC, Telpak Docket, O . cit., AT&T, Testimony of J. F. Magee (38 organizations were interviewed). 176 .L 'Land, Roads & Power Service . .Entrance L ,Engineering $50,000" Services Freight & Taxes “ Spare & Test Equipment Battery Plant 40 000“ - - 'Eand Roads & ’ .____$Bu11d1ng E§§§§P0wef Service Entrance. Engineering Serv. ‘_ Antenna ' _ . System & , -Freight & Taxes Tower Spares & Test Equipment 30,000v ______Battery Plant Building ” Antenna System & Tower 20,000" Microwave & ‘ Accessories qb Microwave & 10,0000 Accessories REPEATER Figure 42. Cost studies. Source: Motorola. TERMINAL Before the FCC, Telpak Docket, o . cit., 177 The option of owning was further stimulated by the possibility of firms banding together and Sharing the cost and use of a private microwave system. Although this policy of Sharing was not extended to the new frequencies (post- Above 890), the pre-89O policy enabled some firms to Spread the burden of fixed investment and lowered the capital re- quirements of owning. Three Specific cases illustrate the comparative ad- vantage of owning a private microwave system. The J. L. Hudson Company, a Detroit department store, contemplated installing a private microwave system between its downtown store and its two suburban stores, Northland and Eastland. Though the system was to include Several communic- ation services, Specifically it would enable the three stores to transmit credit approval signals. If Hudson's leased an equivalent amount of telephone circuits from Michigan Bell, the estimated cost would be on the order of $10,000 to $15,000 per year.1 If Hudson's de- cided to construct its own radio relay system, the system would cost $10,000 to $12,000 a year.2 Thus, the cost of building a private microwave System would be roughly equiva- lent to the annual leasing rates charged by Michigan Bell. AS one private microwave consultant Observed: If the microwave equipment were amortized over a period of ten years, the annual cost, including maintenance and interest on the investment, would 1Leo G. Sands, "Low Cost Industrial Microwave Systems," Industrial Electronic Engineering and Maintenance (January, T961), 3:1, p. 8. 2Ibid., p. 8. 178 be aroynd $2,000 or 20% of the cost of leased lines. [Emphasis minéT As a Second example, the Southern Railroad system was confronted with the alternative of leasing its voice channels from the Bell System between Washington and Atlanta or con- structing a microwave link. In leasing from the Bell System, Southern's cost would be $128,000 a month or $1.5 million a year.2 Bell's facilities included 255 voice channels, but did not include certain VHF equipment desired by the railroad. Capitalizing the total bill, Southern estimated that its annual licensing charges would be $1,628,765 per year.3 If Southern constructed a microwave system between Washington and Atlanta, the cost would range between$316 million to $4.1million. This cost also includes the VHF equipment Southern desired as well as real estate costs. The railroad estimated that the annual cost per year, if it owned and operated this system, would be $730,000.4 Breaking this cost into channel miles, the Southern Railroad esti- mated that electing to lease would cost it $2.00 per channel mile; electing to own would cost it 78 cents per annual channel mile.5 1Ibid., p. 8. 2Before the Federal Communications Commission, in the Matter of American Telephone and Telegraph Company regulations relating to connections of telephone company facilities with certain facilities of customers, Southern Railroad System, Docket No. 12940, p. 27,1960. (Hereafter cited as Railroad Interconnection Docket). 31bid., p. 27 41bid., p. 27. 5Ibid., p. 27. 179 A third indication of the comparative advantage of own- ing private microwave verSus the cost leasing faCilities is a study conducted by the American Electric Power System. This study is useful in that it illustrates the volume cross- over point where the advantages of owning facilities exceed that of leasing them. If the end-user consumes one to four voice channels then it is less expensive to lease channel facilities from the common carriers rather than own a micro- wave system. If the volume exceeds six to eight voice channels (Figure 43), then the cost advantages Shift from leasing to owning. (It is appropriate to note that the bulk communication market to which the Telpak tariff is directed is defined by AT&T as six voice channels and above.) And, of course, as the voice channel volume exceeds twenty and as the system's distance increases, the economics of owning be- come pronounced. What implication does the diminution of capital cost attending private microwave hold for the radio relay equip- ment market? In assessing the capital requirements Of a nationwide coaxial cable system, it was apparent that the Bell System alone possessed the resources to undertake the capital expenditure inherent in such a system. And given AT&T's vertical integration, it is evident that Western Electric manufactured and supplied the cable to the Bell System. The innovation of radio relay systems in the early post-war era and the fact that Western Union was not integrated RELATIVE “ANNUAL COST RELATIVE ANNUAL cbs'x‘ RELATIVE ANNUAL COST 01 180 I ICHANNEL e CHANNELS ’— 5.. .. -... (I) O U _l ‘ a 3 3 0.. w 2 .E 5 J U m _._=r—-"‘ POWER Lima. 2.1—7 #1 l i l l . L . I , 50 IOO IJO 200 Figure 43. !§_CHAN ELS 1//’i .. .2 J .— {D o. Q .J 3 z a z < N z . ... S 4_1 u - O: o 1 1 so IOO' Iboi’ 2'0 Mkfii (E) r-. ‘r I *' . . l I . f L 24-CHAN LS [/1 ///r m / 5 ' k - O o 5 § ,3; / «9'. _ <~ J" /*é$ ‘ ‘ .g‘ 4“ qé GRO‘RJE _J—‘— E ‘ «a “‘ ..I 4 . m _,_J'— c: / I J. l J_1 I 1.1 i L L_.L1 ‘ o 50 no up so MILES MILES (c) (F) Microwave cost figures. Source: S. C. Bartlett, ”Microwaves and Their Use in Power System,” Communications and Electronics, No. 46 (January,i1960), American Institute of Electrical Engineers, Transactions, Communications & ElectrOnics, p. 1098,, 181 into the equipment market offered one Opportunity for heavy route relay suppliers (both Philco and RCA participated in this market). However, when Western Union encountered financial stress, this market outlet was foreclosed to the non-integrated supplier. Raytheon, of course, never got off the ground. As an equipment supplier, Raytheon's attempt to establish a nationwide radio relay system can be termed as the attempt of a non—integrated supplier to integrate forward. Given the magnitude of capital outlays relative to firm Size, Bell System alone was successful in establishing a trans- continental microwave relay link--even subsequent to some rather hefty commitments made on the coaxial network. And again, Bell's TD-2 equipment as well as its TH and TL relay gear was manufactured by Western Electric. In short, Western Electric enjoyed preeminence in supplying heavy route radio relay apparatus. The one "break" in the domestic market ap- pears to occur with the rejuvenation of Western Union's nationwide relay system fifteen years later. Perhaps it is too harsh to suggest that this system is largely underwritten by the Air Force; at any rate, Western Union's purchases have created one additional outlet for heavy route microwave equipment suppliers. As emphasized earlier, the introduction of private microwave avails to the consumer in the product market an additional alternative of owning. Translating this Option into the equipment market, if the consumer elects to lease, in effect, Western Electric receives the equipment order; 182 if the consumer elects to own his own system, then the non— integrated microwave supplier gets the order. It is apparent that the reduction in capital costs and the per unit savings of owning a private system have permitted greater market Opportunities to the non-integrated equipment suppliers. In recapitulating the legal and technological restraints attendant the communication equipment market, we offer the following conclusion. First, the patent as a prOperty right limiting the use and application of knowledge existed as one restraint in the communication equipment industry. This restraint has receded as a result of the ascension and impact of the public sector --particularly in the area of research, procurement, and the innovation of new technology. Second, the availability and use of the frequency Spectrum as dictated by the state of the art, effectively limited the application of commercial radio relay techniques. In the judgment of the FCC, sufficient Spectrum in the microwave region now exists so that its rationing of these bands has diminished. This judgment was embodied in the "Above 890 docket." Third, the capital requirements Of both heavy route metallic and radio relay circuits effectively precluded applic- ation of these techniques. We have attempted to demonstrate that these restraints are tending to weaken, and in particular, that the end-user of bulk communications is now capable of investing in the ownership of his own relay system. 183 Finally, as the three restraints of patented knowledge, the frequency Spectrum, and capital requirements have re- ceded, the market potential to the nonintegrated firm has broadened. Thus, the patent no longer appears to inhibit his use and application of radio relay techniques, the availability of his raw resource is now established, and his equipment prices do not act as a prohibitive cost to the end-user in weighing the alternative to invest in (own) or lease multichannel communication services. Market Structure In addition to an assessment of restraints falling under the category of legal and technical barriers, a second classification to be analyzed is the market structure of the communication industry. Since the burden of Chapter II was to establish the existence of vertical integration, this chapter will deal with integration as it indirectly affects market entry. We will be concerned with two policies Of the Bell System that, owing and the Western-AT&T structure tend to inhibit the market access of the nonintegrated equipment firms. The first policy is referred to as interconnection; the second, as pricing. 1.815.": {99393227 9}} The discussion of interconnection will include an historical summary of the effect of such a policy, the application of the policy to television broadcasters, to rival common carriers, to railroads, to private microwave 184 systems, and finally a general assessment of interconnection and its relevance to the problems of market entry. From the formidable patent position acquired on loading coils and telephone repeaters, it is evident that AT&T assigned a strategic value to the control and ownership of long distance telephone facilities. Once control of domestic long distance facilities was secured, a stringent policy of interconnection was invoked by the Bell System, i.e., AT&T generally denied rivals access to the toll circuits by pro- hibiting them from interconnecting their apparatus, switch- boards, lines, etc. to the Bell System. Bell's intercon- nection policy will be analyzed under the technology of metallic circuits and radio circuits. Metallic circuits will include new Bell telephone companies and chain broad- casting; radio circuits will include interconnection with common carriers, with the railroads, and with private micro- wave systems. During the formative years of the telephone industry control of long distance facilities conferred to AT&T competitive advantages vis-a-vis the independent telephone companies. As a means of controlling the independents: Bell System refused to connect with independent telephone systems for the exchange of messages either in the local exchange area where duplicate faCilities existed or for long distance service. Inasmuch as the Bell System was the pioneer in the long distance field, refusal to connect with independents confined them within the limits of the particular territory served.1 1 1939 Telephone Report, 0 . cit., pp. 136-7. Also: John Reynolds, The U.S.I.T.A. Story--The Story of the United 185 Subscribers of non—Bell local telephone companies who desired to make long distance calls were required to purchase dual services; one equipment provided local exchange service, the other, Bell's, permitted access to toll circuits. There was the additional choice Of simply taking complete tele- phone service from one company, namely, the Bell System. In exercising this option to avoid duplicate telephones, Bell's non-interconnection policy tended to retard the growth of the independent telephone companies.1 In 1912-13, under pressure from the Justice Department, AT&T revoked its policy of denying to independent companies access to its long distance facilities. The agreement, known as the Kingsbury Commitment, was hailed by the inde- pendent telephone carriers as a landmark in its relations .with the Bell System. However, the interconnection privilege was granted to non-competing telephone companies only. How- ever, as late as 1944, the Bell System denied toll access to an independent Philadelphia company, the Keystone Telephone Company. Thus dual service forced . . . many businessmen to have two phones. This became a hot political issue which subsided only when the Bell System bought Keystone for about 13 million.2 States Independent Telephone Association, USITA, 438 Pennsyl- vania Building, Washington, D.C. 1See Horace Coon, American Tel and Tel (New York: Long- mans, Green and Co., 1939), p. 9i and N. R. Danielian, AT&T, The Story Of Industrial Conquest (New York: The Vanguard Press, 1939), p. 46. 2"Independent Companies in Telephone Business Outpace Growth of AT&T'S Bell System," The Wall Street Journal, XLII: 79 (February 5, 1963), p. l. V 186 Today, independent telephone companies enjoy interconnection to AT&T'S long lines network. A second instance of the value of AT&T'S long distance circuits occurred in the struggle over broadcast chains in the early 1920's. Transmitting its programs via its toll facilities, Bell established the Red Network of twenty-Six affiliated stations. The denial of toll access to rival broadcasters, particularly RCA, led,among other factors, to the cartellization of the broadcasting industry and the supplying of broadcast channels (there were even hints that the 1926 RCA-AT&T agreement eXtended into the television re- laying field).1 Thus, in providing telephone or AM broadcasting channel, Bell's control of long distance metallic circuitry conferred leverage in protecting and delineating its market position. AT&T and Broadcasters Radio Relay.--Confronted with applicants seeking to construct microwave relay systems cap- able Of transmitting video Signals, the FCC ruled that the interests of frequency economy dictated that the domestic common carriers only would be reSponSible for providing the intercity channels for television transmission. In 1948 microwave relays of AT&T and Western Union were available and both filed their reSpective tariffs with the FCC. The end-users of these services, represented by the Television Broadcasters Association (TBA), petitioned the FCC to suspend both Bell and the telegraph company's tariffs. Subsequently, * lTelecommunication Reports, op. cit., p. 6. 187 Philco, and A. B. DuMont entered the preceeding and requested that the hearings be narrowed to the issue of interconnection rather than tariff rates. Philco and DuMont charged that Bell's FCC tariff No. 216 denied them the right to link their private relay channels to the channels of the Bell System. The FCC granted the Philco request and the hearings and decision became known as Docket 8963. The point at issue in these hearings was the telephone company's interconnection policy relative to broadcasters providing their own relay systems. Bell's policy held that it would not furnish a customer video channels if those channels were linked "directly or indirectly" with video channels furnished by non—Bell facilities. Permission to interconnect was granted in those cases where Bell was un- able to provide the facilities, but only for an interim period pending the availability of Bell facilities. Figure 44 exemplifies Bell's interconnection policy. Bell Bell Non-Bell Figure 44. Bell-non—Bell interconnection. 188 If a broadcaster at B receives his video signal via Bell's facilities (A—B) and then elected to transmit the signal from B to C over non-Bell facilities (given B—C Bell's link) then the broadcaster would be denied Bell's A to B channels. In Short, AT&T'S command of the A-B link negated the broadcasters option in selecting other subsequent alternative routes. Bell's control of the A-B link, in effect, gave it control of the B-C link as well, a policy enforced by the denial of channel interconnection. The Philco link extended from B to C, paralleling the Bell route, and Philco sought to interconnect its radio relay system with AT&T at point B. In defending her policy, the telephone company sub- mitted legal, economic, technical, and administrative evidence to the FCC. AT&T explained that unrestricted interconnection would duplicate facilities and result in an adverse economic effect on the investment of the common carriers, The burden of this argument was epitomized in the phrase "cream skimming"-- a condition that existed when rival relay facilities would link the heavy traffic, low cost routes and leave the high cost routes to the Bell Company. Permitting the common carriers to exist on "skim milk" while the broadcasters provided links over profitable routes would not only subsidize the private relay facilities of the broadcasters, but would discriminate against other video con- sumers. This would result from the fact that video channel 189 tariffs are an average based upon low cost and high cost routes. Delegating to the carriers the responsibility of pro- viding service over the high cost routes would raise the average and hence result in discrimination against those broadcasters who did not provide relay systems. In addition to cream-skimming, AT&T insisted that interconnection ‘bred technical problems in matching equip- ment and the innovation of new equipment. Administrative problems were also considered. Dividing reSponsibility between Bell and non—Bell routes was incon- sistent with good service and efficiency, for no one can say how long it would take to develop the patchwork, part private, part common carrier, part regulated, part unregulated . . .1 Bell's case is best summarized by the contention that: . . . intercity video transmission service can best be furnished by a single common carrier and that the Bell System should be that carrier.2 The position taken by TBA, representing both broad- casters and equipment suppliers, was that AT&T's intercon- nection was both illegal and contrary to the public interest. i v i 1"Separation of the Interconnection-~The Rate Issue of the Current FCC Proceeding of the Intercity Television Relay Services of the AT&T and Western Union," Telecommunication Report, 15:6 (October 9, 1948), p. 13. ' 2Before the Federal Communications Commission in the Matter of American Telephone and Telegraph Company and the Western Union Telegraph Company—-charges and regulations for television transmission services and facilities, Docket No. 8963, Pike and Fischer, 1949, Vol. V, p. 652. (Hereafter cited as Docket 8963.) 190 First, Bell's policy hindered the development of a nationwide video broadcasting system since it reduced the incentive of a broadcaster in constructing video relay routes and that denial of interconnection discourages the construction of additional intercity TV relay facilities at a time when existing facilities are inadequate to meet the requirements of the industry and by deterring construction of new TV stations in areas where Bell System intercity video service is not yet available or planned. DuMont, a manufacturer of radio relay equipment contended that AT&T's . . . prOposed expansion of intercity channels will consist largely of coaxial cables of 2.7 mc band- width which is alleged to be inadequate to meet the needs of the industry . . .2 As the owner of a radio relay link which was denied interconnection with Bell's coaxial and relay systems, Philco pressed the FCC for an expenditious decision declaring it is no good . . . if eighteen months from now the interconnection provision is found to be un- lawful as geanwhile Philco is losing both time and money. Reinforcing its sense of urgency, Philco sought an in- junction from the Federal District Court in Philadelphia pro- hibiting AT&T from exercising its denial of facilities. How- ever, the court refused to issue the court order on the grounds that the FCC alone had jurisdiction. lIbid., p. 654. 21bid., p. 655. 3Telecommunication Report, 15:4 (September 24, 1948), p. 24. 191 In attempting to determine a decision in this case, the FCC strained under two conditions. Previously, the Commis- sion had decided that intercity television channels should be provided by the common carriers. In this regard the FCC ob- served that Bell was contemplating a nationwide system, but . . . it is recognized that the latter are not yet ready to afford the service required and that ade- quate facilities will not be ready for some appreci- able interval of time. To bridge the gap between policy declaration and policy imple- mentation, the FCC ordered that temporary connection between private relay systems and Bell's system be made. . . . until such time as common carriers have ade- quate intercity video channels available to meet the demands of the broadcasters for such channels.2 The mandate applied to private mobile radio pick-up equipment and direct pick-up and relay of video signals as well. However, the Commission cautioned the broadcasters: The Commission desires to emphasize that this Special provision for intercity TV relaying is a purely temporary measure designed to assist the TV industry until such time as a permanent common carrier facility is generally available and those broadcasters who venture into the business of re— laying television programs in these frequency bands should plan to amortize their investment at the earliESt possible date.3 [Emphasis minef] AT&T and Western Union.--Having decided that intercon- nection between Bell and the Broadcasters' private video systems would be granted on a temporary basis, the FCC turned to the issue as to whether the facilities of rival common j 1Docket No. 8963, op. cit., p. 662. 21bid., p. 672F. 31bid., p. 663. 192 carriers should be interconnected. Western Union had re- quested that the FCC issue a generalized order covering the microwave relay systems of all common carriers. However, the FCC ruled that: . . . to adopt Western Union's position would permit the customer to do what the commission could not it- self do without a finding, after opportunity for a hearing, that such action is necessary and desirable in the public interest. The effect of this decision was to reduce the question of common carrier interconnection to a case-by-case specific point decision. That is, each point of interconnection of two common carrier facilities had to be resolved separately by the Commission. Thus, the FCC initiated Docket No. 9539 to determine the feasibility of ordering AT&T and Western Union to interconnect their intercity video channels between New York and Philadelphia. Although Western Union had embarked upon a nationwide radio relay network, the interconnection docket was crucial to the continuation of its system. In addition to the problem of the availability of construction funds already alluded to, there existed the problem of whether the broad- casters would subscribe to the Western Union system; and this decision, in turn, depended upon Western Union's ability 1Before the Federal Communication Commission in the matter of establishment of physical connections and through routes and charges applicable thereto, pursuant to Section 201A of the Communications Act of 1934 as amended, with respect to intercity video transmission service, Docket 9539, Pike and Fischer, 1951, Vol. VI, p. 1159. (Hereafter cited as Docket 9539.) 193 to tie in its relay channels with Bell's coaxial and relay channels. If Bell denied interconnection, broadcasters would be hesitant to relay programs over Western Union's video re- lay segment, and hence the telegraph company would be unable to generate income from its segmented relay system in order to construct extensions leading to a nationwide system. In advancing its case for mandatory interconnection, the telegraph company cited both technical and economic argu- ments. The company stated that its system was capable of handling a 5 mc bandwidth as opposed to Bell's coaxial cable capacity of 2.7 me. In addition, bandwidth of 8 mc could be supplied for either black and white or color video signals. "No technical limitations" restricted interconnection of Bell and Western Union's facilities since the noise and dis- tortion performance of Western Union's equipment was adequate for video signals transmission. The telegraph company advanced certain cost advantages inherent in its system. In the first place, the video channels were capable of being sent in both directions, but not simultaneously. This reversibility in utilizing less facilities was contrasted with the Bell System's "round robin" network. Assuming that the broadcaster at point B wanted to send a signal to point A, Western Union's reversibility permitted the transmission over the same facility, in con- trast to Bell's routing from B through C to A; or through a separate facility to A. Western Union asserted that customer leasing rates would be lowered by the reduction of planf and equipment used in rendering video service. 194 cge.¢i AT&T's Round Robin B Western Union's Reversibility Figure 45. Bell vs. Western Union video relay systems. The telegraph company noted, in addition, that since its intercity channels would terminate on customer premises, the result would enhance the quality of the signal and reduce video rate charges to the broadcasters. In attempting to establish a need for its video channels, the telegraph company stated that certain broadcasters had expressed an interest in the system. Later, ABC, NBC, CBS, and A. B. DuMont Laboratories testified as to their interest in the New York-Philadelphia link. A Western Union witness commented that the Columbia Broadcasting System had expressed interest in a one-year contract for service subject to can— cellation, . . . in the event interconnection of video trans- mission facilities with the Bell System could not be obtained. CBS declined to subscribe stating that the lIbid., p. 1174. 195 . . . absence of clarification with reSpect to interconnection were in part responsible for fail— ure to execute the contract.1 AT&T took issue with Western Union's presentation. The tele- phone company noted that it had in existence at the time of the hearing some 9,000 television channel miles linking twenty- six cities, and that it was completing its transcontinental video link by 1951. Bell reminded the Commission that Western Union's proposal was, in essence, a joint operation rather than a competitive operation of a video system. Furthermore, the Western Union facilities in connecting only New York-Philadelphia did not meet the requirements for total network service. The telephone company observed that a Commission order to interconnect AT&T video channels with Western Union would tend to inhibit Bell's extension of a nationwide system since AT&T would have to deal with the uncertain factors of Western Union plans as well as uncertainties of customer requirements.2 Although AT&T acknowledged that the technical problems attendant the interconnection of different equipment was "not insoluble,” nevertheless complications existed in the following areas: 1. The problem of introducing new equipment and operating procedures. 2. Specification of points which equalization and other adjustments would be necessary. 3. Locating sources of trouble and placing of its reSponsibility. lIbid., p. 1174. 21bid., p. 1173. 196 4. Difficulty switching problems. Turning to the cost advantages alleged by Western Union's channel reversibility, the telephone company stated that Western Union had not documented its cost savings. Bell ex- plained that the transmission of video programs required two separate interexchange channels in the system, although it was possible to reverse programs if the customer gave up a channel for about an hour. Bell observed further that its double routes could carry two programs simultaneously while reversible channels could handle only one program at a time. Finally, a "round robin" technique conferred the ad- vantage of permitting any one station in a network to origin- ate or receive programs. Commenting on Western Union's termination of facilities on customer premises, Bell contended that Flexibility of operation would be impaired by termin— ation of intercity channels on customer premises and that it is undesirable placing competing networks in the hands of the customer. Addressing itself to the question as to whether a suf- ficient need existed for video relay facilities, AT&T des- cribed its network between New York and Philadelphia. The company had constructed video channels available on coaxial cable and six channels on radio relay resulting in a total supp1y of thirteen channels; eight southbound and five north- bound. The telephone company concluded that the adequacy of video channels between New York and Philadelphia argued \lDocket 9539, op. cit., p. 1172. 197 hard against the interconnection of still additional facili- ties. In rendering his decision, the hearing examiner asked, was there a clearcut need of Western Union's relay system? Thus, while commending the alleged advantages of reversibility, etc. of Western Union's system, the Commission concluded that: . . . such positive advantages in the absence of a showing . . . of a need for the operation of the Western Union channel do not justify an order for interconnection. On the question of video channel availability, the Com- mission cited Bell's thirteen channels and observed: There is no evidence in the record which indicates that such channels would not meet the present and foreseeable requirement of the existing and definitely contemplated television network for video Eransmission service between New York and Philadelphia. As to the interest expressed by the broadcasters, the FCC concluded that: none of the network witnesses showed any actual need for the New York channels and none stated a definite intention to utilize such facilities if interconnection were ordered.3 On the issue of competition among common carriers, the FCC declared that: Lack of competition in the field, while a factor to be considered, is not in itself sufficient to require a finding that interconnectiOn would be in the public interest, and no reasonable proposal to establish competitive facilities on an interfionnected basis in the public interest has been made. 2 11bid., p. 1177. Ibid., p. 1178. 31bid., p. 1158. 41bid., p. 1157. 198 In sum, the FCC decided not to order interconnection since such a determination must be based upon ". . . definite facts and not uncertain probabilities.”l In dissenting from this decision, Commissioner Hyde ob- served that the effect of Docket 9539 was to grant the Bell System a monopoly in the rendition of intercity video channels. Hyde examined the alternatives and observed: . . . in the absence of interconnection and in the absence of a service substantially paralleling the existing Bell System, no common carrier can com- pete with Bell in the intercity video transmission field. Thus, without interconnection, Western Union had an all or none option in radio relaying facilities. Recalling the financial position of the telegraph company, it was evident that Western Union could not easily duplicate AT&T's invest- ment in facilities. Directing himself to the future implications of the No. 9539 decision, Commissioner Hyde observed that: By failing to order interconnection of an existing and competing facility in an area where the traffic is of such magnitude and with an even greater po— tential and by failing to indicate expressly on what basis it would order interconnection of any trans- mission link in the future, the Commission is establ- IiShing a precedEnt which cannot but have the effect of discouraging from all time competition in this vital television relay field.3 [Emphasis mine.] AT&T and the Railroads.--Early common carrier pole lines did not extend along or follow railroad rights-of-way lIbid., p. 1157. 21bid., p. 1180. 31bid., p. 1182. 199 since often the roads penetrated thinly populated rural areas. The dependence of the railroads upon communication prompted them to construct telegraph pole lines along their right-of- way, and with the advent of telephone circuits and switch- boards railroad facilities were tied into the common carrier facilities. The link between railroad private circuits and the Bell exchange and toll network was the switchboard (PBX- private branch exchange switchboards). Unlimited inter- connection privileges were granted to the railroads on the condition that Bell-owned switchboards were to be leased by the railroad. Contracts governing the Bell System inter- connection policy with the railroads were known as standard Operating agreements--some of which had been in effect for over half a century. As common carrier facilities expanded and became avail- able to everyone, the Bell System recognized that it could now provide the communication needs of the railroads by leasing services to them. The railroads, however, expressed the view that ownership of its communication network was essential to the overall operation of their system and access of their System to the Bell telephone long distance circuits was uniquely justified. In fact, rather than electing the option to lease their communication channels from the Bell System, the railroads were tending to own more of their circuits as they engaged in transferring their communications plant from wire and cable to microwave relay systems. 200 The innovation of microwave by the railroads prompted Bell to reappraise its policy of granting the railroad access to the telephone company's toll and local circuits. The im- pact of microwave altered, as far as Bell was concerned, the traditional interconnection policy extended to the railroads. Under metallic circuits the railroads' pole lines ex- tended along their circuitous rights-of-way. In a sense, the communication facilities were confined along discrete ribbons of railroad property. However, microwave, with its line-of- sight characteristic no longer required that communication circuits be confined along railroad right-of-way. Thus, not only was the interconnection policy accorded the railroads permitting them to circumvent the toll charges of the Bell System, but the trucking industry was clamoring for like treatment. As the latter contemplated plans for constructing microwave systems, trucking firms expressed the need of interconnecting their system to Bell's. On July 15, 1959, AT&T filed before the FCC a revision of its old tariff governing connection of internal communic- ations of customer-owned facilities and interconnection governing through telephone exchange or message toll service of customer-owned circuits. Three provisions of the new tariff revised the unlimited interconnection policy extended to the railroads. First, interconnection of railroad-owned communication plant and the telephone exchange and toll facilities would occur: 201 Pole line network (confined a o ' to right-of—way) i Private microwave system (not confined to right- of-way) i. i Figure 46. Railroad pole lines vs. private microwave. a) In cases of emergency involving safety of life or property. b) In cases where the customer facilities serve 10— cations where it is impracticable because of hazard or inaccessibility for the telephone company to furnish its facilities. Second, unrestricted interconnection would be granted to railroad-owned circuits in existence prior to July 15, 1959. Third, interconnection would be granted to existing circuits where: 1Before the Federal Communications Commission, Rail- road Interconnection Docket, op. cit., American Telephone and Telegraph, Long Lines Department, Tariff FCC No. 134, Ninth Revised, p. 10f. 202 a) A circuit of one type is substituted for another circuit of the same type along the same right-of- ways. And where: c) An intermediate segment of one type of circuit is replaced, for maintenance or other operational reasons, by a segment of another [microwave] type of circuit, providing that such segment together with any other similar segments shall not total more than half the distance between the terminals ofithe circuit . . .1 [Emphasisimine.I By way of explanation, the first provision reduced previously unlimited interconnection accorded the railroads to the limited cases of emergencies, matters of safety, etc. The second provision established July 15 as the cut-off date in which unlimited interconnection would be granted prior to. that month and limited privileges extended subsequent to that month. This clause became known as the "grandfather clause." The third provision applied to the type of circuit in the "grandfather” circuits eligible for interconnection for Bell's facilities; namely, if 50 per cent of a circuit was wire, then interconnection would continue. Stated alternatively, if the railroads replaced more than 50 per cent of their metallic circuit plant with private microwave systems, interconnection of their equipment would be denied by the telephone company. A fundamental issue rested upon how valuable the railroads regarded the interconnection privilege and whether they would be willing to forego this privilege in shifting their com- munication plant from wire to microwave. ___ lIbid., p. lOfa. 203 Of course, it was Bell's contention that the railroad need not face that dilemma. They could simply lease all their circuits from the telephone company and acquire interconnections to toll and exchange facilities. Of the reasons advanced in explaining the new policy, the telephone company cited as most important its public obligation to provide high quality telephone service. It followed that: In order to meet their responsibility to the public and to the regulatory authorities for furnishing adequate, effic1ent and reliable telephone service, the telephone companies must select and provide the facilities by means of which their service is rendered, and must have full control over the design, installationj operation and maintenance of such facilities. Division of the telephone companies responsibility with others is generally detrimental to telephone service to the public.1 TEmphasis mine.] The telephone company illustrated the complexity of modern telephone plant by a recitation of the number of components in the system, the number of connections, the number of station equipment, of PBXs, and of central offices, etc. The division of reSponsibility thesis was extended to innovating new equipment. Private users would tend to retard the introduction of new facilities to the detriment of plant modernization. Further, there existed the problem of repair and malfunction with the attendant issue of the telephone company receiving the blame for problems beyond its control-- if customer-provided equipment was at fault. 1Before the Federal Communications Commission, Railroad Interconnection Docket, o . cit., Joint Petition for Termin- ation of Proceeding, pp. 129877-11 and 129877-12. 204 As to the quality of customer-owned equipment, Bell engineers testified that when the railroads did not use Special terminal equipment in the operation of intercity routes, certain design deficiencies resulted in a two-thirds reduction of Speech power. Again, Bell reminded the Commission of potential cream— skimming of revenues inherent in interconnection. The ability of private systems to pick and choose the points of interconnection would permit them to route their circuits over low cost lines, leaving the high cost lines to the common carrier. Since this cost would be reflected in higher rates, the burden . . . would fall largely on the smaller users who are unable to provide facilities of their own. If Bell System "discriminated” against the small user by per- mitting railroad-owned systems access to Bell's toll circuits, the solution lay in . . . cutting back that discrimination or prefer- ence and not by extension of the privilege to everybody else. The telephone company's case was summarized by Mr. Best of AT&T, who stated that: . . . because the telephone company goes everywhere now, they [Bell] want railroads to use telephone company facilities if the railroads are to have interconnection privileges. 1Ibid., p. 9. 2"FCC Interconnection Hearings Over,” Railroad Signal— ing and Communications (June, 1960), 54:6, p. 48. 31bid., p. 52. 205 The railroads agreed with AT&T that interconnection of private and “public” circuits originated when common carrier facilities did not parallel railroad rights—of-way, but they cited a sixty-year precedent of the unlimited interconnection policy. Referring to communications as the nervous system of the railroad operation, the railroads emphasized the unique- ness of their operation and the necessity for safe, continu— ous, and reliable service. Railroad rights-of-way, including rails, crossties, roadbeds, signaling systems, grade cross- ings, etc. required steady maintenance. Chesapeake and Ohio commented that: Maintenance men and other personnel on line cannot afford to lose the valuable time required to locate a Bell telephone at somefilling station or farm- house before they can talk to their supervisors.1 The railroads were particularly vehement in commenting on the 50 per cent limit imposed on microwave circuits. The railroads offered several reasons for shifting from pole line facilities to private microwave. Microwave circuits were more dependable, provided better quality signals, offered greater channel capacity, and because pole lines were susceptible to washouts, sleet, snow, and other damage, microwave reduced maintenance costs. The railroads, in general, argued that interconnection premised on the requirement that 50 per cent of the railroad 1Preliminary Statement, Chesapeake and Ohio Railroad Company, Draft 8460 applicable to Railroad Interconnection Docket, p. 23. 206 circuits be ”metallic” had the "effect of discouraging the railroads from modernizing their plant” and that maintaining wire plant was ”wasteful and inefficient.” Chesapeake and Ohio testified as to the 50 per cent limit. The net effect . . . is a means of destroying the use of microwaves by the railroads. And some railroad witnesses inverted the cream-skimming argu- ment by declaring: Mr. Having fostered interconnection at a time when it was beneficial to its Bell System companies, AT&T now wants to take over this important segment of railroad communications and provide the service itself except where hazardous or inaccessible-- (costs too much)—-this AT&T wants to leave to the railroads. Brosnam of the Southern Railroad declared that the tariff: . . . in my judgment is designed to make our private systems completely unworkable and in the end force us to come around to leasing all of our communic- ations from the telephone company. In considering the option of leasing facilities and equipment from Bell, the railroad appeared less than enthusiastic. The problem was cost. Mr. Marsh explained that: We can provide and maintain our plant at considerable less cost than we can take it from the telephone company. We would be paying the telephone company twice or more for the service than one can provide it for l RailwaypSignalingpand Communications, op. cit., p. 58. 2Preliminary Statement, Draft 8460, op. cit., p. 11. 3Railway Signaling and CommunicationsJ op. cit., p. 58. 4"FCC Interconnection Hearings Over," op. cit., P- 40- 207 ourselves.1 Adding that, the railroad has no legal right to ”dissipate" its funds: We have the choice of renting facilities from them at a price very much higher than we can provide those facilities for ourselves. The Commission made no decision in this case since on April 24, 1961, both parties filed a joint petition for termination of the interconnection proceeding. AT&T inaugur- ated a new tariff permitting the interconnection of railroad— owned plant with Bell facilities at both ends of a through route for emergency calls and: At either end, but not both for calls related to the safety, cgntinuity or reliability of railroad serv1ce . . . The new Bell tariff eliminated both the ”grandfather clause” and the 50 per cent ceiling on radio circuits. Ex— cept for some minor alterations, the railroad had retained the right to introduce private microwave and yet retain access to AT&T toll circuits. In addition, the railroad market had not been foreclosed to the private microwave equip- ment supplier. AT&T and Private Microwave Systems.——One of the issues broached by the FCC in the "Above 890 MC" docket in 1 Preliminary Statement, Draft 8460, op. cit., p. 11 2 Ibid. 3"Interconnection: AT&T; RR Agree,” Railway Signalipg and Communications, 54:6 (June, 1961), p. 30. 208 determining whether to liberalize private microwave systems was the problem of interconnecting private systems with the Bell toll terminals and long distance lines. AT&T‘asserted its right to deny interconnection of its facilities with private system; while users and microwave equipment suppliers demanded interconnection. The Commission in its report con- cluded: It is clear from the record that from a technical standpoint, interconnection of private systems with common carrier systems is feasible where compatible and adequate transmission standards are maintained. [Emphasis mine.] The lack of any technical barriers to linking private micro- wave with public facilities is reinforced by the fact that AT&T purchases microwave equipment from the non-integrated suppliers (35%) and then integrates the equipment into its own common carrier network. Furthermore, the Bell System must tie into and inter- connect with some 3,000 independent telephone companies; companies that procure their microwave relay facilities from the non-integrated equipment firms. In short, the Commis— sion stated the absence of any engineering obstacles to interconnection of common carrier and non-common carrier facilities. Again, interconnection policy was raised during the second series of the "Above 890" hearings and again the Com- mission noted: 1Before the Federal Communications Commission, The Above 890 Report and Order, op. cit., p. 397. 209 . . . AT&T, Western Union and General have indicated that they have no intention of relaxing existing tariff restrictions on interconnection with facili- ties of others. They suggest that if the Commis- sion's report and order is finalized as now proposed then it will be necessary, for their own protectipn, to adopt more stringent interconnection policies. Following the FCC's decision in the "Above 890” case, the Bell System introduced a new "competitive" private line tariff. The tariff, called Telpak has resulted in a sub- stantial reduction in leasing costs to the volume users of private line services. In addition, the tariff permits Bell customers to secure access to both local and toll cir- cuits of the AT&T system. This privilege stands in contrast to the user of private microwave systems in that duplicate phone equipment, switchboards, etc. are required to convey access to public facilities. One set of equipment is employed for intracompany service, the other set, Bell's, permits access to the toll circuits. In emphasizing the advantages of end-users subscribing their communication needs from the common carriers, the Florida telephone industry, of which Bell is a member, submitted a communication system proposal to the Minute Maid Corporation. The proposal stated: relieves limitation of private communication systems --you will have complete interconnection to telephone serV1ce in general. Citing this advantage of the common carriers, Motorola 1Before the Federal Communications Commission, The Above 890 Report and Order, op. cit., p. 833. 2Before the Federal Communications Commission, Telpak Docket, op. cit., AT&T Testimony, Appendix No. VI, p. 5. 210 submitted that private microwave systems should be able to obtain "equal rights” of interconnection and that: . . . the prOSpective users of private microwave facilities meeting reasonable criteria should have such rights under the tariff without the burden of a large number of “case-by-case" hearings.1 In short, Motorola contends that if AT&T permits intercon- nection of "bulk” and "non-bulk" users with each other, it, too, should be able to offer the same privilege. Motorola observed that: Moreover, the common carriers' prohibition against interconnection of their facilities with private systems has been a significanfi deterrent against operation of private systems. Western Union, in the hearing on the Telpak tariff, also alluded to the impact of the common carriers' ban on interconnection. . . . the absence of interconnection with common carrier facilities is a factor which must be given very substantial weight when considering whether the entire bulk communications market is available to private microwave. Obviously, the inability to connect private systems with common carrier facili- ties is a highly signficant fact--a fact which, in and of itself, would make it uneconomical for many users to build their own private systems. Because of AT&T'S vertical integration, Bell's non- interconnection policy holds implications applicable to the structure of the microwave equipment market. Take the 1Before the Federal Communications Commission, Telpak Docket, op, cit., Motorola, p. 54. 2Before the Federal Communications Commission, Telpak Docket, op, cit., Western Union, p. 44. 3Before the Federal Communications Commission, Telpak Docket, op. cit., Proposed Findings of Fact and Conclusions, Western n on elegraph Co., pp. 15-6. 211 first case involving the interconnection of Bell's video channels versus the broadcasters video channels. Noninte- grated suppliers of heavy route equipment were accorded the potential of market access when broadcasters began construct— ing their own video links. However, when the FCC announced that interstate video channels where to be provided by the common carriers, and that broadcaster relay systems were to be disbanded in the event that Bell's video channels became available, the impact upon the equipment market was crucial. Nonintegrated equipment employed by the broadcasters was to be rapidly amortized pending the introduction of Western Electric's equipment. Whatever incentive existed for the nonintegrated firm to manufacture heavy route equipment, their incentive was diminished by FCC's interstate video channel policy. Again, the market for heavy route equipment was fore- closed to the nonintegrated supplier when the FCC refused to order interconnection between Western Union's video channels and AT&T'S video channels. This decision, in effect, per- mitted Western Electric equipment to dominate the heavy route segment of the equipment industry. The railroad interconnection case illustrates Bell's attempt to prevent the adoption of thin route private micro- wave systems. In this respect, the testimony of certain non- integrated suppliers on behalf of the railroads is indicative of the value they placed upon the railroad industry as one market outlet for their systems. Although AT&T failed to invoke its policy of non-interconnection of Bell channels 212 with non-Bell channels, it is clear that the thrust of Bell's railroad case rested in its attempt to inhibit the railroads in their adoption of private microwave systems. If Bell had been successful in imposing the 50 per cent limit on the rails' use of "nonmetallic" circuits, and if the railroads had determined that interconnection was too valuable a privilege to forego, then the market potential of the non- integrated manufacturer would have contracted concomitant with Western Electric's market expansion. Finally, interconnection exercises its influence in the "new" private microwave market expanded under the Above 890 decision. If the end-user values the interconnection privilege, then the option to lease from Bell is favored over the option to purchase a private relay system. Again that option is translated into the equipment market. In short, because of Western's vertical tie-in with the Bell System, the manufacturing concern automatically preempts in the factor market what the operating companies win in the service market. This is not to argue that AT&T Should be subjected to a policy of mass interconnection with all radio relay systems, but only to suggest that because Western is integrated the interconnection privilege tending to favor the leasing option confers to Western Electric market power not accorded its nonintegrated rivals. 213 Pricing In addition to AT&T's interconnection policy, the Bell System has attempted to compete with private microwave systems through tariff reductions for its private line service. Three tariffs are relevant in assessing the impact of price com- petition between the Bell System and the nonintegrated sup- pliers. The first is the multiple channel tariff; the second, The Telpak (original) tariff; the third, Telpak (revised). Price competition first manifested itself between the common carriers and the private microwave suppliers in Sept- ember of 1955. It will be recalled that prior to the "Above 890” docket on frequent allocation, only Specified consumers could obtain frequency licenses, the common carriers and certain right-of—way and public safety groups. In 1955, manufacturers for the first time filed applications before the FCC to liberalize the Commission's licensing of the micro- wave frequencieS--applications that prompted the Commission to reappraise its allocation policy in Docket 11866 or the "Above 890" case. In September of 1955, AT&T filed a private line tariff known as the multiple channel tariff. The tariff did not apply to users of private line services across the board, but affected only those who leased a given volume of channels. To those volume users the telephone company offered a price discount of up to 28 per cent.1 1Before the Federal Communications Commission, Private Line Docket, op. cit., p. 76. 214 Inasmuch as the tariff applied to the volume segment of its private lease market, AT&T contended that volume users constituted a ”distinct and separate" market that existed apart from regular private line customers. As a distinct market and eliciting a distinct need, the telephone company sought to meet that need with its multiple channel tariff. Furthermore, AT&T noted that the tariff was prompted by the competitive necessity of meeting the services offered by private microwave suppliers; and as a matter of fact, Bell alleged that it lost approximately $9 million as a result of end—users electing to use private microwave.l Another factor prompting the innovation of the multiple channel tariff was its impact upon the size of the private line market. AT&T observed that quantity discount— ing would tend to stimulate greater use of the leasing mar- ket and the use of telephone plant used in rendering private market service. Western Union objected to the private line quantity discount and some six years of hearings, study, and adjudic— ation elapsed on what came to be known as the Private Line Docket (16464-5). In 1961 the Commission issued its initial decision of the Private Line case, and in its evaluation of the multiple channel tariff touched on the following points. On the nature of the volume private line service, the FCC stated that of all the customers, the government stood 11616., p. 78. 215 as the largest user. Since it was government policy that it would not operate its own microwave systems but take its services from the common carriers, there was hardly any "competitive necessity” in retaining government business. If AT&T intended that the tariff be directed to the non- government consumer, then the FCC asserted that the telephone company was under obligation to submit cost studies as to the construction, operation, and maintenance of private microwave systems. Since Bell had not submitted any cost studies, the Commission could not make any valid comparison in order to assess the "competitive necessity" of the multiple channel tariff. Furthermore, the Commission expressed doubts as to whether the quantity discount pricing would appreciably af- fect the option of an end-user in deciding whether to lease or build radio relay systems. However, the Commission's most crucial evaluation of the multiple channel tariff rested upon its cost analysis, and here the FCC declared: There are-no significant differences in the carriers' cost in furnishing a multiple number of channels to a single customer between a given pair of points as compared with the furnishing of the same number of channels to different customers between the same points.l [Emphasis mine.] In short, the Commission concluded that under the multiple channel tariff, AT&T would be levying different charges for like services, resulting in a tariff that discriminated against the small volume user and favoring the large volume fl ,. Ibid., p. 77. 1 216 user. Further, FCC could find no evidence that suggested that the tariff was reasonably designed to meet competition, nor could it determine that the tariff would stimulate the use of facilities in rendering the service. Fundamental to the FCC's decision to invalidate the tariff was its conclu— sion that no significant cost differences existed between service to the large and small consumer. During the interim of the Private Line case, the FCC rendered its decision in the "Above 890" MC docket (1959-60) --and had decided to expand private microwave eligibility. Thus, in its rebuttal to the Private Line initial decision, AI&T‘commented on the competitive impact of the "Above 890" decision. Bell asserted that not only did a volume or bulk market exist in private line communications, but that the Commission's decision to let ”almost anyone" use private microwave added paramount urgency to the neces- sity of meeting competition with a rate to meet potential microwave system users. However, the thrust of Bell's rebuttal rested not against the decision as such, but against the means by which the Commission had reached its decision. The Commission had taken the position that common carrier tariffs could be justified only on fully allocated costs (average cost pric- ing). While AT&T insisted that total revenues should meet joint and marginal costs thus providing a reasonable rate of return, 217 . . . rates for individual services and their comb ponents need not yield identical markups over al- located cost. Marginal cost Should be borne by the service to which they are attributable, but joint costs should be distributed among the individual serviceg in relation to the realities of the mar- ket. [Emphasis mine.] AT&T further contended that the FCC was attempting to reduce a complex rate matter to an ”arbitrary mathematical formula” based upon fully allocated costs. In its objection to rates based upon average cost pricing, AT&T queried: What sense does it make to establish a requirement that regulatory bodies uses and the carriers should be burdened by expensive and time-consuming studies arrived at determining the cost of produCing a seg- ment of service when that achievement is in fact impossible of attainment?JIIEmphasis mine.] ' However, in the Telpak tariff hearings, Bell attempted to justify the tariff by such cost segmenting. Telpak Original Now that the Commission has determined in the above 890 case that users should have freedom of choice between common carriers and private micro- wave service ig is important that the choice be a realistic one. With this prelude, the Bell System initiated a new private line tariff two months after FCC's final decision to Before the Federal Communications Commission, Private Line Docket, o . cit., Brief in support of exception of the Bell System companies to the Initial Decision released July 14, 1961, p. 7. 2Before the Federal Communications Commission, Private Line Docket, op. cit., AT&T Brief, p. 15. 3Before the Federal Communications Commission, Telpak Docket, op. cit., AT&T, Appendix I, p. 3. 218 liberalize private microwave (August, 1960). The tariff, called Telpak, was to take effect on February 16, 1961. AS a new private line service, Telpak consisted of: . . . communication paths of different bandwidth (Telpak channels . . . much like different size roads . . . which are capable, to different degrees of transmitting all forms of electrical communic- ation required by business . . .1 The tariff includes two components, a flat monthly rate per mile for transmission and monthly rates per channel terminal. Telpak was classified into four types ranging in increasing bandwidth capacity. TABLE 34 TELPAK CLASSIFICATION2 J— m Rates per airline Rate per Classific- Kilo- Voice mile per circuit ation cycles circuits month mile Telpak A 48 12 $15.00 1.25 Telpak B 96 24 $20.00 .833 Telpak C 240 60 $25.00 .417 Telpak D 1000 240 $45.00 .187 (Note particularly the reduction in the rates per circuit mile, i.e., decreasing costs.) 1Ibid., p. 4. 2Before the Federal Communications Commission, Telpak Docket, o . cit., Brief and proposed findings and conclusions of Bell System reSpondents, pp. 17-8; also AT&T testimony, Appendix No. VI, an Intercity Private Line Communications Safety Proposal for Minute Maid, submitted by: The Florida Telephone Industry, p. 4. 219 These charges represented a reduction in private line rates by as much as 80 per cent over previous rates. An appreciation of the relative decline of Telpak over previous private line pricing is seen in Figures 47 and 48. In addition to the Telpak classification, AT&T provided that Telpak channels would be subdivided into channels of lesser bandwidths, called derived channels. In effect less than one month, the Telpak tariff was challenged by Western Union in a letter to the FCC. Western Union alleged that AT&T was violating its own tariff and this contention touched off a controversy regarding the nature and type of facilities used in furnishing the new private line service. Two methods exist from which a multiplicity of voice channels can be derived. A first method uses discrete or microwave facilities (also coaxial cable if it exists); the second employs diverse or wire and cable facilities (tele- phone lines). Under the assumption that discrete facilities provide the bandwidths, a single communication path is generated between two points. From the wideband path, voice channels of lesser bandwidths are derived by channelizing equipment. In short, the source of channels of lesser bandwidths come from a single broadband Signal. A second method of deriving or supplying a number of Voice channels is to use the diverse facilities of wire and Cabde and "add up" these facilities in providing a given 220 CHARGES FOR l2 VOICE CHANNELS AND 24 TERMINALS Taanrr No. l35 Foa ‘ IIDIVIDUAL CHAIIELI TARIFF No. 23| Foa MULTIPLE CuauutLa )' 50 IOO 200 300 400 500 AIRLINE MILES Figure 47. Charges for 12 voice channels and 24 terminals. Source: Before the Federal Communications Commis- sion, Telpak Docket, AT&T Appendix No. 11. O 221 CHARGES FOR 240 VOICE CHANNELS AND 480 TERMINALS TARIFF N0. |35 Foa INDIVIDUAL CHANNELS TARIFF N0. 23| FOR MULTIPLE CHANNELS TELPAK 0 5O [00 200 300 400 500 A I R L I N E M I L E 8 Figure 48. Charges for 240 voice channels and 480 terminals. Source: Before the Federal Communications Com- mission, Telpak Docket, AT&T Appendix No. V. 222 quantity of Specified bandwidths. The consumer is not only indifferent, but unaware that his voice channels are provided by "subtracting" the channels from a single signal or "added up” from a multiplicity of lesser bandwidths. All he knows is that his six voice channels, for example, are available to him for use. The difference in the two methods is illustrated in Figures 49a and 49b. In Figure 49a six voice channels exist between points A and B. In Figure 49b only two voice channels exist be- tween points A and B. However, by routing two voice channels through C and D, the end-user winds up with a total of six. Thus, while the figures are similar in the number of voice channels leased to the consumer, they differ as to the ESEBE of deriving those channels and the routing of facilities between the two points. The Western Union letter asserted that AT&T was selling its Telpak services on the assumption of Figure 49a, but actually rendering the services under the assumption of Figure 49b. A Specific example points up the implication of Western Union's contention. If a low volume user of private line service leased two voice channels between A and B via route D, he would be charged by the telephone company the distance from A to D and from D to B. A large volume user of Six voice channels would actually have two of his circuits routed through the multiple points of A, D, B, but he would be assessed under the Telpak tariff only between points A and B; no extra charge would be 223 11A?! Six voice channels derived from 6 d‘screte channels AG) —£-—-——— +©B 1181! Six voice channels derived from diverse channels Figure 49. Discrete vs. derived channels. 224 levied for the point D routing. Three days after the Western Union letter, the Com- mission sent an inquiry to the telephone company question— ing its use of telephone lines or narrow bandwidth facili— ties(diverse) in deriving Telpak channels. The FCC noted that in the past, customers were billed on the basis of multi-channel points and were billed separately for each route. AT&T defended its diverse routing by observing that under all private line services, the telephone company selects the routing and facilities with which to render the service. In cases where channels were derived from diverse facilities, such derivation served the purpose of "effici- ent utilization of plant." Furthermore, according to Bell, Telpak described a service; it was not intended to describe plant facilities used in rendering that service. It is essential for the telephone company to re- tain the choice of routes and facilities for efficieni use of plant and prompt furnishing of service. However, in a memorandum opinion and order on April 12, 1961, the FCC ruled that AT&T could not apply Telpak rates over diverse facilities. Telpak rates were applicable solely over single broadband channels subdivided into lesser band- width channels. The Commission observed that furnishing a 1Bell System Comments on Organization and Adminis- tration of the Federal Communications Commission, Booz-Allen andiHamilton, July, 1962. AT&T letter to FCC, March 10, 1961, Attachment B, p. 5. 225 multiplicity of channels from different facilities over di- verse physical routes was not a "communication path," a "Telpak channel," or a "broadband transmission medium.” Such operations did not consist of subdividing a Telpak channel by means of channelizing equipment. The Commission concluded that Telpak service rendered over diverse physical telephones did not distinguish it from the other private line services that Bell offered. Although AT&T filed a petition requesting reconsider- ation of the FCC's decision, the FCC denied the petition, and on July 21, 1961, AT&T wrote the Commission that exist- ing Telpak services had been transferred to single carrier Spectrum assignments wherever this could be done without new construction and there remained 285 Telpak sections which were stil on diverse facilities pending new construction. Confronted with the FCC's decision that it had violated its own tariff, the Bell System attempted first to challenge the decision with A Petition of Reconsideration; however, on August 3, the telephone company avoided the effect of the Commission's decision by revising its definition of Telpak. Telpak revised read that AT&T could render its service via discrete (microwave) channels 25 via diverse (telephone line) channels supplied at the discretion of the telephone company. It was on the basis of the new tariff that the FCC initi- ated hearings on the issue of lawfulness of Bell's attempt to meet competition of private microwave systems. 1Letter from C. F. Nelson to FCC, July 21, 1961, At- tachment B, p. 9. , 226 The revised Telpak was scheduled to go into effect on September 8, 1961. However, the Commission suSpended the tariff for the statutory limit of three months (after which a tariff automatically goes into effect) and meeting £p_ 2335, attempted to decide on Motorola's petition. Motorola had requested expedited proceedings to adjudicate whether the suspended tariff represented unjust price discrimination. On December 6, the Commission held that it could not make a determination as to the lawfulness of Telpak without "full consideration of all pertinent factors”; thus a hear- ing examiner was appointed and hearings initiated. In stating the substantive issues of the hearing, a general summation of the adversaries' position will be made, followed by an evaluation of the cost criteria employed to justify Telpak pricing. Of the many substantive issues embroiled in the hear- ing, three appear to be relevant; first, what is the defini- tion of Telpak; second, what is the size and importance of the market it affects; and third, what is the proper cost criteria in determining whether Telpak is compensatory or non-compensatory in pricing. As to the issue of definition, the Bell System asserted that Telpak is a new service based upon a need for volume of bulk communication channels. The bulk market owes its origin to three trends in the transfer of information. First, the continued automation of data processing neces- sitates wideband channels to handle the rapid dissemination 227 of both record and voice signals. Second, business is tend- ing to decentralize operations, both in the private as well as the public sector, and this decentralization means more reliance on communication as a means of coordination. And third, the bulk market is stimulated by the need for flexi- bility. That is, end-users desire to use larger channels that will permit them to hook up television equipment, tele- type, telephone facsimile, computers, etc. One company, for example, will employ its channels during the daytime for telephone or facsimile purposes, etc., then hook into and run computers at night. Since the trend in business data processing is growing rapidly, and the need for a hier- archy of different sized voice channels needed, the Bell System is attempting to meet that need with its Telpak service. Western Union's definition of Telpak, in differing from the Bell System's concept, alleges that Telpak is nothing more or less than the old multiple channel Service dressed up in different terminology. The two services are indistinguishable in purpose as well as in operation. Furthermore, Western Union insisted that since the Bell System can use existing physical plant in rendering the Service, the Telpak service reduces itself to quantity discount pricing for volume private line users. 1Before the Federal Communications Commission, Telpak Docket, o cit., Western Union, Proposed Findings of Fact and ConcIusion, p. 21. 228 Reasserting its position taken in the diverse versus discrete facilities controversy, the telegraph company main- tained that Bell is charging different rates for like com- munication between two points. Similar to Western Union's position, Motorola argued that Telpak, rather than a new service, was a form of "dis- count pricing." Motorola referred to the new private line tariff as a "bundling price arrangement” over the Same physical routes that AT&T offered its other private line services. Figure 50 illustrates Motorola's position. In part A two voice channels are leased from Newark to New York City, and four channels are leased from Boston to New York city. Under the traditional private line tariff (No. BS), each end-user is billed for using two- and four-voice channels, respectively. However, Telpak users can get together and jointly lease or share Telpak channels. Thus, if the New Jersey customer and the Boston customer join with a New York customer, all going from New York to Baltimore, then a total of twenty-one leased channels qualifies them for Telpak rates. However, Motorola contends that this bundling exists for pricing purposes only. In Part B, the actual physical routing of Newark and Boston may not connect with New York, but be routed directly to Baltimore. In short, Telpak is nothing but an invisible hand that, by clutching (in Part B) and grouping the two, fifteen- and four-voice channels 229 l\ .VH .Q ..ocH .maouopoz mo mnOfimnHocoo one mmnfiocflm oomomonm .maououoz .poxooa meHoH .:Oflmmfiesoo mGOflumoficsssoo Hmuooom one ouowom “mousom , .menpncp sesame mo ppmpppp a_eaoc6po: .om pcamnm mHmGflEuop Hoccmno nunH I flu mamcfiEHop Hondmno mnflwmnfisuop one mcfiumcfimfluo Unowoq m Hm.z.xuo> 362 mam ad 8 -O .w.z.xcesmz < Hmazoc0az paa>acm IoIqu Immml Ilodal. ImmI Amoaszv namepn smpnwm Aoaez EopmSm com npcoz nomv maoccmco oofio> NH How commendm ¢ MHmm .mmoeemo sesame no 20mam Ham 251 This deficit must be covered by another market of the firm, in this case the Private Line market. Thus, a profit over and above a reasonable rate of return at PZ'must sub- sidize the bulk market. Necessarily the price in the private line market must be above PZ', but could be below Pl'. If, however, both the utility and the regulatory agency assert that the tariff for the private line market exists at P2 in which total revenues equal total costs (average cost pricing) then the deficit incurred by the bulk market pric- ing must be covered by still another segregated market of the utility--in this case the public message market. Finally, if average cost pricing prevails in this market as well, then the utility must exhibit a deficit in overall operations. Marginal cost pricing in firms operating under conditions of decreasing cost must be paid for either by the firm or by the taxpayer. In the former case the firm's ability to segregate its markets would enable the deficit incurred in one market to be underwritten by excess profits in another. In the latter case, the firm would have to receive a direct tax subsidy or become subject to public ownership. Policy Decisions We have seen that the legal-technical restraints to market entry have tended to diminish over time. It also has been noted, however, that given the market structure of the communication industry, the interconnection and pricing policies of the Bell System continues to exert a major 252 influence in barring market access. Finally, what has been the impact of the third variable affecting market entry; that is, policy decision with the public sector. We will examine first the Department of Justice and then the Federal Com- munications Commission. Department of Justice.-~Any historical view of the structural evolution of both equipment and carrier market reveal that patent concentration stands paramount among the causative factors contributing to the present bilateral mono- poly complex. The Justice Department came to this conclusion and it was a very natural one. The strategic role of the patent was further amplified by the 1939 telephone investi— gation conducted by the Federal Communications Commission. In fact, it is generally acknowledged that the findings of the 1939 telephone investigation, following an interruption of the second World War, provided the basis for the Department of Justice's antitrust suit ten years later. The prayer of the government suit sought to divest Western Electric from the Bell System and to separate Western further into three competing suppliers. In 1955, however, the Department's divestiture policy was diSplaced by a consent decree compel- ling AT&T to license its existing and future patents. Very simply, the Justice Department concluded that if patent concentration had induced market concentration, then the problem of policy was to address itself to Bell's patent portfolio. 253 Several factors have tended to suggest that the Justice Department pursued a policy quite irrelevant to the issue of competitive entry. In the first place, while it is true that patent concen- tration contributed to the preeminence of Bell's market structure, it does not necessarily follow that reversing the cause-effect relationship will lead to competitive re- sults. In a sense, the market structure has risen above and become autonomous from its causative source. Inte- gration now exists independent of its patent Sire. Hence, market integration has developed an immunity to any policy directed toward the decimation of patent concentration. In the second place, it is the assertion of this study that forces originating with World War II have tended to diffuse knowledge and technology beyond the traditional province of the existing common carriers and their subsidi- aries. The most fundamental erosion of patented knowledge appears to be the diSplacement of research and development funding from the private sector to the public sector and the concommitant shift of research and development performance from the public to the private sector. Furthermore, govern- ment research and development as an increasing percentage of GNP has tended to increase the pgpg of technological change-- tending to shorten the useful life of a patent. Apparently recognizing that the era of absolute patent dominance was ending, the Bell System, after World War II, embarked on a general policy of patent licensing in order to 254 acquire the patented knowledge of others. Thus, when the Justice Department, in 1956, announced a consent judgment which subjected Bell's patent portfolio to compulsory licensing, the judgment was, in a real sense, an anachronism. The patent barrier had succumbed to the barrier of market integration. Non-integrated suppliers were not granted market access for their products since the Bell operating companies continued to pursue a policy of procuring most of their equipment needs from Western Electric. Compulsory patenting did not disturb the Western Electric- Bell operating company's bilateral monOpoly. The irony of the Justice Department's decree becomes more forceful with the realization that it was concerned largely with the issue as it existed in the 1930's. However, events had bypassed the technology of metallic circuits and the attendant equipment thereof. Radio relay circuits offered a competitive alternative to wire and cable and non- integrated microwave suppliers were attempting to compete with integrated Western Electric. Thus, as the struggle between radio and metallic technicology ensued and as the existence of vertical integration became more formidable to non-Bell equipment suppliers in the 1950's, the Justice Department announced a policy hardly germain to the issue of market entry. The Federal Communications Commission.--In 1934 the Communications Act created the Federal Communications 255 Commission. Among other functions, the Commission was charged with regulating the rates of the telephone common carriers. The FCC was confronted with the Bell System's integration and, although the Act stated that "the manufacturer and sale of and trade in radio apparatus" was subject to the anti- trust 1aws, the enforcement agency was not the FCC but the Justice Department. In assessing the series of FCC policy determinations, it is clear that given the integrated structure of AT&T, the communications equipment market cannot escape involve- ment in decisions presumably directed at the common carriers alone. Take the first case in which the FCC had to decide who would provide radio relay systems capable of transmitting television. When IBM and General Electric applied for licenses to render intercity television service, the Commis- sion, in rejecting their application, asserted that no policy decision regarding entry into the intercity video channel field had been determined. Subsequently, the FCC announced that common carriers only would be licensed to transmit intercity video channels. With Western Union's collapse, only one nationwide radio relay system existed-— the Bell System. Furthermore, narrowing market participants on the horizontal level effectively narrowed the number of participants in the manufacture of heavy route microwave relay equipment. 256 If we look at the FCC's broadcasters decision, the same pattern emerges. AS the demand for television mushroomed at the end of the war and as facilities were unavilable, the broadcasters embarked on constructing their own radio relay links. Again the FCC declared that the intercity relaying of video channels fell within the province of the common carriers. The broadcasters could construct their own links under the precaution that they had better write them off quickly since these facilities would have to be abandoned when the common carrier facilities became available. Again the implications on the potential market outlet for the non- integrated radio relay equipment suppliers was hardly strengthened by this decision. In effect, the nonintegrated suppliers were reduced to the role of subcontractors to Western Electric since the Bell operating companies provided most of the video service. The coup dI etat was administered to independent sup— pliers of heavy route equipment when the FCC declared that there was no compelling need to order AT&T to interconnect its broadband facilities with Western Union. With Western Union left with a segmented radio relay system and unable to use it to generate additional income for expansion, an independent market outlet for heavy route relay equipment was effectively forestalled. More important, compelling evidence suggests that the FCC's decision to limit the participants of intercity video channels to the common carriers, and then prohibit the carriers from interconnection 257 with one another enabled the Bell System to purchase Limp in order to shift from its nationw1de coaxial cable system to its radio relay system. Turning to private microwave systems, it is clear that the origin of the industry was tenuousw—particularly when the raw material input, microwave frequencies were licensed on a developmental baSis. However, as the end—user of communicative service, potential commercial users put the FCC on notice that they desired to exercise the option of owning private microwave as well as leasing private line services. The common carriers fought this request from 1955 to 1960. Following the first decision to liberalize the fre— quencies for private microwave in 1959, AT&T declared that Space communication needs dictated that the Commission rescind its order and when the order stood, the implications for the nonintegrated equipment suppliers was clear. It looked as if the market potential for radio relay would be broadened; and it seemed reasonable to aSSume that the nonintegrated equip— ment firm would be less dependent upon Western Electric as an outlet for his products. The FCC, in its Above 890 decision, announced its in- tention that the "Above 890“ decision in liberalizing the use of private microwave would "Spur competition" in the equip- ment industry. The struggle between the private microwave supplier and the Bell System is in reality a struggle of innovation. The Bell System has a substantial investment in metallic circuits; 258 and although AT&T insists that microwave supplements metallic circuits, microwave also supplants it. Thus, when a customer elects to own his own radio relay system rather than lease his needs from the Bell System, in many cases he is electing radio circuits over metallic circuits. This became evident with the second series of private line tariff cuts (Telpak)--introduced by Bell two months after the "Above 890" decision. Bell priced the tariff as if it were employing microwave system, but in actuality, metallic circuits were used in rendering the service. When the FCC ruled that Bell was violating its own tariff and re- quired that the bulk users be transferred to broadband channels, AT&T avoided the implications of this decision by changing its tariff. However, perhaps the most crucial decision as far as the nonintegrated equipment suppliers are concerned is the fact that the FCC has permitted Telpak to go into effect, while the Commission determines whether the tariff is justi- fied by the costs of the Bell System. As a price reduction to potential microwave consumers, Telpak has swung the option from owning back to leasing. Applications for private microwave subsequent to Telpak have substantially diminished.l And again, as in the struggle 1"Only one private microwave system operating in an area competitiVE with Telpak has been licensed to Operate as a result of the Commission's Above-890 decision." Before the Federal Communications Commission, Telpak Docket, op. cit., Motorola Proposed Findings and Conclusions, p. 42. 259 for a nationwide video system, the FCC's decision to permit Telpak to go into effect has permitted the Bell System to purchase crucial £ifl£° AS the lengthy process of hearings and adjudication take place, the Bell System is permitted to solicit most of the bulk communication customers and pro- vide them Service via its existing plant. Approximately 5 per cent of the bulk customers account for 55 per cent of the market. AS AT&T introduces microwave circuits into its system, it can shunt its bulk customers from metallic to radio relay facilities.1 Thus, the decision to permit AT&T to solicit customers at Telpak rates permits Bell to preempt the bulk market now and hedge on an adverse FCC decision later. If the FCC declares that on the basis of metallic circuit cost, Bell is engaging in pricing below cost, AT&T will have had time to shift its investment mix. Translating these effects into the equipment market, it is clear that the decision to lease under Telpak rates is in reality a decision to use Western Electric equipment; the decision to own resides in favor of the nonintegrated supplier. Telpak, win or lose, has shifted the comparative advantage from the nonintegrated suppliers to Western Electric, and the Short run implications are such that the Commission's decision re- gardingTelpak is effectively nullifying the Commission's 1The Bell System allocated $3 billion for the con- struction of new plant and facilities during 1962. No breakdown as to the investment mix of this expenditure is available. Wall Street Journal (February 20, 1963), CLXI:36, p. 4. 260 earlier decision liberalizing the use of private microwave. By default, Western Electric emerges as the beneficiary of FCC policy. CHAPTER IV INTERNATIONAL COMMUNICATION In addressing ourselves to the potential restraints catalogued as legal-technical, structural, and past policy decisions, it must first be noted that the international communications market differs in two respects from its domestic counterpart. In the first place, the innovation of microwave re- peaters in the form of satellites remain in the stage of research and development. In fact, the pace of technological change is such that transitorized submarine cables may effectively compete with satellites.l On the other hand, there is increased probability that satellites will relay light waves as information Signal carriers (Lasers) and 1U. 5. Congress, Senate, Satellite Communications Hearings before the Subcommittee on CommunicatiOns of'the Committee on Commerce, 88th Congress, lst Session on Satel- lite Communication, 1963, p. 39. Mr. Dingman (Vice Presi- dent, AT&T): "Last year, early last year, even before we put Telstar up, we started working on developing a transis- torized version of an undersea cable. And that development is actively underway, and we have expectations that when it is completed, that cable will carry 720 voice circuits and television, but not concurrently. We hopefully expect that cable will give us lower cost per channel and that is the reason for the develOpment. We would expect that a cable of this type would be available for usage by about 1966.“ See also: letter from D. Sarnoff (RCA) to Leo D. Welch, Chair- man, Communication Satellite Corporation. “In my judgment, it is likely that all forms of traffic, including television, 261 I a} I). I O hence supercede satellites as microwave repeaters.l Given this flux of the state of the art, estimates of the cost of a satellite system, its frequency needs, its capital re- quirements, pricing policy, etc. must remain highly tentative. In the second place, the channel capacity of a satellite system is Such that it is estimated that one system alone is capable of meeting the international communication require— ments for some time. The economies of scale inherent in a satellite system hold that rival systems will not be estab- lished as in the domestic market. This technical imposition necessarily limits the potential outlet of equipment sup- pliers. If historically, patented knowledge ployed a central role in the size and structure of the internation communic- ation industry, that knowledge was soon to be superseded by new technology. The conventional devices of HF radio and submarine cable largely associated with the existing common carriers was challenged by a new technology-satellite relay. As one of the byproducts of the missile age, the new techniques were Sponsored by firms in the aerospace industry. As potential hardware suppliers, these firms sought market will be passing through transistorized cables on a regular commercial basis before the Satellite Corporation is ready to provide such services on a global scale, “ Congressional Record, 109: 79 (May 28, 1963), p. 9208. 1Lawrence Lessing, ”The Lasers Dazzling Future," Fortune, LXVII:6 (June, 1963), p. 162. 263 entry. Much of the conflict surrounding the formulation of a national communication satellite policy had as its base a struggle between two industries; the overseas communication industry and the aerOSpace industry. This inter-industry struggle was to find eXpression in.ttmzsubsequent legislation passed by Congress. Since much of the technology of a satellie system has been associated with boosters, launching facilities, track- ing, etc., the aerospace firms derived most of their compet- ence from participating in the Space programs of either the Department of Defense (DOD) or the National Aeronautics and Space Administration (NASA). In the field of research and development, for example, some 85 per cent of the aerOSpace industry's research and develOpment was financed from govern- ment contracts.l Furthermore, not only did the government substantially undefwrite the research expenditures of the industry, it represented for all practical purposes the only consumer of the final product. In the broad category of space satellites, the follow- ing projects reveal the breadth of functions under investi- gation via satellites and the name of the project. l. Surveillance (Samos satellite) 2. Warning (Midas) 3. Navigational (Transit) 4. Weather (Tiros) 5. Communication (Advent, Echo, Relay, Symcom) 1 National Science Foundation, op. cit., p. 3. 264 Firms participating in these projects as prime or sub- contractors acquired knowledge and competence in such oper- ations as launching techniques, tracking and telemetry stations, guidance, transmitter and receiving stations, as well as acquiring expertise in such fields as metallurgy, the chemistry of prOpulsion, etc. Although the aerOSpace industry encompasses Sixty firms, those firms that expressed an interest in participating in the innovation of a commercial communication system in- cluded Lockheed, General Electric, Hughes, and Bendix. (The Samos and Midas projects were sponsored by Lockheed, and the Advent military communication satellite was con- tracted by Bendix and General Electric.) Nevertheless, the manufacturing subsidiaries of the common carriers had participated in space research. Western Electric, for example, had participated as prime contractor for the Nike missile series; and had supplied the guidance system for the Titan missile as well as constructed the radar network of the Dew Line system. Working with NASA, Western Electric had participated in Project Echo--a passive satellite project, as well as in Project Mercury. As a matter of fact, Western Electric was classified as an aero- Space firm.l Other overseas carriers and their subsidiaries had en- gaged in Space research. IT&T'S manufacturing and research 1Theel96l Aerospace Year Book, 42nd Annual Edition (Industries Association of America, Inc.), pp. 160-1. 265 firms had participated in the design and construction of ground-Space communications network, the Ranger spacecraft series, and missile tracking and transmitting projects. RCAC'S parent firm was preeminent in the weather satellite program of Tiros and Nimbus, as well as prime contractor for NASA'S active satellite program, Project Relay. The point to be emphasized is that in the era of Space communications, the conventional overseas carriers did not stand alone in competence or expertise. As a matter of fact, they were challenged by some aggressive nonintegrated aerOSpace manufacturers. Thus, when the National Aero- nautics and Space Administration entertained bids for the Agency's first active satellite project (Project Relay), not only did the participants include Bell Telephone Labora- tories and Western Electric, International Telephone and Telegraph, Radio Corporation of America (International Common Carriers and their hardware affiliates), but the aerOSpace firms were represented by Collins Radio, General Electric, Hughes Aircraft, Bendix Corporation, Philco, etc.l Thus, government Sponsored contracts had acted as one factor in diffusing communication knowhow and competence beyond the traditional boundaries of the communication in- dustry. In addition, the magnitude of government resources devoted to the total Space effort had added a further factor affecting the integrity of patented knowledge; the viable life of the patent has been Shortened. Thus, Simon Ramo has 1John W. Finney, "RCA Will Build Satellite for TV," New York Times (May 19,-1961). 266 observed: The large government sponsorship in missiles and Space has added a new factor of more rapid technical guide obsolescence. He added further: The missile and space requirements have pushed the art so rapidly and technological Obsolescence has been so quick as almost to preclude the attainment of a base of stabilized products. In summary, government sponsored research holds two implications: it has tended to diffuse communication expertise beyond the traditional provinces of the communication indus- try and as an impetus to greater technological change has necessarily increased the rate of technological obsolescence. Frgquency .. In Chapter II it was observed that conventional over- seas communication was limited to the high frequency or short wave bands of the radio Spectrum. However, as a natural re- source, Spectrum utilization has been expanded to the micro- wave range as the result Of satellite repeaters. Nevertheless, the problemsof frequency designation and allocation continue. A first problem in frequency designation occurred between the aerospace industry and the overseas communication industry. In January, 1961 the FCC allocated to the carriers frequencies for experimental satellite use in the 6,000 band. lSimon Ramo, “The Impact Of Missiles and Space on Electronics," Proceedings of the Institute of Radio Engineers, 50:4 (May, 1962), p. 1240. 2 Ibid., p. 1237. 26? Subsequently, when NASA established frequency requirements on its first active satellite project a month later (Project Relay) in the 6,000 band, the aerOSpace firms alleged that the FCC's earlier assignment conferred a competitive advant- age to the common carriers.1 NASA explained that the 6,000 bands were requested by European countries participating in the satellite project. More crucial to the operation of a satellite system may be the problem of frequency interference between ter- restrial microwave and satellite microwave. As observed in the discussion on domestic frequency problems, the optimum frequency range for space communications appears to lie within the 1,000 MC~10,000 MC range. The Ad Hoc Report of the international carriers proposed that the FCC allocate for Space communication a total of 2975 MC of Spectrum Space.2 This Space is currently used by private microwave systems in the domestic market. The problem of potential interference is seen in Figure 52. Again: since no satellite system has reached the oper— ational stage, the problem of frequency interference remains under study. For the present time, the FCC has observed that cochannel sharing of terrestrial and Space microwave bands appears feasible. l"Clash over Radio Use of Space," Business Week (March 11, 1961), p. 117. 2Before the Federal Communications Commission in the matter of an inquiry into the administrative and regulatory problems relating to the authorization of commercially oper- able Space communications systems, Docket No. 14024, reply of American Telephone and Telegraph Company, p. 5. (Cited as Docket No. 14024.) 268 A - Interference at Spacecraft due to terrestrial station 9V B - Interference at earth station due to terrestrial station 5V t \ C - Interference at terrestrial station due to ace v ’ 1 53¢- — Space vehicle _q>fiv E T s}. D - Interference at terrestrial station :25 - earth station of earth-Space system 1; a- terrestrial system -—so- desired signal Figure 53. Source: Space interference potential. Before the FCC in the matter of an in- quiry into the administration and regulator prob- lems relating to the authorization of commercially operable Space communications systems, Docket 14024, reply of AT&T, p. 5 (cited as Docket 14024). 269 Capital Requirements In tracing the transition in the domestic market from metallic circuits to radio circuits, it was observed that the capital requirements associated with the latter was tending to decline. It was further contended that the re- ceding of the cost restraints tended to induce greater mar- ket access to the independent supplier. However, in the international market, capital requirements are tending in the opposite direction as seen in Table 34. TABLE 37 COST/CHANNEL-MILE FOR CABLE VERSUS SATELLITES Es Elmafea Estimated Cost per Estimated Channel- Channel- Total Cost Channels Miles Mile Cable 1963 (TAT—3) $70,000,000 128 400,000 $175 Cable with TASI (TAT— 3) 70,000,000* 233 933,333 75 Satellite 1975 420,000,000** 2,000 7,500,000 56 Satellite 1980 495,000,000** 5,000 18,500,000 27 *This figure is probably low (therefore conservative) since the addition of a TASI unit increases both the initial and annual maintenance costs. TASI were obtained during this **Including contingencies. No cost data relating to study. Source: "Telesat-Business Planning Study for a Commercial Telecommunication Satellite," Part 1, Lockheed Air- craft Corporation, Missile and Space Division, Sunnyvale, California, October, 1960, p. 68. 270 The cost projections are dependent upon such variables as the nature of the satellite system, the number of ground stations, the probability of successful launching, the aver- age lifetime of each satellite, etc. Thus, only AT&T offered to assume the investment burden of a private satellite systemm—a proposal originally amount- ing to $170 million.1 The proposal assumed the establishment of a low orbit active satellite system employing fifty satellites and twenty-six ground stations. With the ex- ception of the Bell plan, all other private proposals have embraced a joint venture concept in which several firms would pool their resources. Some conception as to capital costs attending a space communication system is revealed by the FCC's Ad Hoc carrier report-ma study undertaken by the U.S. overseas carriers. In short, the capital requirements of an Operational Space communication system plus the fact that one system only will be established means that the independent equipment supplier must look to that system as the potential market outlet for his products. One of the variables that influenced the degree of market entry was the ability of equipment firms to construct and launch experimental satellites. Telstar, as a tribute to AT&T, certainly held within its ownership implications 1Before the Federal Communications Commission, The Above 890 Docket, op. cit., Testimony of Charles Mapes, 1960, p. 13. 271 TABLE 38 SATELLITE COST RANGES Cost Configuration ($ million) (a) 20 medium-altitude satellites in random polar orbit 45 to 94 (b) Two pairs of satellites in synchronous orbit 50 to 100 (c) Configuration (a) plus 10 medium-altitude satellites in random equatorial orbit 67 to 141 (d) Three pairs of satellites in synchronous orbit 75 to 150 U.S. inc. Other Hawaii Countries Ground Stations ($ million) ($ million) (a) For medium-altitude satellites including tracking station 26.5 to 34 45.5 to 63 (b) For high-altitude satellites 7.5 to 9 17.5 to 21 Source: Before the Federal Communications Commission, Report of the Ad Hoc Carrier Committee, Docket 14024, pp. 13—4. that influenced the Size of market participation. Again, the Telstar project emphasizes the advantages of vertical inte- gration as it relates to the capital costs of the equipment firm. Western Electric and Bell Laboratories jointly engaged in the research and fabrication of the satellite. In addi- tion, successful eXperiments included a complex of ground receiving, sending, and telemetry stations. The total ex— penditure of the Telstar project included the costs of land, buildings, antennae, raedom as well as research and developu ment outlays. The latter, incurred by Bell Laboratories was billed to AI&T (some $45 million) and as a public utility, this is doing business.1 The telephone company is entitled to earn sufficient income to cover this expense. It it evident that as a manufacturer vertically inte— grated with a public utility, Western Electric is conferred certain cost advantages not accorded an independent supplier. Specifically, Western and Bell Laboratories' expenses en- countered by ncnintegrated suppliers must be borne from their profits. This advantage became evident in a letter from the FCC to AT&T in what the Commission said: We have noted, for example, the substantial amounts that Bell Laboratories is billing your company This billing prompted the FCC to request information regard- ing AT&T's overseas tariffs. iIn sum, the capital requirements associated with either the establishment or the experiment of a commercial space system are substantial. For the nonintegrated firm unable to enjoy the virtues of public utility pricing, the capital requirements and risk of satellite experimentation became prohibitive. In this sense, market entry is further restricted. 1Interview with Mr. Barnard Schwartz, staff member of Subcommittee on Antitrust and Monopoly, U.S. Senate. 2U. 5. Congress, Senate, Small Business Committee Hear- ings, op. cit., p. 56. Letter from FCC to AT&T, July 6, 1961. . 273 Structural In the domestic market, the indirect implication of vertical integration upon market entry was traced by assess: ing the interconnection and the pricing policies of the Bell System. Since no system is in operation, one can only con- jecture as to the influence of interconnection in the over- seas market. While RCAC as a common carrier has expressed some apprehension as to AT&T's interconnection policy, the economies of scale dictate that rival systems sponsored by nonintegrated Suppliers will not establish the intercon- nection problem associated on the domestic front. The pricing of overseas communication services via satellite may indirectly affect the growth and potential size of the equipment market. In this connection it is note- worthy that the Bell System advocates the standard of average cost pricing, the contrast to the expousae of the incremental standard in the domestic bulk market. In a letter to Senator Russell Long of Louisiana, an AT&T official observed: However, by using the new facilities in combination with existing facilities, costs can be averaged and and this will help avoid the necessity or rate in- creases during the period of initial buildup.1 Policy Although the parameters of cost, frequency, knowledge, and type of space system continue to evolve, the policy 1U. S. Congress, Senate, Space Satellite Communic- ations, Review of the Report of the Ad Hoc Carrier Committee. ,Hearings before the Subcommittee on Monopoly of the Select Committee on Small Business, United States Senate, 87th Con- gress, lst Session, Part 2, November 8-9, 1961, p. 744. 274 alternatives relating to the ownership and operation of a satellite system have been crystallized by Congressional legislation. The examination of a communication satellite policy will first survey how the communication carriers and the aerOSpace firms interpreted the definition of a Space system; second, will trace the evolution of a national communication satellite policy; and finally, will assess the Satellite Act as it relates to the problem of market entry. The common carriers and the aerOSpace firms, in attempt- ing to justify their right to participate in satellite owner- ship, differed in their interpretation and emphasis as to the conceptual nature of a satellite system. Is it a Space communication system essentially communication technology or is it essentially space technology? As the most articulate Spokesman for the carriers, AT&T emphasized the communications component of such a system. Furthermore, Bell asserted that a space communication system was evolutionary in nature, not revolutionary. Since satellites will merely provide the means by which broadband microwave techniques employed for continental communications can be extended across the oceans to supplement existing common carrier facilities, it seems appropriate that the United States should look to its common carrier industry for the experience, competence, andlfinancial ability to pioneer with satellite systems. 1U. S. Congress, House, Communications Satellite, Hearings before the Committee on SCience and Astronautics, 87th Congress, lst Session, 1961, Part 1, p. 310. 275 In emphasizing the communications component of a total system, AT&T reminded the AerOSpace industry that it had contributed the transistor, the solar cell, the travel- ing wave moser for low-voice receivers, FM feedback receiv- ing systems, and low-voice horn reflector antennas. AT&T remarked that: Government-paid research provides the transportation and industry-paid research provides the communic- ation. AT&T offered the analogy between a terrestrial microwave repeater in emphasizing the communication aSpect of a satel- lite system; and the telephone company asserted that functionally they were identical. The telephone company conceded that Space technology was necessary for the successful operation of the system, but AT&T reminded the aerOSpace firms that: . .. it should not be forgotten that many of the devices that guide the rockets and missiles, control their performance and make them useful have come from the research laboratories of the communications industry. Taking issue with the AT&T's definitional emphasis of a satellite communications, the aerOSpace industry's view- point was articulated by Lockheed, General Electric, and Hughes aircraft. lTelephone Engineer and Management, May 15, 1962, p. 90. AT&T Chairman F. R. Kappel at 1962 Annual Stockholders Meeting. - 2Before the Federal Communications Commission, Docket 14024, op. cit., ReSponse of American Telephone and Tele- graph, p. . 276 In the first place, the aerospace firms emphasized the Space technology inherent in such a system. Thus: . . . a satellite communications system represents a virtually different and unique adventure wholly unlike the traditional extension of existing facili- ties. Hence, rather than evolutionary in nature, it was revolution“ ary and unique. The aerOSpace firms observed that the Space component--the launching, orbiting, tracking, guidance, attitude control, etc.——represented the largest segment of technology of the system. Furthermore, over 90 per cent of the total cost involved "Space technology."2 The obser- vation that a satellite was essentially a repeater prompted General Electric to observe that the U.S. was not in a "microwave race" with the U.S.S.R., but rather engaged in a "Space race." 1Before the Federal Communications Commission, Docket 14024, 0 . cit., General Electric, Petition for Reconsider- ation, May 29, 1961, p. 17. 2The aerospace concept of Space communication found sup- port in an advisory report to the National Aeronautics and Space Administration. The report observed: "Satellite relays are more nearly analogous to a major new technology than merely an ‘improved' cable or microwave system. Increased communic- ations capacity (permitting new uses), new international implications use of governmental launch facilities, and operation in the Space environment clearly make it more than another technical step in communications technology." The Commercial Application of Communications Satellites: A Sfudy 6f Major National Policy CCnsiderations, Prepared for the ‘National Aeronautics and Space Administration, United Re- search Incorporated (February, 1961), p. 3. (Cited as United Research Study.) 277 The issue as to the ownership of a satellite system rested essentially upon what each adversary regarded as the essence of Space communication. Naturally, AT&T in assert- ing that a satellite system represented the mere extension of existing facilities, argued hard that the ownership base of a commercial system embrace only the U.S. overseas carriers. (Originally in 1960, the telephone company had offered to go it alone.) AT&T offered as an organizational concept a joint venture consisting of the international carriers. In deciding upon a criteria of allocating the ownership within the common carriers, AT&T stated: The initial capital investment and continuing oper- ating costs of satellites would be apportioned among the U.S. international carriers and foreign communication administrations and agencies partici- pating in ownership on the basis of estiTates of their prOSpective use of the satellites. Ownership determined by a use basis would yield to AT&T up— wards of 80 per cent of the U.S. share of a joint venture, and some 40 per cent if foreign interest participated. The carriers would be permitted, under the Bell plan, to own their own ground stations. The joint venture would decide on leasing policy, assignment of channels, etc. Turning to the issue of supplying Space hardware to the joint venture, AT&T stated: Manufacturers and suppliers of satellite equipment and launching will produce the satellite, build the ground stations and supply the rockets, etc. The 1Before the Federal Communications Commission, Docket 14024, OR. cit., Response of American Telephone and Tele- graph, May 1, 1961, pp. 4-5. 278 carriers, who are responsible to the public for its quality, adequacy and cost of the communic- ations services they render should have control over the choice of the equipment to be used. Thus, the aerospace companies would participate as sup- pliers rather than partners for: The launching of satellites will be an essential prologue, but nevertheless only ancillary to the operation of one portion of the communication system. In summary, the virtue of the Bell plan was epitomized by the following observation: The proposal we advance need not disturb the exist- ing pattern of regulation or effect the competitive positions of the carriers. In commenting on the Bell System's ownership proposal of a space venture, both Lockheed and G.E. expressed appre- hension that AT&T would emerge with a diSproportionate share of the ownership base. As nonintegrated equipment suppliers, the aerospace firms expressed the intention of supplying a satellite system with its hardware components. But two factors became apparent to the aerospace firms. First, one space system only was to be established--and this alone would provide the market for satellite equipment; and second, the overseas common carriers were integrated as manufacturers (AT&T, IT&T, and RCAC). In addition, if the carriers were permitted to construct and own their own ground stations, it 1U.S. Congress, Senate, Small Business Hearings, 22. cit., Testimony of AT&T, p. 252. 21bid., p. 251. 279 was not inconceivable that carrier subsidiaries would pre~ empt the equipment market. Lockheed, in particular, drew at- tention to the situation by commenting on the integration of carriers, manufacturers, and research laboratories. Lockheed observed: . . . it is extremely difficult to envision a satel~ lite communication system controlled by international carriers who are also hardware manufacturers in a joint venture which would preserve more than token competition in the hardware market.1 [EmphaSiS mine.] In pointing out the importance of the research and development stage in inhibiting market access of independent Suppliers, Lockheed commented: If the international carriers through their related hardware companies conducted all of the research and development prior to the actual organization of the joint venture and then contributed such research and development to the joint venture, all outsiders would be effectively excluded from the research and de- velopment phase. If the international carrier Should so preempt the research and develOpment phase as pre- liminary to forming a joint venture, they will through the control of design and engineering Specifications be able to discourage or preclude effective bidding by other hardware manufacturers for the ultimate equipment requirement. Confronted with a single satellite system and given the vertical nature of the carriers subsidiaries, the aerospace industry offered an alternative plan for a proposed Space venture. Alluded to in Chapter II, the plan held that an entity called a common carriers' common carrier be created. 1Before the Federal Communications Commission, Docket 14024, gp. cit., Comments of Lockheed Aircraft Corporation on Petition or General Electric Company, p. 4. 21bid., pp. 5-6. 280 This organizational entity would reside between the carriers and their equipment subsidiaries. The carriers' carrier would own and operate a satellite system. It would lease to the carriers the channels necessary for the rendition of communication service. It would, in addition, purchase equip- ment and hardware associated with the establishment and operation of a space communication network. The ownership of a carriers' carrier would include not only the U.S. overseas carriers but interested aerospace firms as well; and GE's plan suggested that the general public be allowed to participate in ownership. GE's entity was entitled Comsat; Lockheed's called Telecomsat. Never- theless, each embodied a similar plan. The aerOSpace firms were quite eXplicit in citing the virtues of a carriers' carrier: . . . by including all hardware suppliers who choose to enter--whether integrated with or independent of communications carriers—-and by precluding any one carrier from exercising a dominant position, will minimize the possibility of anti-competitive con- duct which has sometimes accompanied vertical inte- gration.1 Both the GE and the Lockheed plan permitted the carriers' carrier or the common carrier to own their own ground sta- tions. Nevertheless, Hughes Aircraft strongly urged that the ground stations and satellites of a space venture be owned and operated as one unified system. 1Before the Federal Communications Commission, Docket 14024, op. cit., Comments of Lockheed Aircraft, pp. 26-7. 281 Of course, AT&T had reservations as to the organiz- ational plan of the aerOSpace firms. Not only was such an entity unprecedented, but the telephone company insisted that the creation of a "stranger corporation” would disrupt existing communication relations and aggravate future ad- ministrative problems. The telephone company inverted the charge of dominance by stating: Indeed, in view of the small number of inter- national common carriers, the General Electric formula appears designed to vest control in the aerospace group. While the Defense Department concentrated on active satellites (Projects Score, Courier, and Advent), NASA con- centrated on the passive satellite research. (Recalling Chapter II, a passive satellite merely reflects, but does not amplify the microwave signal.) Perhaps the most dramatic of NASA's efforts occurred with Project Echo--an orbiting balloon that permitted the ricochetting of a microwave signal. AT&T cooperated with NASA on the project and, in fact, invested frgm $600 million of their own funds in constructing receiving equipment and other ground facilities. In July of 1960, NASA initiated discussions with DOD which permitted a realignment of their reSpective research 1Before the Federal Communications Commission, Docket 14024, 0%. cit., Reply of American Telephone and Telegraph Company, ay 5, 1961, p. 11. 282 in satellite communication. NASA, as a result of the DOD agreement, was permitted to engage in active satellite re- search if such research did not overlap the military effort.l Completing this arrangement, NASA embarked on its own active satellite program soon to be known as Project Relay. The following month, AT&T approached the civilian Space agency and inquired as to the feasibility of leasing launch- ing vehicles and facilities for the hoisting of private satellites. In October of 1960, NASA'S Administrator, Dr. T. Keith Glennan, in a Speech in Oregon, outlined plans of accelerating a communication satellite system.2 Dr. Glennan offered to lease government boosters to private industry on a cost reimbursable basis and in testi- mony before the FCC, AT&T announced their intention of establishing a world-wide active satellite system. The last month of the Eisenhower administration saw several develOpments. In the first place NASA began pre- paring Specifications fpr bids on the Project Relay. On December 12, AT&T President, P. R. Kappel, in a letter to Dr. Glennan expressed interest in the government's leasing offer and suggested that since NASA's active satellite project lU.S. Congress, Senate, Communications Satellites: Technical Economic and International Developments, Staff Re- port, Commiftee on AeronauticaT‘andepace Sciences, 1962, p. 193. Also: Philip J. Klass, "Indecision Bogs Communic- ations Satellites," Aviation Week and Technology (April 17, 1961), pp. 104-5. 20.5. Congress, Senate, 0 . cit., Committee on Aero- nautical and Space Sciences, p. I93. 283 (Relay) and AT&T'S active satellite project (Telstar) were similar in purpose: the material interest could be best served if our efforts were combined in this field so as to avoid wasteful duplication and delay in the develOpment of a final system.1 AT&T offered to build the satellite and to bear the cost of the satellite and its launching. Furthermore, Bell ob- served that it would make available to the experiment its receiving station at Holmdel, New Jersey, a station con- structed for the Echo Project. AT&T suggested: . . . that full information on satellite perform- ance be made available to NASA. And concluded: If, as we are confident, this experiment is success— ful, it is our plan to move as promptly as possible toward the establishment of a commercial satellite communications system which will be integrated with existing carrier common carrier cgmmunications facilities, both here and abroad. NASA did not accept the telephone company's offer. Had such an agreement been consummated, it would have eliminated the planned competition for NASA'S Project Relay. Subse- quently, when the Space agency announced competition for Pro- ject Relay, Bell Laboratories and Western Electric joined with six firms in offering bids. lU.S. Congress, House, Communications Satellites, Hearings before the Committee on Science and Astronautics, Part 1, 87th Congress, lst Session, 1961, pp. 402-3. 2Ibid., p. 403. 31bid., p. 403. 284 If any doubt existed as to a national policy regarding the: residence of a communications satellite policy, Presi- chmat Eisenhower removed that doubt in his last day in office. the declared that the government should aggressively encour- age pmivate enterprise in the establishment of a commercial cxnnmunications satellite policy.1 In addition, he directed INASA.and the FCC to cooperate closely in establishing an early private-system. The change of administration brought a new head to the National Aeronautics and Space Administration, Mr. James 'Webb. Mr. Webb exhibited some hesitancy in following through on Dr. Glennan's offer of government launching boosters for private satellite research. One of the alleged virtues of such an offer was that it would permit the Space agency to be reimbursed for the launching of private satellites and hence cut down on NASA's budget for Space communication. One of the first acts of Mr. Webb was to return to Congress and request a reinstatement of the $10 million dollar cut. Mr. Webb explained to the House Space Committee that: This increase will provide full governmental as against partial industry financing pending neces- sary policy decisions as to the best means for wider industry participation. . . . This will postpone the necessity for negotiating arrangements for financial participation by igdustry until a proper basic policy can be laid. lU.S. Congress, Senate, op. cit., Staff Report, p. 193. 2U.S. Congress, House, 1962 NASA Authorization, Hear- ings before the Committee on Science and Astronautics and subcommittees Nos. 1, 3, and 4, 87th Congress, lst Session on HR 3238 and HR 6029, 1961, Part I, p. 192. 285 Furthermore, Mr. Webb prophetically testified: In other words, once you have committed yourself to one company or a group of companies, or committed yourself to completely competitive development, you then have to travel up that road. Subsequently, Mr. Webb returned to Congress and in a plea for a supplemental appropriation of $50 million on satel- lite research "to expedite what industry might take longer to do."2 Meanwhile, NASA and the FCC completed a memorandum of understanding. There were indications that the agreement represented one more step in determining the size of the ownership base of a commercial system. The memorandum stated: Both NASA and the FCC recognize as conditions of fact (3) that in accordance with traditional com- munications policy in this country, overseas com; munications are provided by private enterprise, subject to government regulation and that at the present time overseas voice communications are provided primarily by a single company and over- seas record communications are provided by several companies. Thus, in accordance with "traditional policy," NASA and FCC agreed that: l . . . private enterprise should be encouraged to undertake development and utilization of satel- lite systems for public communication services. 1Ibid., p. 221. 20.5. Congress, Senate, op. cit., Senate Small Business Hearings, p. 304. 3Federal Communications Commission, memorandum of understanding between FCC and NASA on reSpective civil com- munications activities, Public Notice G, 1271, February 28, 1961. 41bid., p. 1. 286 Throughout the Spring of 1961, NASA weighed the seven cxmnpetitive proposals on its Project Relay Satellite; and on Bday 18 RCA was judged the winner.1 Both the communications and aerOSpace industry Speculated that the NASA award con- veyed to RCA commercial advantages in the establishment of a satellite system. However, the day of the RCA award one of the rejected bidders for the Relay Project, AT&T, received a call from Mr. Webb.2 Mr. Webb reinstated and offered the Glennan booster lease to the telephone company. And when the offer and commitment became public, Mr. Webb suggested: . . . it will advance by some period of time the bringing into being of a commercially viable system. Thus, the new administrator was to have it both ways; public expenditures would Speed what industry could not do, but private expenditures would more quickly establish a viable system. In seeking to advance the state of the space art, NASA'S Telstar agreement had within its ownership implic- ations that reached beyond the boundaries of pure research and development. In an advisory report to NASA in February, 1961, the Space agency had been forewanuxiof these implications. The report stated: 1John Finney, "RCA Will Build Satellite for TV," New York Times, May 19, 1961, p. 2. Subsequently, a second government project, Syncom, was awarded to Hughes Aircraft. 2Conference memorandum, July 10, 1961, between Mr. James Nunn, Assistant Chief Counsel of NASA, Mr. N. Peterson, Senate Small Business Committee,and author. 287 In the absence of a deliberate decision (as to ownership), the processes of the research and develop- ment phase may inadvertently decide the operational issuei1 IEmphasis mine.] If the space agency exhibited an ambivalence affecting the ownership base of a satellite system, the FCC did not. Following the NASA-FCC agreement reaffirming the “traditional" policy of communications in the U.S., the Commission initi- ated Docket No. 14024 as an inquiry into the problems of owning and administering a commercial satellite system. All interested parties were invited to solicit their opinions. Both the aerospace group and the common carriers were repre- sented; the former advocating a broad base of ownership, the latter, a narrow base. In May of 1961 the FCC, in declaring its first report, accepted the common carriers concept of a satellite system rather than the aerospace industry's. The FCC stated that: Communication via satellite will be a supplement to rather than a substitute for existing communication systems operated by the international common car- riers, thereby becoming an integral part of the total communication system of each such carrier. [Emphasis mine.] Hence, the Commission observed: We fail to see why ownership participation by the aerOSpace and communications equipment industries will be beneficial or necessary to the establish— ment of a satellite communication system to be used by the common carrier industry.3 1United Research Study, op. cit., p. 4. 2Before the Federal Communications Commission, Docket 14024, op. cit., First Report, p. 2. 31bid., p. 4. 288 The Commission summed its decision on the ownership base by asserting: We have concluded that the recommendations made herein with reSpect to the formation or arrange- ment of a joint venture (or joint undertaking) composed onl of existing common carriers engaged in international telephone and telegraph communic- ation is deserving of consideration and eXplor- ation as an effective means of promoting the orderly development and effectuation of such a system. [Emphasis mine.] In the meantime, Lockheed had pulled out, but General Electric and General Telephone pressed for entry by filing a petition for reconsideration of the Commission's report. July, 1961 was a crucial month in the evolution of a national communications satellite policy. Reacting some- what after the fact, on July 24, the President issued a policy pronouncement that, given certain conditions, private enterprise would own and operate a space communications system. Coinciding with this statement, NASA announced its agreement with AT&T to launch Telstar, and the FCC in re- jecting the petitions of General Electric and General Tele- phone and Electronics formed an Ad Hoc Carrier Committee composed only of the international common carriers. Subse- quently, General Electric withdrew all efforts to seek ownership.2 Meeting in the late Summer of 1961, the Ad Hoc Com- mittee issued its report in October. The report reiterated the observation that satellites would add to but not replace 1Ibid., p. 4. 2General Electric disbanded its Comsat Corporation. 289 1 Hence, the ownership of a existing overseas facilities. Space System would include the international carriers only. The vehicle for this joint venture would be embodied in a nonprofit satellite corporation, the purpose of which would be to: . . . develOp, construct, operate, manage, and promote the use of the satellite system, other than ground stations . . .2 The ground stations were to be owned by each common carrier. Furthermore, the equipment subsidiaries of the carriers (AT&T, IT&T, and RCAC) elicited an interest in supplying the joint venture with its communication and Space apparatus and equipment. In short, only integrated equip- ment firms would be allowed to participate in the ownership of a satellite system. Nonintegrated aerospace firms would participate as suppliers, not as owners. It became apparent that the non-profit was a slight misnomer since the carriers could include contributions to the joint venture in their rate base upon which they are entitled a reasonable rate of return. Since the source of revenue existed at the ground stations, it was important for the carriers to return private ownership of the stations. And finally, the existence of manufacturing subsidiaries within the joint venture left the problem of market access 1Before the Federal Communications Commission, Docket 14024, op. cit., Report of the Ad Hoc Carrier Committee, p. 9. 2Ibid., p. 18. 290 by the nonintegrated aerospace firm less than clear. The Ad Hoc Committee, with Slight modifications, be- came embodied as the Kerr Satellite Bill. Broad Base Within the confines of the President's pronouncement that a satellite system was to be subject to private owner- ship, the broad base plan was essentially the organizational structure promulgated by the aerospace industry. Lockheed's carriers' carrier corporation included the participation of the carriers, the hardware firms, and the general public. General Electric's plan permitted 50 per cent of the corpor- ation to be owned by those participants in the FCC 14024 docket with a 10 per cent limit imposed on any individual company. The general public would be permitted to own the other 50 per cent. Thus, both plans permitted the noninte- grated as well as the integrated hardware companies to participate in the ownership base. Both plans embodied the criteria laid down by the Justice Department in responding to the FCC Docket 14024 on May 3. The Justice Department suggested that any joint ven- ture must meet the following conditions: (1) All interested communication common carriers be given an opportunity to participate in the owner- ship of the system; (2) All interested communication common carriers be given unrestricted use of nondiscriminatory terms of the facilities of the system whether or not they elect to participate in ownership; (3) All interested parties engaged in the produc- tion and sale of communication and related equipment be gIVen an opportunity to participate in ownership of the system; and 291 (4) All interested parties engaged in the produc- tion and sale of communication and related equipment be given unrestricted opportunity to furnish such equipment to the system whether or not they elect to participate in ownership.1 [Emphasis mine.] However, when the FCC issued its first report on May 24, 1961, it modified the third criteria by excluding the aerOSpace firms from ownership. The Commission declared that the aero- Space industry would be permitted to participate as sup- pliers rather than owners to a commercial venture. However, subsequent to the FCC report, the Justice De- partment continued to press for broadened membership. In a meeting called by the FCC on June 5 between the interested participants of Docket 14024, the Justice Department restated its criteria of a broad ownership base;2 and on June 14, Judge Loevinger testified before the Celler Antitrust Com- mittee: We still feel that all four points were valid and should be considered, and have by no means aban- doned urging them upon the FCC.3 Subsequently, on July 26 before the House Interstate and Foreign Commerce Committee, Mr. Loevinger modified the third criteria on ownership to read: 1U.S. Congress, Senate, 0p. cit., Small Business Hear- ings, p. 465. 2U.S. Congress, House, 0 . cit., Committee on Inter- state and Foreign Commerce, p. 134. "The Department of Justice then urged the Commission to consider the desirability of widening the base of ownership as the plan is being developed so as to lessen the likelihood that the system will be controlled by a single company. 3U.S. Congress, House, Antitrust Consent Decrees and the Television Broadcasting Industry, hearings before the Anti- trust Subcommittee (Subcommittee No. 5), Committee on the Judiciary, House of Representatives, 87th Congress, lst Ses- sion, June 14, 1961.” 292 All interested manufacturers should have an un- restricted oppprtunity to participate in the’fur- nishing of equipment.1 [Emphasis mine.T Mr. Loevinger testified that the ownership criteria was per- haps "too doctrinaire."2 -With the Justice Department's position essentially consonant with the FCC, only the administration was in a position to broaden-the ownership base of a space satel- lite system. Such a bill was introduced and it incorpor- ated the general concepts expoused by GE and Lockheed. The final satellite Bill, as a compromise, is an amalgam of the Kerr Bill and the Administration Bill (Figure 54). V The Compromise Bill can be summarized under the topics covering ownership, ground stations, and the hardware market. As to ownership, it will be recalled that the Kerr Bill advocated a "private" joint venture with ownership participation restricted to the international common carriers. lU.S. Congress, House, op. cit., Interstate and Foreign Commerce Committee, p. 131. 21bid., p. 154. 3The integrity of a "private corporation" continues to be challenged. Prior to the satellite legislation, critics of the concept of a private system alleged that the govern- ment investment in Space vehicles and communication satel- lites represented a "give-away." However, even supporters of a private corporation are finding entity in view of con- tinued public expenditure ($55 million) in Space communic- ation by NASA. See: U.S. Congress, Senate, Nomination of Incogporators, Hearings before the Committee on Aeronautical and Space Sciences, 88th Congress, 1963, pp. 80-2. 3 Kerr Bill [ End-user #]5 Y Common Carriers / International —> Satel ite Corpo ation Figure 54. Common Carriers ___T ‘1 Inte- Non- grated inte- Sup- grated plier sup- lier Siground station, 293 Administration Compromise Bill, Bill [End-user End-user l International International Common {'— Common Carriers ‘ Carriers Satell'te Satell’te Corporation Corpor tion ‘ I Common Public Common I Private Carriers. carriers l . E l Ground :Stations Ground {Stationj E j\\\\ !\\\\\\ A Inte- Non- Non- grated inte- inte Sup- grated grat. plier Sup- Sup- plier plier Compromise satellite bill. 294 The Administration Bill broadened the ownership base to in- clude both. Thus, the carriers' carrier concept was em- bodied in the Compromise Satellite Bill. The Compromise Bill provided for the formation of a U.S. Satellite Corpor- ation composed of two classes of stock; 50 per cent of the corporation's stock would be sold to the general public as Class A stock. The general public would be entitled to elect six members of the Board of Directors to the company. The remaining 50 per cent of the stock, Class B, would be sold to the carriers. Although the carriers could elect Six board members, they could not receive dividends from their investment. However, the carriers could include stock contributions into their rate base upon which they could earn a return. Finally, whereas the Kerr Bill excluded the noninte- grated supplier from ownership participation, the Compromise Bill, like the Administration Bill,pennits ownership in the public half of the corporation. The Compromise Bill, in this sense represents a strange amalgam. The vertical integration of the international carriers is left intact. Furthermore, since the carriers are per- mitted to own ground stations, their hardware subsidiaries will undoubtedly supply the receiving equipment. On the other hand, since the nonintegrated suppliers are now granted permission to integrate forward (partially, since they are not common carriers) and Since the corporation may construct and own ground stations, the final Bill conveys to the 295 independent supplier a form of market access. It is essential to note, however, that we have likg firms operating on both Sides of the market. That is, equipment firms sell apparatus to an organization in which they themselves are partial owners. To deliver us from this potential conflict of interest, the FCC is charged with the mandate of insuring: - . . . effective completion in the procurement by the Corporation of apparatus, equipment, and services . . .1 In reviewing the triad of restraints applicable to the domestic equipment market in both domestic and international segments, this study offers the following observations. First, in the domestic market the legal and technical barriers to entry no longer assume the proportions that they exerted historically. Patented knowledge as a barrier appears to be less important than formerly; the magnitude of the frequency Spectrum has permitted expanded eligibility, and the capital requirements for both heavy and light route systems have tended to recede. However, as the predominant form of market structure, vertical integration continues as the chief bar to entry in the equipment market. Not only has the Bell-Western Electric precluded entry in the procurement of equipment by the Bell operating companies, but entry is further inhibited by AT&T'S interconnection policy and by her recent pricing. 1U.S. Congress, Senate, op. cit., Subcommittee on Antitrust and Monopoly, p. 244. 296 Finally, it has been observed that policy determin- ations within the public sector have tended to reeenforce rather than dissipate the existence of vertical integration. ’Ihe FCC in particular appears oversolicitous in regarding 'the interests of the Bell System as seen in limiting entry into the intercity video channel field and permitting the 'Telpak tariff to take effect while its cost legitimacy cone tinues under investigation. Of more crucial import is the failure of the Justice IJepartment to address itself to the problem of market power associated with vertical integration. Since a communication satellite continues to remain in the research and development stage, less certainties attend the problems in international communications. It may well be that the future technical advances in transitorized cables and the probability of the laser may consign the de- bate of metallic vs. radio circuits to academic interest. Nevertheless, patented knowledge does not appear to be an overriding bar to satellite communications; and the micro~ wave bands are available for transoceanic use. Although cost parameters fall within a wide range, precise capital requirements attending a viable system continue as an un— known; and these “csts, coupled with the economies of scale, suggest that one system only will be available in the near future. Attention was drawn to the vertical nature of the over- seas common carriers, and it was this structure that prompted 297 the aerOSpace industry as nonintegrated firms to seek mar- ket entry. Again, the policies of the FCC continued to favor the existing international carriers in their bid to limit ownership participation of a satellite venture. This bias of the FCC was epitomized by Commissioner Minow, who after participating in the drafting of the expanded owner- ship base of the Administration Bill, proceeded to testify against it. And again, the Justice Department's ambivalence as to size of the ownership base came previously close to deferring to the FCC. More dramatic and perhaps more crucial as a variable in determining public policy was a research and development launching contract negotiated by NASA in its ostensible mandate to advance the state of the communication art. These decisions, derived from the public sector, were premised upon the existence of the overseas communication market structure and as Such tended to reinforce the entry restrains confronting the nonintegrated firm. In postulating the virtues of vertical combination, the Spengler thesis holds that market power is associated primarily with horizontal integration and it is to this power that public policy Should address itself. This study does not confirm the Spengler thesis. Rather, we have suggested that the problem of entry turns on the existence of verti- cal power. In the domestic market, an attempt has been made to document not only the entry deterrants associated with disproportionate vertical integration, but to record the exercise of that power in isolating the nonintegrated supplier. 298 In the international market, this study has postulated that the formulation of a national satellite policy originated as an attempt by the nonintegrated equipment supplier to gain a market outlet for his goods and services. This entry problem got "out of hand" when the issue evolved into a charge of "give away? filibuSter and cloture--a long road from the original problem of market access. Given the problem of market entry, what policy Options confront both the domestic and international equipment markets? CHAPTER V POLICY ALTERNATIVES Domestic Market The domestic communication equipment market is amenable to several policy formulations. One choice is to maintain the status quo and treat vertical integration as the norm for the equipment industry. The Consent Decree is premised essentially on this policy. However, maintaining the status quo suffers from two difficulties. In the first place, the problem of competition and competitive entry is relegated to a position of secondary importance; and the nonintegrated firms' market outlet is left to the discretion of the integrated firms' decision to make or buy. In short, the nonintegrated supplier continues as a subcontractor in the factor market, while his position remains less than certain in the product market (due to Telpak). A second problem attending a status quo policy is that it continues to convey to the integrated supplier a quasi utility status. As such, vertical integration rationalizes the FCC's regulatory extension into the equipment market. Whether the FCC's regulation of Western Electric is real or token in nature, it is not without its inadequacies. 299 300 In fact, the 1939 Telephone Investigation revealed that: Western computed costs for individual products do not provide an authentic basis for testing the reasonable- ness of the prices of these products nor do its over- all profits from sales provide any better basis for testing the reasonableness of its prices for its pro- ducts. The Commission requested authority to prescribe to Western Electric a System of standardized cost accounting. Subsequently, in 1941, a cooperative study between the FCC and the National Association of Railroad and Utilities Com- missioners (NARUC) cooperated in a joint study of Western's operating results. These reports have been issued annually since 1948. Nevertheless, a Hoover Commission Report con- cluded: The prices and profits of Western have never been the subject of a definite investigation by the Commission. Again, the Justice Department's Consent Decree admonished Western Electric as to its cost accounting procedures. Thus: Western is ordered and directed to maintain cost ac- counting methods that conform with such accounting principles as may be generally accepted and that af- ford a valid basis, taking into account the magnitude and complexity of the manufacturing operations in- volved for determining the cost to Western of equip- ment sold to AT&T and Bell operating companies for use by them in furnishing common carrier communic- ations services. 11939 Telephone Investigation, op. cit., p. 322. 2U.S. Congress, Senate, 0 . cit., Subcommittee on Anti- trust and Monopoly of the Committee of the Judiciary, p. 213. 3U.S. Congress, House, 0 . cit., Celler Hearings, P- 2595. 301 And again, a recent study Sponsored by the Bureau of the Budget concludes: Since January 1, 1956, accounting compliance reviews have been accomplished for only 14 of 24 Bell System companies and 9 of 40 independent telephone com- panies. . . . In 1960 Bell System purchases from the Western Electric Company, a Bell Subsidiary, amounted to $1.8 billion, which amount becomes part of the rate base on which the Bell companies expect a return. Apart from occasional review of periodic reports, no examination of the books of Western Electric or other leading telephone equipment manufacturers has been undertaken to determine the reasonableness of charges to the Bell System.1 The evidence suggests that meaningful regulation of Western's prices and profits has been cursory at best. As one observer points out, Western "is limited in business conduct chiefly by executive discretion, not by external market forces or authority“2; and amplifying the observation that Western Electric is subject primarily to the discretion of its management, an AT&T vice president is quoted as ob- serving: The Western has deliberately limited its profits. That is one of the important restraints of self- regulation practiced by the Bell System.3 1Organization and Management Survey of the Federal Com- municatiOnS CommissiEn for the Bureau of the Budget, Vol. 1, Chapter I-XIVVTMarch, I962), Booz Allen and Hamilton, p. 286. 2John Sheahan, "Integration and Exclusion in the Tele— phone Equipment Industry," Quarterly Journal of Economics, Vol. 70 (May, 1956), p. 249. Also: Bell System Comments on the Booz Allen and Hamilton Report on the FCC, July, 1962, p. l. Bell's rebuttal: "The fact that accounting compliance re- views have not been made more frequently for more companies is much less significant that it appears. Any direct or im- plied criticism on these grounds overlooks the fact that all the companies in the Bell System follow the same accounting practices." 3Arthur W. Page, The Bell Telephone System (New York: Harper and Brothers, 1941), p. 147. 302 In sum, pursuing a policy of status quo neglects the issue of market access for the nonintegrated firm, and further lends a static bias to the structure of the communic- ation equipment industry. A second policy recommendation contends that only the common carriers be permitted to render service to the bulk communication market. The position is outlined as follows. Private microwave permits the rendition of both voice and record signals and hence challenge the traditional mar- ket dichotomy of the telephone and telegraph companies. In fact, this new competition in a properly con— strued regulatory sense, must be viewed as a significant reduction in monopoly power for majoi segments of the telephone and telegraph markets. In reSponding to this "new competition," the common carriers have introduced several new services. The Bell System, in particular, has introduced a series of new tariffs, the most notable of which is Telpak. As a direct challenge to private microwave, Telpak offers the consumers of volume bulk communication a viable alternative to owning a radio relay system. Western Union, for competitive reasons, like- wise offers a form of Telpak service, although, as we have seen, they are doing so under protest. In addition, the Bell System is offering WATS, WADS, and Dataphone. WATS stands for wide area telephone service and permits consumers 1Bernard P. Herber, "The Impact of Microwave on the Telephone Business," Public Utilities Fortnightly, 70:62 (August 16, 1962), p. 219. *Dr. Herber held a fellowship with the Mountain States Telephone and Telegraph Company-~an AT&T operating subsidiary. 303 with heavy long distance telephone needs to obtain such service at flat monthly rates. The independent telephone companies protested this tariff, although it has gone into effect. A second service, WADS, stands for wide area data service. Similar in concept to WATS, WADS applies to users of teletypewriter service (FCC has ruled that this tariff is discriminatory). A third service, introduced by Bell, is Dataphone. This tariff permits phones to interconnect computers permitting "machine-talk." In Short, the above 890 decision has generated not only competition gmppg the carriers but a new competition between carriers and private microwave systems. Given this new competition, the expansion of private eligibility of microwave system has resulted in three problems: first, a problem of regulatory inequality; second, potential waste of microwave frequency bands; and third, neglect of the inherent economies of scale possessed by the carriers. The first problem, the problem of regulatory imbalance is summarized by comparing the carriers to the private micro- wave suppliers. Thus: . . . one side of the competitive market-—the priv- ate systems and their suppliers--face little or no regulation. However, the other side of the competi— tive market, the established common carriers such as Bell and Western Union are closely regulated as public utilities.1 1Bernard P. Herber, “Telephone Industry Reaction to Microwave Competition, " Public Utilities Fortnightly, 70: 9 (October 25,1962),p.-634. 304 'This condition, described as “regulatory inequity" is further intensified by the burden of Federal excise taxes accompany- iJig common carrier services. The existence of regulatory inequity, so the argument holds, means that: In some manner, the relative underregulation of the private microwave Systems and their supEIiers should be e uated (or at least brought closer together) with the re ative overrregulation of the common carriers. [Emphasis mine[T In short, the implication is that the FCC should redress the underregulation of the private systems and their sup- pliers by encompassing them within the regulatory authority of the Commission. The second point relating to the problem frequency waste centers on the limited size of the frequency bands in the microwave region. Since the bands are scarce, expanded eligibility, as embodied in the FCC's Above 890 decision, only tends to increase the problem of scarcity-~particular1y 'when common carriers' facilities are in existence. Why create a precondition to inefficiency in the use of scarce economic resources in general (land, labor, and capital) and the scarce frequency spectrum in particular?2 It follows then, that: i i There is good reason to challenge the “economic propriety" of the Above 890 decision in terms of use of the scarce frequency spectrum . . .3 11bid., p. 636. 21bid., p. 636 31bid., p. 640. Again the implication exists that the Above 890 decision should be rescinded in favor of the carriers. The final argument Supporting the view that only the carriers be permitted to render volume communication service rests upon the thesis of economies of scale. Since the carriers possess inherent economies of scale, why Should the FCC expand private microwave with: . . . the full knowledge that diseconomies of small scale will likely make them less efficient than the common carriers. In granting this position, it follows that: . . . there appears to be good reason from the standpoint of efficiency in resource use to permit natural monopoly power condition in the form of a regulated oligopoly market structure to continue to provide the nation's rapid communication needs. Perhaps the dissimilarity between the preceding position as outlined and the observations in this study stem from different concepts as to the relevant market. The preceding discussion has included the common carriers, the private microwave systems, and their suppliers. We, in turn, have focused upon the equipment market with specific emphasis upon the vertical structure of that market. It is our con- tention that the nonintegrated firm is confronted with several forces whose residence is traced to vertical inte— gration. Thus, in the product market the nonaffiliated supplier is faced with Bell's Telpak tariff as well as AT&T'S policy of purchasing of existing private microwave lIbid., p. 638. 21bid., p. 641. 306 systems. In the factor market, we have noted the dependence of the nonintegrated supplier upon the captive subsidiaries of the common carriers and Specifically have noted the lever- age power accorded the procurement policy of Western Electric. In short, the longevity of the supposed "new competition" in the bulk market is tenuous at best and hardly seems to sup- port the statement that a "significant reduction" of monopoly power is occurring in the communication industry. More im- portant is the view that, in the name of “regulatory in- equity," FCC's jurisdiction should be extended to include the manufacturers of private microwave systems. Since the integrated manufacturers are regulated, it follows that like supervision be extended to the independent suppliers as well. A policy advocating an administrative drift so as to include the industry's competitors is reminis- cent of the railroads' pressure to bring the trucking carriers under the roof of the ICC;1 and no known empirical study exists that documents the position that the equipment indus- try would prosper more effectively under government regu- lation than under the forces of the market place. Turning to the issue of Spectrum waste, the thesis that the FCC should revoke the Above 890 decision holds within it several implications. In the first place, a de- cision to withdraw the raw material essential to private microwave systems would be a decision to deny the product 1James C. Nelson, "The Motor Carrier Act of 1935," Journal of Political Economy, Vol. 44 (1946), p. 465. 307 market to the independent suppliers. Furthermore, rescinding the Above 890 would resolve the alleged dilemma of regulatory inequity in that private microwave systems subsequent to the Above 890 decision would be nonexistent. A second implication in advocating a policy to restrict private microwave use is the assumption that the new services introduced by AT&T (WATS, WADS, Telpak, etc.) derives from the benevolence of the Bell System rather than from the pres- sures of the market. While some may assert that the former is the case, AT&T'S briefs before the FCC, suggest that priv— ate microwave triggered this host of new services and tariffs. While the magnituide of the microwave bands remain finite per given point of time, the pace of technological change may hold surprises as to the available use of the frequency spectrum. One supporter of restricting the micro- wave bands to the common carriers has observed: The future may witness the use of light waves (Lasers) to provide a mass communications medium which will cause microwaves to appear as outdated in communic- ations as a Conestoga wagon is today in transport- ation.1 Finally, does it follow that the common carriers alone should provide volume communication services since they exhibit economies of Scale? 1Bernard P. Herber, "Technological and Market Struc- ture Changes in Communications,“ Business Topics (East Lan- sing: Michigan State University, Graduate School of Business Administration), 11:2 (Spring 1963), p. 60. 308 One difficulty in answering this question is whether a firm can segregate its joint costs in order to establish the existence of scale economies for a Specific service. Pre- sumably this hurdle is not insurmountable, although AT&T was reluctant to do so in the private line case and did not con- duct a cost study of the actual plant inventory in the Telpak case. Yet, in granting this knowledge of economies of Scale, presumably these economies were in existence before the FCC's decision to stimulate private microwave. If so, why were not these economies passed on to the consumer prior to the 890 decision? And if Telpak now conveys to AT&T a rea- sonable rate of return, does it not suggest that the bulk tariffs prior to Telpak earned unreasonable profits? But more important, if we grant that economies of scale exist and are known to the carriers, it does not follow that these economies are derived from the economies of manufacturing or vertical integration. In fact, the vitality of such nonintegrated suppliers as Collins Radio (sales $207.7 million, 1962) and Motorola (sales $346.8 million, 1962) argues hard that the optimum manufacturing Scale may be considerably less than the dimensions of Western Electric (sales $2.5 billion, 1961).1 A final policy choice holds that the communication equipment market is amenable to competition and that vertical 1 . . . Standard Corporation Descriptions, Standard and Egor's Corporation, 1963. 300 integration inhibits the attainment of that goal.1 This Study supports Such a conCIUSion and suggests the following steps in promulgating competitive entry into the equipment market. First, the Justice Department in returning to its position of 1949 Should demand the divestment of Western Electric from AT&T. Furthermore, the General Telephone's integrated system should likewise receive careful scrutiny. Again, the Department may find it necessary to split Western into several competing firms. The point is that divestiture would permit the Bell associated companies to expand the number of alternative equipment sources as well aS broaden the factor market potential to the nonintegrated supplier. It is conceivable that Western Electric, acting as other equipment manufacturers, may be tempted to tap the product market by selling private microwave systems to end-users. In this sense, both product and factor markets will be sub- ject to competitive aeration. Second, vertical disintegration would remove the quasi- utility status surrounding Western Electric. Western's di- vestment would remove the FCC's rationale for overseeing the company's profits and prices. Rather than extending govern- ment regulation into larger areas of the equipment indus- try, divestment would tend to confine the Commission's activities to the tariffs of the carriers. In short, the 1Before the Federal Communications Commission, Celler Hearings, op. cit,-Hearings for Bell System's defenses of vertical integration, Part 11, Vol. I, pp. 1973-2000. 310 equipment industry would be deregulated and exposed to mar- ket forces. In addition, the FCC should reexamine the inter- connection policy of the common carriers. Interconnection of carrier and private microwave facilities could be per- mitted at reasonable rates to the carriers and if the feared "cream skimming" reached demonstrable portions, the Commis- Sion could adjuSt the interconnection rates accordingly. Third, the Government Services Administration (GSA) as the purchasing agent for the U.S. government should re- evaluate its procurement policy with reSpect to volume com- munication channels. Certainly the agency, in taking its communication needs automatically from the carriers, did little to stimulate and encourage competition in the equip- ment market. Common carrier subscription in the light of the avail- able economies of private microwave suggest that government procurement practices amounted to an outright subsidy to the carriers. Assuming that these economies exist, Government procurement policy could effectively stimulate competition in the private sector. Finally, one of the dramatic transitions occurring within-the past twenty years is the diSplacement of research funding from the private to the public sector. Not only is the U.S. Government underwriting a larger share of the nation's total research and development, but in Specific industries, notably the communication industry, that burden is approaching 80 per cent. 311 One of the assertions of this study is that the firms Sponsoring a technical alternative in the communication in- dustry owed much of their origin to government research and procurement activities. While the competitive effects of research and development contracts were perhaps not pursued as a matter of eXplicit policy, the research and development contract holds within it a powerful tool in broadening the base of new technology and hopefully generating the birth of new firms. The Government research and develOpment contract can be employed as a deliberate policy directed to increas- ing rather than diminishing a competitive environment within the private sector. This study concurs with Dr. Charles Hitch who observes: The problem in managing governmental research and development is not how to suppress competition, but how to divert it into more productive channels.1 It is appropriate to note that a Federal patent policy per- mitting the prime contractor to retain patent title on in- ventions arising from publically funded research tends to negate whatever competitive implications the research and development contract holds for the private sector. The international market, like its domestic counter- part, is confronted with Several policy alternatives. One such alternative is to continue the status quo as now 1Charles J. Hitch, "Research and Development in the Competitive Economy," Proceedings of a Conference on Research and Development and its Impact on the Economy (National ‘SEienceiFOundation, 1958), p. 139. 312 embodied in the recent communication satellite legislation. This legislation, it will be recalled, permits 50 per cent of a U.S. satellite corporation to be owned by the inter- national carriers and the other 50 per cent to be owned by the general public. We have suggested that the carrier half of the corporation retains the existing vertical structure of the three largest carriers. Furthermore, the ability of the nonintegrated suppliers to purchase up to 10 per cent of the public half of the joint venture represents a partial forward integration of those suppliers. A national Space com- munications policy appears to contain some elements of com- pulsory integration suggested in Chapter I by Chamberlin. This type of market arrangement may lend itself to a potential cartelization of the equipment market. Several dominate suppliers could purchase their 10 per cent limit in the public half of the corporation and proceed to rotate equipment contracts to each other. In short, it is diffi- cult to envision arm-length bargaining when common ownership Spans the same market. It has been asserted that competition will be main- tained by the new mandate directing the FCC to insure com- petitive bidding, where feasible, in the purchases of the satellite corporation. Although the Commission may be cap- able of the task, the fact that it has not determined the reasonableness of the prices in the overseas product market hardly assures the FCC extension into the equipment market. For example, an FCC letter to AI&T‘in July, 1961 stated: 313 As you are aware, the Commission has never had before it data on which to properly evaluate your overseas communication service. Such an evaluation can no longer be delayed.1 Subsequently, the Commission commented that the figures sub- mitted by Bell were so rough that they were "almost mean- ingleSS." Thus, the extension of the FCC's authority into the overseas equipment industry casts-some skepticism as to whether Such regulation is possible and more important, whether it is desirable. A second policy alternative is to place the joint ven- ture under government ownership. Two Congressional bills incorporated this approach. The Government corporation would purchase and own both ground stations and satellites; and then lease these facilities to the common carriers. From the standpoint of maintaining competition and precluding the extension of vertical integration in the factor market, public ownership offers advantages not contained in the present satellite corporation. However, politically, public ownership met with little enthusiasm. Furthermore, public ownership does not address itself to the problem of exist- ing vertical integration in the overseas market since the lessors could still purchase from their equipment subsidi- aries. A third policy choice, recommended by this study, is to retain the idea of a "private" joint venture, but prohibit lU.S. Congress, Small Business Hearings, op. cit., p. 56. 314 vertical integration. That is, all existing common carriers ——AT&T, IT&T, and RCAC--could participate in the ownership of the corporation on the condition that they disaffiliate from their equipment subsidiaries. Furthermore, if each carrier desired to construct and own satellite ground termin- als, they would be permitted to do so. In addition, no non- integrated aerOSpace firm would be permitted to purchase stock ownership to the full corporation. In short, full vertical integration as a matter of public policy would cease and partial forward integration would be disbanded. The virtue of this approach is that it removes the FCC's rationaszor the extension of government supervision into the equipment industry. A policy of divestiture is premised on the ob- servation that the equipment market should be left to market forces rather than assume a quasi public utility status. In this regard, recent research contracts by NASA hardly aug- ments a policy of technological diffusion. Specifically, Mr. James Webb, Administrator of NASA, initiated and. consummated a contract between the Space Agency and Bellcom. Bellcom, a subsidiary of AT&T and Western Electric,1 will perform the role of systems advisor for the Apollo manned lunar program. That the range of new technology generated by the govern- ment's Space program will be available to Bellcom was alluded to by Mr. Webb who stated: 1U.S. Congress, House, 1963 NASA Authorization, Hear- ings before the Committee on Space and Astronautics, 87th Congress, 2nd Session on HR 10100, 1962, p. 159. 315 . . . a necessary result of the close relationship between Bellcom and NASA is that a new company will become privy to the kind of information re— garding current and future plans and programs of NASA that could give the Bell System a competitive advantage in connection with other works. Perhaps this contract epitomizes the narrowing rather than the broadening market bias of recent government decisions. First, Bellcom will have access to the most crucial U.S. research investment for the next ten years. Second, Western Electric, Bellcom's part-owner, will be permitted to solicit equipment contracts to NASA subject to the discretion of NASA'S administrator.2 Third, the recent proposal to permit NASA'S prime contractors to retain patent titles from government financed research could erect the potential barrier of patented know- ledge. 1U.S. Congress, House, Systems Development and Manage- ment (Part 5), Hearings before a Subcommittee of the’COmmittee on Government Operations, Military Operations Subcommittee, 87th Congress, 2nd Session, 1962, p. 1702. 21bid., p. 1763. Mr. Roback (Committee Counsel) ". . . If and when on some new project the fact that Bellcom may be privy to a considerable amount of Special information which confers a competitive advantage, then the Administrator (of NASA) will on a case-by-case basis decide whether or not it is appropriate to permit bidding by Bell companies. . . ." Also Space Technology Laboratory was drOpped as Air Force systems advisor because of a conflict of interest in being integrated with a Space hardware manufacturer, Thompson- Ramo Wooldredge. BIBLIOGRAPHY Company Publications American Telephone and Telegraph Company. Annual Report. 1946. Bell System Comments on the Booz—Allen and Hamilton Report on the FCC. July, 1962. Bell System Comments on Rand Corporation Memorandum. RM-2845- NASA, October, 1961. Leland L. Johnson, Communications Satellites and Telephone Rates: Problems of Government Regulation. Bell System Comments on Organization and Administration of the Federal Communications COmmission, by Booz-Allen and Hamilton TJuly, 1962). AT&T letter to FCC, March 10, 1961, Attachment B. Bickett, H. R. and T. W. Spicer, "Indirect Regulation of Western Electric." (Notes from which informal talk was given December 20, 1962, to Amherst Group, American Telephone and Telegraph Company.) 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