"What Killed Ma Bell?"
Melvin D. Barger
Dated: April 1984
MA BELL, the world's biggest company and
largest private telephone system, went to her Eternal Reward on January 1.
Although she was reincarnated as a new, slimmed down AT&T and seven regional
holding companies, the successors to the old Bell System will be vastly
changed from the giant telephone company which was such an intimate part of
American life for most of this century. The most significant changes are the
separation of AT&T from the Bell operating companies and the introduction of
increased competition in the telephone field. Most of us who believe in free
market economics think the change will be beneficial.
But before we say a last farewell to Ma
Bell, we should at least hold a post mortem to find out the true causes of her
demise. What killed Ma Bell? Why did she have to die? How did her terminal
Some believe the Bell System was brought
down by the U.S. Justice Department. The Justice Department had wanted to
break up AT&T for a long time and had first attempted it with a 1949 civil
suit. While that lawsuit had been settled by a 1956 Consent Decree which left
AT&T virtually intact, a second Justice Department suit filed in 1974 was more
successful and resulted in the dramatic divestiture settlement which was
announced on January 8, 1982 and carried out two years later.
Another hero of the AT&T breakup is
Federal Judge Harold Greene, who presided over the case and inserted some of
his own convictions in the settlement - such as the order divesting the new
AT&T of its lucrative Yellow Pages operation. Perhaps it was Judge Greene's
unfriendliness that convinced AT&T management to accept divestiture rather
than even harsher terms in a final ruling later on.
Finally, Ma Bell may have been partly
done in by her critics. The Bell System had made a lot of enemies over the
years. TV comedians like Joan Rivers roasted the telephone company before
audiences of millions, while crusaders like Ralph Nader lashed out at the
system in books and articles. None of this helped a company that craved and
needed the public's support and good will.
It's true that all of these forces
played a part in Ma Bell's demise. Yet the real cause of her demise may have
been her long status as a "regulated natural monopoly." While this regulation
may have appeared to be Ma Bell's great strength, it was also a weakness that
proved fatal over time. And in the 1960s, a number of serious problems
developed which AT&T was not equipped to solve under the old status.
The Key to the Problem
Perhaps the key to understanding Ma
Bell's illness and demise is in a little-known but important book entitled
Bureaucracy, by Ludwig von Mises. 1 First published in 1944 and
largely reflecting Mises' experience with governmental bureaucracies in
Europe, the book shows why bureaucracy is necessary for certain types of
organizations and why it becomes harmful or ineffective for other types of
organizations. Unlike those who merely denounce bureaucrats, Mises had a
sympathetic understanding of bureaucracy as "a method of management which can
be applied in different spheres of human activity." He noted that bureaucratic
methods are a necessity for handling the apparatus of government, and that
what people consider as an evil is not bureaucracy as such, "but the expansion
of the sphere in which bureaucratic management is applied." 2
Mises defined bureaucratic management as
"management bound to comply with detailed rules and regulations fixed by the
authority of a superior body." But business management, on the other hand, is
management directed by the profit motive.3For a profit-seeking
organization, "success" is not whether the organization closely follows
certain rules and procedures, but whether it is profitable.
In the United States, however, many
private companies-while still profit-seeking organizations-have been driven
toward bureaucratization by government interference of one type or another.
The most bureaucratic types of private organizations are those whose prices or
activities are regulated and those who engage in a great deal of government
business or depend on the government for the right to carry on their business.
In a sense, many of these private businesses have to serve two masters: they
must be profitable, and yet they must carry out rules and regulations which
might inhibit their ability to compete. They are, to quote Mises, expansions
of "the sphere in which bureaucratic management is applied."
The Bell System was a victim of
bureaucratized management, although it was a privately owned corporation and
operated on a profit-seeking basis. But its profit-seeking activities were
carefully monitored and restrained by authorities. Bell was subject to three
of the four methods which, Mises noted, government authorities apply to
interfere with the "height of profit" in private companies: 1) The profits
that a special class of undertakings is free to make are limited; 2) The
(government) authority is free to determine the prices or rates that the
enterprise is entitled to charge for the commodities sold or the services
rendered; and 3) The enterprise is not free to charge more for commodities
sold and services rendered than its actual costs plus an additional amount
determined by the authority either as a percentage of the costs or as a fixed
fee. (Not applicable to Bell's case was the fourth method described by Mises,
which allows the enterprise to earn as much as it can, with taxes absorbing
all profit above a certain amount 4
A private business is doomed if its
operation brings losses only and no way can be found to remedy this situation.
Its unprofitability is the proof of the fact that the consumers disallow it.
There is, with private enterprise, no means of defying this verdict of the
public and of keeping on. The manager of a plant involving a loss may explain
and excuse the failure. But such apologies are of no avail; they cannot
prevent the final abandonment of the unsuccessful project.
It is different with a public
enterprise. Here the appearance of a deficit is not considered a proof of
failure. The manager is not responsible for it. It is the aim of his boss, the
government, to sell at such a low price that a loss becomes unavoidable.
LUDWIG VON MISES
Most private companies encounter some
political interference with their profit-seeking activities. But public
utilities and defense contractors usually receive the most direct controls
because, to a certain extent, they owe their existence to government favors.
In the case of the Bell System, this government control went back more than 70
years, and it set the company up for serious trouble when changes came in the
The Leadership of Theodore N. Vail
Bell's venture into bureaucratized
management started in the 19071919 period under the leadership of Theodore N.
Vail, whom Bell people revere as the architect of the modem system: "Alexander
Graham Bell invented the telephone, but Theodore N. Vail invented the Bell
System," Bell people have said. 5
What Vail invented was a unique way of
organizing the system under private ownership while getting government
approval of the concept of a "natural" monopoly which should be operated "in
the public interest." A number of competing telephone systems had blossomed in
the early part of the century, and in some cases people served by one system
could not be connected with people hooked to another in the same area. To
Vail, this was wrong and inefficient, and he apparently did not believe that
market forces would solve this problem. Moreover, the most serious threat to
AT&T was not competition from other companies; it was the threat of being
taken over by the federal government to be run as an arm of the Post Office.
This was a very real concern, and in view of the fact that other major
countries ended up with government-owned telephone systems which often
performed badly, we owe Vail a great debt for keeping the U.S. telephone
industry in private hands.
No Friend of the Market
But Vail was no friend of the free
market or of competition. A distinguished business philosopher, he produced a
number of essays and speeches which show that he clearly favored using the
power of government to help him reach the goals he sought for the telephone
industry. "One Policy, One System, Universal Service," was his emphasis, and
he also said, in 1911, that a "public utility giving good service at fair
rates should not be subject to competition at unfair rates." 6
This seemed a reasonable idea in a time
when the public was indignant about the profits of huge corporations and
trusts. The concept of giving good service and accepting only "fair" rates in
return seemed to show remarkable restraint. It also seemed reasonable to
accept government regulation. Vail noted in a 1915 speech that the telephone
was considered a necessity: "Society has never allowed that which is necessary
to existence to be controlled by private interest." But he defended the
monopolistic aspect of the Bell System because of its efficiency and devotion
to service and the public interest, and he felt that regulation would work
well provided men "of the highest standard" could be appointed to the
regulatory bodies for life, with careful provisions made to safeguard their
independence from corporate or political pressures. 7
Although Vail's beliefs appeared wise
and sound, any present day student of business and government would know he
was not talking about the real world of commerce and politics. For one thing,
"fair rates" sounds marvelous in a speech, but it becomes elusive when
regulatory officials actually try to make rate decisions. Few subjects today
are more controversial than the rates charged by public utilities, and "rate
hearings" by state commissions are sometimes the scenes of near-violent
demonstrations with frequent heckling and name-calling.
No Government Body Can Be Free from
It is also unrealistic to believe, as
Vail apparently did, that any government body can be free from corporate or
political pressures. What he idealized, of course, was a statesmanlike group
that would make profoundly wise decisions in the public interest and without
the aim of benefiting or penalizing any part of society. As we know, however,
all regulatory bodies are subject to pressures of various kinds, to say
nothing of the convictions and prejudices held by individual members. And even
lifetime appointments do not make people "independent" as Vail wanted them to
be. For one thing, persons on lifetime appointments always know that their
status, if necessary, can be changed by public vote, and they are also
vulnerable to other public sanctions.
Still, it is to Vail's everlasting
credit that his prescription for the Bell System did work well for many years.
AT&T built what was considered the best telephone system in the world. Bell
System officials usually won cooperation from federal and state officials and
were left free to manage the telephone business in most important ways. They
carried out their mission of service with great skill, and they also took care
not to flaunt their monopoly position. The telephone operator was always
pleasant and helpful, the service truck always arrived promptly, and Bell
people would go to any lengths to get systems working again when there was
Moreover, the system moved ahead on the
technical front, and we came to expect frequent improvements: rotary dialing
that eliminated need for calling the operator, direct dialing of long
distance, WATS service, and better telephones. With a system that covered more
than 80 per cent of the nation's telephones, Bell could do extraordinary
things to get long distance calls through when circuits were busy in certain
areas. With service like that, why would anybody want a different kind of
But trouble was never far away from the
Bell System. One of the prickliest matters was Bell's ownership of Western
Electric, the manufacturing subsidiary that produced most of the equipment for
AT&T. A plus-$12 billion-a-year business in 1982, Western Electric had long
been under attack. Indeed, it was to force the divestiture of Western Electric
that prompted the U.S. Justice Department's 1949 civil suit against Bell. To
AT&T, Western Electric was a necessary part of its operations and helped it to
assure a high quality of service. To others, it was simply another
manufacturer that was able to maintain a government-sponsored monopoly
position because the 22 Bell operating companies were captive to it and had to
buy most of their equipment from Western Electric. Some believed that Bell
officials manipulated Western Electric's bookkeeping, and the like, to produce
tax advantages for the company. Whatever the facts, there was no denying that
Western Electric held a monopoly position that simply wouldn't have existed in
a nonregulated environment. This was a festering issue with companies that had
the expertise and technology to compete with Western Electric, but were denied
entry to the market.
More serious trouble came for the Bell
System as a result of its ratemaking and costs policies. In 1934 Congress
passed the Communications Act which gave the newly formed Federal
Communications Commission jurisdiction over AT&T (although state regulatory
bodies also controlled the local Bell companies). According to a recent AT&T
publication, the Communications Act "put into law the long-standing AT&T
principle of providing universal telephone service at reasonable cost. One
result was to subsidize lower residential rates by raising the cost of long
distance service and business services-an action that set off a continuing
controversy in the ensuing years." 8
The Achilles' Heel
This rate-setting policy, seemingly an
advantage in the 1930s, became the Bell System's Achilles' Heel in the 1960s.
It also shows, more than almost anything, how far the Bell System had been
able to stray from the usual constraints that face business organizations in
the marketplace. No business with competitors can deliberately reduce its
prices to one group of customers while making up the difference by
overcharging other groups. This would be certain to bring at least two
undesirable effects: 1) There would he excess demand for the underpriced
commodities or services, bringing additional losses to the business, and 2)
competitors would swoop in to capture the overpriced part of the business,
making the original pricing strategy unworkable.
But Ma Bell could adopt such a pricing
policy because of the telephone company's monopoly position, which the
government protected. Company officials knew that certain parts of its markets
were tempting targets for potential competitors. But both Bell policy and
public policy, backed by the police power of government, kept raiders out of
these markets. More than almost anything, this policy showed how responsive
the Bell System was to political moods and trends. The practice of holding
down residential rates and overcharging long distance users was really a
subtle form of the "soak the rich" policies that had come to dominate
government thinking in the 1930s. It is also true that residential users, as a
group, command more votes in state and federal elections than do long distance
and business users. What the rate policy really meant is that long distance
and business users were being taxed, with Ma Bell as the collector, to
subsidize residential service. This gap became very large over time. An Ohio
Bell official said early in 1983, "We're collecting, on the average, about $12
a month for basic local service from each residence customer. The gap between
this $12 price and the $25 cost is currently recovered from other services
priced considerably higher than their costs." 9
This unusual rate-making policy might
have continued virtually unnoticed for a number of years except for two
developments. One, the FCC in 1968 issued its famous "Carterfone" decision
which opened the way for business and residential use of interconnecting
equipment. Then, aided by new technology, a company called MCI was given FCC
authority to proceed with long distance services in a selected market. A 1978
federal appeals court decision later upheld MCI (and others) in serving long
distance customers, previously a Bell fiefdom.
The Bell System's Dilemma
Critics of the Bell System approved of
these moves and there was widespread agreement that it was about time AT&T
faced some "real competition." Dismayed AT&T officials tried to fight back by
accusing competitors of "cream skimming," i.e., taking the most lucrative
markets and ignoring other telephone services. This is the same argument the
government uses to protect its monopoly on first-class mail, and it actually
has merit. It really is not fair to place one organization under tight
control, with bureaucratic management, and then suddenly expose it to
competition from other firms who are free to select their markets. Mises would
have understood the Bell System's dilemma immediately: It was following
pricing (or rate-making) rules that had been worked out over time by public
authorities. Its assignment had been to promote widespread use of an essential
necessity, the telephone. It carried out this mission and then, abruptly, FCC
and federal court decisions brought a radical change in the rules.
It's hard to say what the long-term
effect of these new rules will be, but it's clear that the Bell System was
already being devastated by competition even before the 1982 divestiture
announcement. A large number of all new business installations were non-Bell,
and MCI and Sprint have captured part of the long distance market.
Competitors' shares of both long distance and business markets could balloon
to enormous size unless AT&T is able to counter this competition.
Lack of Flexibility
Meanwhile, the Justice Department in
1974 had again filed suit to force the divestiture that has now taken place.
AT&T Chairman Charles L. Brown noted that Bell - which had been barred from
entering the computer field by the 1956 Consent Decree - faced a "fence with a
one-way hole in it"- a hole that admitted Bell's competitors but did not
permit the company to compete back. 10It's also true that the
Carterfone and MCI decisions were of the same order. Bound by regulation and
excessive rules, the company simply did not have the flexibility to strike
back at these new competitors in the way any lean, marketing-oriented company
is likely to do.
Even without divestiture, giant AT&T
would eventually have come to grief if it had attempted to continue under
close regulation while new competitors plucked away at its choicest markets.
For one thing, where would it have found the revenues to continue subsidizing
residential service? And how could it have elevated residential rates to
reflect their true cost when these matters are controlled by state public
utility commissions? The company was in a no-win situation, and Bell officials
were glumly aware of it.
What killed Ma Bell? Well, a number of
forces moved against her in the end: competitors, critics, the FCC, the
Justice Department and federal courts. But she really passed on because her
method of management - the bureaucratic management that is useful for public
institutions - is ill-suited for competitive battles. From the sound of their
advertising and the restructuring they're undergoing, AT&T and the new Bell
offshoots are becoming more attuned to the demands of the marketplace. They'll
need to become attuned. There are lots of hungry competitors out there who
want a piece of the action, and there will be dramatic shootouts in pricing,
services and technology.
People who hail the new competition in
the telecommunications field should not be too critical of Ma Bell in her era
of monopoly. Her performance and service were marvelous compared with the
performance and service of government-owned telephone systems elsewhere. If
the choice is only between a government-owned, government-operated enterprise
and a private, profit-seeking enterprise regulated and controlled by
government, the Bell System record seems to say that the latter is better.
The mistake, which both the public and
Bell accepted, was in believing that anybody should be granted a business
monopoly enforceable by law. It's true that the early telephone industry
appeared chaotic and inefficient when two telephone systems in the same area
could not connect with each other. In short order, however, the needs of the
customers, merger, or improved technology would have overcome this problem.
And "natural" monopolies, to the extent that they exist, become outmoded. The
railroads, for example, once had a monopoly on fast overland transport; this
was quickly bypassed by the trucking industry in the 1930s. In the same way,
the telephone companies' natural monopoly on service in a given area may soon
be bypassed by a profusion of new technologies.
The 22 Bell operating companies, which
will continue to be regulated under the umbrellas of the seven holding
companies, may have trouble maintaining their position when new methods of
bypassing them are marketed. AT&T itself, with its prestigious Bell
Laboratories, Western Electric, and Long Lines may become a strong competitor
in pushing these new technologies. But its protected, captive market is gone.
Ma Bell was a grand old lady in her day.
We might agree with Art Buchwald, who called her "the only monopoly I ever
loved." But we wouldn't really want her back.
At the time of the original
publication, Mr. Barger was a corporals public relations representative and
writer in Toledo, Ohio.
1 Ludwing von Mises, Bureaucracy (Cedar
Falls, Iowa: Center for Futures Education, 1983; N.Y. 1969; an unaltered,
unabridged reprint of the 1944 Yale University Press edition).
2 Ibid., p. 44.
3 Ibid., p. 45.
4 Ibid., pp. 65-66.
5 Alvin von Auw, Heritage & Destiny (New
York: Praeger Publishers, 1983), p. 5.
6 Theodore N. Vail, Views on Public
Questions, 1917. A privately published collection of writings and speeches.
7 John Brooks, Telephone (New York:
Harper & Row, 1975, 1976), p. 144.
8 AT&T Communications, a pamphlet
published by the new AT&T to explain the divestiture and the services it will
offer in the future, p. 6. From AT&T, New York.
9 W. E. MacDonald, The New Ohio Bell in
the Age of Information, Speech before Toledo (Ohio) Rotary Club, February 28,
10 Alvin von Auw, p. 29.
Reprinted with permission
from The Freeman, a publication of The Foundation for Economic Education,
Inc., April 1984, Vol. 34, No. 4.
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