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How AT&T Works


Theodore Vail

Finally Hubbard found the man with the plan: Theodore Vail. Vail was in charge of the U.S. Postal Service, which had taken great advantage of technological innovations such as the railroad and the telegraph to make it the envy of the world. Vail took the helm and sized up his quarry: Western Union. Western Union had seen possibilities in the "electrical toy, "after all. They had just started offering their own telephone service using Bell telephones.

Vail began legal proceedings against Western Union for patent infringement. Western Union was a huge company -- it had money to spend and an army of patent lawyers. Against huge odds, Vail enlisted a legal army of his own. With the law on his side, and an uncompromising attitude, Vail forced a favorable settlement with Western Union. The news of the deal was explosive, and overnight Bell Telephone leapt into the communications arena as a preeminent power.

After the settlement, Bell Telephone's fortunes and stock price rose steadily. In 1881, Bell issued its first annual report, which showed 100 percent growth in distribution from the previous year. As good as this news was, Vail felt that time was not on their side. Up to that point, Bell Telephone had functioned on a franchise system. Independent businesses paid a fee to deliver Bell telephone service in a specific territory. Bell Telephone earned revenue by selling franchise licenses and leasing telephones. Until Bell's patents expired, the company was the exclusive manufacturer and provider of telephones. The patents were set expire in 1894, opening up the telephone market to intense competition.

Vail's vision of a national utility controlled by a single company could not be fulfilled without a major shift in strategy. Vail saw the development of long-distance telephone service connecting the entire country to a single network as his solution. Vail believed that Bell Telephone's future would be secure if it could build a national network and function as a national utility before its exclusivity ran out. This was an expensive proposition, but it would be even more expensive for a viable competitor to build out a network to challenge Bell Telephone.

Vail may have been a little ahead of his time, as the capital outlay was too rich for some powerful members of his board of directors. Costly capital investment eats up profits and pays a lower dividend on shares of stock. Revenue spent towards building out the network meant less money in the pockets of investors and board members. Frustrated by opposition from the board, Vail resigned in 1887.

When the time came for Bell's patents to expire, the company had not built the network Vail felt was necessary to discourage competition. By the end of the century, Bell Telephone had to vie against 6,000 competing companies, serving 700,000 customers. Bell's customer base had grown to nearly one million. The telephone was becoming a part of American life.

So was part owner J.P. Morgan. The infamous "robber baron" had built an empire of commerce so powerful that if it existed today, it would be illegal. He seemed to control the entire financial system with his companies and his cash. In the depression of the late 1800s, J.P. Morgan single-handedly stopped the slide of stock prices. Fellow "robber barons" Rockefeller and Carnegie were powerful financial titans, but they did not possess the combination of will, cash and power that Morgan did.