How AT&T Works

AT&T's story is one of innovation, conquest, endurance and revival. Since its birth in 1876, AT&T started a communications revolution, established an invincible monopoly, was dismantled by the government and rose again as a major player in a new era of digital communications. In this article, we'll learn exactly how AT&T works.

At the time of its breakup in 1984, AT&T had been in business for 107 years. As the largest company on earth, AT&T employed more than a million people. Despite its size and age, AT&T remained an engine of innovation, developing world-changing technologies like the transistor, the solar cell and Unix. Throughout much of its existence, AT&T's total dominance of its core business was constantly challenged by its only true rival: the government of the United States of America.


"Ma Bell," as the company was known, was a monopoly in two senses of the word. Its aim was to remove all competition to make way for its national telephone system. It also enjoyed government sanction for much of the 20th century. That policy ended in 1984, when the Department of Justice forced AT&T to split into eight different companies. The 1984 settlement separated local phone service from long-distance service. AT&T took long distance, while the other seven companies -- commonly known as the "Baby Bells" -- managed regional, local phone service. The break up rendered AT&T's prior mission irrelevant, and the new companies had to discover new reasons for being. To know how AT&T works now, it's important to see how AT&T worked in the past.

The Beginning

The company that eventually became AT&T began with the telephone's inventor, Alexander Graham Bell. Bell was born in Edinburgh, Scotland, in 1847. His father, Melville, was a speech instructor specializing in teaching the deaf to speak. Alexander followed his father in the family business and took his expertise to the United States at Boston University's School of Oratory in 1873. There, Bell was given more opportunities to explore his interests in the transmission of speech via electric signal. The fathers of two of his students, Thomas Sanders and Gardner Hubbard, encouraged Bell's investigations and financed his project. With Thomas Watson as his research assistant, Bell went to work. At the time, the telegraph was the only means of electrical communication available. It functioned on an intermittent electrical signal, carrying electrical charges in short bursts of Morse code. Bell guessed that for speech to travel through wires as an electric charge, it would have to be a continuous, undulating signal.

On March 10, 1876, Bell's intuition became reality. As the story goes, Bell and Watson were at work in separate rooms. Bell had a simple microphone to pick up his voice and Watson had the speaker to recieve the signal. Bell spilled liquid on his desk and said reflexively, "Watson come here, I need you." Watson wasn't within earshot, but he heard the request just the same. He received the call from the telephone. A patent attorney, Hubbard had already filed patents in Bell's name for the device. Now he and Sanders formed a company to sell this new invention to the world: the Bell telephone.

At first the telephone got quite a bit of attention as a technological wonder, debuting at the Philadelphia Centennial Exhibition on July 25, 1876. But the initial excitement waned and customers were scarce. Bell returned to Scotland and left the business operations to Hubbard. Without visionary leadership, Bell Telephone looked as if it wouldn't last the decade, much less conquer the next century. Hubbard offered the company to William Orton, then president of Western Union, for $100,000. Orton passed, dismissing the telephone as an electrical toy.

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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.


One Policy, One System: Universal Service

After a long power struggle, J.P. Morgan finally won control of American Telephone & Telegraph in 1907. (Bell Telephone's new name as of 1899.) One of his first acts was to return Theodore Vail to the position of chairman. Even at 62, Vail was fully committed to making his vision a reality. This time he had Morgan to stave off any mischief from the board. Of course, he also had to do what Morgan told him to do.

Vail returned to a company that scarcely resembled the efficient organization he had built. Long-distance service had grown, but slowly. Conditions for workers had become dangerous, and their morale had fallen. Vail's response was to set what many considered an impossible goal: a transcontinental telephone line stretching from New York to San Francisco. He demanded that it be finshed by 1914 -- the same time that the Panama Canal was scheduled to be completed.


This was no mean feat. Long-distance lines had been plagued by a phenomenon called attenuation. The electrical signal traveling down a copper line will weaken as the length of that line increases. Long distance lines compensated for this by increasing line thickness. The New York to Chicago line was one-sixth of an inch thick. The distance needed to achieve a New York to San Francisco connection was impossible to overcome with available technology. In order for the transcontinental line to work, AT&T would have to invent something which would amplify the signal as it went. Vail had proposed an achievement requiring technology that did not yet exist, and he knew it.

A group of high-level AT&T engineers put the word out that whoever developed a method to amplify phone signals would recieve a huge reward. Dr. Lee de Forest presented his invention, the audion, to the engineers. It was the first three-element vacuum tube. Though it needed some work to be effective for telephony, it was the key technology AT&T needed to make good on its promise.

It was also an example of the many tremendous, if occasionally inadvertent, contributions that AT&T has made to technological innovation in its 130 years. Until it was replaced by the transistor, the vacuum tube enabled the development of radio, television, radar and computers.

For AT&T, these potential uses were secondary to their basic aim: "One policy, one system, universal service." This was Vail's ambition for AT&T, and the transatlantic line realized this ambition. Much the same way the Panama Canal brought two oceans together, AT&T's New York to San Francisco line would bring America's two coasts together.

Not only did AT&T achieve this goal, but it finished ahead of schedule. As this milestone was nearing completion, Morgan acquired Western Union for AT&T. The idea of this emerging superpower now having access to Western Union's network became a concern for lawmakers known as trustbusters. Trustbusters sought to use government power to limit the ability of giant companies like US Steel and Standard Oil to control their markets by fixing prices and eliminating competition. In 1912, they took aim at AT&T.

At the time, AT&T was developing into a monopoly. Its national local and long distance network excluded independent phone services from its use, and it had already grabbed enough of the market to dictate prices and contain the growth of its competitors. Morgan wanted to fight the anti-trust charges all the way to the end, and he did. JP Morgan died in 1913 at the age of 76.

Vail was never a "robber baron." The former head of the U.S. Post Office did not see the objectives of his company and those of his government as being mutually exclusive. Without Morgan to disagree, Vail settled with the U.S. government; AT&T agreed to allow some independent telephone companies to use their network. In return for the government's demands, AT&T became another kind of monopoly: one sanctioned by the government. After the Kingsbury Commitment, AT&T had a mandate to function like a national utility and expand its service to every corner of the union.


What AT&T Did (and Still Does)

After the Kingsbury Commitment, AT&T was off and running. Now with government sanction, AT&T was free to fulfill Vail's vision of "universal service." In the succeeding decades after 1913, AT&T consolidated its hold on the market and continued to expand almost uninterrupted until 1949. By that time, AT&T was a monopoly with no equal.

To give a sense of the scope of AT&T's functions at it height, imagine if Alexander Graham Bell invented the automobile instead of the telephone. AT&T would have owned and built the entire interstate highway system, every service station, even every traffic light and road sign. No one would "own" a car. Automobiles would be rented to subscribers. Every toll booth would pay Ma Bell, and there would be no freeways to drive on -- much less free roads.


That's exactly what AT&T did for telephones. It manufactured the device and built the network for that device to transmit its messages along. The Bell System represented the world's first complex electronic network. The standards AT&T set for the composition of its ever growing network are the same standards and systems applied to networking today, no matter what kinds of devices are being connected.

AT&T breaks the network down in to three elements: transmission, switching and management. One way or the other, all modern networks are organized in this way.


Transmission covers all media used to transmit a voice signal. In the beginning, copper wires strung between exchanges carried the signal. As distances increased, attenuation forced long-distance lines to become thicker to help maintain the signal. Properly spaced loading coils helped diminish resistance on the line, decreasing the need for thicker wires. The development of vacuum tube repeaters ushered in the transcontinental telephonic age.

Transmission technology continued to evolve with the development of the transistor. The transmission path evolved to broadband delivery via coaxial cable, wireless relay, satellite communication and fiber optic cable. AT&T built and deployed cables across the ocean floor and underground over long distances. Enabling transmission was key to AT&T's growth, as well as essential to achieving "universal service."


Without switching, you would need to have a cable for each person you called via landline. Switching enables specific routes to be used over and over again. Your call begins at your local exchange. Depending on where it's going, it will then be relayed to a long-distance call center or to another local exchange, moving from node to node along a hierarchal chain until your call reaches its destination.

In the early days of the telephone, operators did the switching manually. A caller would tell an operator where he wanted his call to go, and that operator would have to figure out how to route that call through the transmission network. As time went on, a hierarchy was established for routing calls. For long distance, your local exchange would use one of 2,000 toll offices to one of 140 primary centers, which then connects to one of eight regional centers and then back down the chain to the local exchange for the location of your call. AT&T kept this hierarchy in use until the 1980s. By then, the switching had become automated and instantaneous. (For more information on switching, check out How Telephones Work.)


The development of this hierarchy was the result of network management. We take network management for granted today, given that all electronic data transmission now travels over a network. AT&T had to develop it from scratch. As phone traffic increased, management became as important to making calls happen as the equipment enabling the call. What began as individual operators discovering the best way to complete a call circuit became a highly complex combination of automated systems and traffic monitors coordinating millions of calls a day.

AT&T could manage increasing volumes of traffic because it controlled the network. As a de facto national utility, AT&T could direct its resources through a central command structure. This approach could not have been achieved in a system of multiple networks managed by multiple competing providers. A monopoly had to build and manage a single system before providers could compete for delivery of service on that system. For proponents of the monopoly, the network and its management justified its existence.


The End of Monopoly

AT&T paid dearly for its monopoly status. Each time the government took action against AT&T for anti-competitive behavior, Ma Bell had to give up a piece of its future. One example of this was the "consent decree" it signed in 1956. This was a contract AT&T made with the United States government. The decree set very specific limits on AT&T when it came to conducting business outside its basic function. AT&T could remain the telephone monopoly, offering its phones and phone service to the public, but at a price.

That same year, Bell Labs' scientists won the Nobel Prize for inventing the transistor. Transistors are the building blocks of integrated circuits and microchips. The information age would not exist without the innovation of the transistor. The 1956 consent decree forced AT&T to put the transistor patent in the public domain. That meant AT&T couldn't make any money off of other companies using transistor technology for its products.


Not that AT&T was trying to do so in the first place. The 1956 consent decree completed a process which began in 1949, when the government filed its lawsuit to break up AT&T. Bell Labs invented the transistor in 1947 as an improvement on the vacuum tubes AT&T was using to improve the quality of its long-distance service.

The transistor had many more applications than boosting a phone signal, but the last thing AT&T could do was keep such a revolutionary technology all to itself. Otherwise it would risk even more ire from "trust busting" lawmakers. As a gesture of good faith, AT&T said it would share its transistor technology to any company willing to pay $25,000. The companies that became licensees made their names in transistor and semiconductor technology: General Electric, Texas Instruments, IBM and Sony, to name a few.

At the time, AT&T insisted that its monopoly served the public interest. The innovations pioneered by Bell Labs, and AT&T's lack of interest in exploiting them, appear to confirm this notion. To list the number of important innovations, inventions and technologies that came out of Bell Labs over the 107 years AT&T was "Ma Bell," is more than the scope of this article. Even the highlights are impressive:

AT&T remained a colossus from 1913 to 1982. In 1982, the company had its last run-in with the government. Despite the Kingsbury Commitment and the 1956 consent decree, lawmakers in Washington continued to hammer away at Ma Bell. At that point, AT&T was spending $360 million in legal fees to defend its monopoly status. It was fending off anti-trust suits from dozens of states, the federal government and the private sector. When Chairman Charles Brown learned that the federal judge on the case thought AT&T was going to lose no matter what, he decided that a negotiated surrender was better than an unconditional one. In 1982, he announced that AT&T was going to break up into separate companies by 1984. It was the end of the road for Ma Bell.

In the 1984 breakup, AT&T split into eight pieces as "Ma Bell" gave birth to seven "Baby Bells." The Baby Bells were seven companies made up of AT&T's 22 operating companies: Nynex, Bell Atlantic, Ameritech, BellSouth, US West, Pacific Telesis and Southwestern Bell. In the deal, AT&T kept its name, its long distance business, its manufacturing arm and Bell Labs. The Baby Bells appeared stuck with the least profitable parts of the Bell System: local service and the century-old copper wire network to carry it.

The conventional wisdom was that AT&T reserved the best parts of the company for itself. However, AT&T wasn't built as a collection of interchangeable modular pieces. AT&T may have had the profitable long-distance business, but not the means to deliver that service "door-to-door." In order to bring the signal from a long-distance line from one phone to the other, it had to pass through a Baby Bell's local copper wire system. The Baby Bells charged access fees for use of that last mile of wire connecting to someone's home. It was as if nerve signals from your foot had to pay a toll to get to your < a href="brain.htm">brain. This put AT&T at the mercy of its former appendages.

Another far-reaching decision AT&T made during the breakup was to give up its rights to wireless telephone service and infrastructure. No one expected the coming revolution in mobile technology with the cell phone. The Baby Bells, initially resentful about the breakup, appeared to have had the better part of the deal. Paradoxically, a Baby Bell became AT&T's salvation in its darkest days.


After the Breakup

AT&T went from nearly $150 billion in assets before the breakup to $34 billion in total assets. That's a 77 percent drop in asset value, and it happened with the stroke of a pen. AT&T spent the years after 1984 trying to preserve its long-distance business and seeking new streams of revenue in a rapidly changing, competitive market.

AT&T went from the safe confines of monopoly power into the "sink or swim" environment of the free market. The 1984 decree opened long-distance service to outside competition for the first time. In the Ma Bell days, the company depended on long-distance service to keep profits up. Local service was priced nearly at cost, while long distance prices could be inflated without much complaint. The post-divesture AT&T may have had Ma Bell's profit machine, but that machine's potential for driving profits would decline significantly in a "price war" atmosphere. Looking to grab a piece of AT&T's market, long-distance carriers such as Sprint and MCI priced their services low enough to undersell AT&T.


MCI emerged as AT&T's main competitor in the long-distance market. Price wars between these two companies shaved profits away from AT&T. No one knew that the company that would become WorldCom was deceiving Wall Street with overly optimistic performance reports.

Companies looking to grow often borrow capital to invest in their infrastructure. SBC, which began as the Baby Bell named Southwestern Bell, invested in expanding its services to include data, video and voice. By doing this, SBC went from being the smallest of the Baby Bells to being the biggest.

AT&T continued with its plan to end dependence on long-distance as a profit center. This was made more difficult by the exponential increase in long-distance volume in the years following divesture. In 1984, AT&T carried an average of 37.5 million long distance calls each business day. Five years later, it carried 105.9 million calls. Ten years after that,it carried 270 million calls on the average business day. It was hard for AT&T to ignore a 620 percent increase in market demand. But AT&T boldly pursued its strategy. In 1991, the company acquired computer manufacturer NCR, so that it could leverage its networking knowledge and skill toward computer manufacture. Three years later, AT&T finally jumped into the cellular market by purchasing McCaw Cellular, the largest cellular operator in the country at the time.

The McCaw purchase marked a major change in direction for AT&T. In 1995, the company announced that it would separate into three companies: NCR, Lucent Technologies and AT&T. AT&T's manufacturing arm and the Bell Labs name went to Lucent, and NCR went its own way. AT&T's hope for a piece of the computer market did not pay off, and manufacturing was getting in the way of its plan to become a communications services company. AT&T kept many of the Bell Labs' scientists to create AT&T Labs, still an innovator in communications technology.

The restructuring couldn't have come at a better time, because the Telecommunication Act of 1996 was just coming around the corner. This sweeping legislation finally opened up local and long-distance telephone service, as well as cable television markets, to more competition. This represented a golden opportunity for AT&T to follow the trend to converge voice, data and video services into one digital service. It also exposed their primary markets to larger and more dynamic competitors.

Undaunted, AT&T jumped in with both feet. The company spent billions of dollars to convert its entire network from analog to digital data delivery, acquire local phone service providers, purchase cable giants MediaOne and TCI and launch its successful WorldNet Internet service. AT&T also pioneered new media services such as interactive television, broadband Internet service, business-to-business communication solutions, TV phones, Television over Internet Protocol (IPTV) and voice over Internet Protocol (VoIP).

AT&T's fortunes continued to wane with each reinvention. It seemed that no matter how successful one of AT&T's new businesses was, the company still clung to long distance to drive its profits. By the end of the 1990s, AT&T's long-distance revenue was decreasing at a rate of 20 percent per year.

In October 2000, AT&T made an announcement many considered to be the beginning of the end. AT&T had just spent over $100 billion to acquire two cable television providers as part of a plan to offer bundled services under the AT&T brand. It believed that delivering cable TV, long distance, wireless, local phone service and Internet access could create that new stream of revenue AT&T desperately needed. This strategy was central to insuring AT&T's future.

Suddenly, Chairman Mike Armstrong announced that the company was restructuring. AT&T was to split into four companies, each delivering separate services. After going into debt to acquire cable providers MediaOne and Tele-Communications Inc., AT&T was on the verge of bankruptcy. Separating the companies would isolate the debt, and hopefully raise the money it needed to remain solvent. Unfortunately, Wall Street could see that too. AT&T's stock lost $3 per share that day and $6 more per share after that, totaling in a loss of $100 billion of market value for the year.

In 2005, SBC purchased the company for $16 billion. The numbers speak for themselves. AT&T, once the largest company on earth, was bought at a discount by one of its former satellites.

SBC: Ma Bell's Heir Apparent?

Unlike AT&T, SBC used government power to its advantage. Where the government forced AT&T to cede its share of the market to competitors, SBC got laws on the books that protected their markets from outside competition. This tactic, guided by SBC Chairman Ed Whitacre, worked well when the SBC was the smallest of the Baby Bells. When SBC appeared on government radar as a coming giant, the company had to change its approach. Even as SBC opened its territory to competitors, it acquired another Baby Bell (Ameritech) and expanded its reach to Chicago and the Midwest.

Ed Whitacre's acquisitions showed the many potential strengths of SBC. His choice of acquisition, usually a Baby Bell, meant that he was integrating former pieces of a larger company. These pieces had a better chance of meshing well with the core company, something known as synergy.

SBC's strategy of perpetual growth gave it the power it needed when competition threatened its markets. Over time, SBC put itself in position to become worthy of a predecessor to Ma Bell. SBC is not a monopoly by any means, but it has visionary leadership and a grand strategy for the future. Just as the AT&T once contended with triumph and adversity by following its "universal service" dictum, SBC has followed Ed Whitacre's mission of creating a universal platform for digital communications in the information age.

Many have insisted that SBC's purchase of AT&T represents "the end" for AT&T as an independent company. SBC began as a Baby Bell and is the creation of Ed Whitacre -- who worked his whole life for AT&T before the break up. Now SBC-AT&T calls itself "the new AT&T." This new company has the size, the infrastructure and the leadership to play a part in networked media's future.

Times have radically changed since 1984. The technology that first enabled the Internet to reach your home was the telephone line. Now VoIP is poised to overtake "traditional telephony" as the way people communicate. Given the many ways devices can connect to the Internet, from broadband cable to to WiFi, a single company controlling every point of contact between subscriber and service is hard to imagine.

As the largest telecommunications company in the United States, the new AT&T may give that concept a run for its money. Offering a wide assortment of cutting-edge communications services, and promising the delivery of "next wave" technologies like IPTV in the near future, AT&T can stake a claim to communication's future just as it owned its past. After 130 years, AT&T remains at the vanguard of innovation and commerce.

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