Network Effects and Regulation

Vail also understood that monopolization would only be accepted politically if government would be in control of the rates charged by the monopolist. Subscribers did not like the dual system, but they were afraid a return to monopoly would increase telephone rates. In fact, “morganization” in railroads had created popular resistance to the concentration of economic power, the adoption of the first federal antitrust act, the Sherman Act, in 1890, and the divestiture in 1903 of the railroad conglomerate Northern Securities backed by JP Morgan. To avoid this fate, the Bell System actively promoted regulatory intervention as a counterbalance to the monopolization of the telephony service.

Linking regulation to monopolization was fully successful as a strategy, since the adoption of the Willis-Graham Act in 1921, which allowed telephone operators to acquire any competitor with only the approval of the Interstate Commerce Commission and the exclusion of the antitrust authorities. In 1934, the Federal Communications Commission (FCC) was created, with the mandate to enforce the entry-and-price regulation model originally envisaged by the Bell System 30 years earlier.

National monopolies in telephony were the prevalent market structure not only in the US, but also in Europe and the rest of the world for most of the twentieth century. A standardized system of telephone numbers, implemented on a global scale by the International Telecommunications Union (ITU), identified any subscriber in the world. The telephone would eventually also achieve universality in geographic terms, at least in Western countries, even if at a slower pace than expected.

What was the economic rationale behind monopolization? The experience of the independents proved that a monopoly was not necessary to ensure investment in infrastructure. On the contrary, competition between literally thousands of independent carriers had advanced the penetration of the telephone service far more than in Europe, where state-owned monopolies had been the norm from the origin of the industry in most countries.

From a network theory perspective, the monopoly facilitated the harvesting of all the network effects derived from a single infrastructure providing service to all existing users.

As relevant as the infrastructure monopoly was, the role of the monopolist was to ensure the universality of the service; that is, the possibility for any user to communicate with any other user. As a counterbalance, regulation would then ensure that the benefits would be fairly distributed in the form of low rates, and not monopolized by the network manager.

As Mueller brilliantly described in his analysis of the early days of the telephone,'4 economies of scale were not the driver behind the success of the Bell System. It was network effects and the aggressive pursuit of the largest network effects driven by Vail that led to monopoly. This was not specific to telephony, as a similar evolution can be identified in electricity, railways, aviation, and other network industries around the world.

Vail was probably one of the first individuals to grasp the power of network effects. His experience in the management of the three leading communications networks of his age (posts, telegraphs and telephones) was definitely helpful. Vail would have been a great leader for a digital platform in Silicon Valley in the twenty-first century.

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