Interconnection Policy and Technological Progress

I. INTERCONNECTION POLICY BEFORE 1996 II. INTERCONNECTION AND THE TELECOMMUNICATIONS ACT OF 1996 III. THE INTERNET AND INTERCONNECTION I. INTERCONNECTION POLICY BEFORE 1996 The network effect in telephone service makes a larger system more valuable to the consumer than a smaller system in the absence of interconnection. (1) Interconnection with no settlement payments among firms eliminates the network effect as a competitive factor and allows small firms to compete with large firms. Although network effects were not developed formally in the economics literature until the 1970s, nineteenth century railroad, telegraph, and telephone executives recognized the critical role of network effects in their strategic interactions with competitors. The emergence of network effects in telephone competition has been a joint product of technology and regulation. The characteristics of interconnection requested by competitors of the dominant firm has changed in a manner corresponding to the current technology. While public policy toward interconnection has also evolved, there is no mechanism that automatically adjusts the policy to changing technological requirements, and dominant firms can be expected to resist the extension of interconnection policy to accommodate new technological requirements. The earliest telephone competition after the fundamental AT&T patent expired, occurred without interconnection, but the large number of potential customers without telephone service and the short distance covered by most telephone calls allowed both AT&T-controlled companies and their competitors to flourish without interconnection. As AT&T developed a monopoly long-distance network, its control of interconnection between AT&T-controlled telephone companies and the long-distance network became an important source of competitive advantage. The antitrust settlement of 1913, the Kingsbury Commitment, provided the first interconnection requirement, but also led to the end of effective competition and the beginning of regulated monopoly. During the regulated monopoly era, there were no competitive interconnection requirements. AT&T controlled service on an "end-to-end" basis and prohibited foreign attachments while interconnecting with noncompetitive independent domestic telephone companies and with foreign telephone companies that serve geographic areas separate from those served by AT&T. The Communications Act of 1934 established a "duty of every common carrier engaged in interstate or foreign communication by wire or radio ... in cases where the Commission, after opportunity for hearing, finds such action necessary or desirable in the public interest, to establish physical connections with other carriers...." (2) At the time that provision was passed, the relevant connections were among carriers serving separate geographic territories, but the provision stipulated a statutory basis for the Federal Communications Commission ("FCC") to mandate interconnection when competition began. Technological progress, especially the dramatic decline in the price of electronic components, upset the established regulated monopoly industry structure and price patterns during the 1970s. As entrepreneurs recognized that the cost of providing both long-distance service and specialized terminal equipment was below the price charged by AT&T, they attempted to enter the industry in competition with AT&T. While the earliest private-line microwave systems operated without interconnection, most competitive entries required some form of interconnection. Because interconnection could only be required after opportunity for hearing when the FCC found that interconnection was necessary or desirable in the public interest, the early competitive interconnection requests were debated throughout many years of hearings on a wide range of specific issues. (3) The FCC's grant of interconnection authority to specialized common carriers created initial competition in long-distance private-line circuits that was later extended to switched long-distance service. …