Seven years ago, "deregulation" was the rallying cry of an economic revolution advocated by Democrats and Republicans alike. The idea came into political vogue when President Carter tossed out federal rules governing air routes and prices. Since then, federal regulations have melted away in one industry after another. But in many cases, it appears that the real winners have been the largest multinational corporations, not the entrepreneurs and small companies that were supposed to gain a new opportunity to compete.
The most obvious cautionary tale lies in the telecommunications industry. Last summer, IBM Corp. announced that it was acquiring a major stake in MCI Communications Corp., one of the few serious long-distance competitors of American Telephone & Telegraph Co. That alliance "implicates deregulation," says a former Justice Department lawyer who helped prosecute the antitrust case that led to the breakup of AT&T. "It says that it's going to be difficult for the industry to be structured with a bunch of small companies nibbling at each other all the time. This is elephant-rutting season."
The irony is that it was MCI chairman William G. McGowan who signaled the end of small-company competition in the industry by rushing into the arms of IBM. This was the same McGowan who was largely responsible for forcing deregulation of the industry in the first place, and promoting the idea that smaller companies could compete.
In the late 1960s, after starting and selling a few technology businesses, McGowan sunk his small fortune into MCI, then little more than a shell corporation.The phone industry was heavily regulated and dominated by AT&T, a sanctioned monopoly. That didn't faze McGowan. His strategy was not to nibble around the edges of AT&T, but rather to make a daring lunge at its underbelly, the delicate political coalition that allowed AT&T to control the industry.
To succeed, McGowan needed lawyers -- lots of them -- and so rather than investing in the usual product-oriented research and development, he spent his money on what an MCI executive later called "legal R&D." He spread his business among the capital's top communications-law firms, creating conflict-of-interest problems should AT&T ever try to retain them against MCI. He hired away a commissioner of the Federal Communications Commission and former government lawyers with connections to high places. Before congressional committees, the FCC, and the Justice Department's Antitrust Division, McGowan and his proxies attacked AT&T's monopoly on the grounds that it denied consumers the benefits of competition.
In a time of widespread suspicion about the motives of multinational corporations, McGowan's campaign was well received. The FCC ruled consistently in MCI's favor during the early 1970s, permitting the company to offer businesses "private line" service -- long-distance connections that typically go from one specific phone to another. AT&T responded arrogantly, writing a bill and then spending some $1 million to try to ram it through Congress -- an effort that, had it been successful, would have put MIC out of business. Meanwhile, the Justice Department had filed an antitrust suit against AT&T, a case that closely mirrored MCI's own antitrust suit against the phone company.
All along, McGowan led Washington lawmakers to believe that he would not move beyond private lines to the consumer long-distance market in competition with AT&T. After all, that would disrupt the system of regulated subsidies that kept the cost of local phone service low. Nevertheless, AT&T argued that long distance was a "natural monopoly" with enormous economies of scale and that McGowan's service was just "creamskimming" AT&T's profits by selectively competing on high-density routes without supporting the huge cost of the nation's basic phone network.
By 1973, though, it was clear to McGowan that private lines wouldn't be enough. The company was losing money and was technically in default to its bankkers. So the MCI chairman reneged on his promises. He filed a complicated and deceptive petition with the FCC that, once accepted, he interpreted as giving him the right to sell regular long-distance service to commercial customers and to consumers. The FCC, furious at his sleight of hand, dragged him into federal appeals court. There, Judge Skelly Wright ruled in 1977 that MCI could compete against AT&T in the long-distance market.
For a few years, MCI had a gold mine. It could undercut AT&T's high consumer long-distance prices because it didn't have to subsidize local service, as AT&T did. McGowan became one of America's richest entrepreneurs as MCI hauled in $1 billion a year in revenues.
But the gold mine turned out to have an unexpectedly short play. McGowan's foray into regular long distance had been a desperate ploy to save his company, not a well-considered long-term strategy. Now that he was in the game, though, he had to justify why MCI shouldn't pay its fair share of subsidies for local phone service, then called "separations and settlements" payments. McGowan argued successfully that MCI didn't have equal access to the nation's telephones, because, among other things, a caller using its service had to dial many more numbers than when using AT&T. Furthermore, McGowan said, as long as AT&T owned the long-distance network as well as the nation's local exchanges, MCI would never be on equal footing with its giant competitor. So, he reasoned, MCI should never have to pay a full local subsidy -- a situation that would always give MCI a major cost advantage over AT&T.
That argument fell apart early in 1982, when AT&T settled the Justice Department antitrust case by agreeing to divest all of its local operating companies. Since then, MCI has been required to pay an ever-increasing subsidy to the local phone companies. With its cost advantage steadily eroding, MCI's profits have sharply declined.Barring political intervention, where MCI has equal access, it will be paying the same local subsidies as AT&T by the end of this decade, a bleak prospect for a company whose entire strategy rests on undercutting the leader on the cost of long-distance calls.
That is why McGowan turned to IBM for cash. To compete in telecommunications evidently requires an alliance with a company as powerful as AT&T. "It's an open question if long distance is a natural monopoly or not," says Alfred Kahn, President Carter's economics adviser on inflation, and the father of modern deregulation. "Sooner or later we've got to find out. [This alliance] may be the only hope for effective competition." If it is, the hope that the painful restructuring of telecommunications would bring vast new competition may be gone.