E C O N O M I C R E P O R T O F T H E P R E S I D E N T

Another industry that saw major changes at the turn of the last centurywas telecommunications. The Bell system had enjoyed a monopoly in telephoneservice in the United States until its basic patents on the telephoneexpired in 1894, after which a wave of new competitors began providingphone service. The Bell system had concentrated on serving major cities andbusiness customers, leaving many smaller communities unwired. Many ofthese independents extended service to the underserved communities, whileothers concentrated on competing with Bell in some major urban centers. By1907, new entrants accounted for almost half the market. Service levelsincreased rapidly with this new competition: telephone penetration (measuredas the number of phones per 100 people) rose from fewer than 2 in 1900 tomore than 10 by 1916. Many of the new entrants adopted the latest innovationin telecommunications, automatic switching, much more quickly than the Bellsystem, which continued to rely upon operators to connect calls manually.Yet despite the advantages of this new switching technology, within a fewyears the number of independents began to decline. Faced with competitivepressure from the Bell system, most independents either failed, wereacquired, or signed sublicensing agreements that allowed them to connectwith the Bell system but limited their ability to compete with Bell.The competitive failure of the independents was due at least in part to theBell system’s successful exploitation of the network dimension of telecommunications.The Bell system invested heavily in the technology and equipmentneeded to create a long-distance network. Although most customers atthat time used the phone almost exclusively for local calls, businesses foundthe long-distance service very attractive. The independents tried but wereunable to duplicate Bell’s long-distance network connections, particularly inmajor urban areas where the Bell system had its largest networks, and wheremuch of the long-distance business originated. Bell allowed the survivingindependents to interconnect with its system, but only under the competition-restrictingsublicensing agreements. Many independents chose thisroute, even though it meant signing away their own ability to expand andchallenge Bell in the future.In this case, the network characteristics of telecommunications proved criticalto the competitive outcome. By providing long-distance services that itsrivals were unable to duplicate, the Bell system was able to keep more peopleconnected to its network and exploit economies of scale in long-distance service.But as it connected more users to its network, the Bell system also madeit difficult for other companies to compete effectively. Without effectivecompetition, the Bell system was in a position to limit service and set pricesfor that service at monopolistic levels.Government policy toward these new technologies and new industries wasas varied as the industries themselves. In the cases of telephones and electricity,102 | Economic Report of the President