Can regulation save Google?

What the tech giant can learn from the rise and fall of AT&T

The internet is often praised for its openness. It provides easy and cheap ways for people to communicate, to express themselves and to access a variety of services. Billions of people are empowered by free messaging apps, social networks and search engines that they can all use without many noticable constraints.And yet, the openness of the internet seems under threat. As software keeps eating the world, more and more aspects in our lives become connected and smart. Many see this as progress, but there is a real risk that much of the interent used will eventually be controlled by only a handful of companies.

One of the most powerful software companies is of course Google. Google is in an incredibly strong position because many users start their online experience always at one of their services. For the past few years, these services were their search engine, their communication and productivity services like Gmail and G Suite, and the Android platform for phones and tablets. Now they are pushing their software further. Google Home and Cast provide media streaming, smartwatches with sensors and Android wear can monitor your health and Android auto will help you find your way around. All these services provide Google with an enormous amount of data and a dominant position that is self-reinforcing. The more data Google has, the better their services work, and the better the services work, the more people will use them and thus provide data.

Criticism around Google’s dominant position is growing. In Europe, the European Commission has started an antitrust investigation into the company’s search engine business and it’s Android platform. According to the commission, Google is abusing it’s dominant position. The case will be decided in 2017 and could force Google to change part of its business model and to pay a fine. But it could go even further. In 2014 the European Parliament adopted a motion in favour of breaking up the company. Of cours the EP does not have the power to make that happen but they called upon the commission “to prevent any abuse in the marketing of interlinked services by operators of search engines” and “to consider proposals with the aim of unbundling search engines from other commercial services” in the long run.

According to Tim Wu, in his book The Master Switch, this kind of power struggle is far from new. It is part of a pattern that we have seen in information and communication businesses before. In his book, Wu investigates the rise and fall of AT&T. During seven decades of the twentieth century, AT&T held a government backed monopoly position in the American telephone market. At their peak AT&T controlled the long distance telephone network, many of the local telephone networks and they were in the position to set the industry standards. But despite initial government backing, it was an intitrust investigation that led to its breakup in the 1980s. How did AT&T obtain and lose its dominant position, and can Google learn from AT&T’s fate?

Technology is essential but only a start

The story of AT&T begins in the 1870s. At the time, the dominant mode of electronic communication was the telegraph, a system invented in the 1830s that used a network of wires and machines to send and receive encoded messages. At the time, the telegraph network in the US is run by Western Union, a strong and profitable monopolist.

Halfway the 1870s, a number of inventors, among whom Alexander Bell, Thomas Edison and Elisha Gray, are independently from each other working on a promising new technology: the telephone. While the telegraph relied on coded messages, the telephone was to use a microphone and a transmitter. This would eliminate the need to encode messages and therefore make electronic communication easier, quicker and much more accessible.

For the inventors, it was a true race against the clock. On February 14, 1876, Alexander Bell was the first to file a patent for the telephone, just before Gray who filed for a patent on the very same day. This seems like an achievement but Bell quickly finds himself in a legal and financial nightmare. Other inventors, who had applied for patents for similar technologies, and companies that feel threatened by the telephone try to stop Bell from obtaining the patent.

Bell is low on capital and therefore struggles to pay for lawyers and to finance the manufacturing of the telephones. In late 1876, the problems become dire that Bell in late 1876 even tries to sell his patent rights to Western Union for $100,000 (approximately $2.4 million today). Western Union refuses. As their telegraph business flourishes, they don’t see any benefit in working with the struggling Bell to develop the telephone. They hire Edison and Grey and start working on their own telephone system.

Bell changes his strategy and with funding from Gardiner Hubbard he founds the Bell Telephone Company. The company has the right technology and a patent, and quickly obtains the exclusive right to rent and use telephones in the area around New York City.

Theodore Vail turns the telephone into a business

Even though the Bell company has great potential to become a success, it turns out to be difficult to turn the telephone into a business. In 1878 the company attracts the 33-years old Theodore Vail, an ambitious man who had worked his way up from a mail clerk to General Superintendent at the Railway Mail Service. At that moment, the Bell Company is still struggling with three challenges: building the telephone network, increasing the production of telephones to meet demand and fending off competition from competitors like Western Union.

All three challenges require significant amounts of money to be overcome. Vail manages to raise some capital from old business friends, but it’s not enough for everything. So Vail develops a new business model in which local franchisers raise local funding set up local networks. The franchisers rent Bell telephones on 5-year contracts. Thereby Bell needs less capital and obtains a secure cashflow.

Now that the company has a viable business model, Vail decides to start suing competitors, Western Union in particular, for patent infringement. The case is costly and takes over a year, but on November 10, 1879, Bell wins and Western Union is forced to give up its telephone patents and tens of thousands of phones and subscribers.

It is this event that delivers the Bell Company a strategic and powerful advantage. The Bell Company now has the technology, a patent and many more customers. And of course, its main competitor is no longer an existential threat.

One system with a universal service

Vail turns out to be a strategic ceo with a clear goal: to develop one system with a universal service. He is convinced that telephone networks are only useful when all phones are conneted to the same network and that the telephone business hsould therefore be seen as a natural monopoly. To achieve his goal, Vail aims to obtain the monopoly on local calls, on long distance lines and on manufacturing of telephones.

For local calls, the Bell Company develops local subsidiaries: the Bell Companies. For long distance calling a new subsidiary is created: the American Telegraph and Telephone Company (AT&T). AT&T constructs new long distance lines and facilitates the calls. And to achieve universality of devices, the company buys telephone manufacturer Western Electric. This company eventually grows into the country’s main manufacturer of telephone equipment and makes sure all devices work on AT&T’s network. The result is remarkable: in 1894, the year the patent expires, AT&T is a telephone giant with hardly any competition.

A natural monopoly?

Vail leaves the company over a dispute in 1888, but returns in 1902. By that time, the company is again in troubled waters. Independent telephone companies are eating away market share because they are often cheaper and provide better service.

In 1907, Vail becomes president again. He still sees no good in competition in the telephone business and argues that the telephone business is a natural monopoly. According to Vail the country needs “a single network unhindered by competition, lack of interoperability and regulatory intrusions.” Destructive competition, he argued, is in the long run never beneficial because “all costs of aggressive, uncontrolled competition are eventually borne, directly or indirectly, by the public.” He sees that monoplies can lead to negative consequences for consumers, but insists that for the telephone a monopoly is a better arrangement as long as it is held in the right hands.

A regulated monopoly

In the following decade, Vail works hard to achieve the desired monopoly position. At first he focuses on his competitors. Through a suffisticated combination of acquisitions and agreements, the company manages to get control over the market.

Then came the Government. In the beginnig of the 1910s, teh government is still afraid that AT&T will dominate the market. Its starts an antitrust investigation, which ends in 1913 when AT&T agrees to divest from Western Union and to allow non-competing independent telephone companies to connect with the long distance network.

In 1921 the Government eventually gives in. With adoption of the Willis Graham Act it acknowledges that the telephone is a natural monopoly and that “there is nothing to be gained by local competition in the telephone industry.” Regulation becomes the policy tool to protect consumers.

For the next seven decades, the telephone market remains a closed system run by AT&T with oversight of the Interstate Commerce Commission (ICC). Standards and pricing are determined by the ICC in close cooperation with AT&T. In the 1970s a new antitrust investigation was intiatied. This time the company was unable to convince the Government of their natural monopoly and eventually led to a break up into seven regional comapnies.

Can regulation save Google?

The story of AT&T is remarkably similar to that of Google. Like AT&T, Google has a very powerful position controlling the way people communicate. Strictly speaking it may not have a monopoly, but people and businesses cannot ignore the company when they want to be successful online.

AT&T was able to convince the government that the telephone was a natural monopoly. More than one infrastructure would be ineffcient and bad for everyone. For Google such an argument would be much harder. They have always argued for an open internet and stressed that they as a company remain vulnerable to competition because “the competition is just one click away”.

Now that they are moving into new markets and regulatory bodies are becoming more critical, this may be a risky strategy. Unlike AT&T’s infrastructure, their software can eventually end up in almost anything. It is much more opaque what they control and how they will go about with that.

Regulation may buy Google time. It shows they are prepared to take responsibility and that they care about users. But in a more digitalised World this strategy may need to be enhanced.