Carterfone and Unbundled Network Elements
Fred Goldstein, February 2003
...The Bell System marketing strategy of vertical integration was supported by state and federal regulators, along with a bevy of excuses...
...LECs could not refuse service to companies who chose "foreign attachments" rather than the LECs' own terminal gear. The LECs were thus forced to sell unbundled services at regulated prices, in order to support competition...
...Today's situation is remarkably analagous. With over thirty years of technological progress since Carterfone, the network can be unbundled in a much more granular manner....
The ILECs are now gunning after Unbundled Network Elements. Number one on their hit parade is local switching, arguably the least "necessary" element for competition. But if you give an ILEC an inch, it will take a mile. Their real position is more likely to be the one that the extreme-right Cato Institute recently took, calling for all UNEs to be abolished promptly, except that unbundled local loops would be allowed to linger for only three years.
This type of silliness is not new, of course. ILECs have fought competition every step of the way, and would be happy to roll the clock back. The most important unbundling decision of all time was the FCC's 1968 Carterfone ruling, which unbundled terminal equipment (PBX systems, modems, telephone sets, answering machines, etc.) from switched telephone service. A whole new industry, known especially in its early days (pre-1984) as "Interconnect", was thus born.
Before Carterfone, LECs (they were all incumbent, of course) had monopolies on telecom service and on the devices that connected to it. The Bell System marketing strategy of vertical integration was supported by state and federal regulators, along with a bevy of excuses: Competition for "terminal equipment" would lead to "cream skimming" and harm universal service. The "integrity of the network" had to be preserved. Investment would be suppressed.
The LECs accepted a trade-off, of course: Their monopoly rents were regulated, such that as a whole they achieved a target rate of return on their "rate base" of undepreciated (underdepreciated is more accurate!) plant. Economic efficiency, however, was not a goal; individual prices were fatuous as industry accounting practices were designed for opacity, not transparency.
With Carterfone and the birth of terminal equipment competition in 1969, the FCC recognized that unbundling was acceptable. Of course the original Carterfone regime didn't take away bundled services. The network sans terminal gear was available to the new "interconnect" companies, who often claimed that the unbundled network services provided to their customers were inferior to those provided to those who rented LEC terminals as well. The LECs did not take this change easily. It was fought over in court for years, finally settled when Telerent Leasing's case against the North Carolina PUC and the Mebane Home Telephone Company (now called Madison River Communications) got to the Supreme Court. The LECs' last gasp was in Congress, where Wyoming's sole representative, Teno Roncalio, introduced the "Consumer Communications Reform Act of 1976", a.k.a. the "Bell Bill", which, had it passed, would have overturned Carterfone as well as the 1969 MCI decision that had started the move towards long-distance competition. Even after defeat, the Bells' biggest fans continued to carry on the torch. Until his death a few years later, C. Ray Krause continued to pen phillipics against what he perceived as a breakup of the network. The Cato Institute would have been proud.
It is important to note what Carterfone actually required: LECs could not refuse service to companies who chose "foreign attachments" rather than the LECs' own terminal gear. The LECs were thus forced to sell unbundled services at regulated prices, in order to support competition, rather than deny service to those unwilling to play by the LECs' own preferred rules.
Eventually the FCC solidified its terminal equipment rules. First came registration, which permitted unbundled terminal equipment (interconnect gear) to be attached to the network without needless protective coupling arrangements. A few years later, the Computer II decision completely separated services from equipment, moving the embedded terminal gear into a separate company that became AT&T Information Systems. Divestiture coincided with its implementation, but Computer II was decided before divestiture was even being openly discussed. The term "fully separate subsidiary" became part of the lexicon, as the newly spun-off RBOCs were allowed to start such subsidiaries from scratch to compete with AT&T and their own former installed base.
Today's situation is remarkably analagous. With over thirty years of technological progress since Carterfone, the network can be unbundled in a much more granular manner. ILECs are required to sell UNEs to their competitors at regulated prices which, following a court-blessed methodology, are assumed to provide reasonable rates of return. ILECs are fighting their battles before regulators, before the courts, and in Congress. I think of the Dingell-Tauzin bill as "Teno's Ghost".
And the right response is not hard to imagine. An end to terminal equipment competition would have been a disaster. Fully separated subsidiaries were a big help; divestiture was a truly effective, if slightly blunt, instrument. We can't go backwards. Today, the ILECs need to be split up, offering UNEs on a uniform basis to their retail arms as well as to competitors. Local loop competition is not going to be economically viable within the foreseeable future; access to the loop, and to other monopoly UNEs, needs to be structurally ensured.
