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Telegraph: "Era of Wasteful Competition" Dont be a FOOL; The Law is Not DIY

The Telegraph Bubble

Morse, an artist who had visited Europe, assumed that the United States would follow the model of European ownership of telegraph. Morse and his partners had not planned nor were they prepared to build a commercial telegraph service. In addition, access to significant commercial capital was limited. Unable to persuade the USG to purchase his patent rights and operate the telegraph networks, Morse sold patent licenses to anyone willing to invest and "obtained private funds to extend their line to Philadelphia and New York." This ushered in the "Era of Wasteful Competition." A plethora of small companies arose building lines from city to city, sometimes overbuilding networks on the same routes. Investment poured in during a telegraph bubble. Many networks were built. Many networks failed. Many investors lost their investment. James Reid wrote that many of these networks "passed out of existence like smoke." [Reid at 222] [WU Report 1869 at 5 ("As the Government declined to assume the ownership and control of so doubtful an undertaking, the inventor had no recourse but to appeal to the enterprise of the people for the means required for its development. Capitalists, however, were slow to invest in a scheme so novel and precarious, and, as a natural consequence, there was great difficulty in obtaining funds wherewith to build lines.")] [Lindley 1974 at 256 ("The combined hopes of an extensive telegraph system and quick profits proved to be an elusive will-o-the-wisp. The industry experienced unbridled, reckless construction programs in the late forties and early fifties. Competing companies constructed duplicate lines where business for one line barely existed. Numerous companies struggled bitterly for survival. Questionable construction techniques minimized costs but produced inoperable lines which required rebuilding. And instead of the projected dividends companies promised their investors, the outcome of these feverish construction programs, as often as not, was bankruptcy.")] [Lindley 1971 at 4] [Smithsonian Guide 1986 ("This corporate cornucopia developed because the owners of the telegraph patents had been unsuccessful in convincing the United States and other governments of the invention's potential usefulness. In the private sector, the owners had difficulty convincing capitalists of the commercial value of the invention. This led to the owners' willingness to sell licenses to many purchasers who organized separate companies and then built independent telegraph lines in various sections of the country.")] [Field 247 ("The next two decades were a period of rapid, and at times chaotic, growth of the telegraph industry under private ownership.")] [Hochfelder] [Beauchamp at 57 ("An Era of Methodless Enthusiasm in which a veritable plethora of new companies joined the stampede for profits" R.L. Thompson.)]

Excess competition disciplining prices is not a favored market condition for providers. Network economics, however, are characterized by high barriers to entry, high fixed costs, and low incremental costs. It's expensive to enter the market, and the provider in the market that captures the greatest market share will be able to spread its costs among the most customers. The market is also characterized by network effect; the value of the network increase with the increase number of people that can be reached on that network. The larger the network, the greater the value, the more people want to be on that network. Finally, network economics is characterized by scale; the per mile / node cost of building and operating the network goes down as the quantity of line and equipment purchased and installed goes up. Install a few switches and the cost is X; install a lot of switches, and, to put it simple, the network operator gets a volume discount.

Industry leaders at the time thought competition was inefficient and wasteful. Their incentive was to drive towards consolidation. In a time before the Progressive Era had given teeth to anti-trust law, policy was powerless to respond (other then to ponder government ownership of industry)>

Sen. James Rood Doolittle (WI), during the debates over the Post Roads Act, described this period as follows:

"From 1844 down to about 1856 there were various competing lines of telegraph built up all over the United States, and as a general thing they were failures upon the hands of those who were operating them. Although they were a great convenience to the country the men who put their money into them and engaged in building them failed. O'Reilly had his great telegraph line; other persons had their telegraph lines; but from 1854 to 1856 the gentlemen who were interested in the lines came to an arrangement by which the lines were consolidated more or less throughout the country: and in 1860, after the lines had become consolidated, this act (trancontinental telegraph) was passed by Congress letting out this matter of telegraphing across the continent to the lowest bidder, and the contract was taken in behalf of this consolidated telegraph company, and the line was built." [Post Roads Act Leg. His. at 3486]

Western Union said of this period:

"The effect of the construction and operation of rival lines of telegraph between the same points is to augment the expenses without increasing the business. While, therefore, one line might have been worked successfully, the construction of a second, and sometimes a third, resulted in the operation of all of them at a loss. Practical men saw that there was but one remedy for these difficulties, and that was by a consolidation of all the rival interests into one organization." [WU Report 1869 at 6]

"The operation of these separate and irresponsible lines, during the brief period of their existence, retards the progress of legitimate telegraphy, and impairs the general unity of the system. Any assistance which is given to further such schemes has the direct effect of aiding a class of speculators to fleece a credulous public, by inducing them to invest their money in the construction of lines which never have paid, and never can pay, the expenses of operating them, and which are of no benefit to any persons but those who originate them, and profit by their construction." [WU Report 1869 at 36]

See also [Testimony of Norvin Green May 20, 1890 at 2 ("There is, however, nothing extraordinary in that. The railroads have to do that to keep from going into bankruptcy. Every manufacturing company in the country consults their competitors about maintaining rates and agrees upon them. All the rolling mills have agreed to maintain rates, and so have the carpet and other manufacturers. It is an absolute necessity to prevent destruction from wasteful competition.")] [Hearing to Amend Communications Act of 1934 (statement of Western Union Director of Contract Department Joseph Egan]. AT&T and the Post Office were in agreement that competition was inefficient. [Postmaster Report on Government Ownership of Telegraph 1914 (page 10: "The history of this business clearly establishes the futility of competition as a means of regulating its conduct in the interest of the people.") (page 11: "Competition applied to this public utility has clearly been shown to result in waste and inefficiency due to duplication.")] [Clarence Mackay at 266 (In the 1880s, "The "Mutual Union," the "American Rapid," the "Bankers & Merchants," the "Baltimore & Ohio," the "Southern," the "Board of Trade," the "Pacific Mutual," and the original "Postal" were formed, and all were competing with each other as well as with the Western Union in the most wasteful manner.")].

Sen. James Nye (NV) observed that every one of these acquisitions by Western Union "increases the tax upon every one of us that has to use that telegraph, for this additional purchase is counted in as the cost of the line, and we have to support it with its additional cost." [Post Roads Act Leg. His. at 3486]

This initiated a market cycle demonstrating network economics for commercial providers that would be repeated for both telephone service and Internet service:

The telegraph "Era of Wasteful Competition" can be compared to the telephone era of "Dual Service" when there were 1000s of independent telephone companies and the Internet era known as "the Internet Bubble" when there were 1000s of dial-up ISPs. Western Union's solution in a period of unregulated industrial growth was simply to acquire or eliminate all of its competitors. AT&T's solution, as articulated by AT&T President Theodore Vail in the early 1900s, was "One System; One Service" - if AT&T could become a government sanctioned monopoly, it could make multiple incompatible and wasteful telephone systems go away; there would be one telephone system in which all telephones could reach and talk to all other telephones. Broadband Internet Service Providers solution to 1000s of dial-up ISPs was the elimination of the underlying common carrier telephone network, setting up the broadband network as an unregulated service that broadband providers did not have to share with competitive internet service providers.

1845

Morse and Vail hired Amos Kendall, former Postmaster General and member of Andrew Jackson's "Kitchen Cabinet", to manage their new company. Morse and his partners form the Magnetic Telegraph Company. [Smithsonian] [Standage 53][Beauchamp p. 58][Smithsonian Guide 1986] Morse sold licenses to other telegraph companies, with the anticipation that it could all be bought by the USG. [Smithsonian Guide 1986] [USPS 2015 ("The first license agreements contained a provision that the rights to the telegraph were subject to purchase by the U.S. Government until March 3, 1847, after which time "the rights of all those who now engage in the enterprise, will become absolute, and not to be divested without their consent." ("Morse's Magnetic Telegraph," Vermont Family Visitor, August 1, 1845, 27, AAS Historical Periodicals Collection, http://search.ebscohost.com, accessed April 3, 2015.) ")] Magnetic Telegraph Company extends the DC-Baltimore line to Philly, NYC, to Boston. [Smithsonian][Branch p. 22][Smithsonian Guide 1986] [Encyclopaedia Britannica 1889 at 650 ("became the great line of the North")] "The cost of construction, including wire, posts, labor, &c., is about one hundred and fifty dollars per mile." "The average performance of the Morse instruments is to transmit from eight thousand to nine thousand letters per hour. The usual charge of transmission is twenty-five cents for ten words, or less, sent one hundred miles." [Census 1852 107-09] New York & Boston Magnetic Telegraph Co. established [Beauchamp 58]

1846: Mexican American War

Canst thou send lightnings, that they may go, and say unto thee, Here we are? - Job 38:35.

Quoted on the cover of the Erie and Michigan Telegraph Company Articles of Incorporation 1846

1847

"The Magnetic Telegraph from Baltimore to Harpers Ferry has been completed, and the first flash from this lightning line, was emitted on Tuesday last. An efficient operator has been procured, and communications are now hourly sent to and from Harpers Ferry. This wonder of the age (the Magnetic Telegraph) is annihilating space, as distance but give enchantment to the [charmed]. In a few months more, and the most remote borders of our Union will be linked together by a chord of iron, and intelligence transmitted so speedily, that the time will scarce enter into the account." - [The Telegraph, Spirit of Jefferson, page 2, Col. 2, Aug. 15, 1848 (part of the Baltimore & Ohio line)]

"The following table exhibits the annual receipts of the 'Magnetic Telegraph Company,' extending from Washington to New York, which was the first organized in this country:

From Jan. 27, 1846
to July 1, 1846:
$4228.77
to July 1, 1847: $32,810.28
to July 1, 1848: $52,252.81
to July 1, 1849: $63,367.62
to July 1, 1850: $61,383.98
to July 1, 1851: $67,737.12
to July 1, 1852: $103,860.84

Total amount received up to July 1852: $385,641.42. In 1852, the telegraph charges from Washington to various cities were as follows: Baltimore, 20 cents; Boston, 75 cents; Buffalo, 90 cents; Chicago, $1.25; Cincinnati, 70 cents; Louisville, 90 cents; Milwaukee, $1.35; Nashville, $1.35; New Orleans, $2.20; New York, 50 cents; Philadelphia, 30 cents; Pittsburg, 45 cents; Portland, Me., 95 cents; St. Louis, $1.20." [Encyclopaedia Britannica 1889 at 650]"

1848

1849

1850

1851

1852


James Gamble, picture, 1869, UC Libraries, Public Domain

1853

"But the oft-quoted remark of Mr. Stephenson, that where consolidation is possible there competition is impossible, was never more truly illustrated than by the telegraph. Again and again competing lines have been constructed, only to be bought by the Western Union. Between 1872 and 1879, the rates between Washington and Boston were reduced by competition four times and raised three times. [Hubbard 1883 p. 526]
"Another serious evil which the system had to contend with was the existence of competing lines upon the more important routes. The effect of the construction and operation of rival lines of telegraph be tween the same points is to augment the expenses without increasing the business. While, therefore, one line might have been worked successfully, the construction of a second, and sometimes a third, resulted in the operation of all of them at a loss. Practical men saw that there was but one remedy for these difficulties, and that was by a consolidation of all the rival in terests into one organization." [WU Report 1869 at 6]
"Superficial, sudden, unsifted, too fast for the truth, must be all telegraphic intelligence. Does it not render the popular mind too fast for the truth? Ten days bring us the mails from Europe. What need is there for the scraps of news in ten minutes? How trivial and paltry is the telegraphic column?" - New York Times, Aug. 19, 1858 [LaFrance]

1854 Era of Consolidation

1855: Western Union

1856

1857 Treaty of Six Nations and the North American Telegraph Association

1853: North American Telegraph Association formed [Lindley 1974 at 258 (association formed to address "harmonize methods of doing telegraph business" particularly network reliability and outage issues and notifications)]

Norvin Green, having learned his lesson from the "wasteful competition" between People's Telegraph and New Orleans & Ohio Telegraph, and who was feeling threatened by Western Union, sought an agreement where the companies would divide the market and agree not to build in each other's territories and not to complete. [Linley 1974 at 259] "In 1857 the six largest telegraph companies entered into a cartel called the "Treaty of Six Nations." ... This set of principles evolved during negotiations, so that by the time the agreement was completed, the signatories divided the country into six sections and assigned monopoly control of each section to one form. Some of the smaller competitors objected and began to undertake the construction of competitive lines. Negotiations to satisfy these firms were concluded in 1859 (under the auspices of the North American Telegraph Association), which essentially resulted in their buyout by or merger with the six major firms. Thus, only 15 years after the first telegraph line had entered service, the consolidation of the industry from lively competition to a cartel of a few small firms was complete." [Nonnenmacher] See also [Thompson, Wiring the Continent, at 361 ("In short, the new alliance aimed at nothing less than a monopoly of the nation's telegraph business by the signatures of the six-party contract")] [Nairn at Chap. 3 ("The financial pressures these produced brought about a 'pooling' arrangement, designed to exclude new competition, and a price-setting and volume-allocation cartel involving the six largest telegraph companies.")] Treaty of Six Nations was between:

[Beauchamp p. 64] [Smithsonian Guide 1986] [History Pacific Telegraph ("Eastward of the Mississippi the land is gridironed with telegraphs, they are all in the hands and under the control of only eight companies. These companies are mammoth concerns that lay large dividends, serve the public well, and make the public pay roundly for being served. A league binds all the companies into one grand confederation, known as the 'North American Telegraph Association,' of which Amos Kendall is President, which determines the tariff of rates, legislates on all questions of conflicting interests, and - so said Mr. Burnett of Kentucky over and over again in Congress - arranges to crush out lines that may be built to compete with any of those already in existence.")] [Nonnenmacher (Map of Treaty of Six Nations)]

The members of the North American Telegraph Association would collude in 1860 to ensure that Western Union was the sole bidder for the USG's Transcontinental Telegraph contract, and that it could bid for the maximum allowed rate. Another 'Nation', the Pacific telegraph companies, would in effect join the association.

1859

1860

1861: Civil War