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Chapter 11: Monopoly Buster

According to the Oxford English Dictionary, the word “Internet” was introduced around 1974 and, even then it only appeared in a few technical journals. The same is true for the expression “Information Superhighway.” The word “cyberspace” came even later, making its first appearance in a science fiction novel in the 1980s. Finally, “World Wide Web” has been with us only since 1991, when Sir Tim Berners-Lee, a U.K.-born MIT professor, coined it.

Computers originally had the sound of science fiction. I read Norbert Wiener’s Cybernetics (subtitled Control and Communication in the Animal and the Machine) in the college computer lab at Ann Arbor. It was groundbreaking mathematical thinking and it underlined the concept of the stored program computer whose feedback mechanisms enabled the machine itself, once carefully taught, to recall both data and programmer instructions and then make decisions.

By 1966, I understood that wherever computers eventually took us, it would not happen until computers could talk to one another quickly, efficiently, and cheaply. We were moving into a digital world and my instincts moved me to lead the charge.

Sure, there were going to be thick brick walls standing in my way, but I was not intimidated. The first brick wall was the enormous amount of capital needed. The second was the monopoly power of the telephone company with the protection of lawmakers in Washington and in every state capital in the United States. The third wall was engineering a technology solution that really worked and that the prospective customer would love.

To pull them down, first I brought in a UNIVAC guy from Houston named Sy Joffe. He said that the smartest telecommunications engineer at UNIVAC was an ex-Navy man named Ed Berg, who had floated around on a rubber raft for two days during the Battle of Midway after Japanese dive-bombers and torpedo planes sank his aircraft carrier, the Hornet. Ed was the brains behind the UNIVAC 1107s and 1108s, particularly the part of them that married computing and telecommunications. A brilliant engineer, he told me that computers were destined to shift from being giant calculators to a means of communication, and that he could engineer it all like a beautiful digital symphony. Ed became our architect-in-chief for America’s first nationwide digital network, what we envisioned as a highway for computers.

It wasn’t such a crazy dream. After all, it had been years since the Russians launched Sputnik and President Eisenhower decided that the only way to fight Russian science was with American science. He created a new office inside the Pentagon called the Advanced Research Projects Agency (ARPA).

Their mission was to make sure that the United States developed state-of-the-art technology for our military. What made ARPA unique was that it operated independent of traditional military research and development. Over the years, they developed unmanned aircraft, virtual reality, infrared sensing, X-ray/gamma ray detection, artificial intelligence, Star Wars technology, and global positioning systems. By the beginning of the 1970s, they were working on a digital network so that defense forces could communicate during a nuclear attack, even after the United States had absorbed several nuclear hits.

This marked the military birth of the Internet. Our opportunity was to deliver its private-sector sibling. We decided to call it Data Transmission Company—Datran for short—and started building a phone company exclusively for computers.

Ed explained to me that, in his design engineering ideal world, we would need to transmit data at the speed of 25,000 words per second. That doesn’t sound fast today when we talk about nanoseconds and terabits per second, but it was lightning compared with AT&T’s analog phone system. And we believed that if we could send data that fast, our project might develop into a low-cost system for electronic mail so that people could send written messages back and forth over distances more quickly and more clearly than by U.S. mail or by telegram, just as the telegram had beat out the Pony Express horseback riders. The problem was that you couldn’t efficiently accomplish what we wanted to do utilizing analog plant from a phone company.

We studied satellites and fiber optics, but they were too far into the dim and distant future. So like ARPA, we decided that the best available technology was digital microwave. Ed promised that we could make the first digital switch work.

Our plan called for building transmitters right across the country, spaced 20 to 30 miles apart. We scouted land for towers, negotiated permission from farmers, got all our permits in order, and started building towers.

The folks at AT&T, meanwhile, were doing their best to get our dream tossed into the garbage. That’s the reason we headquartered Datran in Washington, D.C. If we were going to make this happen, we wanted our senior managers in the FCC offices ten times a day and camped on their doorstep at night. We would get in the FCC’s face and make them understand that we were never going away.

The telephone monopoly couldn’t make our docket completely disappear, so they got the process slowed to a snail’s pace. They were so powerful that our stuff stayed on the FCC’s shelf, unread, for two years.

Of course, I understand why they were so belligerent. We were threatening their very existence. We were planning to move the same amount of data on $1 of digital capital investment that otherwise required $10 of analog capital. We were going to offer higher-quality, lower-cost, and better customer service than they could. We were going to give people a choice, not just what the phone monopoly said was good for them but what the consumers themselves wanted. If we got the FCC’s permission, they were in serious trouble.

Our original cost estimate for Datran was $375 million, which put us in the same cost neighborhood as Comsat, the company that launched the Early Bird communications satellite in 1965 and took telephone and television traffic into space. But Comsat was a creature of Congress and enjoyed regulatory protection, had a public stock, and, most important, didn’t threaten AT&T.

We were going to have to do it the hard way.

This was doubly true when you factored in that the government hadn’t given any indication they would welcome competition against the Bell System, which meant that we could lose. AT&T argued there was no need for a separate digital network because there was no demand for one. We proved there was. Well, they said, there might be some demand, but not for the data-transmission services that Datran wanted to do. We proved there was. Okay, they said, even if there was a little demand for what Datran wanted to do, AT&T could meet that minor demand in the command-and-control way, so there was absolutely no need for Datran and this free-market heresy.

They never stopped thinking like the telephone monopoly they were. “Bell heads,” we used to call them. They cast doubt on our competence to do what we said we could do, on our technical abilities, and on our financial resources. Both voice and data ultimately would travel digitally with efficiency thanks to microchips, although that was a long way in the future. Yet we knew back then during our initial challenge to the Bell monopoly that this technological breakthrough had to happen. We knew it from thinking through the existing technology and extrapolating forward. But regulated monopolies have little or no interest in innovation; change threatens their long-term write-offs of whatever equipment they’ve already installed.

When the “it’s not necessary” argument didn’t fly, AT&T came up with the old wives’ tale that monopoly status assures good service and if you open up the market to competition, some customers will be left out. They erroneously argued that the free market is free to disregard customers when the cost of doing business cuts too deeply into profit.

You hear that all the time with monopolies: If you privatize the post office, then mail carriers won’t deliver letters to rural North Wherever because it’s too far out of the way and therefore unprofitable. Except FedEx and UPS are in effect private post offices and they’ll deliver anywhere. Anyway, as soon as they came along, offering a better service than the U.S. Post Office, what did the USPS do? They came right back at FedEx and UPS to compete by offering overnight priority mail.

Of course the market was big enough for all of us, but AT&T was arrogant, genetically incapable of accepting a competitive market. When they were finally forced to move out of the monopoly, they just didn’t know anything else. They tried to be IBM and got killed.

We had to spend almost as much money fighting the regulatory battle as we did creating the technology. We had run headfirst into a clash of cultures. Computer people were in a hurry to get things working. Phone company people were in a hurry not to miss the carpool at four o’clock. How else could anyone explain why, in those days, it took two months just to get a telephone line installed?

The man I brought in to run Datran was a young electronics engineer from Texas Instruments (TI) named Glenn Penisten. He had been in charge of new businesses and the semiconductor research laboratories at TI and understood that getting this new network on line wasn’t like lighting up a Christmas tree. You didn’t just throw a switch and be in business. Glenn saw this ultimate goal as a series of smaller, intermediate goals, which was right in line with the way I’ve always set goals. We’d have to build this thing one step at a time.

Standing in our way was the Chairman of AT&T, a tough old South Carolina codger named John DeButts. He was completely imbued with monopoly as the only right religion. He had long ago bought into the idea that by sacrificing some profit for the sake of owning a monopoly, he was doing the right thing and no one should dare question him on that, especially when he was providing the best telephone service in the world at a reasonable price. The fact that he was dead wrong didn’t change his mindset. He said there was nothing broken, so there was no need to fix it.

He was stunned that we were brazen enough to challenge his authority. He believed that our digital network was just another kind of phone call, and he was convinced that God had decided no one else was going to offer phone calls to America. I also think he was insulted when we said straight out, “You guys don’t know what you’re doing and we do.”

Glenn got in to see DeButts, hoping to convince him that digital data transmission was a new field and that there was plenty of POTS (Plain Old Telephone Service) that would always be available to him. Glenn wanted DeButts to understand why he should let us little guys go ahead and make this data world happen. Monopolies are never strategically oriented—they don’t need to be—and DeButts just kept walking around the mulberry bush. He didn’t want to hear what we had to say.

I never had any direct interaction with DeButts, but in my mind the two of us were talking all the time. I kept saying, “John, I’m gonna whip you in Washington,” and I could hear DeButts saying, “Sam, ultimately you might, but it’ll take you thirty years to whip me in every Statehouse.”

He was right. But that wasn’t stopping me.

We needed more than better technology to build a nationwide network; we needed a lot of capital. I decided to look for a cash-cow company that had “really safe” written all over it. I wanted to have a rock-solid financial base, and saw that in a property and casualty insurance company owning triple-A stocks and bonds.

Gulf Insurance Company was run by a classmate from the Management Course for Presidents, August Bushell, and it was exactly what I was looking for. It had a very strong investment-grade portfolio of blue chips and a lucrative fire and casualty business. We could invest the dividends out of Gulf to help build Datran. So we merged Gulf into University Computing in an exchange of stock. Having a high multiple on our stock, we could give the Gulf shareholders a big premium over their market value, just as America Online paid the Time Warner owners in 2001.

August became our partner and joined the UCC board while continuing to run Gulf. But just as we upgraded Gulf’s stock and bond portfolio so that it paid higher dividends, we ran headfirst into major disasters.

The 1970s economic crunch began in 1969, and by 1970 the United States had hit a real inflationary recession. I found out the hard way that not only UCC and Datran, but also Gulf was vulnerable. Everything came crashing down. In 1969, UCC made a $17 million profit. In 1970, we had an $18 million loss. Very bad news.

The economy started looking up in 1971. Gulf Insurance generated around $8.5 million and University Computing earned a $2.6 million profit on $128 million of sales. I concluded optimistically, as ever, that we could put another $5 million in Datran.

But all our markets downturned against us sharply in 1972, and we lost a staggering $83 million on sales of $101 million. We were taught to worry about either inflation or depression. In the ’70s, we got both. Both bond and stock markets crashed. And liquidity for smaller companies disappeared.

Wall Street can be fickle. The capital markets no longer wanted to hear about my plans for a digital future. Earlier, I’d get 100 brokers and bankers calling us. Suddenly, my phone stopped ringing.

You couldn’t give tech stocks away. And safe blue chips dropped to five-times earnings. Treasury bonds dropped 50 percent. People were pulling whatever was left of their savings out of their mutual funds and depositing their remaining cash in bank deposits. Fear ran high. Those bankers and brokers who had once adored us computer-age dreamers were now gone from Wall Street and out selling cars and houses and teaching school.

During those times, when the public scorecard wasn’t good, it didn’t burden me more than I could bear because I kept my own scorecard. I knew that the public scorecard would one day catch up. Eventually, if you’re doing the right thing, it will be there. We simply needed to survive long enough to keep our dream alive. We had to cut back and pay off debt, sell parts of the company, and seek fresh capital.

Our Swiss friend Walter Haefner had come on the UCC board and saw the promise in a digital future, so I turned to him and he came through for us. He liked the idea of Datran enough to make an entrepreneurial bet and, over the next five years, invested $40 million.

Without Walter, Datran would never have stood a chance. But inflation was raging and even though Gulf’s portfolio was blue chip, the oil shock drove interest rates through the roof. High interest rates and inflation forced up the cost of repairing cars and houses and the cost of insurance claims. Then came the fierce April and May winds of West Texas and the Gulf Coast. They blew the roofs off buildings and smashed cars. A hurricane ripped into Corpus Christi and a tornado leveled a part of Lubbock. Gulf Insurance took its biggest-ever underwriting losses. In just one weekend we lost 12 million bucks. It was unbelievable. Of all the risks I worried about, Texas weather was not among them. It was the Mississippi River Flood of 1927 all over again.

I had seen Gulf Insurance as a safe haven, but it turns out that Bobby Kennedy was right when he said, “There are no safe havens.”

Times were tough—the worst decade in my business life. I had to mortgage our stock in Gulf Insurance to secure a $30 million loan, and Walter invested another $20 million.

But the good news was that after five very long and expensive years, the FCC had finally made its decision.

It was yes.

They ruled that competition in the area of data transmission was both practical and desirable. They didn’t have the power to bust up AT&T—their monopoly over voice transmission remained in place—but they said that Datran could transmit data over private lines.

We won.

Unfortunately, that didn’t mean AT&T was going to accept defeat gracefully. They hunkered down for a long war of attrition. They shifted to street fighting in the capital markets and in Congress.

We were negotiating a $50 million private placement and it looked like everything was all set to go, but then our banks told us that “calls had been made”—AT&T had threatened them—and they were pulling out of the deal.

We were close to a deal with United Telecom, a Kansas City–based independent telephone company advocated by their CEO, Paul Henson. Again, United’s board backed out, saying, “We have to live with AT&T.” AT&T had the power to cut United Telecom’s revenue by reducing United’s share of long-distance fees on calls into and out of United Telecom’s local territories. AT&T had monopoly power and they were making predatory use of it.

As the battle heated up, the Bell monopoly ruthlessly used their power in Congress. With one-third of the House of Representatives in their pocket, they introduced the Bell Bill, which would overturn the FCC’s decision for competition.

I walked into the office of the congressman from Plain Dealing, Louisiana, a fellow Louisiana Tech grad, and said, “You’re a free-market guy, an Adam Smith guy—how can your name be on this?”

To him it was simple: “I’ve got a plant with five thousand Bell employees and it’s got a plant manager and it’s got a union leader. And in the past I’ve been refereeing between the plant manager and the union leader and now, with this Bell Bill, I’ve got both of them in here saying, Sign it.”

The Bell Bill did not get passed. This marked the beginning of the end of the telephone monopoly. But a free market would be a long time in coming and we’d have a lot more pain to endure.

We were working with the Bank of Boston to syndicate a $50 million credit for us, with Dallas and Philadelphia National Banks each committed to 5 of the 50 million. But even though the Bell Bill ultimately didn’t pass, it sent a signal to bankers that AT&T and the lawmakers in their pockets would not tolerate competition, and that was the end of our bank syndicate.

In 1974, Americans watched an agonizing presidential impeachment process that ended with President Nixon’s resignation, a first ever in American history. That same year saw the market crash and widespread financial crises.

Still, I felt Datran could be recapitalized—that is, until the interest rates hit 12 percent and another big loan fell through. Glen Peniston and his team of managers came up with a two-year “Hold the Line” plan. I sold some assets, Walter invested more, and we limped through another year. In 1975, Gulf Insurance fell victim to inflation, which was skyrocketing its costs of paying damage claims for houses and cars, and posted huge losses again. We had to suspend its dividends and lose this source of funding for our big idea.

If I’d had five hundred million bucks of my own money to bet, I would have put it on the table and waited AT&T out. But I didn’t have it. Even Walter didn’t have that much. And I couldn’t find anyone else who would put that kind of money up to back my dream.

We built that part of the network that could be built with the capital we had, from Houston to Chicago. When we switched it on—fifty-nine microwave towers connecting those two cities—it worked. It was fast, error-free, much less expensive than AT&T, and praised as a technical marvel. The “begrudgers” could no longer say, “It won’t work.” We started signing up new customers, and even the begrudgers had to admit that we’d been right all along. Chief among them was AT&T, which now came into our market with a data service. They raised prices on local and long-distance phone calls to cross-subsidize the battle with us and undercut our price by 40 percent.

My dream wasn’t to be.

Datran made so much common sense to me that I thought everyone else should be able to see it just as plainly. I thought we could go out and just get it done. But I’d been optimistic about how quickly we could bust the Bell monopoly. More important, the capital markets had disappeared—not just the stock market but the venture capital markets, the bank debt markets, the bond markets, everything. New investments by venture capitalists dropped 95 percent.

In August 1976, after investing eight years and 100 million bucks, I pulled the plug, turned off the lights, and shut down Datran.

I was beaten. And I felt beaten.

Most entrepreneurs, at least when starting out, get emotionally attached to a company. UCC and Datran were my babies. Those companies and I were one. There’s some good in thinking that way, in identifying so closely with your creation, but it can ultimately give you a lot of misery. That’s how I was feeling then—devastated.

This was a difficult time for me personally, not just because of seeing 90 percent of my wealth disappear during the 1970s. After all, one house and one car were still all I needed; but for eight years, through the disasters and the disappointments, I never stopped believing that having a competitive alternative to the telephone monopoly—giving customers a choice—was good for Americans and that ultimately it would be done. Datran was the biggest and toughest thing I’d ever tried. It was the future, but I was there too early and the capital markets had gone away for the entrepreneur.

When someone beats me in a fair fight, I can accept it and forget it. But being done in by a state-granted and state-protected monopoly was different. I decided that I was going to litigate this case even if it took forever, so we made a deal with two law firms. I said, “I’ll spend $200,000 a year forever to get economic justice, and you’ll get 28 percent of whatever we win.”

So they bet their lawyer time, while I paid the expense budget. We slapped an anti-monopoly suit on AT&T and dragged them kicking and screaming into court.

It took four years but when the smoke cleared, UCC recovered $50 million and set the stage for the end of AT&T’s monopoly power. That made me, along with two other American entrepreneurs, Bill McGowan and Tom Carter, a footnote in entrepreneurial history for busting up the telephone monopoly.

*  *  *

Texas inventor Tom Carter petitioned the FCC in 1968 for the right to hook his “CarterPhone”—a two-way radio system that was the original wireless phone—to the telephone network. He was in the offshore oil business and needed a way to communicate from rig to rig out at sea. Until he came along, AT&T categorically refused to allow any non-AT&T equipment to be used, because that’s how they protected their monopoly rights to sell only their own equipment. But the FCC sided with Carter. As a direct result, innovation flourished, creating markets for answering machines, fax machines, cordless phones, cell phones, and computer modems. Hundreds of millions of cell phones are being bought every year now. Thank you, Tom Carter!

Then Bill McGowan petitioned the FCC to allow his Microwave Communications of America to sell “private line” phone service to businesses. The FCC and the courts sided with McGowan. Today, thanks to him, there are dozens of long-distance carriers, giving the customer real choice in the marketplace, and the price of long-distance calls has dropped to the point where some companies no longer even charge for them.

And then there was Datran, the third FCC filing.

It took the Justice Department eight years, but once Carter, McGowan, and I had paved the way, U.S. District Court Judge Harold Greene agreed and ruled in 1982 that those three FCC decisions created competition and that was the right thing to do. He busted up AT&T and the Bell System into eight different companies.

Within three years of the settlement, not only had prices dropped and service improved, but those eight new “Baby Bells” were among the top sixteen most valuable market cap companies in the whole world.

Clearly, what was good for the public customers was also good for the public owners of the former protected monopoly.

Copyright © 2008 Sam Wyly