Popular Science Monthly/Volume 71/September 1907/Notes on the Development of Telephone Service X

by Fred de Land

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NOTES ON THE DEVELOPMENT OF TELEPHONE SERVICE

By FRED DELAND

PITTSBURGH, PA.

XIV. Telephonic and Financial Conditions 1880-1883.

FOLLOWING are the Bell statistics for the four years, 1880-1883: On March 1, 1880, there were 138 Bell telephone exchanges, in operation or about to open, while a year later the number had increased to 408, a net gain of 270 exchanges, or of nearly 200 per cent. Though only three years had elapsed since the first of these pioneer exchanges was opened, on March 1, 1881, 66 exchanges were interconnected by toll lines, Boston had toll communications to seventy-five cities and towns, the total number of places for which licenses to build exchanges had been granted was 1,523, and thirty-two contracts had been given to build connecting toll lines. But, these 408* exchanges supplied telephone service to only 47,880 subscribers located in 463 cities, towns and villages, or an average of only 117 subscribers to each exchange.

At the close of the year 1881, the number of Bell exchanges had increased to 592, with a total of 70,525 subscribers, located in 1,593 cities, towns and villages, while the average number of subscribers per exchange had increased from 117 to 120.

On December 31, 1882, there were 1,070 Bell exchanges in operation, a net gain of 478 for the year, or of 81 per cent. This growth represented an average increase of two new exchanges for nearly every working day in the year. Yet the total number of subscribers was only 97,728, or an average allotment to each exchange of only 91, that is, 29 less subscribers than the average of the previous year. The handiwork of the speculative builder of small exchanges, grasping for quick profits, is here indelibly imprinted on the records. In the large exchanges the high flat rate limited the growth to the wealthy in the resident districts and to the larger business houses and professional offices where telephonic communication was an absolute necessity. This seems a reasonable conclusion to draw from a growth, of only 38 per cent, in subscribers and of 81 per cent, in exchanged.

And the record for 1883 is of the same delusive character. On December 31, there were 1,325 Bell exchanges in operation in 46 states and territories, supplying service to 123,625 subscribers, and giving employment to 4,762 persons. In other words, there was an average of nearly four employees to each exchange, though the average number of subscribers connected was only 93. And as there were many exchanges having more than 300 subscribers, it is obvious that many others had less than 30, and thus were being operated and maintained at a continuing loss.

What were the financial conditions of the country during these four years, 1880-1883? What was the character of the sentiment prevailing among investors that enabled such anomalous conditions to continue?

The year 1880, notwithstanding that a presidential election occurred, proved to be an admirable period for the promotion of industrial as well as speculative enterprises, and telephone projects of every character appeared to meet a hearty welcome at the hands of the investing public. To the older licensees, enriched by the wisdom gained in a whole years experience, it soon became evident that many of the new exchanges were being built and operated only for speculative purposes by local promoters, in anticipation of profitable consolidations, rather than as a permanent investment for local capital. For the question of equitable rates yielding a fair return on a legitimate investment, or the unpleasant results in lowering the character of the service by giving unlimited calls at an unprofitable rate, thus loading the lines with gossip and frivolous conversation, to the detriment of rapid, legitimate service, did not concern the speculator. Where the older licensees endeavored to warn local investors against accepting the speculator's statements without substantial proof, the latter felt justified in agitating a public denunciation of what he termed the extortionate rates of the older licensees. The natural result was that the speculative exchanges had a big list of subscribers at unprofitable rates, until consolidation brought a new management that proposed to take care of the shareholders first and then give the best service possible to the subscribers. This meant an increase in rates to an amount that would insure a fair return on the investment; and then fully one half the subscribers who had been reaping the advantage of unprofitable rates promptly displayed their gratitude by giving up the service rather than pay the increased price.

On January 21, 1881, many of the telephone companies in the east suffered from the most destructive sleet storm that had visited that section in a long period. So great was the weight of the sleet frozen on the wires attached to roof-fixtures that in numerous cases the roofs were wrecked and walls were damaged. Miles of the pole lines went down, and in the main thoroughfares of the larger cities telephone wires were inseparably entangled with telegraph and electric light circuits. By reason of modern methods of construction, a disaster of such a character could not now occur, though greater losses have occurred in several sleet storms. But this was the first serious wreck of the kind that the new telephone industry had had to face, and its disastrous outcome was exceedingly discouraging. The immediate loss to the New York company was nearly $100,000, while the indirect loss in delaying extensions and improvements and in diverting investment from the treasuries of the injured companies was very large.

The only remarkable change in financial circles occurring in 1881 was the flurry in the stock market that followed the assassination of President Garfield on July 3, 1881. To the far-sighted financier that "agitation approaching a panic" may have indicated the beginning of the general depression that gradually overspread the country and proved most severe in 1885.

On July 14, 1881, the New York Tribune editorially asserted that

the agitation that caused the flurry was utterly without foundation and that the proportion of business done upon a cash basis is larger than ever, and the proportion of business done without borrowing, on the capital of the firms engaged, is larger than ever. . . . Nor has there ever been a time when the earnings of the people were on the whole as large as they are now. Wages are good, while prices are relatively low.

But from the telephone speculator's point of view, the ill effect of that July flurry was more than offset, so far as the investing public was concerned, by the admirably wise and now famous telephone decision rendered by Judge Lowell on June 27, 1881, in the suit begun on June 22, 1880, in the Eaton-Spencer case. In part that opinion read as follows:

If the Bell patent were for a mere arrangement, or combination of old devices, to produce a somewhat better result in a known art, then, no doubt, a person who substituted a new element not known at the date of the patent might escape the charge of infringement. But Bell discovered a new art—that of transmitting speech by electricity—and has a right to hold the broadest claim for it which can be permitted in any case; not to the abstract right of sending sounds by telegraph, without any regard to means, but to all means and processes which he has both invented and claimed. . . . The claim is not so broad as the invention. . . . An apparatus made by Reis, of Germany, in 1860, and described in several publications before 1876, is relied on to limit the scope of Bell's invention. Reis appears to have been a man of learning and ingenuity. He used a membrane and electrodes for transmitting sounds, and his apparatus was well known to curious inquirers. The regret of all its admirers was, that articulate speech could not be sent and received by it. . . . A century of Reis would never have produced a speaking telephone by mere improvement in construction.

President Arthur proved a worthy successor to the lamented Garfield, and his strong and conservative policy appeared to win the confidence of the people, many of whom had been led to expect a more radical and less safe administration. Thus the year 1882 opened auspiciously for all speculative interests. But in February came the notorious break in Richmond and Danville, from 219 to 130, that flurried the stock market and increased the general uneasiness concerning all investments. Nevertheless, the total volume of business transacted throughout the country during the year was very large, no less than $350,000,000 being expended in new railroad construction.

The general financial and commercial conditions that prevailed during 1883 may be summed up as follows: There were 9,184 failures with aggregate liabilities of $172,874,000, as against 4,735 failures in 1880 with aggregate liabilities of only $65,752,000. Not only was there a large decrease in the total volume of trade, making retrenchment in nearly every line of industry an imperative necessity, but a general distrust of the integrity of all stocks and all bonds prevailed, with a consequent enormous decline in the market values of many securities, including even those of the new telephone consolidations. An eminent financial writer in referring to the speculative fever that had raged during the previous two years, 1881-1882, declared that:

Our whole people became wild upon the subject of railroad construction, believing that two or three dollars could easily be made for every dollar put up, either by the success of their ventures or by the sale of their securities. In this delusion the capitalist and the adventurer shared alike.

Nevertheless, notwithstanding these discouraging conditions, or the gloomy outlook for the coming year, or the nine thousand failures in other lines of business, or the low market value of the stock of certain large licensee companies organized to absorb the handiwork of the speculator as portrayed in numerous small and unprofitable exchanges, the art of establishing new telephone exchanges, especially in small towns and villages, progressed even more actively in 1883 than ever before. So many investors believed that it was only necessary to establish any kind of an exchange in any kind of a village, no matter how small or how unprofitable the rates might prove, to secure profits of three for one, that the editor of an electrical journal wrote: "No fable concerning the telephone is too gross to receive credence; no prediction of its future can be wild enough to provoke a smile." And the daily papers fed this delusion by constantly referring to millions of dollars alleged to have been made in the telephone business, although the parent company had paid no cash dividends prior to January, 1881, all of which statements many readers accepted as applying solely to exchanges established in small villages, just as three years earlier many investors believed that large profits would be derived from building small branch railroads. And had it not been for the many investments made by farmers in railroad securities, in the aggregate amounting to several millions of dollars, from which no return was secured in many cases, it is quite probable that the farming community would have developed a rural system of telephone service contemporaneously with its early growth in towns and villages.

Again, the infringing telephone companies, and they were numerous, while their promoters were strong in political and financial influence in the '80's, circulated the most absurd statements concerning the millions that had been made in the consolidating of Bell operating companies, and the manipulation of telephone stocks. One statement read: "It is within limits to say that the entire property, rights and franchises of the Bell company and its licensees could be duplicated for one twenty-fifth of the stock capital invested." Yet it is interesting to note that during the three years, 1881-1883, in New York state alone, one hundred and twenty-five infringing telephone companies were organized and capitalized at an aggregate of two hundred and twenty-five millions of dollars, a capitalization authorized by one state only, and three times greater than the combined capital stock of all the Bell companies in all the states of the union, including that of the parent company.

Very fortunately for the investing public, few of these infringing companies ever got fairly under way, even when the highest officials in state and nation appeared to do all in their power to aid in filching rewards honestly won and meritoriously bestowed. Moreover, it has been stated that many of these infringing claims were offered to the parent Bell company for small sums or large sums, depending upon how gloomy or how roseate the outlook was. A comical phase of these infringing competitive schemes was the certainty with which statements would appear in printed circulars, that the telephone was first exhibited to the public at the Centennial Exposition in 1876, and the first telephone line was constructed in Boston in 1877. The fact that they thus admitted that Alexander Graham Bell's telephone was the first telephone did not appeal even to their sense of humor.

Even the announcement on January 24, 1883, of Judge Gray's decision on final hearing in the Dolbear case, and of Judge Lowell's decision the following August, did not appear to discourage investment in the securities of infringing companies, while both decisions served to stimulate the building of small exchanges by speculative promoters and the rapid consolidation of these non-paying properties into overcapitalized organizations.

Judge Gray's opinion in part was:

The opinion in Spencer's case clearly points out that "Bell discovered a new art—that of transmitting speech by electricity—and has the right to hold the broadest claim for it which can be permitted in any case.". . . The evidence in this case clearly shows that Bell discovered that articulate sounds could be transmitted by undulatory vibrations of electricity, and invented the art or process of transmitting such sounds by means of such vibrations. If that art or process is (as the witnesses called by the defendant say it is) the only way by which speech can be transmitted by electricity, that fact does not lessen the merit of his invention, or the protection which the law will give to it. . . . Whatever name may be given to the property, or the manifestation, of the electricity in the defendant's receiver, the facts remain that they avail themselves of Bell's discovery that undulatory vibrations of electricity can intelligibly and accurately transmit articulate speech, as well as of the process which Bell invented, and by which he reduced his discovery to practical use; that they also copy the mode and apparatus by which he creates and transmits the undulatory electrical vibrations, corresponding to those of the air.

On August 25, 1883, the opinion of Judge Lowell on final hearing was delivered in part as follows:

I decided in American Bell Telephone Co. v. Spencer, 8 Fed. Rep. 509, that Reis had not described a telephone which anticipated Bell's invention. The same point has since been decided in the same way in England. United Telephone Co. V. Harrison, 21 Ch. D. 120. It is admitted in the present case that the Reis instrument, if used as he intended to use it, can never serve as a speaking telephone, because the current of electricity is constantly broken; and it is essential for the transmission of speech that the current should not be broken. The defendant (Dolbear) now testifies that the Reis instrument can be made to transmit speech, under some circumstances, if operated in the way which Bell has shown to be necessary. In 1877, he several times expressed the opinion that Bell made the invention, and that Reis did not make it. The experiment made in the presence of counsel, which was intended to prove the correctness of the defendant's present opinion, was an utter failure. . . . .At the former hearing in this case before Mr. Justice Gray and me, we decided that the defendant (Dolbear), whatever the merits of his telephone may be, employs in it a part, at least, of Bell's process. No additional evidence has been given at the final hearing, unless a further explanation of that already given may be called additional; and I remain of the opinion expressed by the presiding justice at that time.

Telephone men were not alone in their realization that self-preservation lay in concentration. For financiers were beginning to perceive the wisdom in the original plan of one great company, to also realize how dependent the future growth and development of the industry was on a centralized policy, and to foresee that the product of unity in purpose, in method, in management, would be serviceable to users and profitable to investors. It was already evident that telephone service had come to stay, that it was an important aid in the transaction of business in every line of industry, and that it was certain to have a revolutionizing effect on many phases of industrial, commercial, professional and social life.

In its annual report for the fiscal year ending February 28, 1883, the parent Bell company said:

From the local companies throughout the country the reports are encouraging. Most of them are now earning and paying dividends, and extending their business with energy. An important feature has been the consolidation of local telephone interests into large companies, covering many counties, and even in several instances the whole or the greater part of entire states. This policy has been assented to so far as its adoption seemed in the interest of convenient and economical management, but it should not be encouraged to an extent that would leave these companies entirely in the ownership of persons who are not residents in the territory where the business is carried on. It has always been our policy to keep local capital and influence interested in the business as far as possible, and to this course may probably be attributed a good part of the success which has attended the development of the business.

A year later the parent company reiterated the foregoing conclusions concerning care in consolidating companies and added:

In spite of the prevailing opinion that the development of the telephone substantially under one control is against public interest, we believe that an intelligent examination of this question would demonstrate that this is not true and that in no other way could the desired results be obtained and the difficulties be surmounted so rapidly and so well as by the present one.

Like the previous year, 1883 was a year of mergers; and when this two-year period closed, the number of Bell companies had been reduced, through absorption or consolidation, from several hundred to less than one hundred, and the parent company was gradually getting into a position where it could strongly influence the policy that should prevail.

In some states practically all the exchanges were absorbed by one strong company; in other states three or four companies aided in bringing about the consolidation, and then divided the territory. For instance, in the summer of 1882 the daily papers told how:

New York and Philadelphia capitalists are visiting various sections of Pennsylvania with a view to consolidate all local telephone companies between New York and Pittsburgh into one general organization, with main offices in New York, Philadelphia and Pittsburgh.

While the promoters failed in consummating so big an undertaking, their efforts paved the way for consolidations more limited in scope. In Massachusetts a combination known as the Lowell syndicate was quite successful in consolidating many exchanges, some of which will be more fully referred to in a following chapter.

Referring to the numerous consolidations of small local licensee companies into new organizations chartered to work on broader plans, the parent Bell company in its annual report for 1883 stated that:

the tendency towards consolidation of telephone companies noticed in our last report has continued and is for the most part in the interest of economical and convenient handling of the business. . . . As methods are devised for making the telephone commercially useful over long lines, the advantages of this centralization of management will be still more apparent, as well as the importance to the public of having the business dona in large territories under one responsible head, with far-reaching connections throughout the whole country. To make this service of the highest value to the people will be complicated enough under one control. Were it in the hands of many competing companies, the confusion resulting would be very serious, as the value of the telephone will be largely measured by its capacity to give prompt connection with all parts of the country.

The parent company also held that the securities issued by its operating companies ought to represent legitimate values, not speculative or estimated values based on what the plant might earn in the future; that the intrinsic value of the telephone securities should be made clearly apparent to investors, and that the established integrity of the investment should be maintained by providing ample sinking funds and reserves to cover every contingency. Its expressed policy was:

to encourage payment of dividends by local companies with a view to getting local influence and capital interested in telephones, but it never encouraged the payment of dividends except when earned.

Such conservative methods were not in accord with the sentiments of speculators who preferred to experiment with the credulity of thoughtless investors, so long as such experiments yielded rich profits. The people believed the newspaper stories about the fabulous profits small telephone exchanges were deriving from limited investments. Then why destroy such honest beliefs by presenting cold facts? Consolidation of exchanges was a good thing; it meant large profits for the promoters.

When these local exchanges were transferred to the management of the new organization, it was quickly perceived that many subscribers were receiving service at rates involving constant loss to the company, as already stated. An increase in rates naturally followed, which, in turn, resulted in some of these low-rate subscribers discontinuing the use of the service. Sometimes from 25 to 50 per cent, of the subscribers to these consolidated exchanges would drop out, and the loss in the income anticipated from these subscribers upset many plans. For most of these new organizations, in expectation of being able to readily dispose of the new securities, had proceeded to reconstruct the old plants absorbed with a view to giving a higher class of service and of promptly and properly handling a large increase in the number of subscribers. To meet the indebtedness thus incurred it was necessary either to sell shares of stock at a price considerably lower than the authorized price, or else to settle the indebtedness with the funds set aside for dividend payments, and in lieu of cash payments to shareholders to issue stock dividends. Again, this inability to raise the funds necessary to make needed extensions and improvements and to keep pace with the growing demands of the public, meant that for an indefinite period the gross earnings must provide for all construction and reconstruction, as well as for the operating and maintenance charges. In other words, in 1883-1886, until improved financial conditions permitted the sale of telephone securities at reasonable prices, growth and progress were necessarily limited within narrow lines that yielded sure returns to the holders of stock certificates.