Engines That Move Markets (2nd Ed) Page 12

  The performance of the shares reflects this outcome, though it should be noted that Western Union’s assets were potentially of value to the Bell Companies, which had the ability to obtain greater use of its fixed assets by combining the two companies. In 1910, Bell did take control of Western Union, but was forced to divest itself because of the hostile reaction of competitors and government to the potential monopoly threat. In 20 years, therefore, Western Union declined from being the dominant player in the industry, with unrivalled scientific and financial resources, to an asset-play takeover candidate. This did not happen overnight, but the decline was inexorable and inevitable as soon as the case against the Bell patent was lost. The technological shift was so profound that there was little Western Union could do to reverse the process. A more clearly defined case of a technological redundancy would be hard to find. For investors, the share price decline initiated by the advent of the telephone was the start of an enduring and unrewarding trend.

  The emergence of the telephone

  Alexander Graham Bell was born in Scotland in 1847. During his early life he was immersed in the science of sound, phonetics and physiology of speech. His father was one of the world’s leading elocutionists, and his mother’s hearing was severely impaired. His father was to produce the definitive text on ‘visible speech’, a universal single phonetic system, and Bell’s future interest in the electrical transmission of speech was therefore grounded in a thorough understanding of the fundamentals of speech.

  Bell’s father had received strong interest in his work from America and following the tragic loss of two of their sons to tuberculosis, the family emigrated to Canada. Within 12 months Bell’s talents had secured him a teaching position in the United States, at the Boston School for the Deaf. His ability as a teacher soon brought him to the attention of the school’s patrons. In 1872 Bell took on the tuition of George Sanders, a child who had been born totally deaf, and who was the son of Thomas Sanders, a prosperous Massachusetts merchant who would play a crucial role in financing future developments. Bell’s ingenuity and knowledge of speech helped the child make huge strides in his ability to communicate.

  Bell was also fascinated by the potential for transmitting sound electrically – and thus there were the main elements for creating a ‘new’ technology. First, he had a thorough understanding of a related field. Second, he had practical experience and the drive to succeed. Lastly, through connections at the School for the Deaf, he had contacts and access to both capital and management advice. Bell’s initial focus was naturally on improvements to the technology of the telegraph. This was understandable, as the telegraph dominated the communication field, and incremental improvements to the carrying capacity or the speed of transfer were clearly likely to be lucrative patents for whoever achieved them.

  Bell was only one of a substantial coterie of knowledgeable researchers who sought to achieve such improvements as the duplex and later the Quadruplex. Bell pursued the development of what he called the ‘harmonic telegraph’. Before the duplex and the Quadruplex, only one message at a time could be transmitted. Bell drew parallels between multiple messages and multiple notes in a musical chord – hence the harmonic telegraph. In this he fought a race with the Western Electric scientist Elisha Gray. Bell faced a number of constraints, not least that he was combining his research with his teaching work. As an alien, he was unable to file a caveat on his work, only a full patent which in turn was only available for completed work. In 1874, Bell sought a patent from the British Crown, but was not only informed that this would not be extended to him in absentia, but also that any remuneration would be at the discretion of Her Majesty’s Postmaster General. Thus rebuffed, and without the likelihood of obtaining legal protection for his work, Bell redirected his research efforts from telegraph enhancement to subjects more directly relevant to his work as a teacher, including the reproduction of human speech.

  In the summer of 1874, Bell pulled together his various areas of research in an experiment which combined the use of a dead man’s ear and an intricate series of connections to a straw stylus which demonstrated the ability to translate sound into physical movement. The experiment enabled Bell to recognise that sound could be uniquely translated into an undulating current defined by its amplitude and frequency. Armed with this knowledge and the view that here was a new and improved method for telegraphy, Bell sought out the father of one of his students for advice. In October he visited Gardiner Greene Hubbard, the son of a Massachusetts Supreme Court judge and a patent attorney. Hubbard was fascinated by technology and excited by the telegraphic prospects from Bell’s work. Hubbard immediately checked the US Patent Office and found that there were at that time no competing patents. Out of the meeting with Hubbard came an equal partnership between Bell, Hubbard and Thomas Sanders, set up to fund Bell’s research. Competition was intense, and the race to establish a working model and patent would only produce one winner.

  The passage of Bell’s research work on the telegraph was anything but smooth. A demonstration in March 1875 to William Orton of Western Union had proceeded smoothly in a technical sense, but had been marred by the suspicion that the process was designed only to pass information on Bell’s work to Gray. At the presentation, Orton had made clear his view that only one system would succeed and that the fact that Gray worked for Western Electric weighed heavily in his favour. Personal enmity between Orton and Hubbard also surfaced during the meeting, and it was apparent that convincing Western Union to use their invention was going to be no easy task.

  Bell returned to his home from Western Union’s Broadway headquarters determined to perfect his invention and add as many functional channels as possible. During this further work he became convinced of the potential to carry the human voice and wrote to his partner Hubbard about the potential for using variable resistance to transmit undistorted signals. In June 1875, with his colleague Thomas Watson, Bell successfully transmitted sounds using induced currents. His partners were not impressed by the diversion this caused from pure development of the telegraph, but despite repeated attempts found themselves unable to constrain Bell’s enthusiasm in this direction.

  In September 1875 Bell began work on the patent application for his work, to include both the improvements to the telegraph and his work on sound transmission, which ultimately become known as the telephone. In November 1875 Bell was married and the newfound need for financial security further stimulated his efforts to obtain patents. Bell initially attempted to have his work patented in Britain, and in January 1876 dispatched a gentleman with the necessary paperwork, but only on his American patent paperwork did he add a clause regarding variable resistance. This would have significance later in the courtroom battle with rival inventor Elisha Gray. Unfortunately for Bell, the patent was never filed in Britain and thus he failed to obtain protection in the richest market in the world, albeit one where communication was controlled by the public sector. On the other hand, and fortunately for Bell, frustration at Bell’s delays led the more commercially aware Hubbard to apply for patent protection. Hubbard instructed his Washington lawyers to submit the patent on Bell’s behalf to the US Patent Office. This was done on 12 February 1876.

  From prototype to commercial development

  The first public showing of Bell’s invention came at the Philadelphia Centennial, a grand scientific convention displaying the latest inventions of the period. The Centennial was opened by President Ulysses S. Grant and Emperor Dom Pedro II of Brazil on 10 May 1876. Nestling among other inventions of the time, such as the first grain binder, Elisha Gray’s musical telegraph and Western Union’s printing telegraphs, Bell’s invention might have gone unnoticed were it not for the intervention of the Emperor of Brazil. Having visited his class for deaf mutes at Boston University, Dom Pedro knew Bell and was interested to see what he was exhibiting. His interest stimulated that of others, including Sir William Thomson (later Lord Kelvin), a fellow Scot and one of the pre-eminent scientists and authorities o
n electricity. Bell explained the theory behind his work, first demonstrating his improvements to the telegraphic apparatus.

  3.4 – Stimulating interest: Bell markets his new invention

  Source: Scientific American, 31 March 1877.

  He then explained ‘undulatory theory’, and offered to provide a rudimentary test run. This involved Bell moving to a different room and speaking to both Thomson and Dom Pedro. For the record, the transmission was Hamlet’s soliloquy and the distance was 100 yards. The assembled audience cheered in response and Bell received both a glowing report from the exhibition’s panel of judges and a medal award for his telephone. This award came despite Gray’s protests to the panel judges that Bell’s invention could not have used electrical current for sound transmission and must have been acoustic in nature. Despite this success, public reaction ranged from unimpressed to dismissive. The Times in London, for example, described Bell’s offering as “the latest example of American humbug”. Many scientists of the day were as sceptical as Gray, describing it variously as either a hoax or an irrelevance. For Bell and his backers, the next stage was to take the invention from a rudimentary working model to a viable commercial entity. In order to achieve this, they needed enough support to finance the new venture and encourage subscribers to make use of the telephone.

  The initial scepticism that greeted the telephone was demonstrated by the difficulty Bell’s colleagues had in raising funds to develop the business. Bell was forced to spend much of his time marketing the new invention, to convince potential backers as to its technical viability and its practical use. Public demonstrations were set up in the presence of venerable scientists, such as Sir William Thomson connecting Boston and New York and conducting a conversation between Bell and Watson. In October 1876 they followed this up with demonstrations between Boston and Cambridge, Massachusetts.

  Bell’s marketing campaign included such ‘stunts’ as using 16 Yale professors rather than a wire and letting the current carrying his conversation flow through their bodies. Despite these efforts, it took until May 1877 for the first telephones to be leased. The sum paid was $20 ($1,500). By August the number of telephones in use had expanded to 778 and it became necessary to enter into a more formal business agreement. The Bell Telephone Association was created, with Bell, Hubbard and Sanders each receiving 30% of the shares and Thomas Watson 10%. At that time the venture had no subscribed capital; it had effectively been bankrolled by Sanders, who had signed notes totalling in excess of $110,000 (nearly $10m) and was himself close to bankruptcy.

  The investing environment of the time was not conducive to raising capital. Recent great leaps forward in technology had created an earlier bubble; when this burst, it resulted in substantial losses for many investors, leaving the public soured with promises of future advances. Even though Bell’s demonstrations attracted favourable press comment, funds were not readily forthcoming. The disasters, bankruptcies and scandals that followed the financing of the railroads were still fresh in investors’ minds. It required more than a concept, however well marketed, to attract funds. The euphoria which surrounded the railroads and which allowed both the overbuilding and the lack of financial or management controls had evaporated.

  Investing opinion was hesitant to invest generally, and sceptical on Bell’s particular invention. Few seemed to share Bell’s view that the telephone would one day replace the telegraph. The best encapsulation of the prevailing opinion of the time is the fact that Western Union, the company that was best placed to understand the commercial importance of fast and accurate information transfer, dismissed the telephone as an irrelevance. In 1876 the Bell consortium, disheartened by their inability to raise capital, turned to Western Union and offered to sell Bell’s patents for $100,000 (just over $8m). Western Union’s president, William Orton, declined the offer, on the grounds that he could not see a viable commercial use for the telephone. “What use,” he asked pleasantly, “could this company make of an electrical toy?”²⁴

  A more detailed reaction can be seen from the minutes of the meeting that considered Bell’s offer:

  “The telephone is so named by its inventor A. G. Bell. He believes that one day they will be installed in every residence and place of business. Bell’s profession is that of a voice teacher. Yet he claims to have discovered an instrument of great practical value in communication which has been overlooked by thousands of workers who have spent years in the field. Bell’s proposals to place his instrument in every home and business is fantastic. The central exchange alone would represent a huge outlay in real estate and buildings, to say nothing of the electrical equipment. In conclusion, the committee feels that it must advise against any investments in Bell’s scheme. We do not doubt that it will find users in special circumstances, but any development of the kind and scale Bell so fondly imagines is utterly out of the question.”²⁵

  Western Union changes tack

  The company was correct in one sense, in that the vision espoused by Bell would involve substantial investment. Western Union steadfastly held to its opinion that the telephone posed no competitive threat until one of its subsidiaries reported, barely a year later, that its telegraphs were being replaced by telephones. At this point it was galvanised into action. In December 1877, Western Union set up the American Speaking Telephone Company. This was capitalised at $300,000 ($25m), and headed by three of its most distinguished and eminent electrical inventors: Thomas Edison, Elisha Gray and Amos Dolbear. This formidable trio was perfectly capable of producing apparatus superior to that of Bell. With capital, backing and the wire network of Western Union behind it, the new company immediately sought to squeeze Bell out of existence.

  Western Union attacked on a number of fronts. The dominance of the company’s wire network made market penetration relatively easy. The company could immediately hook its phones up to existing spare lines, whereas Bell’s group had to string new lines before connection was possible. The second line of attack came on pure technological grounds; Edison had developed a carbon button transmitter which made Western Union’s equipment vastly superior to Bell’s (although this position was swiftly remedied by the purchase of an improved transmitter from the inventors Emile Berliner and Francis Blake). Added to these attacks was a relentless smear campaign waged through the press to the effect that Gray had invented the telephone only to have it stolen by Bell. This, in spite of the fact that in March 1877 an exchange of letters had taken place between Bell and Gray, sparked by claims in the Chicago Tribune that Gray was the true inventor – and included in one letter was an explicit statement by Gray that he did not “claim even the credit of inventing it”. This correspondence was to assume pivotal importance in the events that subsequently unfolded.

  Over the years that have passed since the invention of the telephone, and the creation of the giant company that it spawned, some very different schools of thought have emerged. Some authors, perhaps influenced by the dominant position that the Bell companies later achieved – and the monopoly practices they engaged in – contend that Elisha Gray was the true inventor of the telephone. They say that Bell altered his patent application and in effect ‘stole’ part of Gray’s application. The controversy is important, because it was a potential point of weakness for the Bell companies which speculators and competitors sought to exploit.

  Bell’s patent has been described as “the most valuable single patent issued in any country”. It may well also be the most litigated patent issued in any country. On the same day that Bell filed his original patent, Elisha Gray filed a caveat – effectively a note of intent to file a future patent. The records show that Bell’s filing was the fifth entry and Gray’s caveat the 39th of the day. Some historians argue that since some of Bell’s patent was written in the margin, this provides evidence that it was written after seeing Gray’s caveat. It has also been suggested that the patent officer admitted to having shown Gray’s caveat to Bell. Others argue that Gray initially ridiculed Bell’s invention, th
en congratulated him on his achievement, explicitly saying that he had no claim to it as an invention. Indeed, they argue that Gray only laid claim to the invention of the telephone in 1886 after its practical and commercial viability was proven, meaning little credence should be attached to what was obviously a money-inspired claim.