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[Inventions That Changed the World] Bad Business Decisions: Bell’s Telephone Invention

[Inventions That Changed the World] Bad Business Decisions: Bell’s Telephone Invention

KIM Jae-Yun

July 15, 2011


Welcome to our video program. I'm Jae-Yun Kim from the Industry and Strategy Department I.

What is the most valuable patent in history? Though opinions may vary, Alexander Graham Bell's telephone patent is surely among the first runners. This episode of “Inventions that Change the World” will address the birth and growth of AT&T, the company that grew from Bell's patent. The story of Bell's patent illustrates the influence of decision making by the CEO on corporate growth.

In 1876, when Bell invented the telephone, the telegraph was starting to gain increasing influence on people's daily lives. A company named Western Union was providing telegraph service to companies in US major cities. Western Union was founded by Ezra Cornell, who also founded Cornell University. By the late 1860s, major US cities, including Philadelphia and New York, had telegraph exchange devices. They offered services to businesses and the general public. Innovations like autographic telegraphy and technology that enables simultaneous access by multiple people were also created.

Compared to the existing telegraph infrastructure, the telephone was, at this time, inferior. Audio quality was poor and the telephone itself was bulky and cumbersome. Network equipment had not yet been developed.

Recognizing that it was not easy to start a new business with the new technology, Bell and financial supporters Gardiner Hubbard and Thomas Sanders tried to sell Bell's telephone patent to Western Union. The price was US$100,000, or US$2.25 million in current terms, a very small amount considering current market size.

Western Union President William Orton responded that the telephone had too many shortcomings to be seriously considered a means of communication. He rejected the offer. This marked one of the biggest mistakes in corporate history.

Orton's logic was simple. First, Western Union monopolized the US telegraph market and had huge profits. Orton believed Western Union did not need a telephone business, whose technology was unproven. Besides, he thought their markets were different. Telegraphs transmit text or numerical data through Morse code. In terms of exchanging information with binary numbers, the concept is similar to today's digital technology. Telegraphs were used in the financial, corporate, and defense sectors, where accuracy was deemed most important. The US stock market ticker evolved from telegraph technology in 1866, and money transfers based on the telegraph network started in 1871.

Orton considered telephones as a tool that could enable conversation without a face-to- face meeting. Simply put, telegraphs for him were for the business market, while telephones were for the consumer market.

Second, Bell's telephones had technology limits in terms of audio quality. To hide such limits, Bell used Bible phrases and hymns to be heard over the phone.

Third, Orton had faith that should Bell's telephone amount to anything, Thomas Edison or Elisha Gray would soon develop a better technology forcing Bell out of the market.

Gray is remembered as an unfortunate inventor who applied for a patent two hours later than Bell and thus failed to secure patent rights to the telephone. In reality, because US patents were given on an “invention-first” basis rather than the timing of a patent application, such belief in a two-hour delay may be an exaggeration.

Orton's opinions were very logical. Orton asked Edison to develop a better telephone to prepare for any success from Bell.

In July 1877, Bell, Hubbard and Sanders established Bell Telephone Company. It later became AT&T, one of the world's largest companies, before the US government split the company in 1984. Only 30 years after Bell established AT&T, the company owned Western Union.

What mistakes did Orton make in his seemingly reasonable decision?

The importance of rational decision making can never be overstated. Nevertheless, there is a trap here because seemingly reasonable decision-making can often cause irreversible failure. Such an error often comes when new technology competes with an existing one.

MIT professor James Utterback explains this in a graph. Every technology experiences a decline in innovation speed over a length of time. Technology adoption typically occurs in an S-shaped curve. When a business reaches maturity, new innovations come slowly. New technology can be inferior in terms of efficiency and price so companies with stable market positions tend to ignore new technology. They believe a reasonable consumer would not buy inferior technology.

However, new technology growth draws itself another S curve, and so when time passes the two technologies eventually show the same level of performance. When this stage comes, a company can only decline even if it revamps existing technologies.

This formula can be applied to telegraphs and telephones. When Orton decided telephones were a new technology, telegraphs were a public technology. The performance gap was wide. Orton naturally opposed the new technology. His decision making, however, lacked a long-term view. On the surface, his decision-making was very reasonable. It was, however, a bad decision.

If a new technology eventually turns out to substitute for an existing one, short-term rationality can become risky. Carriages and cars, or beepers and mobile phones are only a few examples of misleading decision making. Decision making, even when making the seemingly obvious choice, thus needs to consider the rational choice over the long term.

Thank you for watching. I'm Jae-Yun Kim.

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