Palm Reaches Out For A Hand

Palm Inc. has learned the hard way that being a pioneer
brings mixed blessings. In the 1990s, the creator of the original PalmPilot
personal digital assistant (PDA) opened up the market for handheld devices that
combine calendars and address books. But its success attracted stronger,
deeper-pocketed competitors such as Dell Inc. and Hewlett-Packard Co., and Palm
piled up nearly a half billion dollars in losses in its most recent fiscal year.

On October 28, shareholders will vote on the company’s best
hope for survival. That day, investors are expected to approve a complex
restructuring in which Palm will merge with Handspring Inc., the innovator
behind sleek smart phones that combine PDA and cell-phone capabilities, to
create a new company called palmOne Worldwide. At the same time, Palm plans to
spin out its software division, PalmSource Inc. The idea behind the revamp is
that, with the resources of the combined companies, palmOne will have more
muscle to fend off increasing competition in Palm’s traditional PDA market and
a better chance of grabbing a slice of the fast-growing market for smart phones.
PalmOne is forecast to have some $1 billion in sales this year. And although it’s
expected to lose $60 million during the year, palmOne says it can save $25
million annually after the merger through layoffs and bulk inventory purchases.
"We’re bringing a new vision of handheld computing together," says
palmOne CEO-to-be Todd Bradley. Investors are applauding: Palm’s stock is at
$26, up sharply from the low of $9 this spring.

BRADLEY: palmOne’s “new vision” is for more PDA-cell phone combos

Still, the celebrations may be overdone. PalmOne looks
destined to be a slow-growing, niche player in the overall mobile-device market.
Its revenues will probably increase at only single-digit rates for the next few
years and it’s unlikely to reach profitability before 2005. With dozens of
rivals using Microsoft Corp.’s Windows handheld software, palmOne’s share of
the PDA market will very likely slide slightly during the next few years, down
from 40% now. And while Handspring’s innovative new Treo 600 should help
regain some ground in the smart-phone market, it will probably never be more
than a minor player, compared with heavyweights such as Nokia and Samsung.
"Palm can be like Apple, in terms of offering simplicity in elegant
packages, but never having more than a 3—5% share of the
market," says analyst Kevin Burden of researcher IDC.

PDAs at Their Peak?

One of the obstacles for palmOne is a simple combination of
math and competition. Palm is still the leader in the market for traditional
handhelds, but rivals are gaining fast. Just a year after releasing its first
PDA, Dell is the fourth-largest seller worldwide. Palm is fighting back by
segmenting its handhelds into $199—499 Tungsten devices for executives and
lower-priced $99 Zire offerings that have attracted new customers. Still, its
dependence on the traditional PDA market creates a longer-term problem. IDC
predicts that demand for the devices will increase only marginally as consumers
opt for smart phones. In 2007, about 15.2 million units are expected to ship, up
from 11.3 million this year.

That’s why Palm is turning to Handspring. By buying the
upstart, Palm is pushing into the growing market for smart phones that combine
traditional organizer functions with the ability to surf the Internet, talk,
play games, and take pictures. Handspring chairman Jeffrey C Hawkins and
co-founder Donna L Dubinsky were the original Palm dream team, winning accolades
for creating the first PalmPilot and the follow-on Handspring Visor device. When
they left Palm in 1998 to found Handspring, the duo jumped into the market for
cell-phone/PDA combos too early, nearly going bankrupt. Now, with faster
wireless connections and sleeker designs, demand for the devices is taking off.
The market is expected to triple this year, to 13.1 million units, and to hit 81
million by 2007, IDC estimates. Hawkins is confident that palmOne can grab a
chunk of that business. "You can compete with these guys, especially if you
have a very unique understanding of the market and the vision," he says.

Handspring, though, is on the defensive in the smart-phone
market. Giants such as Nokia, Samsung, and Motorola are pouring money into
research and are aggressively pushing their better-known brands. This year,
Handspring dropped to 2% of the market, half its 2002 level, because it didn’t
release a new model last year. Nokia dominates the segment with a 61% share,
while Sony Ericsson holds 10% and Motorola has about 6%.

PalmOne’s chore is further complicated by its delicate
relationship with the Palm software company. The restructuring was designed to
give both the hardware and software operations more leeway. PalmSource, which
develops the basic operating system, could market its wares to rivals without
the complications of close ties to the Palm device maker. PalmOne could use
different operating software to satisfy certain customers.

But a key question is whether PalmSource will have the
financial resources necessary to develop new versions of the software–or
effectively support palmOne. At the time of the spinout, PalmSource will have
only $39 million in cash and a few hundred in-house software developers.
PalmSource CEO David C Nagel says he can tap a $15-million credit line and seek
more equity investment if needed. Still, software maker Symbian, whose operating
system is backed by Nokia, and Microsoft spend hundreds of millions annually on
their mobile operating systems. "At best, has a toehold in
this market, and they risk getting left behind in the race for new types of
devices without a lot of money to play the game," says Juha Christensen,
Microsoft vice-president for mobile devices.

Mix and Match

PalmOne has worked hard to keep its options open. Of the
company’s 825 employees, more than 60% are expected to be software engineers
who will work on different operating system improvements for palmOne devices.
Bradley and Hawkins says palmOne will continue to work with PalmSource. But the
company is not wedded to the software and could conceivably mix and match
between programs from Symbian and Microsoft. What’s important, the executives
say, is that palmOne be responsive to wireless carriers’ needs and churn out
new products more quickly.

Bradley also is working to trim costs. This year, Palm
shifted all production and some design work to low-cost plants in China. That
will save $16 million annually and will give the company margins of about 25% on
every device. Earlier, some devices logged margins only in the single digits.

Churning out new devices has had some payoff. Palm in the
past year has upgraded its operating system and switched to faster processors to
allow for more colorful screens. That helped Palm grab 2% of lost share in the
PDA market. Still, even after this month’s restructuring, palmOne’s biggest
battle lies ahead of it.

By Cliff Edwards in San Francisco in BusinessWeek. Copyright 2003 by The McGraw-Hill Companies, Inc