Palm is nine years old, and for its first four years, it lived a charmed life. It created the market for personal digital assistants and dominated that market. Then things got interesting: Competition from hardware and software companies loosened Palm’s grip on the PDA, while at the same time the overall market for technology collapsed. Finally, the ascendance of the smartphone forced Palm to consider the possibility that its handhelds were destined to become a thing of the past.

These combined forces of competition, recession, and the changing nature of what a PDA is have forced Palm to make big, seemingly counterintuitive changes to its business model almost as a matter of course.

Consequently, Palm’s short, eventful history serves as a useful guide to the factors that have shaped, and will continue to shape, the market for PDAs. Here, then, is a chronology of Palm in two parts. Today, we will cover 1996 to 2004. Tomorrow: 2005 and beyond.

1996-2000: Creating a Market

In 1996, the Palm Pilot ushered in the era of the PDA. While other companies, such as Apple (with its Newton), had tried and failed to build a following for their handhelds, within two years of the Palm Pilot’s arrival, Palm was doing more than one-quarter billion dollars in annual sales. By 2000, the company had garnered 65 percent of the 11.2 million-units market for handhelds (here defined as a non-phone device), according to analyst firm Gartner (no relation to the author). Palm’s steady march of increasingly sophisticated handhelds, including the Palm Pilot and Palm III, V, and VII, all featuring the Palm operating system, eventually turned the company into a billion-dollar-a-year business.

Mobile professionals clamored to buy the latest edition of Palm’s handhelds. “There was a unique moment in time where Palm was the poster child for the Internet generation,” says Palm’s senior vice president Ken Wirt. “Palm was super red hot…but nobody ever stayed that hot for long.”

2001 to 2003: Suffering Losses

Indeed, Palm couldn’t keep generating the heat. Its dominance vanished as devices such as the Handspring Visor and Research In Motion’s BlackBerry entered the market. And it wasn’t just hardware that posed a threat: Compaq, Hewlett-Packard, and other PC makers chose to license Microsoft’s competing PocketPC operating system instead of the Palm OS for their handheld devices.

In March 2001, Palm announced that it would sell the m500 and color m505 handhelds, featuring expansion slots for adding peripherals, but the devices were delayed by several months. Palm had prematurely announced the products “to steal some thunder” from rising handheld competitor Handspring, according to Todd Kort, a principal analyst with Gartner. (Handspring was founded by former Palm executives Jeff Hawkins and Donna Dubinsky.)

Instead of inflicting mortal damage on Handspring, Palm’s premature announcement may have killed demand for its existing line. Kort believes that people stopped buying existing Palm products in anticipation of the new models. Then Palm didn’t ship the new devices to retailers until late in the year, making the second and third quarters “disastrous for Palm,” Kort says.

Handspring also succeeded because it learned how to attack Palm’s leadership position in handhelds, according to Ed Colligan, who left Palm for Handspring in 1998, and is now back with Palm as president and CEO. Handspring licensed the Palm OS and developed the Visor handheld and upgrade modules that turned the device into a mobile phone and music player. By outfoxing Palm with more flexible hardware, “we almost instantly got a 20-percent market share,” says Colligan.

Another new rival, Research in Motion, was also making inroads with business buyers by offering wireless access to corporate e-mail. RIM’s BlackBerry device offered a miniature keyboard and gave professionals a secure connection for receiving messages from corporate e-mail servers – features not available from Palm.

Then there was Microsoft, which was putting heat on Palm’s software business with its release of the Windows Mobile operating system, which competed with the Palm OS as a platform for handheld manufacturers. PocketPC handhelds (using Windows Mobile) integrated well with Microsoft’s desktop applications and Exchange e-mail server and continued to grow in popularity.

The presence of viable threats in hardware as well as Microsoft’s alternative OS meant that Palm would give ground between 2001 and 2002 to the Visor, BlackBerry, Compaq’s iPaq, and Sony’s Clié, dropping from a 55.9 percent to a 50.0 percent market share, according to Gartner.

Of course this drop had an impact on the bottom line. During fiscal 2001, Palm lost more than a half billion dollars – after having shown a profit of $45 million in 2000. And Palm would continue to lose money for another three years. The continuing U.S. economic downturn in 2002 and 2003 contributed to a slowly decreasing market for handhelds, which shrunk from a high of 13.1 million units in 2001 to 11.5 million in 2003, according to Gartner. Palm’s revenues were also dropping: by one-third in 2002, and another 16 percent, to $837 million, in 2003.

2003: Enter Smartphones; Exit Operating Systems

Further cutting into the demand for handheld organizers was the emergence of smartphones, which combine wireless voice and data access with the PDA functions of a handheld.

Handspring released the Treo smartphone in early 2002 and by the end of the year was selling more than 50,000 units per quarter. In 2003 Palm shelved development of a Treo competitor, according to Palm’s Wirt, and instead purchased Handspring. Palm introduced the first Treo under the Palm brand in November 2003, and its smartphone business is now growing faster than its handheld unit. According to analyst firm IDC, Palm sold 430,000 smartphones during the second quarter of 2005, an increase of 218 percent over the previous year. During the same period, Palm sold 638,000 of its Zire and Tungsten handhelds.

To the degree that Palm pursues smartphones instead of handhelds, it goes from being a big fish in a small pond to a small fish in an ocean. Palm currently has 3.1 percent of the smartphone market, compared with 36.5 percent of the handheld market, according to IDC.

Yet the decision is sensible, since it is clear that most users want combined PDA and phone functions in a single device. According to Gartner, the market for non-phone handhelds will grow to 15 million units this year, while smartphones will reach 40 million units, indicating that Palm’s greatest opportunity for growth could be with its Treo smartphones.

Colligan says Palm’s management has made it clear that smartphones are central to the company’s growth, a philosophy that required careful explanation to those employees focused on developing handhelds. “You have to be careful about [handhelds] not being perceived as the old thing, or something not as interesting,” Colligan says.

In the midst of Palm’s transition to smartphones, the company decided to stop developing operating system software. In October 2003, it spun off its OS division as PalmSource, which now controls the Palm OS development.

Wirt says the company decided to break off PalmSource because it wanted to avoid the conflicts of licensing software to competitors. “Some people in the company are trying to kill the competition, while others are trying to sell to them,” says Wirt, who saw the same problems when he worked at Apple Computer, which briefly licensed its software to clone computer manufacturers.

Palm also wanted the freedom to use software from other companies. “We said then [when selling off PalmSource] and still believe, if there is a segment of the market that could be served better by different a OS, such as Windows, Symbian, or Linux,” the company would do what was best for its customers, Wirt says.

After the split, Palm continued to design smartphone and handheld devices that run the Palm OS. However, after PalmSource released version 6.1 of the OS (also known as Cobalt) in September 2004, Palm chose not to develop products based on the software.

Palm’s vice president of marketing, Page Murray, says the company did not develop for Cobalt “because we were making substantial enhancements to the existing OS.” The company continued to release handhelds and smartphones that used the prior version of the Palm OS.

Many software and hardware companies are now waiting for PalmSource to complete a new version of the OS that replaces the kernel (the underlying architecture for communicating with the hardware) with a Linux core, according to Douglas Edwards, vice president and cofounder of the mobile software development company Handmark.

Edwards says his company did not develop applications for Palm OS 6.1 because Palm “gave no sign that it would support the platform.” For now, Handmark develops applications for Microsoft’s Windows Mobile operating system as well as the older Palm software; but he remains optimistic about the Palm OS in development. A Palm OS based on Linux “could be robust platform” and a less-expensive alternative to Windows-based handhelds, says Edwards.

In part two of this article we’ll explore Palm’s partnership with Microsoft. Will the company’s embrace of Windows lead to new opportunities – or greater competition? Come back tomorrow and find out.