Palm's Life Line - Part 2

Smartphones from Palm will use the Windows Mobile operating system. So is the company handing over its future to Microsoft?

Perhaps no company born in the pre-dot-com era has been through as many reincarnations as Palm. The company struck gold with the original Palm Pilot in 1996 and had captured 65 percent of the handheld market by 2000 – only to see its commanding lead slip away over the next few years to competitors like Handspring, Research in Motion (RIM), and Hewlett Packard (see part one of this article).

Over the same period, the company’s “family tree” branched into something more like a thorn bracken. In 1995, even before the introduction of the Palm Pilot, Palm co-founder Jeff Hawkins sold the company to modem-maker US Robotics. That company was acquired, in turn, by networking giant 3Com in 1997. A year later, Hawkins and two other co-founders left 3Com to start Handspring. Then Palm separated from 3Com and went public in 2000. In 2003, Palm bought Handspring and spun off its operating-system division, which became PalmSource (and was acquired last month by Access, a Japanese mobile software developer).

With the acquisition of Handspring and its Treo line, Palm became a player – if a minor one – in the smartphone market. The Treo has only a 3.1 percent share of the smartphone market, according to analyst firm IDC. By contrast, the company’s nonphone handhelds, Zire and Tungsten, still command more than one-third of that market . Nevertheless, as we noted yesterday, the cultural ascendance of the smartphone has forced Palm to focus much of its engineering effort on the Treo, and to consider the possibility that its handhelds will soon be a thing of the past.

Clearly, competition and technological change have forced Palm to take many unexpected turns. The latest is perhaps the most surprising: this fall Palm announced that instead of equipping many of its future devices with PalmSource’s Palm OS, it was going with Microsoft’s Windows Mobile 5.0 operating system. That move raises many questions about the company’s future – including whether or not it can sustain an identity separate from Microsoft.

2005: Partnering with Microsoft and RIM

With the divestiture of its software business in 2003, Palm was free for the first time to use another company’s operating system in its products. Douglas Edwards, vice president and co-founder of the mobile software development company Handmark, says that it was clear, from that moment, that Palm would someday partner with Microsoft.

Although it took two years, Microsoft and Palm got together in September 2005, announcing that Microsoft’s Windows Mobile 5.0 would be used on a future version of the Treo. “When Palm got out of the OS business, it made [working with Microsoft] inevitable,” Edwards says.

Insiders at Palm say that while customers are happy with PalmOS, the company needed to switch to another operating system if it hoped to grow to the next level. Indeed, Windows Mobile 5.0 contains features that are not included in the Palm OS.

But, although Palm has good reason to partner with Microsoft, it must now adjust to life as one of many Windows licensees. It must differentiate its products from those of Audiovox, Motorola, Samsung, and other companies. And, like them, it now depends on Microsoft’s ability to keep its operating system competitive with Symbian, Linux, and the Palm OS.

Palm may not find differentiating itself that difficult, though. According to Page Murray, vice president of marketing at Palm, the Treo’s software interface will be different from those of other Windows licensees, because they must follow Microsoft’s strict implementation guidelines, while Palm negotiated an exception to Microsoft’s licensing requirements that allows it to design the Treo’s software so that using it feels like a Palm experience.

And Microsoft wasn’t Palm’s only new-found partner either. Continuing to act on its new strategy of finding the best software for its Treo smartphones, it agreed, within weeks of its deal with Microsoft, to license technology from longtime rival RIM. Under the deal, Treo owners can use RIM’s BlackBerry Connect software to access their corporate e-mail accounts through a secure connection.

The RIM partnership will enable Palm to market its products to vertical markets, such as government and finance, that have favored the BlackBerry over Palm’s handheld because of its email capabilities, according to Edwards. Palm also benefits from the two agreements because the company’s smartphones can now be sold to businesses that use either Microsoft’s or RIM’s email servers. Noting that Palm does not sell email servers, Edwards says “RIM’s competitor is Microsoft and not Palm.”

The Future

The growth of the smartphone market helped Palm to realize, in 2005, its first yearly profit ($77 million) in five years. The company is now trying to jumpstart its stagnant handheld business with a device that combines video and audio playback with communications and business productivity features.

In May, the company released the LifeDrive “mobile manager,” which includes a four gigabyte hard drive for storing business documents and music and video files. The device also provides wireless access to e-mail through either Bluetooth or Wi-Fi connections. And while other Windows-based hard-drive-based multimedia players from companies such as iRiver, Samsung, and Creative Technology are playback-only devices, the LifeDrive can be used to edit Word, Excel, and PowerPoint files.

The LifeDrive could stoke consumer interest in mobile video devices, but its $499 price tag may be a barrier for many people. The device is based on the Palm OS version 5.4, but Palm is leaving the door open to moving to a competitor.

Palm will consider a variety of operating systems for future LifeDrive products, which could take many forms, according to Palm president Ed Colligan. He says the original handheld information organizer concept “has run its course relative to new interests” in multimedia. Palm will develop additional mobile computing products for playing digital media, which means competing with Apple’s iPod.

The market will decide whether smartphones or handhelds become Palm’s biggest sellers. Another big question: How will Palm be affected by its newfound reliance on Microsoft? By embracing Microsoft, Palm is now funding two sides in the battle for mobile software dominance.

Palm still uses the Palm OS on its LifeDrive, Zire, and Tungsten handhelds, and will likely use the software on at least some of its future products. In May, Palm signed a five-year contract worth at least $148.5 million to continue licensing the Palm OS from PalmSource.

Moving the Treo to Windows, however, increases the likelihood that Microsoft will become the leading mobile computing software company, according to software developer Edwards. What’s more, troubles at PalmSource could eliminate one of Palm’s options and require the company to rely on a Windows platform shared by many competitors.

PalmSource’s prospects are an open question. In addition to suffering Palm’s partial defection, PalmSource also lost business from Sony, which stopped selling the Clie in the United States in 2004, and multimedia handheld maker Tapwave, which went out of business in July 2005.

However, PalmSource added a licensee in July 2005, when Korean company LG Electronics decided to use the Palm OS on its future smartphones. In September, the company was acquired by mobile software developer Access Corporation of Tokyo, which may give it a stronger financial backing. Palm has a positive relationship with Access, according to Murray, having previously licensed the Blazer Internet browser from the company.

In sum, Palm’s future depends on fundamental questions about the market for PDAs. Will the smartphone establish itself as the single device that people carry, or will consumers continue to prefer to tote a second device as well, such as a music or video player? Secondly, will Palm’s relationship with Microsoft remain strong? And, finally, will there be a legitimate resurgence of handheld business for Palm, or will the company need to succeed mostly with smartphones? Whatever the answers, if the past nine years are an indication, Palm will not hesitate to make drastic changes to its business model, if it feels the answers to those questions demand it.

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