By Jim Cole, Investing Across Borders

May 2001

When Palm Inc. announced it would miss fiscal fourth quarter earnings and revenue projections by an arm and a leg because of a slowing economy and a product transition, it was time for astute, long-term investors to walk – no, stampede -- away from today’s leader in the handheld device market.

Palm’s own gloomy outlook merely reinforced the story of trouble that was already unfolding in Europe, where its market dominance is withering rapidly against Microsoft’s Pocket PC operating system.

You’d think it would be difficult to say farewell to a company that sells some 70 percent of the personal digital assistants (PDAs) sold today and whose software is used in more than 80 percent of the PDAs on the market. It would be like abandoning Microsoft in the early 1990s, as PC sales were set to explode.

Unlike Microsoft and its dominance of the PC software market, Palm may be on the verge of exiting the leadership stage just as the mobile device show begins.

"Microsoft and Research In Motion have clearly managed to make inroads to Palm's market share," Kevin Burden, manager for IDC's Smart Handheld Devices research program, said in late February. "While Palm continues to reign supreme, for the first time the company is facing a solid threat to its dominance."

IDC forecasts the worldwide market for handheld devices will grow from 12.9 million units in 2000 to over 63.4 million by 2004.

Palm’s role in that wave of growth is in doubt. In March, London-based market-research firm Context reported that from December to January, Palm dropped 4 percent in penetration of the European PDA market, while Microsoft’s Pocket PC jumped about 12 percent. Context said Palm has 55 percent of the market, while Pocket PC has more than 30 percent.

In the most recent quarter, device sales accounted for 96 percent of Palm’s total revenue. Clearly, sales of the popular Palm PDAs will be the primary focus for the company for some time. Even there, however, Palm is slipping. Palm’s market share fell from almost 69.6 percent in October to 65.7 percent in January, while Handspring’s share rose from 14.5 percent in October to 18.8 percent in January, according to market data company NPDIntellect.

In its most recent earnings report, Palm said fiscal fourth quarter revenues would be half what analysts were expecting. The company said it expects fiscal fourth period revenue of $310-315 million and said sales and earnings would be hurt by a product transition, slowing economic growth and competitive factors.

But with the dramatic increase in the types of handheld devices available, including mobile phones that incorporate computing capabilities, Palm’s viability in the next few years depends on continued dominance of its operating system.

According to IDC, smart phones will be the fastest-growing segment of the handheld devices market. From 480,000 in 2000, shipments of smart phones will increase at a compound annual growth rate (CAGR) of 164% to over 23 million by 2004. In comparison, the overall handheld market will earn a 48% CAGR.

And the battle for dominance of the PDA-phone market may not be a Palm vs Visor vs Blackberry vs Compaq iPaq rumble. Instead, it will likely be among the Nokias, Ericcsons, Kyoceras, Siemens and Samsungs of the world – mobile phone makers who are packing their newest phones with PDA software and capabilities.

Japanese handset maker Kyocera was first to market with a PDA-phone, which uses the Palm OS. Samsung is also rolling out a Palm OS-based mobile phone. If only the story ended there. Alas, Hewlett-Packard told CNet in February that this fall in Europe and Asia it will begin selling a Jornada, PDA-phone combo, powered by the Pocket PC operating system. And, French handset maker Sagem and Japan’s Mitsubishi also plan to sell Pocket PC-based PDA-phones.

Clearly, as PDAs and mobile phones converge, Palm will have its work cut out for it.

Jim Cole writes about technology for Investing Across Borders. He is the former technology editor of TheStreet.com and most recently was editor-in-chief at Scudder Weisel Capital.