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Palm's Slipping Grip

By Stephen H. Wildstrom Companies that compete head-on with Microsoft often suffer a very strange fate. Once-dominant players such as Word Perfect, Borland, and Lotus Development assisted in their own downfall by somehow losing their ability to make sound strategic decisions while caught in Redmond's basilisk stare.

The latest player to show serious signs of the Microsoft Muddle is Palm Computer (PALM), whose future looks increasingly uncertain, even as products it makes or licenses continue to hold more than 70% of the worldwide market for handheld computers. The lead, especially in profitable, high-end models, is threatened by increasingly attractive products from Compaq Computer, Hewlett-Packard, and others based on Microsoft's Pocket PC software.

Palm is running out of time to regain its grip, and the prospects aren't good. On Nov. 8, the company capped a tumultuous and painful year by announcing the resignation of CEO Carl Yankowski. During the not-quite two-year tenure of Yankowski, a former Sony Electronics and Reebok executive, Palm went public and saw its stock hit a high of $96 -- only to become mired in a series of product miscues and massive losses. The stock is closed on Nov. 9 at $2.65.

FIVE CEOs. Management turmoil at the top has been a persistent problem for Palm since its visionary founders, Donna Dubinsky and Jeff Hawkins, departed in 1998. They wanted to spin Palm off from parent 3Com, but management said no. So Dubinsky and Hawkins left to found Handspring, which is both Palm's largest licensee and leading rival. With the appointment of Palm Chairman and former 3Com CEO Eric Benhamou to run the company on an interim basis after Yankowski's departure, Palm has its fifth CEO in just a bit more than three years.

Benhamou says Palm has already started its search for a new chief. Meantime, the company will be run by an executive council headed by Benhamou and including David Nagel, head of Palm's operating-system group; Todd Bradley, an executive vice-president who heads Palm's hardware group; and CFO Judy Bruner.

The interim CEO also says both Palm's reorganization plans and its business are on track. By yearend, Nagel's Platform Solutions Group, which handles operating-system development and licensing, will be operationally separated from the rest of the company and will function as an internal, wholly owned subsidiary.

OVERHAUL NEEDED. Benhamou doesn't forecast when Palm would return to profitability but says: "While economic slowdown persists and consumer confidence has fallen following the September 11 terrorist attacks, we are encouraged the sell-through has rebounded to levels above that of the summer months."

However, Palm's problems go far beyond sluggish sales in a troubled economy. To compete effectively against Microsoft-based products, especially for the more lucrative corporate market, Palm desperately needs a complete overhaul of its basic operating system (OS) software, which has changed relatively little since the 1996 release of the original PalmPilot.

The new OS is needed to allow Palm to move to faster processors, such as the Intel StrongARM chips used in Pocket PCs, to support higher-resolution displays and to offer better access to corporate networks.

RIVALS AND CUSTOMERS. The trouble now is that the OS project has been beset by management turmoil of its own, and the new version is unlikely to be ready before late next year at the earliest. The effort has been headed since August by Nagel, a former research chief at Apple Computer and AT&T, who is also in charge of readying Palm's increasingly autonomous software division for its spin-off.

The separation would end a confusing situation where Palm, as the leading supplier of handheld devices, finds itself in head-to-head competition with customers for its software, which include Handspring, Sony, Kyocera Wireless, and Samsung. But pulling off a successful split of software and hardware operations will be a major challenge for the new, still-to-be-found, CEO.

There's little danger that Palm and its partners will lose their dominance in the handheld market. You can buy a Palm or Handspring for less than $150, while new Pocket PC models start at around $500. Still, the only thing really exciting in the Palm product pipeline is a much improved replacement for the wireless Palm VIIx, but that has been delayed until early next year.

TAKEOVER TARGET? Meanwhile, the Palm VIIx's presence on the horizon has forced a sharp reduction in the existing model's price. The major risk to Palm is that it will keep its market share in unit volume but end up with most of the sub-$200 market, where it's very difficult to eke out any margin, and almost none of the $400-plus market, where the profits are.

Palm's problems can still be overcome and the company positioned for a return to profitability if sales pick up next year, as expected. But Palm doesn't have much time to find a strong CEO to get it back on track. An alternative: Palm, with a market capitalization of just $1.5 billion and around $500 million in cash, could be a very tempting takeover target. And that's something that could be on the mind of the next CEO, too. Wildstrom is Technology & You columnist for BusinessWeek. Follow his Flash Product Reviews, only on BW Online

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