Why Palm Has Its Hands Full

The No. 1 maker of handhelds overestimated demand. Now it must cope with a bulging inventory, growing competition, and discounted prices

Just six months ago, Palm CEO Carl Yankowski gloated that he couldn't manufacture the company's hot-selling handheld electronic organizers fast enough. America's growing love affair with personal digital assistants had helped the company breeze past forecasts and double its revenue for five consecutive quarters.

Turns out, that romance was just a flirtatious interlude. Just as Palm ramped up production in February of its hottest-selling products, consumers put the brakes on spending for high-tech gadgets. "The sudden change...has been jarring," Yankowski announced last month.


  No kidding. Palm is learning a tough lesson in Business 101 about overestimating demand. In April, Yankowski was forced to slash Palm's workforce by 300 employees, to about 1,250, and delay construction of a new corporate headquarters. The Santa Clara (Calif.)-based company is struggling to conserve cash and appears to be locked in an escalating price war. The danger is that consumers will become accustomed to bargain-basement prices on the company's hottest gadgets, which could hurt margins permanently.

The outlook is a far cry from earlier this year, when executives crowed about white-hot holiday sales and rejoiced in the prediction from researcher International Data Corp. that the handheld market would soar 52% annually through 2004. At the same time, however, they ignored signs of a slowdown in sales of consumer goodies after Palm hit the 11 million unit-sales mark. "We were never able to tell the demand ceiling for our products because we never had enough of them," says Palm Chief Marketing Officer Satjiv S. Chahil.


  Now Palm has too many. It signed long-term commitments to buy liquid crystal display screens and radio transmitters because of a components shortage that had crimped sales. The decision means it now has about $200 million in unsold finished goods and components on its books and, analysts estimate, perhaps $100 million more in the pipeline. That cuts deep into Palm's $600 million in unrestricted cash.

Worse, Palm is locked in a price war with rival Handspring Inc. that is eroding profit margins at a rapid clip. Granted, Palm has virtually no choice in its efforts to clear old inventory. It also must make way for a string of new products -- including the new m505 color replacement for the popular Palm Vx model, and a new wireless model due later this year.

What's more, handheld competition -- already one of the most hotly contested consumer-electronic markets -- is expected to get even more intense as a string of new entries join the fray this year, and new, lower-priced models Compaq, Sony, and Hewlett-Packard hit the stores.


 Despite the current slowdown, demand for handhelds is expected to remain relatively strong. After all, in its third quarter ended in Feb. 28, Palm still beat expectations with profits of $9.3 million, or 2 cents a share, on revenue of $470.8 million. On May 17, the company slashed estimates for the current quarter from a respectable $300 million-to-$315 million down to a measly $170 million-to-$190 million. It also is taking a $300 million charge to writedown excess inventory as well as other, unspecified restructuring charges. But the inventory crunch illustrates that handhelds are not yet essential equipment. Says Giga Information Group technology analyst Robert Enderle: "To most people, they're still a luxury item."

Palm doesn't have the luxury of waiting for that to change, though. The company is expanding its corporate sales force with an eye to boosting revenues with larger purchase orders and ending its reliance on onesy-twosy purchases in retail stores.

It also is expanding efforts to convince educators to buy handhelds instead of desktop computers. Working with the Stanford Research Institute, Palm this year will donate handhelds to at least 100 high school and study how students and teachers use them.


  The company will need every sale it can get to reassure investors. Palm's stock (PALM ) is trading around $7 a share, well off the 52-week high of $67.375 set Nov. 3. Merrill Lynch & Co. analyst Steven Fortuna says both Palm and Handspring "look a little bit risky" in the near term.

Palm must take even greater risks with marketing and promotions to keep its market lead while simultaneously positioning itself for an eventual sales uptick. The company is working to deliver the message that handhelds do more than store addresses and appointments. "The worst thing you can do during a slowdown is slow down everything, so we're planning much more strategically," Chahil says. That's a must, if Palm wants to live to gloat another day.

By Cliff Edwards in Santa Clara, Calif.

Edited by Douglas Harbrecht

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