Palm's Secret Weapon for the Pre

As recently as late 2008, Pandora Networks' Chief Technology Officer Tom Conrad still had big doubts about the prospects for smartphone maker Palm. In November, Conrad was among a coterie of software developers invited to Palm (PALM) headquarters in Sunnyvale, Calif., to take an early, up-close look at an operating system for use in the company's phones. "I was totally skeptical when I walked in," says Conrad, who met Palm execs along with representatives of MySpace (NWS), Intuit (INTU), movie site Fandango, and Epocrates, a maker of mobile software for physicians.

Conrad and fellow programmers accepted Palm's invitation partly out of curiosity about the new mobile OS. And partly they were there to take the pulse of a once-proud Silicon Valley pioneer many had long since written off. Conrad still had a fondness for Palm products and figured the brand still had cachet with consumers. "If by some miracle they had come up with something special, I knew there would be a market for them," he remembers thinking. And Palm delivered. After two days of briefings about its WebOS software, "I left a total believer."

Palm has been winning over a lot of skeptical software developers lately, an unlikely turn of events considering the Pre, the first smartphone that will run WebOS, has yet to hit stores. Attracting programmers to Palm is also notable given excitement over competing mobile operating systems from Apple (AAPL), Research In Motion (RIMM), Nokia (NOK), and the Google-backed Open Software Alliance. Normally, developers flock to devices with the most market share. But many developers contacted by BusinessWeek say they would rather write for Palm than other platforms such as Microsoft (MSFT) Windows and in some cases, Google's (GOOG) Android. "From my point of view, Palm is No. 2," says Ge Wang, co-founder of Smule, a maker of popular iPhone apps.

Financial Results Disappoint Analysts

Apple's iPhone remains the "it" device for legions of mobile programmers. But even runner-up status among developers could be more than enough to help Palm carve out a niche of the fast-growing smartphone business, where success depends largely on the availability of a range of useful tools, games, and other applications spawned by an ecosystem of coders.

If ever a company needed a success, it's Palm. On Mar. 20, Palm announced a stunning 70% drop in smartphone sales from a year earlier, and a net loss of $90 million—30% larger than what Wall Street expected. There is virtually unanimous agreement, even among management, that if the Pre bombs, Palm has little chance of survival. But its shares having risen more than fivefold in six months, Palm is enjoying the benefit of the doubt amid investors, analysts, and—crucially—software developers.

Palm's successful effort to court coders dates at least to mid-2007, when former Apple Chief Financial Officer Fred Anderson, a partner at private equity firm Elevation Partners, championed the deal that gave Elevation 25% of Palm.

Hampered by Dated Products

One of Elevation's requirements was that Palm's board appoint former Apple hardware czar Jon Rubinstein as chairman and as head of product development. Palm had recruited Rubinstein to the task, just days after the one-year noncompete clause he'd negotiated upon leaving Apple lapsed. The promotion won Palm fans, piercing the gloom that had enveloped the company in recent years as a flurry of delays and product development missteps left it with a dated product line. "We were more compelled by Rubinstein being involved," says T. Rowe Price (TROW) portfolio manager Dave Eiswert, who snapped up a 15% stake in the company.

Rubinstein's presence paid other dividends. Apple veterans such as engineer Mike Bell joined Palm, too. For one, there was more opportunity to make money on options—given Palm's beaten-down stock and Apple's sky-high shares. It was also a rare opportunity to work on a clean-sheet-of-paper project. "Apple is a mature company," Rubinstein, known as "Ruby," said in an interview with BusinessWeek late last year, likening Palm today to the sickly Apple he joined in 1996. "If we build a great product, people are going to care. For whatever reason, there's a lot of passion around Palm." Soon, veterans from companies including Silicon Graphics (SGIC), Nokia, and Microsoft came on board.

Mike Abbott, who had run Microsoft's efforts to help developers build apps using its .Net software tools, became Rubinstein's point man to develop a new smartphone operating system, dubbed the WebOS.

Paying a Premium

For anyone outside the company, the task seemed hopeless. Apple had jumped so far ahead with its iPhone that it seemed unlikely Palm or anyone else could come close. Yet Palm's team of veterans were motivated by the fact that no smartphone operating system had ever been built from the ground up for the modern smartphone—a powerful, general-purpose computing device that was fast becoming as central to consumers' lives as their PCs. Even Apple's iPhone software was based on a version of the Mac OS.

So Palm set out to create software that would require no synching with a PC, and that would solve problems only a phone in your pocket could solve. For example, because the devices would combine access to GPS, online maps, and your contact list, Palm phones could ascertain when you were running late for a meeting even before you did—and could be programmed to send an e-mail to let your host or an associate know your ETA. Engineers also set to work on a new screen design that would make it easier for consumers to find and keep track of what apps they were using.

Meanwhile, Palm management worked with Elevation to ease fears about the company's financial health. On Dec. 22, Elevation Partners announced a $100 million investment, a move that assuaged concerns investors and developers might have about Palm's ability to survive long enough to benefit from the new platform. Convinced the stock could easily climb to 20 over time, Elevation even agreed to pay $3.25 a share for a stock that had been trading under 2 in previous weeks. "We saw an interest in paying a premium, to tell the world this is going to be a very valuable company," Elevation partner Roger McNamee said at the time.

Comparisons to the iPhone

A dearth of competing high-profile announcements in the runup to the announcement of the Pre and its software also benefited Palm. Apple had no smartphone news at the Macworld show, held in January. And of the thousands of product announcements at the annual Consumer Electronics Show in Las Vegas, where Palm was to unveil its new phone, none did much to steal Pre's thunder. "It looks like the Palm experience could be on par with the iPhone experience," says Martijn van Tilburg, a partner with design consultancy Artefact.

Developers say Palm made another wise decision: It adopted widely known technology standards, enabling millions of Web programmers to write apps for WebOS. Rivals such as Research In Motion and Nokia require developers to use special software tools and methods. To write for iPhone apps, programmers must know how to write for the Mac. "Palm has really made it very simple to develop for its platform," says NPD analyst Ross Rubin.

And like Apple and RIM, Palm was building both the hardware and the software; so it was able to make the many technical trade-offs needed to achieve the best performance and the fewest glitches. Microsoft, by contrast, licenses software to phone makers, who in turn may or may not deliver a top-notch experience.

Support from Developers

Within months, Palm was a crowd favorite among developers. After all, the company had done more than any other to establish a market for applications for mobile devices. Back in 2000, some 70,000 firms were creating programs for Palm's groundbreaking Palm Pilot PDA.

Of course, Palm still has everything to prove. If the WebOS turns out buggy or the Pre turns out to be clunky, developer support will wane as fast as it waxed. Palm has yet to announce pricing for the Pre, or how much of each application purchase it will keep for itself. And until Palm lands carrier deals beyond Sprint Nextel (S), rival products from Apple, Nokia, Microsoft, and RIMM give access to larger pools of customers. "If Palm can sell millions of devices, it will open up the floodgates," says Cassidy Lackey, vice-president of mobile app distributor Handmark. "But they've got to prove there is a software economy out there."

Ironically, some developers see Palm's desperate straits as an advantage. Google's Android has a lot of potential, but winning the smartphone wars is not a do-or-die proposition for a company that commands more than 60% of Web searches. "There are a lot of people rooting for Palm," says Rob Hoxie, a manager with DataViz, a developer of mobile apps for office workers. Critically for Palm, many of those cheerleaders are adept in writing software.

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