Innovation Close-up: HTC

(The headline of this story has been corrected to indicate that HTC is based in Taiwan.)

There's a lot to like in HTC's new HD2 smartphone. Start with the huge 4.3-inch touchscreen—the largest available, according to T-Mobile, which introduced the device in March. Add the same Qualcomm (QCOM) Snapdragon processor that powers Google's (GOOG) Nexus One, also made by HTC. Include a 5- megapixel camera with flash. And put it all into a sleek package that fits in a shirt pocket. What you get is a very nice phone that has no future. Because the HD2 is powered by a soon-to-be-obsolete version of Microsoft's (MSFT) mobile operating system, it is basically a pretty orphan. It demonstrates how even an innovative company (No. 47 on our list) can be hobbled by suppliers peddling out-of-date technology.

Microsoft was early to recognize the importance of handhelds, but whatever first-mover advantage it had is long gone. Successive versions of its mobile software have been quirky and clunky, saddled with the company's determination to treat the devices as if they were shrunken PCs, complete with an on-screen "Start" button, just like in Windows. While Microsoft struggled to get the software right, BlackBerrys took over the corporate market, and then Apple (AAPL) rewrote the rules for the consumer market with its iPhone.

Version 6.5 of Windows Mobile, released last fall, placed a nicer-looking interface over the same old software—and did nothing to arrest the company's slide. Microsoft's share of U.S. smartphone subscribers fell to 15.7% in the three months ended in January, according to comScore. That was a decline of four percentage points from the preceding quarter; already trailing Research in Motion (RIMM) and Apple, Windows Mobile may fall behind Google's Android platform, too.

While Microsoft just unveiled two phones aimed at younger, social networking users, its next-generation operating system, to be called Windows Phone 7, won't show up until late this year. The new software will not be backwards-compatible, meaning HD2 users shouldn't expect to be able to run it or applications written for it. So T-Mobile customers are being asked to plunk down $199 and sign a two-year service agreement for a phone whose freshness date is about to expire.

That's a shame, because the hardware is superb. Start with that screen, which makes movie watching on a plane or train a pleasure. T-Mobile ships the HD2 with the two Transformers movies preloaded (which gives you an idea of the demographic it's after) and an app from Blockbuster (BBI) to find and download more. The screen's size, and the vibrations the virtual keyboard provides for tactile feedback, make it easy for stubby-fingered users like me to type even in portrait mode.

Elegant hardware doesn't compensate for baffling software. HD2 uses Sense, HTC's proprietary, intuitive user interface. But it's way too easy to stumble from the Sense interface into Windows Mobile's. The front of the phone has two buttons side by side. Pressing the one with the "home" icon takes you from wherever you are back to the main Sense desktop screen. Pressing the one next to it with a Windows logo takes you to the main Microsoft desktop screen, which has an entirely different look and feel. I'm used to this sort of Windows phone weirdness, and even I kept pushing the wrong buttons.

Let's recap: a great phone with a doomed operating system that relies on the troubled Blockbuster chain for its movies and the sometimes spotty T-Mobile network for its signal. The HD2 shows that when it comes to handhelds, hardware innovation is less than half the battle.

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