Internet Mini Case 1 Palm, Inc



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Internet Mini Case 1

Palm, Inc.

Maryanne M. Rouse
Palm, Inc. competes in the handheld device, operating system (OS) software, and wireless services markets. Founded in 1992, the company was acquired by U.S. Robotics in 1995. Palm launched its first organizer products, the Pilot 1000 and Pilot 5000, in the United States in early 1996 and in France later that year. In June 1997, Palm became a subsidiary of 3Com, when that company acquired U.S. Robotics. In December of the same year, the Palm Pilot was selected as one of Information Week’s “Most Important Products of 1997” and named Newsweek’s “High Tech Gizmo of the Year.” In December 1997, Palm began licensing its Palm OS platform. The platform comprised the Palm OS; the Palm user interface; standard personal information management applications, including a date book, an address book, a to-do list, a memo pad, and a calculator; developer tools; HotSync data synchronization technology; Graffiti script recognition technology; and Web-clipping software.
Palm’s 1999 acquisition of Smartcode Technologies added advanced wireless communications capabilities to the Palm OS and positioned the company to address the convergence of voice and data streams in the rapidly developing market for mobile information appliances, including cellular telephones, messaging devices, data communicators, and “smart” phones.

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This case was prepared by Professor Maryanne M. Rouse, MBA, CPA, University of South Florida. Copyright © 2005 by Professor Maryanne M. Rouse. This case cannot be reproduced in any form without the written permission of the copyright holder, Maryanne M. Rouse. Reprint permission is solely granted to the publisher, Prentice Hall, for the books, Strategic Management and Business Policy – 10th Edition (and the International version of this book) and Cases in Strategic Management and Business Policy – 10th Edition by the copyright holder, Maryanne M. Rouse. This case was edited for SMBP and Cases in SMBP – 10th Edition. The copyright holder is solely responsible for case content. Any other publication of the case (translation, any form of electronics or other media) or sold (any form of partnership) to another publisher will be in violation of copyright law, unless Maryanne M. Rouse has granted an additional written reprint permission.

In September 1999, 3Com announced plans to make Palm an independent, publicly traded company. Palm went public on March 2, 2000, with an IPO of 23 million shares at an initial price of $38. Concurrently with the IPO, America Online, Motorola, and Nokia purchased a combined total of 5.9 million shares at that price. Immediately after the IPO, Palm had 560.9 million shares outstanding, of which 3Com owned approximately 94.8%; these 532 million shares were then distributed to 3Com’s shareholders, completing the spin-off.


In June 2000, Palm acquired Actual Software Corporation, a provider of e-mail solutions for the Palm OS platform. Concurrently with the launch of the Palm m500 series in March 2001, the company acquired peanutpress.com, renamed Palm Digital Media, a web-based storefront featuring approximately 2,000 titles from many of the major U.S. publishing houses. As part of that acquisition, Palm also acquired the Peanut Reader, now called the Palm Reader, an eBook reader application for Palm Powered devices. Palm Digital Media was combined with Palm’s OS and platform business to form the Platform Solutions Group; the hardware side of the business, which included the Palm series of handhelds as well as hardware add-ons, software, and accessories, became the Solutions Group. Other key acquisitions included ThinAirApps, Inc., a privately held New York based developer of software that enables secure wireless access to corporate e-mail, which became part of the Solutions Group, and specified assets of Be, Inc., a provider of software solutions for Internet appliances and digital media, which was integrated into the Platform Solutions Group.

Restructuring: Breaking Up Is Hard to Do

In July 2001, Palm announced a bold turnaround plan to maintain its market leadership position in a rapidly evolving competitive environment: It would essentially split Palm in two. PalmSource, the renamed Platform Solutions Group, would develop and license Palm’s operating system and software, and the Solutions Group would focus on building the hardware. Under the new corporate structure, Palm’s Solutions Group would license the Palm OS platform from the newly separate PalmSource as the foundation for its Palm handheld devices.


In July 2003, Palm filed with the Securities and Exchange Commission the required registration statement for the spin-off of PalmSource in a tax-free transaction to existing shareholders; shareholders were expected to approve the transaction at the company’s annual meeting on October 28. The benefits Palm touted included:


  • Greater clarity of mission and focus for both businesses

  • Increased speed and responsiveness to technology change and customer needs for both companies

  • Increased number of potential licensees for the Palm OS

  • More direct access to capital markets for both companies, given that they could be more easily understood by investors and securities analysts

The strategy appeared to be designed to help Palm avoid the fate of tech companies that didn’t split their hardware and software, such as Apple Computer. While Apple delayed, Microsoft licensed its Windows OS to a broad range of hardware makers and became the industry standard. With Microsoft now challenging Palm in handheld software, with its Windows CE and Pocket PC and Pocket PC Phone Edition products, several members of Palm’s Board, many of whom were also former senior managers at Apple, strongly supported the split. The strategy was expected to enhance Palm’s licensee relationships by addressing their concerns that, while they licensed the company’s software, they also competed with its hardware.


The breakup was not, however, entirely smooth. Eric Benhamou, Palm’s CEO, received a flood of e-mails from concerned staffers, expressing doubts about the split and asking him to reconsider. Many employees on the hardware side argued against the breakup, noting that without the software unit, the hardware subsidiary would find itself in an intensely competitive, low-profit commodity business. Some Palm executives, including the company’s CEO, Carl Yanowski, quit after finding their job responsibilities diminished under the new structure. Some who remained continued to question the breakup. In response, Benhamou, who served as Chairman of the Board of 3Com and who had stepped in temporarily as CEO at Palm, called a company wide employee meeting at which he announced unceremoniously, “The split will happen. Get over it.”
The separation process raised a number of nettlesome issues, including which entity would retain Palm’s high-profile brand and the terms of the licensing agreement. Senior managers at both groups developed detailed presentations intended to persuade Benhamou and the Board on the brand issue. PalmSource won the contest for ownership of the brand on the basis that encouraging hardware makers who licensed Palm’s software to label their devices as “Powered by Palm” would give the brand more exposure than if it were limited to Palm’s own hardware. Although terms of the final licensing contract have not been disclosed, it was expected to reflect that Palm’s hardware group would be PalmSource’s largest customer.

Acquisitions and Mergers
Palm’s acquisitions had supported the company’s product development strategies. Palm’s target market had been relatively sophisticated professional users seeking usability, convenience, flexibility, and expandability; however, Benhamou saw the opportunity to broaden the company’s reach into the business market by positioning its devices as business tools. One way Palm was seeking to increase its appeal to businesses was through partnerships, such as a current one with McKesson, to jointly market and promote their products to health care professionals. Subsequently, Palm announced that key product strategies going forward would include:



  • Moving from basic PIM-oriented solutions to networked PIM and communications applications

  • Moving from relatively sophisticated consumers to the broad consumer market and toward the emerging enterprise market

  • Transitioning from mostly stand-alone solutions to mostly wireless solutions

  • Shifting from a U.S. focus to a global focus, including new markets such as China, India, and Latin America

  • Moving from a first-generation microprocessor (the Motorola Dragonball) to the ARM generation solutions

In early June 2003, Palm and Handspring, a maker of handheld computers and a global leader in Palm OS based “smart” phones, agreed to a merger that would integrate Handspring into the newly independent Palm Solutions Group in a move that would bring Jeff Hawkins, Donna Dubinsky, and Ed Colligan, who invented the Palm Pilot and built the company, back to their roots. The two companies maintained that the merger would create a stronger competitor in handheld computing and communications and support the Palm Solutions Group’s objectives of growing the market, maintaining industry leadership, and achieving consistent profitability. The merger would leave just two competitors that would still make traditional, stand-alone palmtops that ran the Palm OS: Palm and Sony. Cited benefits included:



  • Maximizing Palm and Handspring's combined scale and operational excellence to take full advantage of future growth opportunities

  • Delivering an unmatched portfolio of innovative mobile products from traditional and multimedia handhelds to wireless handhelds and “smart” phones

  • Adding Palm's strong brand and distribution channels to Handspring's highly regarded Treo product line and carrier relationships

  • Enhancing the Palm management team including hardware and software design, engineering, and marketing to help drive handheld computing into deeper and broader solutions

The merged companies expected greater revenue opportunities. They also expected to obtain improved operating efficiencies of approximately $25 million in cost savings annually. The cost savings assumed combined employee reductions of approximately 125 people, elimination of overlapping programs and unnecessary real estate, and the advantages of increased volume in manufacturing and distribution. Handspring employees were expected to move to the Palm Solutions headquarters in Milpitas, California. Palm and Handspring shareholders were expected to approve the merger in separate meetings on October 28, 2003.
Operations
Palm relied heavily on outsourcing for manufacturing and distribution. The company also used third parties to provide services including customer service, data center operations, desktop computer support, and facilities services. Palm outsourced some product R&D as well by entering into agreements for the development and licensing of third-party technology. The company’s distribution facilities were physically separated from manufacturing locations, requiring additional lead time to move products to customers. Although Palm relied on distributors, retailers, and resellers to sell its products to end users, the company also sold products directly from its Palm.com web site. Palm’s introduction of three new, lower-priced handhelds in late fall 2002, including the Zire, which sold for under $100. The company believed it could design a product to be sold at that price and still meet profit margin targets while giving the Solutions Group a market of four times as many consumers. The lower-priced products would also benefit the company longer term as first-time Palm users sought to upgrade.
Finance

Palm reported a fiscal 2002 year-over-year revenue decline of $528.5 million, or 35%, and a net loss of $108.8 million, or 10.6% of sales, despite gains made in its fourth quarter. (The company announced that its fourth quarter loss had narrowed to $27.5 million as it had cut expenses while sales rebounded from a year earlier, when product delays had cut its revenue in half.) In addition to reducing its workforce through layoffs and attrition, Palm cut marketing expenditures for product branding, advertising, and promotion and R&D costs. (Overall, sales and marketing expenses as a percentage of revenue increased, however, because of lower revenues.) Although Palm’s revenue growth rate had been faster than the industry’s, the company had reported losses in five of the previous six quarters as the slowing global economy had led both consumers and businesses to spend less on technology, affecting sales at Palm and rivals such as Handspring, which licensed the Palm OS. Palm’s shares closed at $.74 on October 1, 2002, having lost over 95% of their value in the tech meltdown of the preceding 18 months. (Access to detailed financial information for Palm, Inc., is available via the Palm site, www.palmsource.com, or www.freeEdgar.com)



The Industry
For more than a year, the handheld device market had struggled with demand, deflated by a U.S. economic slowdown that forced consumers to think twice about buying electronics even as device makers cut prices on older models and rolled out new products with advanced features. Overall global shipments of hand held computers in 2001 totaled 13.1 million units, according to researcher Dataquest, up 18% from the previous year but well behind the explosive 114% increase in shipments from 1999 to 2000. Analysts predicted that a weakening global economy plus a buildup of channel inventories would lead to 2002 industry sales of up to 20% lower than those in 2001, with only modest industry wide gains in 2003.
While a weak global economy had strongly influenced industry sales, there was also concern that the market may have been becoming saturated: Most consumers who wanted electronic organizers already own them, and current users saw little reason to buy others. However, because hybrid devices with sophisticated features were expected to lure experienced users back into the market, the ability to develop and introduce new products was critical to building competitive advantage. And, while innovation and alliances would be critical to attracting and retaining traditional business customers, industry observers believed that a product priced below $100 would lure a whole new segment of users into the market.
Competitors
Palm competed in three segments: the handheld device, OS software, and wireless service markets. Palm’s handheld computing device products competed with a variety of “smart” handheld devices, including sub-notebook computers, keyboard-based devices, “smart” phones, and two-way pagers. The company’s principal competitors in the handheld segment included HP/Compaq, Casio, Handspring, Sony, Sharp, and Research in Motion (RIM).
Although Palm still sold far more handhelds than Compaq (Palm’s global share was approximately 40%), the iPaq, because of its higher price tag, generated comparatively more revenue than the average Palm. Sales of the iPaq had grown quickly since the device was introduced in 2000, with first quarter 2002 sales reported at $160 million, up 18% from a year earlier. At the end of April 2002, market share estimates by industry research firm Gartner place the former Compaq product line at number two, with a 10.1% global share, while HP, which came in at number six with a 4.4% share, saw its worldwide unit shipments off 43.9% from a year earlier.
As HP completed its post merger integration of Compaq, managers from both companies noted that the HP unit that included handhelds would be made up of products from both HP and Compaq, but it had not specified whether it would keep both the iPaq and HP’s Jornada. Analysts speculated, however, that the iPaq product line, with its greater market share and growth prospects, would be the survivor. In 2004, HP/Compaq was focusing on getting large companies and government entities to use handhelds. BMW sold the iPaq as an option with its Z3 in Germany, allowing executives to use it for navigation in the car and as an organizer outside the car.
Handspring fell from number two to number three worldwide, with a sharp decline in unit sales, resulting in a market share drop of more than five percentage points, to 9.9% for the same period. Sony, with shipments up 250% from the prior year, moved into the number four position, with a 7.7% global market share. Sharp, which began shipping its Linux-based Zaurus to the United States in April 2002, gained the number five spot, helped by its strong performance in Japan. Casio, with 4.4% of the global market, placed at number seven, just behind HP.
In the United States, Palm was the leader, with a 47.5% market share, while Handspring maintained the number two spot, with a 14.6% market share at the end of April 2002. Sony had 10.8% of the U.S. market, followed by Compaq with 8.6% and RIM with 5%.
On July 2, 2002, a San Francisco startup, OQO, announced that it had developed a computer that was only slightly bigger than a deck of cards but as powerful as a desktop. It could be used as a handheld or connected to accessories to transform itself into a notebook or desktop. Unlike handhelds then on the market, OQO’s device ran the Microsoft Windows XP operating system, didn’t have to be synchronized with a PC to receive e-mails, and had more memory, processing speed, and storage. It also had sockets for connecting the device to accessories such as a folding keyboard or DVD player, and it came with a cradle that transformed it into a PC by hooking it up to a keyboard, mouse, and standard video monitor. Other companies, including IBM, were working on similar “modular” computers, which were expected to pose a real threat to the popular handhelds.

Of more immediate concern were plans by Danger, Inc., a San Francisco startup, to introduce a “hiptop” device, essentially a laptop no larger than a bar of soap, in late October 2002. Danger’s T-Mobile Sidekick would offer wireless Internet, e-mail, and instant messaging, all in a combination cell phone, personal digital assistant, and digital camera. The Sidekick was to have a black-and-white screen that swiveled and flipped to reveal a full keyboard with an adjacent thumbpad that would serve as a joystick for playing games. With an “always on” wireless Internet connection, the Sidekick would alert users when e-mail arrived, and AOL Instant Messenger would allow real-time chat. T-Mobile Wireless would provide unlimited Internet use to Sidekick owners for $39.95. Danger believed that the $199 price tag would make the Sidekick extremely competitive.


Competitors in the wireless services segment included EarthLink, Go America, RIM, and other device manufacturers, such as Sony, that offered Internet services. Palm’s wireless services also competed indirectly with other providers of wireless access, ranging from dedicated providers of Internet access such as AOL Time Warner to local phone companies and telecommunications carriers.
The company’s Palm platform competed with operating systems from Microsoft, Java-based platforms such as those used by cellular telephones, proprietary operating systems from companies such as Sharp Electronics, and systems based on Linux. Microsoft appeared to be investing aggressively in efforts to assist its licensees in marketing handhelds that used Microsoft’s operating systems, including the Pocket PC 2002 operating system.




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