How Palm Got Cool Again The company created the handheld computer market, then sank into a miasma of infighting. But a little gadget called the Treo has given it a lifeline.
By Paul Keegan

(Business 2.0) – On a foggy day in the fall of 2001, the top executives of Handspring gathered in a drab conference room at a hotel in Monterey, Calif. The mood was tense, the debate heated. The company, co-founded three years earlier by Jeff Hawkins--the inventor of the Palm Pilot personal digital assistant, who had quit Palm in 1998 after a feud with his boss--was being hammered by the tech bust. Its Visor PDA had been a critical success, but the company was bleeding cash. It was down to just enough money to turn out a few more versions of the Visor, which many in the room argued could still be a hit and save the company. Yet here was Hawkins, Handspring's chairman, lobbying for something that at the time seemed likely to finish off Handspring for good.

Forget Visor, he told his colleagues. Dump the whole PDA business. Let's bet the company on a phone we've been tinkering with. Not just any phone: a smart one that would blend the best aspects of PDAs and pagers and add the ability to surf the Web and shoot off e-mails, along with a host of other features, all in one slim little gadget. Some in the room were aghast. They'd never made phones. What chance would they have against Motorola, Nokia, Samsung, and the other giants who had already collectively blown hundreds of millions of dollars trying to create just such a device? Hawkins held his ground. "Look, this is where the game is going," he argued. "If we're going to risk everything, let's risk it on the future."

Flash forward to a recent morning. Sitting in his Silicon Valley office in jeans and sneakers, Hawkins holds the payoff on that death-defying maneuver in the palm of his hand: a sleek Treo 600, the hottest cell phone on the market and by acclamation the first smartphone to actually deserve the name. And in a twist rich with irony, it may also be the gizmo that saves PalmOne, the successor to Palm Inc., which at various times has been both the beloved company Hawkins founded and his sworn enemy.

Packing more processing power than early home computers had into a frame about the size of a deck of cards, the Treo 600 went on sale last fall and, despite an initial price tag of $600, became a runaway smash. About 100,000 units were sold in the first month. More than 250,000 have been sold to date, and another 800,000 are expected to move as production ramps up during the next year.

Hawkins gives a quick demonstration that helps explain the allure: Thumbing a few buttons on his Treo, he shows how easily he can call anyone in his personal database, check e-mail, and respond with the tiny keyboard (his wife is watching their daughter's softball game and wants him to put the lasagna in the oven). A few more swift strokes and he's watching video clips on a color screen and downloading one of those clever 20,000-plus third-party Palm apps floating around the Internet--this one tells him about the tide and currents in San Francisco Bay, in case Hawkins decides to take his 33-foot sailboat out tomorrow.

"Trust me," says Hawkins, now chief technology officer at PalmOne, "it's hard as hell to make these products."

Indeed, the creation of the Treo involved years of pain and struggle--a lot of it the result of blunders, hubris, and epic corporate dysfunction that at times threatened to overwhelm brilliant feats of product innovation. The problems ultimately drove the Treo's young masterminds back into the arms of Palm, which, desperately needing help itself, bought the rapidly unraveling Handspring for a reported $168 million in October. Palm's market capitalization had peaked in early 2000 at $54 billion--more than General Motors's--but it had seen only two profitable quarters in the past three years and wasn't close to introducing its own smartphone, even as the traditional PDA market was "melting like ice in July," as one analyst put it. Shortly before finalizing the Handspring deal, Palm split itself into two companies, PalmOne for hardware and PalmSource for the Palm operating system.

The Treo has begun to reverse the humbling slide of the famed Palm name. In March, PalmOne surprised Wall Street by announcing that Treo sales helped produce a fiscal-third-quarter operating profit, before charges, of $614,000, which may not sound like much but was the first consecutive quarterly operating profit by a Palm entity since November 2002. PalmOne's stock price has risen a third since January. Another promising sign: The market for smartphones is exploding--sales, essentially zero in 2000, are expected to exceed 20 million units this year. Palm executives believe they can eventually grab as much as 20 percent of that market.

Perhaps most important, the elegance and desirability of the Treo has achieved what a few months ago seemed unimaginable: It has made the Palm brand cool again. In the world of gadgetry, that aura of hipness, of making the coveted gizmo of the in-crowd, directly drives sales. "If PalmOne didn't have this product," says analyst Charlie Wolf of Needham & Co., "it would be dead."

That's not to say the Treo guarantees Palm everlasting life. PalmOne's market cap is about $745 million, and it has just $240 million in cash. By comparison, Nokia--which could release 10 smartphones incorporating Treo-like features during the next 18 months--has a market cap of $65 billion and spends nearly $5 billion a year just on R&D. Even Dell, the dreaded killer of rivals' profit margins, is eyeing the smartphone game. Says Todd Bradley, former head of Palm's hardware division and now chief executive of PalmOne, who bears much of the responsibility for making the company execute crisply enough to fend off the giants, "We're not afraid of them." But since its inception, Palm has always had an unsettling tendency to move in spastic, three-step lurches: a magical moment of invention, followed by unsteady business execution and other setbacks, followed by a frantic dash for cover and deeper pockets. And it has recently made some potentially troubling missteps. The Treo may have given Palm back its cool. But can the company keep from losing it again?

Sitting at his desk, googling on his Treo, Hawkins, tall and still boyish at 46, says he has no interest in story lines about the prodigal son's return. He displays not a trace of sentimentality about coming back to Palm, which he started on a wing and a prayer in 1992 with $1.3 million scraped together from Tandy and two venture capital firms. "I don't dwell on the past," he says. "I'm here saying, 'OK, what am I going to do going forward?'"

Could be he'd just rather forget. Hawkins and his original Palm team, which included CEO Donna Dubinsky and their marketing guru, Ed Colligan, first established the Palm pattern in 1995. Lacking enough money to bring early versions of the Pilot to market, Palm sold itself to U.S. Robotics for $44 million, and Hawkins, Dubinsky, and Colligan took jobs there. Though they chafed under corporate control, everybody got along well enough to make the Pilot a monster hit when it launched six months later, selling a million units in 18 months--one of the fastest adoption rates of any new consumer product. Hawkins had created the first electronic organizer that was affordable ($299), small enough to fit in a shirt pocket, simple to use, and easily synchronized with a desktop computer.

But just when the house was really rockin', the party nearly got shut down. 3Com, then a fast-growing networking company with revenue of $3 billion a year, gained control of the fledgling Palm subsidiary by acquiring U.S. Robotics in 1997. 3Com was run by Silicon Valley veteran Eric Benhamou, and Dubinsky clashed repeatedly with her new boss over strategic questions. The rawest issue for the young Palm team, however, was Benhamou's refusal to give it more independence by spinning off Palm into a separate company. With Silicon Valley booming in the late '90s, Hawkins & Co. wanted in on the action, but Benhamou thought Palm's management team wasn't mature enough to leave home yet. "Palm had not solidified in terms of its processes, its ability to stand alone, its ability to obtain a sustainable business model," Benhamou says. "It had to age a little bit."

Hawkins, Dubinsky, and Colligan promptly quit over the issue. Benhamou still insists he was right. "In my 30 years in high-tech, the single best decision I ever made was that one," he says, adding with a shrug, "I've lost better people, and I've lost worse." In any event, the Palm refugees formed Handspring and quickly tried to smoke their old company. In just over a year, they had licensed Palm's OS and produced the critically acclaimed Visor organizer, which soon snatched a quarter of the handheld market. Handspring's 2000 IPO made Hawkins and Dubinsky billionaires on paper.

When the tech bubble burst the following year, Palm posted heavy losses, but tiny Handspring was hit even harder. Hawkins had already drawn up plans for his first smartphone, but once again his team was running out of money. Handspring simply didn't have enough capital to develop his complex new gadget while also competing in the handheld space with Palm, which had begun flooding the market with low-priced models.

It was a crucial turning point. The most petulant, irresponsible decision would be to stop making Visors completely and attempt what even the biggest phone makers in the world had failed to do--create a small, affordable, easy-to-use smartphone. As they hashed it over in the Monterey conference room, Colligan feared the worst. Dubinsky was on the fence. As for Hawkins--well, was there ever any doubt what he wanted to do? This was, after all, the son of Robert Hawkins, an incorrigible dreamer who never made much money on his outlandish inventions but once did manage to create an enormous, 16-sided boat with eight retractable legs nicknamed the Bubble Monster.

"I say, 'Imagine the end of your life,'" Hawkins explains. "Am I the guy who created two organizer companies?" He contorts his face the way people on reality TV shows do when they eat bugs. "No, I wanted to do something new. So we figured, hell, we're going to go for it."

Despite their puny size, the renegades at Handspring had enormous ambitions. They still hungered to overtake Palm, which remained a billion-dollar enterprise that dominated the handheld market. But Hawkins believed that his old company was making a crucial mistake by focusing on Internet access when voice was clearly the new killer app for wireless devices. The point was driven home on a trip he'd made to Wall Street in 2000, as he was trying to take Handspring public. One of the bankers he met thrust her Nokia phone, Palm V organizer, and BlackBerry pager at him and cried, "Can't you make one device that does all this?" Hawkins thought he could, and set about transforming his Visor into a real phone. For its blending of three gadgets into one, it would be called the Treo.

As he's done ever since inventing the Palm Pilot, Hawkins walked around with fake models of his new invention, pretending to make phone calls, type e-mails, and surf the Web. He designed a clamshell lid with a clear window so you could see who's calling, read messages, and check your calendar. Opening the lid allowed you to make calls and peck out e-mails on the small keyboard. A button on the side permitted one-handed scrolling through the phone book, messages, and webpages. Palm's OS was adapted for various phone functions, including an easy way to make three-way conference calls.

The Treo 180 won rave reviews as a breakthrough device when it was introduced in October 2001. Some of its innovations were astoundingly simple--like software that requires only the first letters of the first and last names to locate a phone number--which suggested that the big cell-phone companies had lost touch with the end user some time ago. For the previous decade, while Hawkins and his crew had been creating consumer-friendly devices, Nokia and Motorola were schmoozing with their true customers--executives at carriers like Sprint PCS and AT&T Wireless that purchase cell phones and then cheaply resell them or give them away as enticements to get people to sign up for expensive calling plans.

But this advantage actually proved a double-edged sword for Handspring. It naively thought that all it had to do was make phones consumers loved and let the company's usual retail partners such as Best Buy and CompUSA sell them like hotcakes. "We didn't realize that the carrier needed to certify every device to be on their network," Colligan recalls. "We had to reshift the entire company in six or eight months from thinking we could just stick it into the retail sales channel to realizing, 'Wow! The Treo is just not going to sell this way.'"

Meanwhile, Hawkins discovered problems with the Treo. During anonymous visits he would make to stores periodically, customers told him that even the newer 270 and 300 models were too clunky. He dumped the funky clamshell lid, made the phone slimmer, and raised the keys on the keyboard so a thumb could find them more easily. He made the battery last longer and added a five-way tool that allowed better navigation of the phone's main functions.

As he perfected the Treo 600, Hawkins knew that this phone wasn't just functional--now it was truly cool. Adding to Handspring's excitement was that Colligan, after months of long flights and spurned advances, had finally lined up his first major carrier, Sprint. Other carriers usually responded to Colligan's pitch about Handspring creating the first real smartphone by saying, essentially, "You can't be serious." In the summer of 2002, however, Sprint was preparing to move its 15 million customers onto an upgraded network that would allow access to the Internet, and it was desperate for a device that would let consumers take advantage of those expanded features. It quickly became intrigued by early versions of the Treo. "They thought this was so kooky it just might work," Colligan recalls.

What really sold Sprint, however, was Handspring's willingness to design the phone to optimize its performance for Sprint's network, something Nokia and others were reluctant to do. "They went the extra mile for us, and it made a huge difference," says Eric Martin, a Sprint device marketing manager. The Treo 300 launched in August 2002 and quickly became one of Sprint's most popular phones. Soon, AT&T, Cingular, and T-Mobile signed up with Handspring, noticing that with each new version of the Treo making e-mail and Web surfing easier, customers were racking up ever-bigger phone bills. (Even large players like Sony Ericsson and Siemens still can't claim to have four of the top five carriers onboard, and PalmOne is working on an agreement with the fifth carrier, Verizon Wireless.)

But just as Handspring was planning the launch of its crown jewel, the Treo 600, Hawkins & Co. were running out of money again. They were stuck with a hugely expensive lease that eventually cost $76 million to get out of and had virtually no Visor revenue to subsidize the Treo. Exactly how dire Handspring's straits were last summer, when Palm offered to acquire the company, is the subject of some dispute. Dubinsky says she had already arranged $40 million in new financing, but some analysts greet that claim with skepticism. Benhamou, who had become CEO of Palm in 2001, says, "We knew that there was a very serious probability that if we could not buy Handspring, it would not make it."

These two antagonists, in the end, could no longer deny they desperately needed each other. Palm hadn't had a rock-the-world innovation since Hawkins and his team left. And the youthful Handspring rabble-rousers were by now 40-something and anxious to protect their investment by letting Palm give the 600 the debut it deserved. True, they'd lose their independence after years of fighting for it, and seeking safe haven in Benhamou's company must have stung. But the move had a certain inevitability about it, like a family that fights like the dickens but always ends up back together in the end.

When the Treo 600 launched last October, critics fell all over themselves praising the new gadget, and so many early adopters flooded the wireless-carrier stores to buy it that clerks had to turn people away. Overnight, it seemed, the words "Palm" and "cool" were suddenly being used in the same sentence again.

The blending of Handspring into PalmOne has apparently gone fairly smoothly, despite the history of bad blood--perhaps partly because Dubinsky and Benhamou no longer have day-to-day duties (she's on the PalmOne board, and he's chairman of both PalmSource and PalmOne). Hawkins, meanwhile, spends about half his time at his Redwood Neuroscience Institute, a think tank studying how the brain works. As chief of the wireless division, Colligan has to tolerate only the occasional irritation of people telling him how things used to be at Palm. ("I go, 'Wait a minute, you can't tell me that--you weren't even here!'" he says.)

Right now, much of the focus is on Bradley, the CEO who must implement PalmOne's business plan, which analysts say is simply a matter of making sales of smartphones increase at a greater rate than handheld sales are falling. Bradley, 45 years old and a former executive vice president at Gateway, defied conventional wisdom in 2002 by launching a stripped-down PDA called Zire--priced at $99--that proved to be the fastest-growing handheld ever, selling a million units in its first seven months. He has also kept PalmOne the market leader in the higher-end models that professionals need to handle large files like photos, video, music, and PowerPoint presentations. Yet Bradley clearly recognizes that PalmOne's future is not in the steadily commoditizing handheld business, but in phones: Now, instead of spending a third of the company's R&D budget on smartphones and two-thirds on handhelds, he has reversed those numbers.

Still, Bradley is facing issues that, considering Palm's history of blowing leads, give some observers pause. For one thing, despite its recent quarterly operating profit, PalmOne still posted a net loss of $9.3 million because of restructuring charges. More troubling, it hasn't been able to produce enough Treos to meet the torrid demand, leaving on the table as many as 25,000 Treo sales per quarter, by one analyst's estimate. That's potentially dangerous, particularly with the impending flood of competing smartphones from larger players--after all, it doesn't matter how cool the Treo is if consumers can't get their hands on it. Bradley blames the snafu on a worldwide shortage of liquid-crystal display screens and says he's lining up more suppliers. But earlier this year, PalmOne said it would have the production issues licked by February. Now it concedes that they're still a problem.

The larger matter is just how, in the end, little PalmOne can avoid getting swamped by the huge cell-phone players. Bradley's answer is simple: "Dealing with these behemoths is not new for Palm or Handspring." PalmOne, he says, has learned from past experience that the big boys can be had by out-innovating them and beating them to market with ever-more-compelling--and high-margin--devices. "I'm sure Nokia and Samsung will add features, but by then we'll be setting the bar that much higher. That's our heritage."

Which invites the question of what kind of mind-blowing innovations the next Treo will sport. That's a closely guarded secret at PalmOne, and a matter of fevered speculation in the industry. Among analysts and other observers, the thinking is that, possibly as early as midsummer, PalmOne may roll out the Treo 610, an enhanced model that will feature a higher-resolution screen and Bluetooth networking technology. Another rumored upgrade: a better camera. In general, though, the speculation is that PalmOne's main focus will be on selling the 600 at least through early 2005.

Hawkins, however, is already thinking way beyond the next iterations of the Treo. At his think tank, he's writing a book proposing a theory of intelligence he hopes will launch an entire scientific movement on brain research. When you ask about the movement he's already done so much to launch--persuading the entire world to run around with tiny gadgets in their pockets--Hawkins says he's just getting started. One reason he wanted to sell Handspring to Palm, he says, is that he'd been working on a secret project that needed the backing of a larger, better-funded company. "It's a pretty big idea," he says. "Maybe the biggest idea I've ever had."

Is it a phone? "Nope, not giving you a hint," he says. It will, however, answer the questions that everybody in the mobile-computing industry is constantly asking right now: Where's it all going? What's the next great leap? Or, as Hawkins puts it, "What's going to happen to all this stuff?"

A product that provides an answer to that? Now how cool would that be?