PalmOne ponders Microsoft, Linux options

The Milpitas, Calif.-based firm has evaluated both Microsoft-based operating systems as well as at least one version of Linux as a potential alternative operating system to the Palm OS for its handheld devices, CNET News.com has learned.

Sources familiar with the tests said PalmOne has been quietly exploring operating systems to augment the Palm OS for some time. The company has also been exploring partnerships that could let it use a tailored version of the Linux OS to run on its devices, according to a source familiar with the company's efforts.

The tests could presage a blow to Palm OS owner PalmSource, which counts PalmOne as its largest customer. All PalmOne devices currently use the Palm OS.

"In a perfect world, since they are really just a hardware company, they would have smartly designed products based on PalmSource's OS, Microsoft's OS and RIM's platform," said Brian Blair, analyst with San Diego-based hedge fund Dorado Capital.

Currently, PalmOne devices solely use the Palm OS from former software subsidiary PalmSource, which split with PalmOne just more than a year ago. The separation of the hardware-making PalmOne and the software-developing PalmSource was meant to allow the two companies to chase new opportunities and markets.

Analysts said they would not be surprised to see PalmOne support other operating systems, adding that if the company wasn't looking at alternatives, it would discredit one of the major reasons for the split.

On Monday, Needham & Co. analyst Charles Wolf wrote a report saying a Microsoft-based Treo is "virtually certain," although he gave no time frame for a release.

Representatives from PalmSource and Microsoft declined to comment for this story.

Although PalmOne has thus far released products exclusively using the Palm operating system, it has been keeping its options open. The company pays PalmSource a per-unit royalty, with a $40 million a year minimum, under a contract lasting until 2006. But the deal is not exclusive, so the company can sell products using other software as well.

Analysts said they believe PalmOne support for a Microsoft OS could help PalmOne sell more devices to large businesses, many of which use Microsoft software. The business market is seen as a key growth area for the most capable of mobile devices--phones and handhelds that can access information stored on a corporate network.

Former Palm rival Handspring had been laying plans for a device with Microsoft's OS prior to Handspring's acquisition by Palm in late 2003, Blair said. The newly formed PalmOne has been reaching out to Microsoft as well. The two companies have inked a deal that lets the latest Treo, the Treo 650, connect directly to Microsoft's Exchange servers. In addition, PalmOne earlier this year released a keyboard that works with devices that run Microsoft's Windows Mobile OS.

Blair said the two companies are going further and that he believes PalmOne will release a Treo using a Microsoft OS sometime next year.

"I think it is something that PalmOne needs to do," he said.

PalmOne has long maintained it is not solely committed to the Palm OS, but the company has been mum on any specific activities.

Marlene Somsak, vice president of corporate communications at PalmOne, said the company is "open to evaluating other operating systems if doing so would grow the market or otherwise meet customers' needs."

However, Somsak would not say what actions PalmOne has taken in the past or discuss future plans.

Since the split, PalmOne has seen its sales of smartphones grow, thanks to the popularity of its Treo 600. However, PalmSource has felt the pain as some key hardware partners have scaled back their use of the Palm operating system. Sony recently said it would pull back its handheld efforts, getting out of U.S. and European markets but continuing to sell devices in Japan. Sony was at one time the second-largest maker of Palm OS-based devices.

PalmSource also faces stiff competition from the likes of cell phone giants such as Nokia, which is backing the Symbian OS for smart phones, and, obviously, Microsoft with its Pocket PC Phone Edition and Smartphone operating systems.

Shipments of handhelds, PalmSource's core market, have been sliding over the last few quarters. About 2.1 million units shipped in the third quarter, down 4.6 percent compared with the second quarter, and down 8.7 percent compared with the third quarter of last year, according to IDC.

PalmSource can find solace in its licensing agreement with PalmOne. That deal lasts until 2006, so PalmOne isn't likely to drop the Palm OS anytime soon. But if PalmOne were to ship products under another OS, it could mean a limit to potential growth.

Analysts said a Microsoft-PalmOne deal makes sense for a number of reasons: The move would fit PalmOne's well-known effort to sign up third-party software vendors; Palm devices are now powerful enough to run Microsoft's relatively bulky Pocket PC Phone Edition software; and corporate buyers would be receptive to Palm devices running Microsoft's OS.

"Corporations are likely to be more receptive to smart phones running Microsoft's Pocket PC Phone Edition operating system than the Palm OS, if only because Pocket PC phones should integrate more seamlessly with Microsoft Exchanges server software, used in the majority of corporations," said Needham's Wolf.

Needless to say, that spells bad news for PalmSource, which would necessarily suffer if it lost significant business from PalmOne, the leading handheld maker and PalmSource's biggest partner in terms of revenue.

The Palm OS became the market share leader for handhelds early on--as soon as the company's devices first hit the stores, in fact. Its lead since has been ground down as Microsoft's products have improved and the Palm OS has adopted some of the advanced features of OSes from Microsoft.

Devices have also become more powerful and have reached a point where they can adequately use Windows-based products. For example, PalmOne's Treo devices, which are likely to be the devices that will first use a Microsoft OS, at the high-end come with a 312MHz Intel XScale processor. Many Microsoft OS-based handhelds, such as those from Dell and Hewlett-Packard, use the same processors.

The Palm OS was used in 51.7 percent of handhelds shipped worldwide in 2003, while Microsoft's OS was in 38.3 percent of devices. IDC says Microsoft should take over the top spot at the end of this year, with 45.9 percent of the market, compared with 45.1 percent for the Palm OS, and grab a 51 percent share by 2006.

Using the royalty-free Linux OS would enable PalmOne to reduce the costs of building its handhelds. By how much is not certain, but analysts estimate that the company currently spends anywhere from $5 to $15 per device for the Palm OS, depending on the price of the gadget.

The market for Linux-based handhelds is growing as companies develop niche OS versions for embedded devices. Handheld devices running Linux include Sharp's Zaurus, which uses Lineo Linux, software developed by Motorola subsidiary Metroworks, as its OS.

Sharp recently said while it will continue to sell the Zaurus to corporate customers in the United States, it is cutting back on its handheld efforts, ceasing further development and ending sales in stores. The company will continue to sell and develop handheld devices in Japan.

PalmSource has also been working on its OS products. It recently announced Cobalt 6.1, its first OS aimed at the smart-phone market--a category it's looking to grow into to go beyond its core handheld business.

Cobalt, previously code-named Sahara, has been in development for about a year. Among its features are telephony capabilities, a native e-mail application, a Web browser and integrated Wi-Fi and Bluetooth wireless features. It also adds improved security features and enhanced capacity to open several programs simultaneously.

CNET News.com's Stephen Shankland contributed to this report.