A Shrinking Market Squeezes Handhelds

Once the Next Big Thing, some analysts say that personal digital assistants are headed for the tech dustbin.
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Is there any hope left for the humble handheld?

The device was once considered technology's Next Big Thing. But with shipments falling, manufacturers pulling out of the market, and even the company that popularized them focusing on other businesses, handheld computers are increasingly looking like a passing fad.

The remaining players continue to release new devices and add new features. But the market appears limited right now, and few analysts see a resurgence.

If handheld manufacturers knew how to expand the market, they would do it, said David Linsalata, who covers the sector for research firm IDC. But "at this point, the handheld makers have flat-to-no growth," he added.

The declining fortunes of the handheld market are most meaningful for

palmOne

(PLMO)

, the market share leader. But the stalling market could also affect

Hewlett-Packard

(HPQ) - Get Report

and

Dell

(DELL) - Get Report

, which hold the second- and third-largest shares of the sector.

That the market is shrinking is fairly uncontroversial. Last week, IDC

reported that handheld shipments fell 8.7% in the third quarter from a year ago. IDC projects that manufacturers will ship 3.6 million units this year, down from 6.4 million units in 2001, which represented the high-water mark for sales of handhelds, or personal digital assistants (PDAs).

And IDC predicts that the market will only get worse. In 2008, the firm expects just 2.4 million handhelds to be shipped.

Amid this decline, high-profile manufacturers are pulling out. Earlier this month,

Sharp

reportedly decided to withdraw its Zaurus handhelds from the U.S. market. In June,

Sony

(SNE) - Get Report

announced that it would cease shipping its popular PDAs to North America and Europe. Meanwhile,

Toshiba

has also been reportedly cutting back handheld shipments.

In the short term, these cutbacks have boosted the market share of the remaining players. H-P, for instance, claimed 30.6% of the handheld market in the third quarter, up more than 7 percentage points, according to IDC.

But that could be just a one-time bump. Despite a bigger share of the pie, even the existing players have already been hit by the shrinking market.

In its fiscal first quarter, for instance, palmOne saw handheld revenue fall 14% from a year earlier. While the company's unit shipments were actually up 10%, those totals were boosted by sales of some of its lower-end devices, reflected in the fact that the company's average selling price dropped 21% from the first quarter last year.

Investors increasingly believe that the success of the company's Treo line of smartphones, which some consider the next evolution of the handheld, is the

key to its long-term success. palmOne has encouraged that view by shifting the bulk of its development efforts to its smartphone business.

Smartphones typically offer PDA features such as address books and calendars, in addition to allowing voice calls and providing links to the Internet over the wireless phone networks.

But the handheld business is still important to palmOne. The company, which sparked the initial boom in sales of PDAs with its Palm Pilot products, received more than half its revenue in its

first quarter from handheld sales. More than 70% of its unit shipments in the quarter were of PDAs.

And palmOne hasn't abandoned the PDA market. The company offers some seven different handheld devices from the entry level $99 Zire 21 to its $399 top-of-the-line Tungsten models.

On Wednesday, the company began shipping its latest model, the Tungsten T5. Among the features on the device are 256 megabytes of flash memory; an extra long, high-resolution screen; and a new program finder.

Nor are palmOne's remaining market rivals standing still. Last month, Dell introduced three new Axim handhelds, which feature higher-resolution screens and faster processors than their predecessors. Two of the new PDAs also offer built-in Bluetooth and Wi-Fi networking. H-P released a similarly featured iPaq handheld this summer.

The market penetration of PDAs is only about 8% in the U.S., said Ken Wirt, a senior vice president at Palm, in an interview this summer. In contrast, PDAs have about 2% to 4% penetration in the European market and 2% or less in Asian countries. All three markets represent growth opportunities, he said.

What will drive that growth is new uses for the devices, he said. PC sales also went through periods of slow or no growth, he noted, only to revive when new applications or uses were found for them. Over the last two years, chips and displays inside PDAs have become increasingly robust.

"The market doesn't grow again until you get the changes in applications that come along with

the hardware upgrades," Wirt said. "That's what we're in the process of inventing now."

Other analysts agree that PDAs are currently lacking the hot features or software that might drive sales. Additionally, the market for the devices suffers from the perception that handhelds have limited use, some say.

"I think

the market has stagnated to where it is because people really use handhelds for two functions: contacts and calendar," said one buy-side analyst, who asked not to be named. The analyst's firm is long palmOne and Dell.

One possible new use for the device could be as a mobile means to access the Internet. Some have posited that the growth of wireless networks might drive PDA sales, just as the Internet helped spark sales of PCs. While Wi-Fi access points are becoming increasingly widespread, laptop computers don't always offer the optimal way of hooking up to them because of their heft, bulk, limited battery life and long boot-up times.

But Linsalata thinks that's doubtful for the time being. PDAs have their own battery issues. Their small screens often have a difficult time displaying full Web pages. And even the fastest PDAs often take much longer to load a typical Web page than an average laptop.

"The browsing experience may be so subpar that you're not interested in having it," he said. "Internet access on a

PDA device is not a compelling enough proposition."