REPORT #1- Personal Digital Assistants

The Personal Digital Assistant, or PDA, is a phrase coined to refer to a new class of lightweight, handheld devices designed for use as personal organizers with communications capabilities. When U.S. Robotics (now a 3Com subsidiary) introduced its PalmPilot product in 1996, nobody really thought that this sleek-looking gizmo originally created by Palm Computing Inc. would turn into a cult phenomenon and in turn open up a brand-new market.

In 1997 alone more than a million units of PalmPilot were sold. Today, PalmPilot has become the industry pacesetter, inspiring almost fanatical loyalty among its users.

The success of PalmPilot has shown the way to Microsoft, which is now hoping to take over the PDA market share with its Windows CE product. We will analyze some of the major strategic obstacles competitors face to succeed in this industry segment, focusing in the role of complementary and competitive products.

There is a tradition in the computer industry that says it takes three versions of anything to finally get it done "right". Anyone who has been tracking the evolution of the personal digital assistant has probably experienced this same exact situation.

From the beginning, very few of these products had been usable (or very affordable, for that matter). Although companies like Sony, Tandy, Sharp, and Hewlett-Packard too name a few, invested a lot of time and resources in launching a "first generation" of products, they all met with little or moderate success. Indeed, there is a long list of failed attempts during this stage to design an electronic organizer that really worked.

The revival of digital assistants started in 1996 thanks in part to the Japanese electronics manufacturers like NEC, Hitachi, and Casio, who continued developing their own versions of the handheld computers over the years. Despite the earlier complaints about user-unfriendly handwriting recognition systems and unfamiliar software options, everyone from Microsoft to Compaq tried to introduce a new wave of handheld terminals.

A few years ago, Apple released its Newton product line raising high expectations in the computer industry. While the Newton was an important breakthrough, there were some problems with it. First, it was too big: consumers did not want to carry an organizer around that could not fit very well in a pocket. Furthermore, it was expensive: the option to spend in the range of $700-$1000 on an organizer compared unfavorably with a more useful laptop computer. Nevertheless, it introduced the concepts of handwritten input and PC connectivity.

The third generation, represented by U.S. Robotic’s PalmPilot, finally offered consumers a small unit at an affordable price, leading to the current revolution in handheld computing. The introduction of its Pilot 1000 and Pilot 5000 products was a huge success, with well over a million units shipped in the first 18 months of the business.

While 3Com attributes much of the product's success to good design, it is important to recognize the value of the fanatical developers, many of them previous Newton enthusiasts.

Microsoft, as part of its "Windows Everywhere" campaign, is developing and trying to push its own operating system for handhelds and other small devices, Windows CE. In the meantime, the Palm OS holds a 72 percent share of the worldwide personal companion market.

The most common features found in current PDA models include:

• An address book that lets you capture standard address information such as names, mailing address, phone number, and e-mail address,
• a datebook that lets you enter appointments and schedule ,
• a memo pad for jotting notes,
• a to do list that lets you add items and check them off as they are done,
• a basic calculator.

Additionally, new models include an expense report application that helps you keep track of business expenses as well as several games. More recently, advanced features come with an Internet e-mail program.

Other features include software called HotSync that allows you to attach your PDA by a serial cable to your Windows PC or Macintosh to quickly backup and exchange information between them. Users can also use desktop versions of the PDA applications as well most popular PIM (Personal Information Manager) software to enter information on the computer and transfer it to the PDA.

One of the key features of these devices is the capability of third-party software developers to write applications on a PC that can then be transferred and run on your PDA, so customers are not limited to the software that comes on their machines.

Some of the PDAs (like the PalmPilot) do not contain a keyboard, but use a handwriting-recognition system to enter data. Recently, more models include an interface to connect additional hardware components, such as modems, memory cards, barcode readers, etc. Newer models also offer an infrared port that allows communication with peripherals such as printers or other PDAs.

Additional features that are being introduced by manufacturers to differentiate their products include color displays, backlight screens, longer battery life, and wireless communication capabilities.

Finally, design choices have to be made in order to attract the attention of consumers. Of course, the physical form-factor of the unit: weight, size, and style all play a key role in gaining market share. Last but no least, a handheld organizer should be easy and intuitive to use and take no more than a few minutes to learn.

The current sales figures show the 3Com "connected organizers" to have a PDA market share of a hefty 63% worldwide (Dataquest, 1998) and 72% in the US (IDC, 1999). A major factor for the Pilot’s phenomenal success is that they are simple and easy to use, while many of the competitors have spent a great deal of time and money on making a "do it all" PDA that most users have found cumbersome and overfeatured. Additionally, the Pilot was made to leverage the network effects of the ubiquitous PC. US Robotics, Pilot's original owner - now part of 3Com, created the Pilot as a companion to the PC. It basically is a mobile organizer possessing the ability to synchronize with any PC’s Personal Information Management tools through a serial cable. Undoubtedly, its small size and effective handwriting-recognition technology were other positive features that differentiated it from others.

3Com, or more specifically its subsidiary Palm Computing Inc., has continued their success by successfully taking on a growing number of "Pilot-killers" like a champion. Their competitive strategy has included selectively licensing their operating system to allow and support outside hardware and software complementers in an effort to add value by increasing the functionality of the PalmPilot products. There are currently more than 12,000 software developers for the PalmPilot platform. With more applications to run on the PalmPilot, they hope to keep customers locked in to their operating system. Palm Computing is also expanding their leadership by making localized products in different languages, including French, German, and most recently Japanese.

In the effort to take on the onslaught of the Microsoft Windows CE predators, Palm Computing is moving to increase the connectivity as well as the functionality of its products. Pilots are now equipped with the ability to view most Microsoft, Corel, and Lotus office-type files among others. This is a necessary feature to capture and retain PC users as customers. In the upcoming release of the PalmPilot VII, wireless connection to the internet will be made possible from the pilots, with emphasis on email and on providing specialized "lite" Web content from providers such as ABC and Dow Jones.

Of equal importance is Palm Computing’s growing trend of forming alliances and partnerships with what they call "best of breed" companies. Strategic partners who base their products on the PalmPilot include IBM with its WorkPad PC companion, Franklin Covey (makers of popular time and life management planning concepts), and Symbol Technologies (makers of bar-code scanning technology). More recently, Palm Computing has announced intentions to collaborate with the European consortium Symbian (see Alliance section to follow) on developing standards for wireless communication technologies for handheld devices, and possibly combining PalmPilot’s successful hand-writing recognition technology with Symbian’s well designed EPOC operating system. This is likely the best weapon for 3Com to keep its customer base away from the Windows CE devices and to have the right scalable platform to continue competing in this market space.

Recently, eight PDA vendors signed on to utilize the Microsoft Windows CE operating system in order to make "Pilot Killer" PC companions as well as "Palm-sized PCs" (heavier, mini-notebook computers), including Hewlett Packard, Philips, and Casio. The clear advantage they have are the immediate network effects in the familiar Windows OS environment they offer and in the slew of familiar Windows applications Microsoft is developing for the CE platform. With Windows, these devices will have a much higher ability to act as complementers to the PC through more applications. These vendors have jumped on the Windows bandwagon with the hope that the interoperability among each other will boost their market shares against the PalmPilot, which has its own OS. Some are also trying to differentiate themselves by having color displays and other amenities, but more or less, they are all under strict guidelines by Microsoft.

With the prevalence of Microsoft Windows, it is somewhat surprising to find that 3Com continues to dominate this market. However, there are several key reasons that this is the case. First and foremost was the inability of Microsoft to develop a working version of Windows CE at the time that PalmPilots became popular. 3Com enjoyed a huge advantage in time to market and the Windows based suppliers have been playing catch up ever since. A second problem is that while the Windows CE PDAs are more powerful, they are also more complex. This power is necessary to run many applications, yet it makes it more difficult to do simple tasks, such as entering contact and scheduling information that is highly valued in a PDA. Most of the users looking to run applications already own laptops, so the WinCE supporters are finding themselves between markets: too weak to compete with laptops, but too complex at the present time to beat the easy to use PalmPilot

With the increased importance of connectivity comes the impending convergence of the wireless communications and mobile information device industries. At the present time there are two important alliances that are addressing and enabling this convergence.

Symbian is an independent partnership that was formed to set the standard for mobile wireless operating systems and is made up of some of the world's leading mobile computing and telecommunications companies such as Ericsson, Motorola, Nokia, and Psion. Symbian utilizes a new operating system, EPOC. EPOC's Features include compatibility with all leading Windows 95 and NT 4 spreadsheets, word processors and databases, and application interoperability with Microsoft, Lotus, Corel, WordPerfect and others. Additionally, Symbian has already developed an electronic mail utility that can be used without an ISP and the group also aims to facilitate other mobile standards and technologies such as wireless application protocol (WAP). At the present time, the Symbian group has focused mainly on smart phones, but with developments like this, it is clear that it will not be long before they enter the PDA market space.

Another relevant partnership involving wireless communication is the Bluetooth consortium. Bluetooth is made up of over 500 companies also in the telecommunications and computer industries with the goal of developing the technology for a global standard in wireless connectivity. Bluetooth uses a short-range radio link to exchange information and enable wireless connectivity between mobile phones, PDAs, laptop computers and other wireless peripherals and devices.

It is not surprising to find that companies such as Ericsson and Nokia are heavily involved with Bluetooth and Symbian. Both of these alliances could play a major role in the future of the PDA market as well as the mobile computer market in general. As the PDA and wireless communications markets converge it will be very interesting to see what becomes of the EPOC operating system and whether or not a single standard for wireless connectivity can indeed be created.

The current market for PDAs is far from stable, but rather in a state of rapid fundamental development. In our analysis, we identify three current key underlying market characteristics (entry barriers, competitive situation, and profitability). Also, based on these, we attempt to make predictions about the direction the market is taking further below in section IV.

PDAs have been showing rapid technological advancements since they appeared, based on substantial r&d commitments by the key competitors. As the market grows and competition increases, the pace of development is likely to accelerate. This, in turn, should 1) drive the required upfront non-recoverable investment in r&d expenditures necessary to stay competitive higher (increasing sunk costs), and 2) favor players who have experience from former PDA generation developments (increasing relevance of progression along experience curve). Based on these two factors, we argue that entry barriers for new players - already high - should continue to increase. This argument should hold at least in the medium term as long as high performance of portable communication devices still represents cutting edge technology. The observation of high entry barriers is further supported by the fact that the value of brand names already plays a key role and should continue to do so.

While high entry barriers protect the existing players to a certain extent, we have seen above that the market is highly (and increasingly so) competitive. The incentive to enter this market despite high entry barriers comes from the market potential (expected size), and profitability.

However, with increasing competition, it should be hard to maintain the current profitability: The upfront investment (r&d) represents a considerable share of fixed costs to overall product cost. In a high fix cost business, it is the dominant strategy to price competitively in order to sell large quantities and thus recover the upfront investment. This is already starting to show in the PDA market: The leading player, 3Com, points out that its prices may not be sustainable over 1999 (3Com SEC 10-Q, Jan. 11, 1999). If prices will fall more than the costs of sales (which seems realistic), gross profit margins will decrease. However, we believe that the entry barriers will prevent a complete erosion of profit margins at least in the near future, in particular since there are only a few players in the market, there will be strong incentive to keep healthy margins overall.

Given the rapid change in the PDA industry today, an analysis of the competition and complementation in the industry needs to look into the future. To cope with the high level of uncertainty about the factors that will constitute the outcome, we try to identify and analyze a number of fundamental developments that are to a certain extent already observable (standardization, consolidation, functionality), and reason on the direction they will likely take in the future.

A key underlying factor that will affect these developments is the ‘industry standards question’, which we will analyze first. After that, in order to use a systematic approach in predicting outcomes for the market, we look at the market from the supply (producers) and the demand (consumers) sides separately. While both are closely related, our predictions for the development of each side will differ.

At this early stage, the PDA market has not achieved standardization on any level, from the operating system to the API for add-ons, to protocols for communicating with other machines and the Internet. As the market matures, it will be inevitable to see either de facto or formal standards at different levels, to allow for the increasingly needed interoperability and connectivity of the products.

A major factor in this is the OS that the system uses. At this stage we have three distinct operating systems, Palm OS, Windows CE, and EPOC. Each of these is separate enough to have its own advantages and disadvantages. Whilst PalmPilot has the dominant consumer base, its OS is proprietary and tailored for simple PDAs. There are questions of its ability to function and interoperate with the new technologies it would need to support, and as stated the consumer base is still only a small part of the potential future market. EPOC has the major handicap of small current operator and programmer base, but it is a highly optimized and promising platform for higher functionality including its current target of telecommunications for smart phones. Even Palm is considering EPOC for a joint effort with Symbian participants. Windows CE is perceived as being slow and clumsy, but it has the advantage of a massive consumer and programmer base (see previous section on WinCE-based PDAs). This simple fact gives Microsoft the advantage of high switching costs, as people are more used to writing for Windows. To learn a new operating system would represent considerable time, effort, and expense. It would also not be surprising if Microsoft limited interoperability with its desktop machines for the new generation of PDAs that had a different operating system, but this raises legal questions similar to the ones it is presently facing. However, this does not seem to be an obstacle for Microsoft.

In section III, we observed that a few players with deep pockets are already dominating the market, due to high entry barriers in the form of substantial sunk investments that precede product innovations. Closely related to this point is the value of strategic alliances. They result (among others) from the fact that even companies like the market leader 3Com (with sales of > $ 6 bn / year) predict that they will not have the resources to compete on a stand-alone basis. This makes them seek strategic alliances and drives an overall trend of consolidation in the industry.

This trend for strategic alliances, mergers, acquisitions, and other consolidation activities goes beyond the PDA industry alone. Much rather, it is already reflecting a convergence of industries that were formerly separate. As we argued above in section II., hand-held devices are moving away from ‘stovepipe solutions’ and as information appliances converge with the communications industry. This convergence of related industries can be observed by substantial m&a activities over the past year (e.g. 3Com acquired Lanworks Technologies, Inc. and EuPhonics, Inc.; Lucent Technologies acquired nine companies; Cisco Systems acquired nine companies; Northern Telecom acquired four companies, including Bay Networks). Along the same lines is the large number of strategic alliances (e.g., this year, 3Com announced partnerships with IBM, Hewlett-Packard and Toshiba America). We would therefore expect to see substantial further convergence of these industries in the future. In the longer run, it seems likely that there will be a consolidated networking / communications industry with a few large players.

Key drivers for this trend of consolidation and convergence are the increasing importance of network externalities (see above section II.), vigorous competition, rapid technological development, need for financial resources, and uncertainty about future industry standards (see SEC 10-Q of 3Com, Jan. 1999). The latter – which enters the PDA market for example via the uncertainty about the future operating systems standard – gives incentives to partner with players to develop enough critical mass to have the market power to set future standards. In an environment with a very high level of uncertainty such as the PDA market is today, this is a strong incentive.

With time, as a result of the convergence and cooperation of manufacturers, all surviving PDA makers will be able to offer all functionality possible for PDAs with increasing interoperability across platforms (there may even be only one left), the same way cell phones inter-operate today. They will all eventually offer personal information management, wireless communication of multiple media (data, voice, and music), paging, internet access, some mobile computing, and other new yet to be conceived applications. At some point in time, there will be products that contain all of these features.

For the near future, although manufacturers of information appliances will attempt to consolidate devices and different markets will converge (telecommunications companies offering internet access in their cellphones, PDA makers offering paging services), the all-in-one information appliance will likely not win the acceptance of most consumers. Despite the fact that people do not want to have to carry around four or five pocket sized information appliances, they will still prefer to have a few inexpensive devices that excel at particular functions. Often times you compromise a great deal of functionality when you combine several items in one device. For example, there is the simple problem of being able to talk and take notes at the same time on the same device with modern day "smart phones."

In the long run, we believe the successful information appliance maker will be the one who offers the consumer the freedom to select any subset of functionality from the widening array of functions to include them into their desired device. Though these different functions would previously have been from different markets and of different nature, they will be transformed as features in an extensively versioned product. There will be every conceivable version of each product available at all price ranges to try to cater to everyone, with certain products finding their own niches, like Sharp is already doing with its Mobilon and its attached digital camera. Expect to see everything from the basic low memory phone, calendar, no-wireless Internet device at a low price, all the way up to the top of the line voice activated, color screen, full wireless Internet access, telephone, pager, high memory, removable storage media, fast processor, long battery life, mini computer at a much higher price. Versioning is such a good idea for the manufacturers, as once they have their product designed it is very easy for them to produce different versions by adding or removing features and software, thus allowing them to easily try to cater to a bigger segment of the market.

There is also the issue of how the PDA products will interact with the integrated PC platform. There will be more power afforded into the information appliance to allow more complementation to the PC, especially if Bill Gates has his way. But, we do not foresee a complete convergence between the two. For example, if an individual wants to use even mildly complex applications such as spreadsheets and word processing, a laptop will continue to be the logical choice. PDAs will always be limited by their inefficiency in entering large amounts of data or text. The types of functions desired of a device when one is mobile will remain different, though with more overlap, from those in a stationary setting.

The PDA market is a rapidly changing and evolving market and will continue to be that way for the near future. On the product side, it appears as though the market is converging towards a single device that will combine the features of today's cell phone, PDA, pager, etc. However, it will take some time before the technology is advanced enough for this model to achieve high functionality across the board. This move away from a ‘stovepipe solution’ to the integration of functionalities will make network effects increasingly important for the consumer.

On the producers side, these network effects as well as the standards question and other factors (e.g. high sunk costs in product development) give the industry strong incentives for cooperation. A large number of alliances and mergers and acquisitions in recent months already reflect this trend.

In the meantime there are many challenges to be overcome from the specific technical aspects of wireless communication to the collective agreement on certain standards. However, with the resources of the companies involved and with the size of the market at stake, rapid progress will undoubtedly be made. It will certainly be an interesting and exciting time for people on the move as we turn the corner into the 21^st century.