April 8, 2004 12:38 PM PDT

Parts shortage could hang up Treo 600 sales

A display parts shortage could slow production of PalmOne's new Treo 600 smart phone, threatening to hurt sales momentum for the popular device and put the brakes on the company's latest rebound.

PalmOne--formerly Palm--has supplies to meet production estimates for the current quarter, according to PalmOne Chief Financial Officer Judy Bruner. After that, the picture gets cloudy, executives said, because the company can't accurately forecast availability of components for LCD (liquid crystal display) screens used in the devices.

"There is a possibility that we will be pleasantly surprised (by additional supply)...but we're guiding to the units that have been committed to us," Bruner told CNET News.com this week. "There are always supply issues we have to battle...We have to take this one quarter at a time."

News.context

What's new:
Competition with TV makers over LCD screen parts is clouding the production schedule for PalmOne's Treo 600.

Bottom line:
The scarcity of the Treo 600, as well as some of the positive reviews it has received, has helped to build up demand for the device. That may be good for the image of the product, but manufacturers don't want to see consumers on waiting lists for too long.

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The Treo 600 is taking off as LCD screen manufacturers are getting large orders from TV makers, a higher-margin business that is pushing companies like PalmOne to the back of the supplies line. Specifically, the company can't lock in manufacturing contracts for a component called "IC drivers," Bruner said.

There is enough glass supply in the market to meet demand--thanks to the construction of several next-generation manufacturing plants--but supplies of components, such as a backlight, color filters and drivers aren't as abundant.

Some analysts said that the situation could last as long as two years.

"It's a minor shortage now, but we're projecting it will be more problematic as the year goes on," according to Jerry Benson, vice president at research firm DisplaySearch.

Supply problems are not uncommon in the high-tech gear market. Numerous manufacturers are constantly vying for a limited number of components, such as screens and memory. This makes it tough for manufacturers caught off guard by unexpected consumer demand to quickly increase manufacturing.

Just last month, Apple Computer had to push back the international debut of its iPod Mini because of stronger-than-expected demand in the United States and limited supply of tiny 4GB hard drives.

"This industry is always dealing with some sort of component shortage, and the sweet spot where demand meets supply is a constantly moving target," said Kevin Burden, an analyst with research firm IDC. "What makes it particularly tough for PalmOne is that they are small when you look at their competitors, and consider that they are negotiating for the same components as cell phone makers who ship in really high volumes."

Preventing a replay of history
PalmOne has responded to supply problems in the past by locking into long-term parts contracts for devices. But that strategy has risks, too. In 2001, the company got stuck holding onto excess inventory when sales of its m500 and m505 devices fell short of expectations. Some of those devices still linger in the market, and it took the company a while to recover.

Answering the smart-phone call PalmOne's Bruner said the company has made major changes aimed at preventing a repeat of the 2001 fiasco. The company has streamlined operations and overhauled its supply chain and management processes, making it better able to withstand short-term supply and demand swings.

The situation with the Treo 600 also may be less risky for PalmOne, because primary customers for the device are wireless carriers, rather than consumers. "Our selling model is different because...purchases we are making on components are based on product commitments by carriers," Bruner said.

PalmOne has Treo 600 deals with many major U.S. cellular carriers including AT&T Wireless, Cingular Wireless, Sprint and T-Mobile. Verizon Wireless, one of the largest cellular carriers in the United States, also plans to sell Treo 600 devices. The company posted a link on its Web site Wednesday indicating that the Treo 600 would be available soon, but later removed the link.

But dealing with these carriers--and signing up new ones--won't be easy, analysts said. Carriers can be just as fickle as consumers in choosing and abandoning product lines, and their decisions can have a sudden impact--both good and bad--on manufacturers.

Analysts noted that PalmOne may be in a stronger negotiating position with suppliers over the Treo 600 because of the attention the device has received, DisplaySearch's Benson said.

"The Treo 600 is a cool product, so it's a risk to be a fair-weather supplier," he said.

Treo 600

During PalmOne's recent third-quarter conference call, the company said it had shipped 137,000 Treo 600 units--significantly above expectations--while acknowledging the shortage. Company executives said they would ship 160,000 units this quarter and predicted revenue from the sale of those devices of up to $75 million. They said they believed demand was greater so they were looking for additional suppliers. PalmOne is estimating that revenue in its current quarter will be in the range of $245 million to $255 million.

One indication of supply problems for companies is brisk business among resellers on auction sites such as eBay, where consumers frequently bid up to get devices. A handful of Treo 600 devices have been sold and are currently being auctioned on eBay for well above their retail price.

Oddly enough, the scarcity of the product, as well as some of the positive reviews it has received, has helped to build up demand for the device. That may be good for the image of the Treo 600, and for those who are able to purchase the device, but manufacturers don't want to see consumers on waiting lists for too long.

"It's a double-edged sword," said Justin Udelhofen, an analyst with investment bank Needham & Co. "The market is taking it as a strong sign of demand, but at some point it will become a question of whether they're able to deliver products."

Fast-moving market
Despite the current popularity of the Treo 600, a slip in supply could open the door for rival products. IDC's Burden expects smart phones based on the Symbian and Microsoft Windows operating systems to be introduced this year that will be as equally appealing to consumers as the Treo 600.

The precariousness of device sales was underscored this week, when cell phone handset market share leader Nokia cited its inability to keep up with phone trends, especially in the midrange, as one of the reasons it missed first-quarter sales forecasts.

PalmOne maintained its market share leading position in the U.S. device business, according to IDC, but shipments of handhelds have been sagging over the last few quarters and are being replaced by phones with organizer capabilities.

PalmOne recently laid off 12 percent of its work force and said it is shifting more investment into smart phone development--moves that came after it acquired Handspring last year. That signaled a change in emphasis to a higher growth part of its business, which coincided with a run up on its stock.

The Treo 600's $449 price helped to boost the average selling prices of PalmOne's devices from $169 in the third quarter last year to $233 in the third quarter this year. That helped increase the company's revenue by 23 percent in the third quarter compared with the same period a year ago. It also significantly narrowed losses.

Still, it has a long way to go in expanding its smart phone sales. Although PalmOne beat forecasts by shipping 137,000 Treo 600s in its third quarter, the device made up only a fraction of the 938,000 devices the company sold for the period.

Analysts said PalmOne needs to cash in on as much of the Treo 600's popularity as possible, in part to ride the momentum of a recent financial revival.

"All smart phones have a short window of opportunity to make their market and make significant money for a company, and that is why many companies are concentrating on their speed to market," Burden said.

 

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