Palm Inc. shareholders on Tuesday approved separating the company's hardware business from its software operations, sending both entities into a fiercely competitive, dramatically changing market.

In addition to the spin-off of PalmSource Inc., which will develop and sell the Palm OS, shareholders approved the $240 million acquisition of rival handheld device maker Handspring Inc.

PalmSource and the new hardware company, PalmOne Inc., are scheduled to begin trading Wednesday on the Nasdaq stock market.

"It's a good move for them," IDC analyst David Linsalata says of the split. "You'll see a much clearer focus from both companies."

As a combined company, Palm has had difficulty selling its operating system to companies wary of buying software from a hardware competitor. Spinning off PalmSource is expected to alleviate that problem and make it easier for the software company to develop and sell new products for a variety of mobile devices beyond traditional PDAs.

"We are at the beginning of a new phase in the growth of smart mobile devices," David Nagel, PalmSource president and CEO, said in a statement. "As an independent company, PalmSource can accelerate the acceptance of Palm OS as the leading software platform for a wide range of innovative new products."

While Palm remains the leader in the handheld-device market, it has seen that lead erode steadily.

In the third quarter ended Sept. 30, Palm saw its market share drop to 35.6% from 41.8% in the previous quarter, IDC reported Monday. Its closest competitor, Hewlett-Packard, increased its market share to 24.5%, up 52.5% from the previous quarter.

Beyond competition, the bigger problem for handheld device makers is the overall market decline. Year to year, the number of shipments in the third quarter rose just 1.1% to 2.37 million units. IDC is predicting an overall decline for the year, unless "holiday season demand proves particularly positive."

"The bigger question is not only what's going to happen to Palm, but what's going to happen to the handheld device market in general," Linsalata says.

Handheld devices are generally defined as pocket-size gadgets designed to access and manage data, including office documents, multimedia, and games, but do not include telephony. Handheld devices may include wireless capabilities for Internet access and text communications.

The introduction of smart phones--cellular phones that include many of the capabilities found in handheld devices--is poised to eat away at the PDA market. What's uncertain is whether handheld devices will find enough customers among businesses looking to provide sales or service reps with remote access to customer data through corporate extranets. The PDAs' larger screens give them advantages over cell phones.

"What's going to be really interesting is the next year," Linsalata says. "As converged devices [smart phones] enter the scene, it'll be interesting to see how handheld devices will expand with new technologies into new market segments."

Handspring brings Palm considerable expertise in the area of converged devices with its Treo 600, a combined cell phone and PDA.

As to the extent of HP's threat to Palm, that will depend on whether HP can continue its third-quarter surge, which was driven by the release of five new products at the end of the second quarter. What's uncertain is whether the gain in market share was because of the way HP handled its sales channel or actual customer demand.

"If the momentum carries through to the fourth quarter, then HP is poised to be a big threat to Palm," Linsalata says.

In spinning off PalmSource, Palm will distribute all the shares of PalmSource it owns, about 86% of the total, to stockholders of record as of the close of business day Tuesday. Palm shareholders will receive about 0.31 shares of PalmSource common stock for each share of Palm common stock they own.

In the Handspring acquisition, Palm will issue about 13.9 million shares to Handspring stockholders, who will receive 0.09 Palm shares for each share of Handspring common stock.