RIM: What the hell happened?

May 30, 2012, 5:14 PM UTC

FORTUNE — If aliens had disembarked at Orlando’s Marriott Hotel in early May, they would have probably thought the BlackBerry the latest and greatest technology on Earth. Everywhere, devotees tapped away at their glossy black smartphones’ keyboards. Banners hanging on the walls extolled the Blackberry’s superior security features and “amazingly fast” Internet browser. Thousands lined up to hear the confab’s leader — Research in Motion CEO Thorsten Heins — unveil the future.

Observant visitors might quickly have realized they didn’t land at a typical business convention, though, but at a conference for RIM (RIMM) developers — the diehard of the diehard. And, worse, that many of the attendees also had Apple (AAPL) iPhones and Google (GOOG) Android devices stashed in their pockets, like contraband. They might have even heard the whispers of disappointment ripple through the crowd in response to Heins’ meager announcements. They would have surely realized that, in fact, the BlackBerry is not ascendant — but that it is fighting for its life.

RIM’s woebegone story is the stuff of science-fiction epic. A technology juggernaut that emerged from a sleepy Canadian backwater, RIM came to dominate the smartphone industry in a few years. Its BlackBerry managed to become an indispensable tool of the global elite in Davos and Washington D.C. as well as a status symbol to tweens shopping Tokyo’s Ginza and San Francisco hipsters alike. Just three years ago, Fortune named RIM the world’s fastest growing company, as it expanded profits at a monster rate of 84%. But after months of increasingly dire struggle, RIM announced this week that it had engaged JPMorgan (JPM) and RBC Capital to “review” its strategic options, all but confirming that the end of RIM as we know it is finally at hand. The behemoth appears to be wasting away at time-lapse speed. What happened?

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The plunge seems precipitous, but the downfall has been a longtime coming. RIM’s stock has plunged some 90% since its 2008 high. Five years have passed since the iPhone came out and, unlike most other phonemakers, RIM still doesn’t have a viable competitor to sell. It wasted time denying the growing appeal of iPhones and Android devices, losing favor with consumers and developers in the meantime. Even worse, it no longer has a stranglehold on IT managers, a growing number of which are now letting employees bring their device of choice to work.

Until now, RIM’s response has been the same: BlackBerry 10. As delays of the new operating system piled up, the refrain began to ring hollow. Devices powered by BlackBerry 10 aren’t expected out until later this year. “This is a train that’s left the station,” says Mike Abramsky, a former RBC Capital Markets analyst who spent over a decade covering RIM. “You just can’t put that genie back in the bottle.”

A prototype savior. A test device of upcoming Blackberry 10 models.

RIM’s decision to enlist two major banks in evaluating its options means the company is highly likely to put itself — or at least major parts of its business — on the auction block. The company could ditch the hardware business and spin itself into a software and services company, licensing its still-valuable email service and infrastructure to other phone manufacturers. (That is a solution one of its former co-CEOs is said to have proposed.) Or it could throw its weight behind a strategic partnership like Microsoft (MSFT) and Nokia (NOK), or just sell off the entire business. None of the options are good.

Of course, there was a time when RIM could do no wrong. Based in tiny Waterloo, Ontario, the company started out as a consulting business in 1984. It later developed and sold digital barcode readers used by the movie industry to scan through spools of film, as well as two-way pagers. In 2003 it launched the first BlackBerry, wowing employees with push email and teeny-tiny QWERTY keyboards. IT professionals loved the product because of ample security controls — they could, for instance, shut off access to websites deemed inappropriate or remotely erase the contents of a lost device with the push of a button. It wasn’t long before BlackBerries became the accessory of choice for working professionals and chief information officers were purchasing thousands of email-enabling servers from RIM.

In Canada, RIM became a darling. And all across the world, “CrackBerry” addicts were signing on by the millions as BlackBerries became the smartphone of choice for a whole army of increasingly mobile professionals. “It was a great source of pride in Canada,” says Abramsky, the former RBC Capital Markets analyst. “It was almost like Apple is in the United States — a local tech company that’s also a leading player on the world stage.”

The tide started to turn in 2007, when Apple introduced the iPhone. At first, many — including, of course, RIM’s managers — dismissed its potential in the enterprise. After all, Apple’s Steve Jobs had made it clear that catering to enterprise customers wasn’t a priority, once referring to CIOs as “chief information orifices.” Google’s Android was also developed with consumers, not corporate users, in mind. It didn’t matter. Before long, employees who had stood in line to buy shiny new touchscreens began bringing their new phones to work.

Both iOS and Android managed to overtake RIM precisely because they appealed to everyday users, not enterprise customers. They launched user-friendly app stores with millions of sleek, time-sucking apps. (RIM was unfashionably late to launching its own application store.) And they gave users access to the full web, not the miniaturized version offered on BlackBerries and low-end handsets. RIM’s device — once the poster-child for mobile innovation — fell badly behind.

“For years and years we asked RIM to give us the ability to control every last little aspect of the devices and RIM went right with us,” says Bob Burkhart, director of new product innovation at Nationwide Mutual Insurance. “They were so busy doing what we wanted them to do that they took their eye off the ball.”

Happier times. Then-CEOs Jim Balsillie and Mike Lazaridis in 2006.

Then-CEOs Jim Balsillie and Mike Lazaridis brushed off the threat from Apple and Google. They believed that users wouldn’t want to type emails on a touchscreen device, and that their superior security controls would keep IT departments faithful. But employees wanted the latest, coolest gadgets so badly that they were willing to pay for them out of their own pocket. And, in the midst of an economic crisis, CIOs couldn’t ignore the cost benefits of letting employees purchase their own phones. They also discovered they could get many of RIM’s security controls from a growing list of eager third-party vendors.

RIM was losing its grip on the enterprise and consumer markets, but the company’s management was still in denial. In the fall of 2010, Balsillie and Lazaridis called the sales team in to discuss RIM’s roadmap, including plans to launch an iPad competitor, the PlayBook. “Mike came in to that sales meeting about as arrogant as you could be,” says a former RIM executive. “The feeling at that time was that we were substantially behind Apple in the smartphone category. But he had no doubt that we would succeed given the products we had coming.” The Playbook was a disastrous flop.

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By the time 2015 rolls around, it’s expected that 55% of business devices will be purchased by employees, not CIOs. And, when given the choice, most consumers — at least in North America — are choosing Apple or Google, not BlackBerry. From healthcare to retail to financial services, companies are rolling out so-called “bring your own device” (BYOD) programs.

If they haven’t done so yet, they’re surely thinking about it. Jim Spicer, CIO of Wells Fargo, says his employees operate primarily on BlackBerries, but “we’re looking into whether or not we would consider allowing personal mobile devices.” Even traditional BlackBerry-only shops like the U.S. government have started allowing employees to bring iPhones and Android devices into the workplace — or army base.

From a windowless office at Fort Bliss’ Mission Command Complex in El Paso, Texas, Michael McCarthy oversees the U.S. Army’s Smartphone Project, an ambitious undertaking to arm 1.2 million American soldiers with mobile devices. Just a few years ago, when BlackBerries were the only smartphones certified to handle government data, McCarthy’s task would have been simple enough. But these days, even the Department of Defense is jumping on the “consumerization” bandwagon and letting soldiers fill their camouflaged cargo pockets with all sorts of devices.

Cooking up something new, hopefully. Current CEO Thorsten Heins at this year’s Blackberry World.

“We’ve tried big tablets, little tablets, Android phones, Windows phones, iPhones and even iPods,” says McCarthy, a former artillery officer. “Initially we looked at BlackBerries as well but the soldiers preferred not to use them.”

To keep tabs on the various devices, McCarthy uses software from Sunnyvale, Calif.-based Good Technology, one of the largest players in a growing pool of mobile device management providers. (Good also counts UBS (UBS) and insurance provider Nationwide among its customers.) Good and its biggest competitor, another fast-growing Silicon Valley startup called MobileIron, have both benefitted from RIM’s declining popularity and recent missteps.

Last October, MobileIron CEO Bob Tinker was schmoozing with customers at a San Francisco restaurant when he noticed some of his guests furiously hitting the buttons on their BlackBerries. As it turned out, a massive network failure had shut off email access for millions of BlackBerry users. For three days, RIM users had to turn elsewhere for their email fix. In hindsight, the outage was like watching a life support patient’s monitor flicker.

“The rise of the iPhone and some of the missteps by RIM have driven an acceleration of our business,” Tinker says from a dimly lit conference room at his company’s Mountain View, Calif. headquarters. (Speaking of outages, an electrocuted squirrel caused a block-wide power failure on the day of Tinker’s interview with Fortune.) Tinker says MobileIron has added 1,400 new enterprise customers in the last 12 months. Good Technology CEO King Lee says his company’s 100% year-over-year revenue growth would not have been possible without the effects of consumerization and BYOD, not to mention BlackBerry’s fall. Good is preparing to file for an IPO.

It isn’t that RIM hasn’t tried. In recent months, the company has pushed its own mobile device management offering, called Mobile Fusion. “We’ve been managing fleets of tens of millions of devices for years now,” David Heit, VP of strategy at RIM, told Fortune last March after Mobile Fusion was announced. “So where we are in the learning curve is incredibly far.”

The BlackBerry maker is known for its unmatched security features, but that may no longer be enough to succeed even in this space, as companies like MobileIron, Good and others have had a significant head start. And, even if Fusion succeeds in gaining market share, it won’t help RIM sell many more phones. In fact, since it supports iPhones and Android devices, the opposite could even be true.

RIM still has plenty of assets, zero debt and over $2 billion in the bank. Despite some the high-profile outages, the NOC infrastructure it’s built is quite reliable and its email service is fast and relatively affordable. RIM also has 77 million subscribers worldwide, and is extremely popular in Indonesia and parts of Latin America. It’s got its die-hard fans in the United States too, like President Barack Obama and homemaking queen Martha Stewart, who carries two BlackBerries at all times.

The company’s refrain when asked about falling behind Apple and Google has been: Blackberry 10.

The company’s trajectory, though, is dismal. It has lost millions of subscribers in North America, and recently warned that its “financial performance will continue to be challenging for the next few quarters” and that it expects an operating loss for its fiscal first quarter, which ends on June 2. After several disappointing quarters, co-CEOs Balsillie and Lazaridis resigned and former COO Heins took over as CEO earlier this year. Heins, a longtime RIM insider, first downplayed the company’s troubles. But in recent weeks he has changed his tone, acknowledging that “substantial change” is necessary. And yet, up until now, he’s also been touting BlackBerry 10 as the answer to RIM’s problems.

“RIM doesn’t just want to have its cake and eat it too,” says Nirm Shanbhag, Managing Director of Interbrand San Francisco, which tracks brands’ global value (not surprisingly, RIM’s has been on the decline). “It doesn’t even know what it wants for dessert.”

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At a kick-off party at the recent BlackBerry World conference in Orlando, free booze and chocolate covered mango-on-a-stick are being passed around. Several thousand attendees are strolling through a large showroom, sipping their drinks and checking out demos of BlackBerry apps made by the likes of Cisco (CSCO) and SAP (SAP). There are no new BlackBerry phones to be seen. But there is a pimped-out police car with a flashy dashboard powered by QNX, the operating system RIM has repurposed as BlackBerry 10. A crowd has gathered to ogle the shiny car. One young executive from a Canadian mobile operator admires the RIM-powered gadgets inside, then pulls out an iPhone and glances down at his email. “Don’t tell anyone,” he says jokingly, quickly putting the device back in his pocket.

Later in the evening, RIM’s Heins makes an appearance. At six-foot-six-inches tall, it’s easy for the newish CEO to exude confidence. “It has to succeed,” Heins says when asked about the upcoming BlackBerry 10 operating system. “Failure is not an option.”

Increasingly, it is looking like failure is a likely possibility. There are plenty of defectors right here in the room, at RIM’s own party. Outside, from everyday consumers to IT dudes, customers are ditching RIM hand over fist. The majority of Silicon Valley developers aren’t even considering creating apps for the company’s platform — at this point, they’re more likely to develop for Microsoft’s upcoming Windows phones than RIM.

So will Heins sell the business off piece by piece, go the partnership route, or try to stick to the current plan of pushing BlackBerry 10? Only one thing is clear: The odds of RIM regaining its former glory are about as good as the chance of aliens descending on Orlando’s Marriott next May.