Pando

The switch to subscription has meant huge growth for Adobe

By Kevin Kelleher , written on March 25, 2016

From The Money Desk

Over the past year or so, cloud computing has been one of the more reliable areas of growth inside the tech industry.

For the most part, though, the rewards have gone to the companies providing a cloud infrastructure for others, such as Amazon's Web Services, Microsoft's Azure and, lately, Google's cloud services. Share prices of all three companies are up between 26 percent and 54 percent during the past year, while the Nasdaq Composite has declined 5 percent.

There is a less visible area of tech that has been benefiting from the transition toward the cloud: software companies that used to sell their wares in shrinkwrapped boxes. One of the clearest examples of that success is Adobe. For years, the company had sold programs that helped content creators like artists, filmmakers and web designers do their jobs, but the model was a sell-once-and-hope-they-upgrade affair - and increasingly antiquated as broadband made more programming possible over the Internet.

Four years ago, Adobe made an abrupt shift to a digital model, nudging its longtime customers into a cloud-based alternative, paid for by monthly subscriptions. Customers could sign up for individual programs like Acrobat, Illustrator or Photoshop one by one, or they could subscribe to collection of such programs with Creative Cloud. Adobe also made a push into digital marketing following its $1.8 billion purchase of analytics firm Omniture.

At the time, this struck many as a risky play for Adobe. Many companies were still holding back from cloud software because of security concerns. The subscription model was unproven and would surely weigh down profits during the transition. And that's if it worked at all: The plan also risked cannibalizing a proven and reliable business model. Beyond that, the move into digital marketing meant a simultaneous push into an area where Adobe historically had little experience.

Looking back, the moves all look like prescient ones. Adobe's stock has risen 174 percent in the past four years and 27 percent in the past year alone. As expected, revenue did fall, dipping 8 percent to $4 billion in 2013, then rebounded 18 percent to $4.8 billion over the following two years. Profits also took a hit at first, but grew 56 percent to $2.08 a share last year. That figure is expected to grow 37 percent this year.

Much of that rebound has to do with Adobe's rapid shift to the subscription model. Subscriptions now make up more than two thirds of Adobe's total revenue, up from 28% in 2013. Many of those subscribers are first-time customers to Adobe, including photo enthusiasts who use mobile apps such as Photoshop Lightroom. Adobe released a Cloud Photography Plan in 2014, bundling together a number of these photo apps and charging $9.99 a month. Since then, more than a million subscribers have signed up for the service.

Adobe's plan is to convert many of new subscribers to move up to its core Creative Cloud combo. Currently, about half of all subscribers opt for the full suite of cloud programs as opposed to a single app. Last week, CEO Shantanu Narayen said nearly a third of Creative Cloud subscribers are new to the service, rather than having transitioned over from the older Creative Suite product. “People who may have formally pirated or used our products casually are paying for the service because its far more affordable,” Narayen said.

These initiatives are driving Adobe's new growth. Revenue from Adobe's media business, which includes Creative Cloud, fell 1 percent in 2014 but rose 19 percent in 2015. In the most recent quarter, growth accelerated to 33 percent to reach $932 million in revenue. Digital marketing revenue, which had held steady at a 10 percent growth rate in the past two years, also accelerated to 14 percent to $406 million.

Adobe's move into marketing software seemed odd several years ago, when people wondered how creative tools and marketing tools would mesh. But Narayen saw them in fact converging, as creators needed to track customer engagement data on sites, apps, videos and other content. Just this week, Adobe signed a partnership with comScore to share video data, having made a similar deal with Nielsen in 2014.

These days, Adobe sees data-oriented marketing as driving a wave that's as big as if not bigger than the rise of enterprise-management software or customer-relationship software in recent decades. It also expects marketing data to become a potentially bigger market than its core market of creative programs, estimating the addressable market for its Marketing Cloud business at $20 billion, versus $17 billion for the market of Creative Cloud.

But with the bulk of Adobe's transition to the cloud behind it, some wonder whether the company will start to encounter headwinds as more competitors enter its markets. Narayen said last week that new mobile users will keep growth coming, as will bringing its cloud offerings to overseas markets.

Adobe is also adding more services, such as the cloud version of its Acrobat software, which drew in $200 million in revenue last quarter, and its image-stock library of 1 million videos and 50 million photos and graphics, a business that CFO Mark Garrett said is already pushing up average revenue per user. Later this year, the company will release a design and prototyping product to help developers on interaction design, having observed from its users that these design projects grew by 52 percent in 2015.

Despite those initiatives, Adobe may still find it harder to maintain growth in the long term. Narayen, for his part, doesn't seem to foresee that. “Consumer expectations of technological advances are causing every organization to rethink its digital strategies,” he said at the Adobe Summit this week. “Experiences are the basis for new competition, and businesses in all industries are looking to differentiate themselves with the experiences they are able to deliver.”

In other words, as long as an evolving Internet is keeping businesses having to rethink how they interact with customers, there is an opportunity for Adobe. It's not a sure-fire business plan for the company, but it's also not a bad bet to make.