Few software companies have shown more finesse than Adobe Systems at defining and then consistently dominating a market. Since CEO John Warnock and President Charles Geschke cofounded the company in 1982, Adobe has ruled the graphics market, which includes imaging, illustration, and desktop publishing software and is worth $1 billion, according to the International Data Corporation. Its reign began with PostScript, now the ubiquitous language for defining the appearance of text and images in printed documents, and grew to include graphics software mainstays like Photoshop and Illustrator.
To be sure, Adobe holds a special place in our hearts. Like virtually every other magazine, newspaper, and catalog on the planet, we use Adobe's products to make our publication look the way it should. And in recognition of its track record of developing great desktop publishing products, last year we named Adobe one of the top 50 public companies in the digital universe (see "The Tidal Surge of Desktop Publishing").
But even then we wondered what the software industry's third-largest vendor planned to do about its increasingly flat revenues: total revenues grew just 16 percent in Adobe's fiscal 1997 (ended November) and 3 percent in 1996. With the traditional graphics market nearly saturated and Web publishing a nascent and crowded space, not to mention the industrywide troubles in Asia and Adobe's lingering ties to the foundering Macintosh platform, analysts have grown understandably concerned. Wall Street expects aggressive growth from publicly held software companies, and Adobe has not delivered in recent quarters. Where exactly is the company's revenue story?
Adobe's growth, according to Mr. Warnock, will be achieved by a three-pronged strategy: continued improvement and upgrades of its existing core graphics products, expansion downmarket into the consumer and small office/home office (SOHO) markets, and a strong foray into the lucrative enterprise software market.
The big pictureAdobe's franchise today depends heavily on its graphics division. In 1996, Dataquest reports, 52.7 percent of Adobe's revenues derived from four of its software products: Photoshop (imaging), Illustrator (drawing), PageMaker (page layout), and Premiere (video editing). Photoshop commands an overwhelming 75 percent of the market for photo and image editingsoftware. Corel's Photo-Paint, with just 10.6 percent, is the closest competitor. Adobe's Illustrator holds 24.9 percent of the drawing and illustration market, second to Corel's CorelDraw; Macromedia ranks third with 12.5 percent for FreeHand. (Macromedia, which ran into trouble in 1997, may be on the rebound as an Adobe competitor in the Internet market, thanks to a new focus on Web publishing.) And Adobe's PageMaker controls 30.5 percent of the desktop publishing market, ranking second only to QuarkXPress, which owns 38.7 percent.
Despite a disappointing earnings report for the first quarter of 1998--revenues were $197.8 million, down from $226.5 million for the first quarter of 1997--financial analysts are cutting Adobe some slack because it's just begun an aggressive upgrade of these core products. Adobe is notoriously secretive about its new product releases. To prevent cannibalization of existing versions, the company doesn't announce product upgrades until they are practically on the shelf. But in late April Adobe released the long-awaited Photoshop 5.0, and analysts expect an Illustrator upgrade later this year, followed by a more substantial overhaul of PageMaker in the first half of 1999.Lou Gutentag, a software analyst at J.P. Morgan, raised his rating on Adobe's stock in February to Buy in anticipation of an especially strong product cycle and plans to increase his estimates slightly for 1998 revenues--currently $993.5 million--to reflect the likely effect of the planned upgrades.
Mr. Warnock also has made a point of distancing Adobe's core products from the Mac platform, for which Adobe at one time developed 100 percent of its products. Although it continues to support existing Mac users (and, he insists, will do so until Apple closes its doors), 98 percent of new business comes from Windows users, and Adobe's overall product mix is now 60 percent Windows based. "Analysts are starting to see the separation between Apple and Adobe," Mr. Warnock says confidently. "If Apple has more troubles, our challenge is to grow Windows faster. And if the Mac has any upside, it's just gravy for us."
Photography buffersSuch changes to Adobe's core business represent a positive step for the company; however, they don't add up to the kind of fundamental change in business strategy that appears necessary if Adobe wishes to remain a leader in the evolving graphics market.Mr. Warnock concedes that the developments in the professional graphics space will fuel only short-term growth. The first place he has turned for longer-term growth is the consumer market. Consumer-friendly printers, scanners, and digital cameras began appearing in 1992; last year, according to Dataquest, 18.7 million units of photography editing software were sold to consumers worldwide. As these digital devices become commonplace among consumers and small business users, Adobe intends to provide the software that will allow these customers to produce and alter their own graphics and photo images.
Adobe tested its theory a year ago with a consumer version of Photoshop called PhotoDeluxe. Although consumer products accounted for a mere 1.4 percent of the company's revenues in 1996, Adobe sold 7.2 million unitsof the software to early adopters in 1997, most of it bundled with digital cameras and scanners and a small portion sold through retail channels. Dataquest reports that Adobe has become the leading developer of consumer imaging software, with a market share of 39 percent, twice that of Microsoft's competing product, Picture It.
Mr. Warnock contends that Adobe holds a significant advantage in penetrating the consumer market: minimal development costs. "Historically, when software companies enter the consumer space, they spend a lot of money developing a product, then they sell it for $29.99 and can't break even," he explains. "The volumes you have to achieve to offset development costs are extraordinary." Adobe, by contrast, kept development costs for PhotoDeluxe low and brought it to market quickly by reusing the Photoshop engine. For example, PhotoDeluxe for Businesses, a version designed for the SOHO market and introduced in April, took just ten months to move from concept to delivery. Russ Crabs, an analyst at Soundview Financial, applauds the move: "Because of the bundling deals"--which reduced packagingexpenses while increasing sales volume--"Adobe's development cost relative to goods sold is almost zero. That's not bad for a knockoff."
Even so, it's difficult to see how notoriously finicky consumers and small businesses can provide enough growth to propel a $900 million software vendor into the 21st century. Fortunately, there's more to the picture.
Font of youth"If downmarket were the entire strategy, I'd be less bullish on the company," says J.P. Morgan's Mr. Gutentag. "But Adobe woke up about a year ago and said, We have to go after the enterprise."
Basically, Adobe wants to expand its Internet and publishing divisions in order to grab a substantial piece of the corporate information management pie. Its key Internet product is Acrobat, which converts files into Adobe's Portable Document Format (PDF). Though recipients of PDF files routinely curse them because a proprietary (albeit free) reader is required to view them, the information distributors praise Acrobat for maintaining the appearance of their original documents. Kristy Holch, a principal at the InfoTrends Research Group, calls Acrobat the best alternative for exchanging documents between different platforms. "HTML is a poor substitute for the original document. PDF is by far the only way to deliver the same look and feel," she says. So far 120 government agencies, including the Food and Drug Administration and the U.S. Postal Service, have purchased Acrobat software; its installed base grew 75 percent in 1997.
Through its publishing division, Adobe wants to make better use of the FrameMaker engine. FrameMaker is the company's content management tool for print-published documents. It helps users organize and manage the information contained in complicated documents like corporate training manuals. Although it accounted for just 9.9 percent of Adobe's revenues in 1996, FrameMaker will play an important role in Adobe's enterprise strategy by allowing companies to manage Internet content as well as traditional print documents. "Every company wants to do database-driven publishing in which documents are automatically deployed on the Web," says Mr. Warnock. Because FrameMaker is based on open standards and already supports SGML (Standard Generalized Markup Language) and the newer XML (Extensible Markup Language), which developers are using to customize Web layouts, he thinks it will be easy to repurpose the technology for publishing content on the Net.
Taken together, these developments suggest that Adobe is crossing the line into database-intensive document management software. "Later this year, we'll introduce enterprise server products that enable companies to turn their whole documentation work flow into an intranet infrastructure," Mr. Warnock says. But true to character, he avoids discussing specifics.
So, with good reason, Mr. Crabs of Soundview remains skeptical. Although Acrobat brings in about $50 million in annual revenues, he says, the expense of buying licenses throughout a company instead of just for the graphics department makes for a product cycle so long that "it's hard to see how Adobe will succeed in the enterprise market."
Brick and mortarIndeed, what Mr. Warnock is proposing sounds awfully familiar. The market is crowded with countless other businesses offering intranet and document management software, including Haht Software and Vignette (both funded by Adobe Ventures; see "Something Ventured"), as well as Bluestone Software, NetObjects, NetDynamics, and Wallop. And Mr. Warnock knows that in addition to all of these companies, Microsoft will always loom in the distance. "I don't think Microsoft has ever really understood publishing," he says, "but they've come after Adobe three times and had two failures [PostScript challengers TrueImage and TrueType] and one success [PowerPoint, part of the Office bundle, which forced Adobe to withdraw its presentation software from the market]. We don't suspect they'll stop trying."
The bottom line for Adobe: it's going to take some incredibly impressive server products to maneuver around all those players. And as Chris Le Tocq, an analyst at Dataquest, says, "I have a tough time thinking of Adobe as a systems company, when they've made a name serving professional, individualistic graphic designers."
On the financial front, Mr. Warnock is confident that the combination of an upgrade cycle and a push into new markets will convince analysts and investors that Adobe is capable of delivering real revenue growth. A strategy shift as dramatic as this one certainly marks the end of an era for the leader in desktop publishing. The trick for Adobe will be to mark the beginning of a new one.
ADOBE SYSTEMS AT A GLANCECEO John Warnock
LOCATION San Jose, California
PHONE 408/536-6000
WEB www.adobe.com
OWNERSHIP Public (Nasdaq: ADBE)
FOUNDED 1982
EMPLOYEES 2,702
PRODUCT Desktop publishing, Web publishing, consumer digital imaging, and enterprise document management software
PARTNERS Apple, Compaq, Hewlett-Packard, IBM, Intel, Kodak, Lotus, Microsoft, Xerox
COMPETITORS Avid Technology, Corel, Hewlett-Packard, Interleaf, Live Picture, Macromedia, MetaCreations, Micrografx, Microsoft, NetObjects, Quark
REVENUES FY97 $911.9 million
MARKET VALUE $3.3 billion