Never Sell: Episode 4 - Adobe

The podcast delves into Adobe's evolution from its founding in 1982, highlighting its early innovations like PostScript and Illustrator, and its strategic acquisitions, including Photoshop and more recently, Marketo and Magento. The discussion explores Adobe's current business structure, segmented into Creative Cloud, Document Cloud, and Digital Experience, with Creative Cloud being the primary revenue driver. The hosts analyze Adobe's competitive landscape, particularly in the context of emerging AI technologies and competition from companies like Canva and Figma. They also debate Adobe's pricing power and future growth prospects, emphasizing the potential impact of AI on content creation and Adobe's strategic positioning in the market.

• Adobe, founded in 1982, is a longstanding software company known for its innovative products like Illustrator, Photoshop, Adobe Premiere, and PDF.
• The company initially started with PostScript, a revolutionary device-independent programming language for printers.
• Apple was an early investor in Adobe, owning 15% before selling its shares in 1989.
• Adobe experienced rapid growth in its early years, achieving triple-digit growth annually for the first six years.
• Key products developed or acquired by Adobe include Illustrator (vector-based editing), Photoshop (pixel-based editing), Adobe Premiere, and PDF.
• Adobe did not participate significantly in the tech bubble of the late 1990s and early 2000s due to hesitancy about the internet's potential, leading to slower growth during that period.
• The founders left operational roles but remained on the board until 2016 or 2017.

"Adobe is one of those companies. It was founded in 1982, so almost 42, 43 years now. And so we know Adobe for Illustrators, photoshops, Adobe Premiere, PDF, but they actually started with this product called PostScript."

• Adobe's origins and its first product, PostScript, laid the foundation for its future success.

"In the first six years or so they grew triple digit every single year."

• Adobe's rapid early growth highlighted its successful product-market fit.

"Adobe actually did not participate in the tech bubble... they kind of, you know, held back the company a bit."

• Adobe's cautious approach during the tech bubble resulted in slower growth compared to peers.

• Adobe's acquisition strategy began in 2008-2009 with Omniture and continued with Magento and Marketo in 2018, focusing on marketing and digital experience capabilities.
• Adobe's business is divided into two main segments: content generation (Creative Cloud) and marketing/experience (Digital Experience).
• The Creative Cloud includes tools like Photoshop, Illustrator, and Premiere Pro, while the Digital Experience focuses on enterprise marketing and analytics.
• Adobe's revenue is segmented into Creative Cloud (62% of ARR), Digital Experience (22% of ARR), and Document Cloud (16% of ARR).
• Adobe serves various customer personas: Creative Pros, Marketing Pros, and Business Professionals, each with tailored products.

"They acquired Magento and Marketo in the same year in 2018. So they paid like 1.7 billion for Magento and for Marketo they paid like 4.75 billion."

• Adobe's significant acquisitions in 2018 aimed to enhance its digital experience offerings.

"You've got the content generation ARM and that's where you have creative Cloud... Then you've got the marketing or the experience side."

• Adobe's business is strategically segmented into content creation and marketing/experience.

"Creative Pros, this is Adobe's bread and butter. These are the people who need their work to be pixel perfect."

• Creative Pros represent Adobe's core customer base, focused on precision and quality.

• Adobe has integrated AI into its products, with AI-influenced ARR at approximately $3.5 billion.
• AI First Direct ARR, generated from new AI products launched within the past year, reached $125 million.
• Adobe's AI offerings include Firefly, an AI model integrated into the Creative Cloud suite, enhancing content creation capabilities.
• Adobe's AI strategy is part of its response to market controversies and competition.

"AI First Direct ARR basically is the products that were launched like a year ago... $125 million within like five quarters or so."

• Adobe's AI initiatives have quickly generated significant revenue, highlighting their potential impact.

"AI influenced ARR is right now three, three and a half billion dollar."

• AI's integration into existing products has significantly influenced Adobe's ARR.

"Adobe has become some sort of like, you know, they are kind of dealing with a lot of controversy, a lot of debates."

• Adobe's AI strategy is partly driven by the need to address market controversies and competitive pressures.

• Adobe's enterprise revenue within the Creative Cloud was $2.2 billion, representing 15% of the segment.
• Adobe's enterprise revenue disclosure was seen as underwhelming by some, potentially emboldening bearish views.
• Adobe's market position is characterized by its enduring software products and strategic acquisitions.

"Enterprise revenue are, you know, thought to be relatively more sticky. It's harder to change the workflow you value the relationships and all that."

• Enterprise revenue is considered more stable due to the complexity of changing workflows and established relationships.

"I think I was a bit underwhelmed. Like, if you asked me to guess before they disclosed it, I think I'll probably guess slightly higher than 15%."

• Adobe's enterprise revenue disclosure was lower than some expectations, influencing market perceptions.

• Adobe's revenue primarily comes from Creative Cloud, with a small portion, 15%, from consumer buckets.
• The durability and growth of Adobe's consumer revenue are crucial for shareholders.
• Adobe's enterprise segment is not large enough to sustain the company in case of disruption in consumer markets.

"If you want to be a shareholder, if you want to be bullish on Adobe, you have to believe that the consumer bucket can be protected and it will grow."

• Belief in the growth of Adobe's consumer segment is essential for long-term investment.

• Adobe has struggled to cater to the low-end market, lacking mobile or web-native products and real-time collaboration features until recently.
• Competitors like Figma and Canva have exploited these weaknesses, capturing the low-end market.
• Adobe's attempt to enter the low-end market with Adobe Spark in 2016 was unsuccessful.

"They didn't really understand the commercial model where you open with a freemium tier and then you build your top, top of funnel and then you convert to paying subscribers."

• Adobe's failure to adopt a freemium model hindered its ability to attract casual creatives and small businesses.

• The cost structure and incentives make it challenging for enterprise-oriented businesses to successfully move downmarket.
• Successful market strategies often involve starting low and moving high, as seen with Salesforce and HubSpot.

"Usually you start low, you move high. That's how Salesforce did it. That's how HubSpot's now moving."

• The strategy of beginning with lower-end markets and moving upwards is more viable than the reverse.

• Adobe is heavily dependent on Creative Cloud for operating profit, with digital media having a 5% gross margin.
• Creative Cloud likely has a 97% gross margin, while Digital Experience has a 70% gross margin.
• Adobe's operating margin was approximately 36% after adjustments.

"Pretty much somewhere between 90 to 100% of their operating profit basically comes from Creative Cloud in a way."

• Creative Cloud is the primary driver of Adobe's profitability, akin to Google's Search.

• AI developments blur the boundaries between companies like Adobe and Microsoft, impacting Adobe's competitive edge.
• AI could enhance Adobe's weaker areas but also allow competitors to close the gap in creative generation capabilities.

"AI kind of makes those things better. It closes the gap there. But likewise for creative generation capabilities that Adobe has always been the best at, AI has the potential to like, you know, make Microsoft and Meta and whoever else, they're all pretty good at that stuff as well."

• AI presents both opportunities and challenges for Adobe, potentially leveling the playing field with competitors.

• ATT (App Tracking Transparency) may negatively impact Adobe by consolidating marketing spend on fewer platforms like Facebook and YouTube.
• Generative AI allows advertisers to create ads within platforms like Meta, potentially reducing reliance on Adobe.

"Generative AI allows advertisers to do the actual ad, create the actual ads inside of Meta. Right. And they can do the analytics inside of Meta."

• The consolidation of marketing platforms could diminish Adobe's role in creative and marketing integration.

• Market fragmentation previously benefited Adobe, but AI and platform consolidation may challenge this advantage.
• AI investments by companies like Google and Meta could diminish the need for Adobe's tools.

"AI just made all of these things easier to pull."

• AI's ease of integration into platforms may reduce the necessity for Adobe's standalone software solutions.

• Adobe aims to unify creative and marketing tools, but integrated solutions from platforms like Meta challenge this value proposition.
• Smaller businesses may prefer embedded generative AI tools within platforms they already use.

"One of Adobe's value props, it's bring together the marketing and the creative, unifying all the tools, creating the end to end process, doing away with the point products."

• Adobe's integrated approach is under pressure from platforms offering built-in creative and marketing solutions.

• The future of creative tools may see increased integration within larger platforms, reducing the need for separate software.
• Companies like Meta and Google are investing heavily in AI to enhance their creative and marketing capabilities.

"That sounds to me should be a core use case for a lot of these AI investments that they are making."

• The integration of AI in large platforms could redefine the landscape of creative and marketing tools, impacting Adobe's market position.

• Adobe is positioning itself as a central hub for asset creation and distribution, emphasizing the reuse of assets across various channels.
• Adobe's Firefly model is distinct due to its training on non-copyrighted content, appealing to enterprises concerned with copyright and proprietary asset protection.
• There is skepticism about Firefly being used outside of Adobe's ecosystem, unlike OpenAI's models which are available as APIs.

"Adobe would probably argue that there's no need to recreate the wheel and that's why it's important to have a central hub because you're reusing the same assets over and over again in all these different channels."

• Adobe's strategy is to centralize asset management to streamline processes across multiple platforms.

"They distinguish their Firefly model by saying that it doesn't use copyrighted, it's not trained on copyrighted content and it's ran safe and it won't use the customer's proprietary assets to train."

• Firefly's unique selling point is its safe training data, making it appealing to cautious enterprises.

• Adobe's Firefly model could gain a significant advantage if legal rulings restrict the use of copyrighted content in AI model training.
• The potential to offer Firefly as an API could position Adobe as a leader if other companies face restrictions.

"If the courts decide that you can't use other people's work in your model development, then Adobe's Firefly model is way ahead of everyone else's."

• Legal restrictions could enhance Adobe's competitive edge in the AI space.

• Adobe faces pricing pressure due to competition and has historically not leveraged pricing as a significant strategy.
• The shift from perpetual licensing to subscription models has masked Adobe's pricing strategies.
• AI could enable Adobe to implement usage-based pricing, allowing for price discrimination based on customer usage.

"Adobe has so many compelling alternatives today and frankly speaking there's no new competitors coming up like almost every month these days."

• The abundance of alternatives in the market pressures Adobe's pricing strategies.

"AI will definitely solve that problem. So they have, for example, if you see their pricing now, it's like if you pay for this plan, you get this much credit for generative AI using."

• AI-driven usage-based pricing could allow Adobe to capture more revenue from high-usage customers.

• Canva's rapid growth and profitability highlight a significant market for low-end creative software, which Adobe has partially ceded.
• Canva's move towards enterprise solutions indicates potential future competition with Adobe in the higher-end market.
• Figma's collaborative design approach and pricing strategy expand the market beyond traditional designers, posing a threat to Adobe's dominance.

"Canva is a name that comes to the discussion for the low end part of the creativity software. And I was actually surprised that...their ARR is $2.5 billion in 2024."

• Canva's success in the low-end market demonstrates a missed opportunity for Adobe.

"Figma is collaborative interface design tool. Right. Collaborative. That's their main theme."

• Figma's focus on collaboration and inclusion of non-designers in the design process challenges Adobe's traditional design-centric approach.

• Adobe maintains a strong position in the high-end market due to its advanced tools and ecosystem.
• The sustainability of Adobe's pricing power and market dominance is uncertain, especially with increasing competition and evolving market dynamics.
• Adobe's ability to adapt to AI-driven market changes and leverage its existing customer base will be crucial for future growth.

"Adobe's editing tools are still considered the best. I don't know that anyone is at their level there."

• Adobe's tools are still preferred by professionals, but the long-term sustainability of this advantage is uncertain.

"It's enterprises that are large enough to have like a dedicated creative function because they're still the standard for creative pros."

• Adobe's strength lies in its enterprise-level solutions and comprehensive toolset for creative professionals.

• Figma, Canva, Runway, and Adobe are key players in the creative software industry, each targeting different market segments and user needs.
• Figma focuses on incremental revenue growth, while Canva aims to be a visual suite for everyone, highlighting its accessibility.
• Runway is positioned as a tool for human imagination, with a focus on video, indicating a broader and more expansive approach.
• Adobe, as an established company, offers creative marketing and document management solutions, reflecting its maturity and established market presence.

"So that's Figma. Canva describes itself as a visual suite for everyone. The focus everyone is. So I think it makes it clear that they are a major player for the low end of the segment."

• Canva's positioning as a tool for everyone highlights its focus on accessibility and broad market reach.

"Runway describes itself as tools for human imagination. More broad, a bit vague, but more expansive in nature."

• Runway's description suggests a focus on creativity without specific constraints, aiming to appeal to a wide range of creative needs.

• Adobe has shown consistent incremental revenue growth, adding between $1.8 billion to $2.1 billion annually over recent years, with an exception in 2021.
• The company is expected to maintain this growth trajectory, assuming business as usual without significant impact from AI.
• Adobe's operating margin is projected to increase, with a potential 40% margin by 2030, leading to substantial operating profits.

"If you assume 2.1 billion incremental revenue for each of the next 6 years, you end up with $34 billion of revenue in 2030. So 40% of that is operating margin."

• This projection assumes steady growth and increased efficiency, leading to significant revenue and profit by 2030.

• Adobe's financial metrics, such as non-GAAP earnings, often exclude stock-based compensation, which can distort the perception of the company's financial health.
• Stock-based compensation has increased significantly, impacting the true profitability and financial evaluation of the company.

"Stock-based compensation for Adobe was $1 billion in 2021. This year in 2025, it's going to be $2 billion, just doubled."

• The doubling of stock-based compensation highlights its significant impact on financial metrics and the need for accurate reporting.

• There is a discrepancy in market perception due to the use of non-GAAP metrics, leading to potentially misleading valuations.
• Investors and analysts often overlook the impact of stock-based compensation, leading to an inflated view of company performance.

"Anytime you see someone on Twitter mentioning like NTM multiples, you can just assume it's wrong. You can just assume that it's wrong doing some finicky stuff."

• This statement underscores the common misinterpretation of financial metrics, emphasizing the need for careful analysis.

• The potential impact of AI on Adobe's growth is debated, with some seeing it as a catalyst for increased revenue and market expansion.
• The challenge lies in sustaining percentage growth as the company scales, with AI seen as a possible driver for re-acceleration.

"You now have to assume that AI will infuse a re-acceleration of incremental revenue growth. And that's not easy. That's not easy for most companies."

• This highlights the uncertainty and difficulty in leveraging AI for significant growth, especially for established companies like Adobe.

• Adobe's revenue streams are segmented, with parts of its business facing significant competition and potential disruption.
• The company must navigate challenges in retaining its market position, particularly in areas with intense competition.

"There's lots of competition. And then outside of that, the other three quarters, that blends in, like the marketing professionals and the creatives."

• This statement reflects the competitive pressures Adobe faces in maintaining its market share across different segments.