Can Adobe run by Shantanu Narayen maintain its high profitability
Last week, Adobe announced that revenue during its recently ended fiscal 2021 second quarter rose 23% over the same quarter in 2020. “From students to creative professionals to small businesses to the world’s largest global enterprises, digital is transforming how we work, learn and play,” Shantanu Narayen, chief executive, said in a call with Wall Street analysts.
Based in San Jose, California, Adobe sells software tools to creators of digital experiences. Designers as well as professional and amateur photographers use its Photoshop to digitally change, combine, enhance and create new photos and videos. For a fee, Adobe offers customers the ability to select and use from more than 150 million photographs, 80 million illustrations, 20 million videos and 38,000 audio tracks. The company’s online creative community has more than 24 million members.
Adobe’s Acrobat reader is widely used, by individuals as well as large global corporations, to convert Word, Excel, Power Point and other documents into PDF formats, which cannot be altered easily by recipients. In 2020, more than 300 billion PDFs were opened in Adobe products.
The company also offers products for screen design and prototyping, 3D, augmented reality and other new media applications. Customers range from artists and freelance designers to Coca Cola, Nestle, Pfizer, Disney, retailer Home Depot and most other Fortune 500 companies as well as state and federal government agencies.
Along with strong revenue growth - 15% in fiscal year ending November 2020 - Adobe enjoys high profit margins since its products face little or no competition. In fiscal 2020, the company earned $4.2 billion in pre-tax income on $12.9 billion in revenues, that is a 33% pre-tax profit margin.
Adobe’s revenues and profits are tied to the overall global demand for digital products and services. They are not dependent on the success or failure of a client or a business, provided it keeps improving its products, creates new, innovative tools and comptetitors do not come up with better and less expensive software.
After taking over as CEO in 2007, Shantanu Narayen, 59 years old, moved Adobe from selling products to charging monthly subscriptions. As a result, revenues are stickier and costs are lower since subscriptions are automatically renewed by charging a credit card, unless cancelled by the deadline by a customer. Also, Adobe’s Acrobat, Photoshop and several other products are sold directly via company-run websites, thereby avoiding paying fees and commissions to retailers and other sales channels.
Subscriptions also make it easier for Adobe to raise prices regularly. Customers have no option but to subscribe to the newer, updated version. Earlier, when customers were able to buy Adobe software and download it onto their computers, they could continue using it for several years, as most now do with Microsoft’s Excel, Word and PowerPoint.
Subcriptions are priced on a monthly basis. So, if Adobe were to raise the monthly subscription price for its basic Acrobat software - currenty $23 - by $1, it may not appear large. In fact, this would be a 4% price increase. The same software sells for $13 a month if you pay in advance for a year’s subscription. But then you have to pay $156 and still cannot use it beyond a year. Here too, if the monthly price is raised by $1, it may not seem high - it would be an 8% price increase.
Adobe, Microsoft and other established software vendors have another barrier protecting their sales. It takes time and effort to learn how to use an alternative product from a competitor and you worry about potential defects. So customers typically renew a software subscription from vendors like Adobe, even if higher priced, provided they do not face major, repeated technical or service issues.
Apparently aware of this situation, and to stay ahead of competitors, Narayen continues to make major investments to improve Adobe’s software and services as well as create new products. In fiscal 2020, for instance, the company spent $2.2 billion, or 17% of its revenues, on research and development.
Adobe has also expanded revenues and profits by using its strong cash flow to buy competitors and companies in related businesses. Since 2005, it has bought nine major companies.
In 2020, it paid $1.5 billion to buy Workfront, a work management platform for marketers, which has more than 3,000 customers and one million users. Both companies had a long standing partnership to jointly sell products and services and shared more than 1,000 customers.
As part of its sales efforts, Adobe partners and sells products and services with Microsoft, IBM and other technology vendors as well as information technology service providers like Accenture, Cognizant and Infosys.
Since December 2007, when Narayen took over as chief executive, Adobe’s market value has risen by 1,300%, more than double the 600% gain of the Nasdaq 100 Index of the largest technology companies. In 2020, he was paid $3.1 million in salary and bonus, plus stock awards and grants valued at $43 million. His current stock ownership in the company is worth $215 million.
In 1998, Narayen, 58 years old, joined Adobe as vice president of its engineering technology group. In 2005, he became president, responsible for the company’s day-to-day global operations, product research and development, marketing and corporate development. He was named chairman of the board in 2017, in place of John Warnock, 80, who co-founded the company and served as chairman since 1989.
Before joining Adobe, Narayen co-founded Pictra, an early pioneer of digital photo sharing over the Internet. He raised $10 million from venture capitalists, according to Forbes. Pictra failed, being too early with its technology, and Narayen tried to sell it to Adobe. Bruce Chizen, Adobe’s then chief executive, asked Narayen to join the company.
Earlier, Narayen held product development roles at Apple and Silicon Graphics.
He has a bachelor’s degree in electronics engineering from Osmania University, in Hyderabad, India, a master’s degree in computer science from Bowling Green State University, Ohio, and a master’s degree in business administration from the University of California, Berkeley. He holds five patents; and once represented India in an Asian sailing regatta.
Growing up in Hyderabad, India, Narayen wanted to be a journalist. But his parents gave him only two options: engineer or doctor. Accepting his parents’ wishes, and being afraid of seeing blood, he choose engineering. His mother was a college teacher and his father ran a plastics company.
Narayen is vice chairman of the US-India Strategic Partnership Forum and sits on the board of Pfizer. He previously served as a director of Dell and was one of six members of former U.S. President Barack Obama’s Management Advisory Board.
Wall Street evidently admires Adobe’s dominant, profitable position. The stock, which has a market value of $270 billion, sells for 17 times estimated fiscal 2021 revenues and 48 times earnings per share. Such a steep valuation implies that Wall Street expects Adobe will continue to show strong revenue growth and high profit margins.
While Narayen has been key to Adobe’s success, he has made some misjudgements. The company was late with products for e-signature and digitization of documents.
This growing market, of connecting and automating how organizations prepare, sign, act on, and manage agreements, is now dominated by DocuSign. It has about one million customers, from individuals to most financial, healthcare and technology companies in the Fortune 500, and over a billion users in 180 countries.
Subscription prices for DocuSign’s cloud based software start at $120 per year for individuals, for five e-signatures a month, and $480 per year for each user in a business account.
Founded in 2003, San Francisco based Docusign had $1.5 billion in fiscal 2021 revenues, 49% higher than in fiscal 2020. It has a market value of $55 billion. Its chief technology officer is Kamal Hathi, who earned a B.S. in Electronics Engineering from M.S. University, Baroda, India.
Adobe has introduced e-signature capabilities in its products, including for its Acrobat PDF file converter. The price of this software starts at $23 per month for individuals in the U.S., who subscribe month to month. In 2020, more than eight billion electronic and digital signature transactions were processed via Adobe’s cloud-based software, the company says.
Since its founding in 1982, Adobe has grown revenues and profits, overcoming competition from products launched by Microsoft and other big competitors as well as start-ups.
Narayen sees major, continuing opportunities for Adobe. Last week, during the quarterly conference call, he told Wall Street analysts, “In a world that requires anyone to be able to create from anywhere, we are building products and services for every surface and platform.”
