On Tuesday, Adobe published its latest quarterly results, showing net income of $47 million, down by 28 percent on a year earlier. It was the fifth quarter in a row in which the maker of professional graphics software, such as Photoshop and Illustrator, had reported a sharp drop in year-on-year earnings.
At most public firms that would trigger a stock market bloodbath. Yet Adobe's share price has soared by 63 percent over the past 12 months. It has defied gravity because investors are bullish about the dramatic shift that the firm is making from being a purveyor of pricey, shrink-wrapped software to one that charges users a monthly subscription fee to access its applications online via the computing "cloud" — vast warehouses of servers run by Adobe and other firms.
Like the music industry, Adobe is abandoning selling its wares on physical discs to rent them out online.
Plenty of big software firms — and ones in other industries — are developing cloud strategies, too. But few have been as bold in their approach as Adobe.
"The transformation of its business model has been pretty drastic," says Brent Thill of UBS, an investment bank. So has the transformation of its bottom line. Instead of forking out up to $2,600 for Creative Suite, its flagship design package, on a disc, customers can now use its Creative Cloud service, which offers the same applications (plus a few additional ones) online, with a 12-month subscription costing $50 a month, or a month-by-month fee of $75. This has caused Adobe's profits to crater in the short term, but investors are betting that they will rebound over time, as the subscription model attracts many new customers who had balked at the prices of its packaged software.
Their faith is all the more striking given that just a few years ago Adobe was in the doldrums. Sales of Creative Suite, which is popular among such folk as magazine designers, had stagnated, even as the volume of digital content being produced worldwide was exploding.
Last week Adobe revealed that more than 1.8 million users had signed up for Creative Cloud, an increase of 405,000 over the previous quarter's total. And it said that for the first time over half of its quarterly revenue of $1 billion came from "recurring" sources, such as software subscriptions and fees for maintenance contracts.
Subscriptions tend to provide a more predictable source of revenue, which is why investors like them. Under its previous strategy, Adobe revamped its packaged software every 18 months or so, which meant it was vulnerable to a sharp drop in revenue if customers shunned an update. Now it can tweak its products far more frequently online, with users barely noticing, thereby greatly reducing the risk of a sudden slump in turnover.
The cloud model offers other benefits. David Wadhwani, who oversees the company's digital-media business, which includes Creative Cloud, says it makes it easier for Adobe to combine various applications to tailor its offerings to particular types of customers. For instance, it has been selling a package aimed at photographers for $10 a month that combines Adobe's software with an online community where snappers can publicize their photos.
For other firms tempted by the cloud, Adobe's experience offers valuable lessons. The company first tested the appeal of online subscriptions in Australia, one of its smaller markets, before rolling them out elsewhere. When it made the announcement at the end of 2011 that it was wholeheartedly embracing the cloud, its senior executives spent lots of time communicating the rationale behind the change, both internally and externally.
Salespeople were encouraged to boost recurring revenue. At a sales conference, the audience was shown a spoof video of a support group for "revenue addicts," as a lighthearted way of driving home the message that subscriptions now mattered more than sales of big-ticket boxed software.
Copyright 2013 The Economist Newspaper Limited, London. All Rights Reserved. Reprinted with permission.
