With a business model built on innovation and recurring revenue, Adobe dominates the creative software space. But as competition rises and AI disrupts the landscape, how can it protect its market share?
In this episode of Business Breakdowns, Jenny Rae Le Roux and Namaan Mian dive into Adobe’s business model, explore untapped growth opportunities, and assess the risks that could threaten its dominance.
Can Adobe stay ahead of the curve, or will challengers like Canva chip away at its creative stronghold?
Business Breakdowns drops on the 1st and 3rd Wednesday of each month. Have a company you'd like to see covered? Reach out by sending us an email.
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Transcription:
0:40
Morning.
Good afternoon everyone.
I'm Jenny Rae Le Roux, the Managing Director of Management Consultant and I'm really excited today to introduce Adobe to you.
You probably know Adobe, but maybe you don't know Adobe.
And that's our goal of the session today is to really get to know this organization not just from a product standpoint, but more importantly from a business strategy standpoint.
1:00
If you were working at Adobe, which by the way, Adobe has an incredibly robust internal consulting practice.
If you were working with a company that was advising Adobe, if you were working in an internal role inside a business unit at Adobe, what would you want to be thinking about, talking about, etcetera.
1:17
Our focus for this is to break down this business very quickly and very concisely.
And our focus will begin with the key high level data.
Namaan is my colleague on the call and he's going to share some insights about Adobe.
He'll introduce himself in just a second.
1:33
Then I'm going to come back and talk a little bit about Adobe's business model.
Then we'll talk about key metrics for Adobe.
And then finally, a few hot takes.
With that, I'm going to turn it over to Namaan to walk you through some of the business basics for Adobe.
Namaan welcome.
1:50
Wonderful.
Thanks so much Jenny Rae, really excited to be with you today.
Everybody.
If you don't know me and my name is Namaan, I'm the Chief Operating Officer here at Management consultant and I had a lot of fun diving deep into Adobe's business as we were preparing for today's episode.
And I think everybody's heard of Adobe, but like Jenny Rae mentioned, you might not know it.
2:07
So let me give you my one sentence overview of what Adobe does.
They deliver cloud based solutions to deliver digital experiences and enable digital transformation.
And you'll hear Jenny Rae when she talks about the business model, talk about right, some of the revenue streams that you'll identify when you look at Adobe's earnings report.
2:25
But just to a very high level summarize that they make money off of subscriptions, off of product licensing and, and from services.
And so those are the three revenue streams that really feed into the PNL that I'm going to break down here for you now.
And so Adobe has an annual run rate of about 21 1/2 billion dollars.
2:44
By the way, if you go to Adobe's 10K, you'll find all of this information on page 55.
So go verify this for yourself.
Check it out, follow along with us.
But you'll find that Adobe's annual revenue is over $21 billion.
Gross profit on 21 1/2 billion dollars was $19.1 billion.
3:03
That's my kind of margin right there.
And so we're gonna, we're gonna break down how Adobe can drive these incredible margins, where this margin is coming from and how they can continue to experience margin expansion in the years ahead.
Now operating income from that gross margin of about 19 billion was around $6.7 billion.
3:22
And so this operating income comes from around 37 million global subscribers and is generated from over 30,000 employees worldwide.
And as Jenny Rae mentioned, Adobe has a rapidly growing internal strategy practice, One of the places right now that Adobe is hiring the most outside of some of these AI engineering and architect roles that we may talk about as we move throughout today's episode as well.
3:48
So that's Adobe.
It's a fantastic business.
It's been around since 1982.
There's a lot that they're doing right.
And we're here today to talk about, OK, how do you take a good business and continue to position it for the future?
Before we get there, Jenny Rae, I'll turn it back over to you so you can break down the business model.
4:05
Awesome.
One of the key questions that we ask inside business breakdowns is, is this a fixed cost or a variable cost business?
And in a business like Adobe, when they have three business lines, the subscription business, the product business or the licensing business and the services business, you actually have to understand which one is the largest.
4:23
So I'm actually going to break down the numbers that Niman just told you into micro numbers to get a sense of what kind of business this is.
And so I'll do a drum roll from the bottom.
About 600 million of Adobe's revenue is in services, about 400 million is in product and the balance about 20 and a half billion dollars is subscriptions.
4:46
So Adobe is a subscription based business, but again, if you want to understand how businesses can get confusing, are they, are they subscription, are they fixed cost, are they variable cost, are they product, are they service based businesses when they have all of these different lines, let's just break down each one of them really quickly and I'll go in that same order.
5:06
The services business, if you look at it, their cost of revenue, which is the variable cost of the business for services, it's 534 million out of about 600 million.
That is a variable cost business, right.
The majority of their cost is that and that is largely their consulting practice.
5:24
They have a $600 million consulting business inside Adobe.
That's where they work with organizations to figure out how to utilize Adobe, how to use the services to create efficiencies, how to build teams that support the Adobe products etcetera and the product In the product licensing side, they have about $25 million out of the 400 pretty good margins.
5:46
But you know you'll see that's a fixed cost business, right, a lot more the cost inside that business is not variable cost in the subscription business.
It's not even 10%, right, 20.5 billion and approximately 1.8 billion of that is direct cost.
6:06
The subscription business is a fixed cost business.
The majority of that is not variable cost.
It is not directly related to the services and the subscription both with the high amount of revenue that they have and also with that cost bent is going to define Adobe's business.
6:22
So Adobe is a fixed cost business.
What does this fundamentally mean?
It means that when Adobe adds a new customer, it adds minor incremental cost, and their major focus is on having a large user base on which they can maximize revenue.
6:38
With that, I'm going to turn it over to Namaan to talk about some of the key metrics inside Adobe that help us understand how they're operating, what they're thinking about, and what you would want to think about if you were preparing for an interview or for a job at Adobe.
Wonderful.
Jenny Rae.
So if the goal is to have a large and growing user base, then the number one metric I think that any SAS company software as a service company needs to be paying attention to is churn.
7:03
And so the number one metric that I'd be managing at Adobe or if I was solving a case interview that had to do with the growth strategy at Adobe would be subscription churn.
And specifically, it would be subscription churn per segment.
And so we've already talked about how right the digital media part of the business, that subscription side of the business drives 90% plus of the revenue and an outsize part of the profit for the company.
7:28
And so when I think about the different customer segments that exist within that business, I think of creative professionals, I think of communicators, so that's marketers, content creators, etcetera.
And then I think of the individual consumer and outside of those 3 segments, or excuse me, inside of those 3 segments, I think of creatives and communicators as the highest value segments for Adobe.
7:51
And one of the reasons that Adobe's been able to grow at the rate it's been able to grow is because it offers these best in class tools in a subscription bundle, right?
So for these folks to get the one to three tools that they want, if you want Illustrator or if you want Photoshop or if you want Indesign, you have to pay a higher price mostly to get access to all of them, right?
8:11
You have to pay to get access to Creative Cloud.
And in effect, what this does is it means that the most popular products at Adobe subsidized the least popular products, but they all add value to the bundle.
And so why can't Adobe get away with this?
It's because they focus on offering the most robust tools on the market.
8:30
And so why should they pay attention to churn and making sure that they're able to keep their customer segments sticky when it comes to Creative Cloud and all these different product offerings that are part of Creative Cloud?
Here's why.
Acquiring a new customer costs five times as much as retaining an existing one.
8:49
That's number one.
Number two, it's been shown that if a SAS company can increase customer retention by just 5%, it can increase profit by up to 95%.
And #3 the success rate of selling to an existing customer is between 60 to 70%.
9:07
You take, you start marketing the new prospects, that success rate drops to 5 to 20%.
So what you want to do if you're Adobe is you not, you don't just want to grow your user base, but you want to increasingly monetize that user base over time.
And so how do you increasingly monetize that user base?
9:23
They've got to stick around so you can continue to pass on price increases to them so you can continue to add to the bundle and increase the value of the bundle.
You want to keep them around so that you can continue to gather product feedback from that user base.
For all of these reasons and more, churn is the number one metric that I'd be paying attention to if I was at Adobe #2 I'd be paying attention to services growth.
9:46
So we already talked about how subscriptions are 90% of my revenue.
I've got to have my eye on the ball there.
But where do I think outsize growth is going to come from Adobe in its next season?
I think it's going to be from services.
10:02
And so the way that I think about services is really it's the digital experience part of the business.
So this includes Adobe's Experience Cloud, which is the tool that enterprises use for marketing commerce.
So think about, you know, e-commerce companies that need data, they need software, they need analytics tools that enable them to track buyer and user journeys.
10:24
That's what Adobe's offering primarily through its services business, right?
They offer e-mail and other analytics options as well.
So to me, this is what sets Adobe part apart from competitors like Canva, right?
So because Adobe offers more robust services, because they offer diversified services outside of just these subscription products, this is where they're able to drive higher margin revenue.
10:50
They're able to drive contracts where they can increase the value of those contracts faster than they can increase prices on the subscription side.
And they're able to leverage their long term enterprise relationships to deepen the value of those relationships over time.
So as every single business in the world looks to undertake a digital transformation or accelerate a digital transformation, this is, in my view, where Adobe's big growth opportunity lies, lies.
11:15
It's in the services.
And then #3 The thing that I'd be paying attention to at Adobe is actually the implementation of AI tools, right?
And, and I did not want this to be my number three.
I think some of the hyper and AI is overblown right now, but I think it's important for Adobe for this reason, right?
11:33
They don't just have competitors like Canva on the consumer side.
They have competitors like Google, Microsoft and others on the enterprise side.
And so Adobe can't afford not to offer AI tools across its design and services portfolios.
Why?
Because enterprise customers, in my experience, move in a pack, right?
11:51
Once an exodus starts from one provider to another, it's hard to stop the Stampede out right?
And how competitors like Microsoft are selling against companies like Adobe is they are offering bundles across a portfolio of services.
So how is Microsoft luring enterprise customers to Azure?
12:11
It's a cloud business, it's using AI tool Copilot as a way to lure people.
And then what are those enterprise customers doing while they're thinking, OK, if I move over to Microsoft's cloud business, I might as well move my other spend to Microsoft as well to negotiate better terms.
And so like this integrated kind of offering that includes some of these AI tools, I think is critical for Adobe to maintain competitiveness, competitiveness with its enterprise rivals.
12:38
So if I was at Adobe, I'd be thinking about focusing on tools that really enable customers in the digital experience side of the business, the services side of the business to gain faster and better insights.
I think this is going to be mission critical for Adobe moving forward.
Those are my three things I'll be managing with Jenny Rae.
12:55
How about you?
13:24
Find the link to create your Job Seeker profile at the link in this episode's show notes.
Nivan, I'm mad at you for stealing one of mine.
I should have never let you go first in this episode.
So I'm going to pivot just to, for, you know, for interest's sake, because of course there are 50 or 100 key metrics that you want to think about in a business like this.
13:45
But one thing that I think I, I just want to frame on this is that our company had a conversation in December.
We had an event called Defend the spend when everybody had to bring what they are spending money on from an enterprise Oregon, a SAS perspective.
And they had to not just explain what they're using it for, but why it was necessary for the business.
14:04
And the seed of that episode actually came out of that conversation because we at the time used both Adobe and Canva and we were considering whether or not we needed both of them.
And it really helped me to highlight what it is about Adobe that makes it a superpower company.
14:21
And a couple of the metrics that I'm about to share.
So my first metric is actually usage days per month.
One of the issues and dependents was around the issue of how often someone was actually using one of the programs.
And so Namaan, I think a predecessor to churn, which is the one that I was going to talk about, is how much usage you're actually getting not just across the platform in general, but on specific portions of the Adobe platform.
14:50
Now, Adobe years ago renovated its business model.
It used to be that you could buy a license and you could use it forever just like Microsoft was.
You could buy a license for Microsoft Office, you buy a license for Microsoft operating system, and then they moved to a SAS model and it was largely predicated on this.
15:09
People use it all the time, therefore they are willing to pay repeatedly for the continued usage of it.
But I think that when you're assessing actual potential risk to Adobe's business versus real upside and potential usage days per month is the number one, where do you invest in your programming?
15:27
Where do you invest in collaborative tools?
And I think what you would find is that a lot of the stickiest things inside Adobe are integrated pieces.
You could use DocuSign in one place, but if you use Adobe's tool, that's powerful.
If you are doing design, you're going to want to use Indesign, you're going to want to use Adobe Illustrator.
15:45
They're still best in class in the market, but I would want to see the data that proves that out.
And I would want to make sure that a large portion of my subscribers were actually utilizing my programming.
And I would like to fashion messaging around how to better use the programs that were there.
16:02
The second metric that I recommended looking at was fixed cost as a percentage of revenue.
One of the things that's very interesting about competitors like Canva or other design programs in the market is that they have an increase in the features that are available largely sourced from a creator pool.
16:22
Adobe has fewer of these.
And so what Canva has done to manage that is that they actually keep a royalty pool as a percentage of their total revenue.
But if Adobe doesn't have those systems in place, I would be concerned that they would think about adding value to the platform and that would add extravagant cost and then actually really eat into their margins.
16:44
So you'd have to be very calculated about the way that you manage that fixed cost as a percentage of revenue.
That subscription business is such a high margin right now on the variable side, but you could really bloat your fixed costs in order to support it.
So I would be super concerned about that.
17:02
The third one that I would be interested in is actually price sensitivity.
My expectation is that Adobe is actually under pricing their products right now based on the value that they offer to their markets.
And you can grow revenue in one of two ways.
17:17
You can grow subscriber usage, which will almost always be the number one metric for a fixed cost business like this one.
But also as Microsoft has proven, you can take the price and you can take it pretty consistently.
And if you're able to do that, you can really substantially grow revenues and add value to your overall platform.
17:35
So when they're thinking about investments, I suspect that Adobe has more price taking capabilities than they're taking right now.
So I would want to do some tests on price sensitivity for both adoption and in the churn process to verify whether or not we were actually at optimal pricing right now.
17:54
Those are the three metrics that I would look at.
Namaan back to you for a couple of hot takes.
Yeah, I love it, Jenny Rae.
So for me, if I'm Adobe, I would stay away from the temptation to democratize design, right?
I think a lot of what's happening in the space right now is the addition of AI and other kinds of automated tools that make the design, the editing, the coloring process easier.
18:19
And I think there's space for that with Adobe's consumer like core customer.
But I think that they risk going too far and turning into a competitor like Canva, which is not what their core customer is looking for, right?
Their core customers are looking for a robust set of tools that are built for professionals, not necessarily a set of tools that dumbs down like this highly specialized process.
18:44
And so I think that one of the temptations in a conversation that's probably been happening inside of Adobe recently is OK, right?
How do we grow our user base?
Well, let's make it easier for everybody to become a designer.
Let's make it easier for everybody to become an editor, right?
And I think what I would be thinking about is how do I double down on my core customer?
19:02
And then how do I make Adobe the place for people who actually know what they're doing?
I think that's the kind of brand mode that's sustainable.
I think that's where you're able to drive some of that pricing power generate that you're talking about.
And that's how you're able to really understand what it is that your core customer wants.
Make Adobe the platform for professionals, not the platform for everybody.
19:22
That would be, I think, my hot take in terms of how I'd be thinking about brand positioning here over the next 12 to 36 months.
Namaan, the spoiler alert for this is that our company actually decided to terminate our contract with Adobe and we are solely moving over to Canva.
19:39
I, I want to just support what you said.
We are not their customers.
I think that is fundamentally what ended up happening and if we were the following would have happened.
This would be the innovation that I would make just to double down on what you're saying.
We would have loved potentially to have access to a high quality designer that we could have had as a fractional designer.
20:01
When we do design, it is completely separate from Adobe.
Those designers are using Adobe, but we're not finding them through Adobe right now.
And so if there were a way to create more stickiness on the platform because people that we were using required us to have an Adobe Cloud, if we were able to expand onto their team, I think there would have been a very different business use case for this.
20:23
But we are fine in the digital space with a good enough design model and we were therefore a Canva customer.
So adding on to the services business, but really providing that that platform for designers to gain more business, bringing more designers into the platform and into the ecosystem, creating real stickiness in the way that they manage their agencies as well as the way that they manage their individual projects, I think could be a really powerful growth unlock for Adobe as well.
20:52
Absolutely.
Well, we'll, we'll wrap this up.
If you've got questions about Adobe as a business, I just want to say it was really impressive to take a look at their business.
It's kind of startling how much people are in general willing to spend on these services.
And also it's really, really valuable to piece apart the parts of Adobe that really have no peer in the space.
21:14
And I'd really encourage you to look at that not just at the surface level of where the competition is going in the market as a whole.
This is a great example of a fast growing market in which Adobe actually has a continued advantage because of some of its careless pieces of the business.
21:35
And so you could get startled into thinking like Adobe will be gone in four or five years.
I'm sure that people at Adobe are waking up worried about that too, but I see a lot of growth potential in the long future for Adobe.
Amazing.
21:51
All right.
Thank you so much.
Generate Namaan.
So we have, we've got about four.
Minutes for questions, SO.
Two ways you can do that number one is just to type it into the chat, whether you're on Zoom or over on LinkedIn or YouTube, etcetera.
Just type those in the chat.
We'll I'll feed them to Namaan generate #2 is if you're on Zoom, just raise your zoom hand and we will call on you.
22:12
So questions about right, what you just heard, questions about case prep, fair game questions about Adobe fair game, Bring them on.
So the first question here from YouTube, shout out YouTube was how do you find all this information on the financials of these companies, right?
22:32
Do you like Google? Like do you have to be, you know, an investor?
How do you get it?
All this information.
Neither I nor I are investors in Adobe.
We probably should have disclaimer that at the beginning, right?
So, so we're not, we're not hyping Adobe so that you go buy stock.
22:48
That's not the reason that we're doing this, but we use public information and we actually almost always start with an industry overview written by someone in the banking space.
Then we move to the 10K itself to bring facts to the story, and then we go back to comparison.
23:05
So my research process for this in general took me under 30 minutes, and that's exactly what I did.
I looked at a bank report, I think mine was maybe Credit Suisse.
It was looking at Adobe.
It was a pretty high level summary.
Then I went in, I looked at the 10K, saw the services breakdown, and we can link to all of this in our episodes.
23:24
If you're not registered on YouTube or if you're not registered as a subscriber on our podcast, please do that because we'll have all the links for you in there.
And then after that, I went back and I looked, I actually was like, why should I buy?
I thought about it from a customer perspective, why should I buy Adobe versus Canva?
23:41
And I was able to find some really clear reasons why Adobe is differentiated and powerful in the design space, just as Namaan mentioned.
Namaan, anything different that you did here?
Yeah, I just want to clarify.
When you say bank reports, I think what you're talking about is like analyst reports, right?
So like so, banks have analysts that are covering sectors and covering companies like that's all they do all year round.
24:01
And so they're putting their analysis out for the public to consume, right?
So that you'll invest in, in a particular stock, right, like through that particular financial institution.
So like analyst reports are what we're actually talking about.
24:17
That's number one.
And then #2 I, I think what I, what I like to do beyond looking at business from a customer perspective is compare my own mind, the business I'm looking at to other businesses I know better, right?
And, and, and start to think about, OK, like, oh, there's a part of our business that was software as a service, right?
24:33
What did I think about when I was managing that part of the business?
Or you know what, Adobe reminds me of Microsoft.
What do I know about Microsoft?
Let me start with a hypothesis and then go really pursue it a little bit and see if I can confirm or disprove some of what I'm thinking.
So I think a part of this process is like being able to break down a business fast, you have to be willing to be wrong.
24:53
And so like come with a point of view, what do you think about the business, then go confirm or disprove it.
And that will get you in the right path much faster.
Awesome.
Thank you both.
We have one more question Mark here over on Zoom.
25:10
Hey, Mark, thanks for joining.
He just has a comment here.
You know, he says that Adobe almost offers too many things, too many tools.
You know, they have like four to five tools that do almost the same thing and they could potentially reduce the number of tools to make it a little bit more simple.
25:30
Do you have any like perspective or insights you would add to Mark's comment here?
I do Mark I so I personally agree with you, but I'm not their customer.
And my guess is you're not their customer either, right?
So like when you're, when you're more like a professional designer, you know, editor, I don't even know the right language, right.
25:48
But like when you're in that professional segment?
You're not cool enough.
You're not.
Cool enough.
I'm definitely not hipster enough, right?
And so I think that there are nuances between Indesign, between Photoshop, between Illustrator that I actually, I'm not in the space enough to know, but there's a reason that those exist, right?
26:05
And so that there's a value proposition for the advanced user that exists that I think makes the case for an enterprise license easier to make because there are different functions inside of an organization that can use those different types of software.
26:21
And it, I think, also is easier for the individual designer, consumer or agency to subscribe to Creative Cloud as well because they're able to kind of do the Nuance type of work that they need to do with one subscription, with one suite of products instead of having to go 4 different places to find like some of the features that they'd be looking for.
26:43
That's the way that I'm thinking about why some of their products don't seem to be differentiated, and that's why I think they still exist.
I'll just tag one last thing on to this before we move on.
When I was at Bain, one of the things that I always found incredibly interesting is that there would be the things that someone offered versus the reasons that people buy.
27:03
They were not necessarily the same.
And so the reasons that people buy Adobe, that that is part of their services business, that their role is to basically have a pulse on that 100% of the time.
Every moment that they wake is to understand why people are buying and why people are staying with them and why they're not leaving.
27:20
And if they're leaving, why are they leaving and filling in those gaps.
And so sometimes what they offer is part of the reason that they buy.
And so it's possible that there's one ancillary use case for one person that helps get it over the edge.
But again, I would go back to my usage metrics.
27:39
When they're building out programs, they're going to think about that differently than why someone ties.
All right.
And I've just linked to Adobe's right 10K annual report here, here in the chat and on all platforms.
And so please go check that out, kind of go to page 55 and you'll kind of find some of these raw numbers.