Adobe’s Uphill Climb Off the Desktop

Published by: Business Week
Written by: Aaron Ricadela

CEO Narayen is keen to put Flash and Adobe's other software on mobile devices, but an impasse with Apple and competition with Google mean it won't be easy.

Adobe Systems Chief Technology Officer Kevin Lynch had good news on Oct. 5 for attendees of his company's annual conference in Los Angeles. The next version of Flash, the company's flagship Web video software, could be used in applications for Apple's iPhone—developers the world over could use Flash to create downloadable games and other tools for one of the most popular smartphones.

But in the back of the minds of many of the 4,000 designers, software developers, and computer-industry execs was the bad news—that because of an ongoing dispute between Adobe (ADBE) and Apple (AAPL), iPhone users still can't view Web pages built with Flash. The upshot: While Flash can be embedded in software downloaded and used on the device, it won't show up for people who use the iPhone to surf the Internet. "They see [Flash] as a mixed blessing," Adobe Chief Executive Shantanu Narayen said of Apple in an August interview. On one hand, iPhone users want access to videos and Web pages built in Flash. But Apple says the software slows the device down.

The conundrum illustrates the chief hurdle facing Adobe, the world's fourth-largest software maker by market value. Under CEO Narayen, Adobe wants to keep its products relevant in a world where computing is shifting away from traditional PCs and laptops toward handheld devices. The company wants to ensure that Flash and other marquee products are as useful on smartphones, netbooks—even car dashboards and TVs—as they are on desktops. By keeping Flash off the Web for iPhone users, the impasse with Apple doesn't help.

An Emphasis on Handheld

Adobe has long been a key supplier of software for PCs and Macs and is expected to sell $2.91 billion worth of software, including Flash, Photoshop, and Acrobat, in its 2009 fiscal year, which ends on Nov. 27. The company controls key industry standards for document publishing and Web-site development, which creates markets for its publishing and software-development tools. Adobe's "growth has always been fueled by creating vibrant technology platforms," then selling products that take advantage of them, Narayen told analysts on Oct. 7 at Adobe's annual financial analyst meeting in Los Angeles.

In pursuit of new growth, the company is spending $1.8 billion for Omniture (OMTR), which makes Web-traffic measuring tools that might give customers such as Disney (DIS) and Nike (NKE) ways to monitor user activity on Web sites built with Flash.

Adobe is also putting new emphasis on software for smartphones and other portable devices—at its Max conference it announced that version 10.1 of Flash, due next year, will be able to deliver software applications and high-definition videos not just to traditional Windows and Mac computers but also to smartphones running operating systems from Google (GOOG), Palm (PALM), Symbian, and Microsoft (MSFT). "We'd love to attack this market," said CTO Lynch in an August interview.

Adobe is altering course as sales of its core PC software have declined. It launched Creative Suite 4, a package of design software, including Photoshop, Illustrator, and Premiere, during the depths of the recession last September. "You couldn't imagine a worse time to launch your bright, shiny new product," says Melissa Webster, an analyst at market researcher IDC. Sales of Adobe's design software, which contribute 58% of the total, declined 19% in the third quarter, which ended on Aug. 28. Overall sales fell 21%.

The Stock's Up 30%

Bullish expectations about Creative Suite 5 and Adobe's ability to preserve profit margins during the recession have helped its stock price rise 30% in the three months from July 9 to Oct. 8, giving Adobe a market value of nearly $18 billion. During the same period, Microsoft shares gained 14% and Oracle's (ORCL) stock rose 1%.

Yet investors are eager for hints of new areas of growth. Narayen, an understated former engineering manager, is keen to put his stamp on the company after succeeding the charismatic Bruce Chizen, who stepped down in December 2007 after seven years as CEO. Mark Garrett is the company's third CFO in less than four years. Chizen orchestrated Adobe's $3.4 billion merger with Macromedia in 2006, which brought Flash, Lynch, and some sorely needed creative spark to the company. He "did wonders for shareholder value," says Scott Kessler, an equity analyst at Standard & Poor's, which, like, is owned by The McGraw-Hill Companies (MHP). "You knew what Adobe was about and who led them. Now there's a lot of confusion."

Adobe's strong suit has long been selling software that lets designers, software developers, businesspeople, and consumers publish information in a visually compelling way, says Chizen, now a venture partner at Voyager Capital. "Anything that fit under that umbrella, I believed was important for Adobe to be in," he says. Taking advantage of Omniture "will require a great deal of execution," since the deal's value is primarily strategic, not financial, Chizen says.

A Free Flash for Android Phone

Wall Street analysts are skeptical of the Omniture deal, saying Adobe overpaid and that the companies' products don't fit together naturally. Adobe shares have fallen almost 4% since the deal was announced.

While Adobe folds in Omniture, it faces a fresh rivalry with Google. The Web search giant recently said it will license a free version of Flash for phones running its Android operating system. But the two companies increasingly compete in such areas as development of online software and delivery of video over the Web.

An area of potential strife is Google's support of a technology called HTML 5, which threatens Adobe's video and Web-applications businesses. Google has been using HTML 5 in products such as its Wave collaboration software, a mobile version of Gmail, and its Chrome Web browser. The Google software helps those Web applications behave like PC software, delivering fast response times and storing information users can access even when they're not connected to the Internet.

Adobe pushes competing software called Air, which lets companies including FedEx (FDX), eBay (EBAY), and Fox (NWS) create Web software that runs outside a browser and takes advantage of a computer's processing power. Adobe even considered creating its own Web browser to counter Google's Chrome, Lynch says.

HTML 5 Heads for YouTube

Google is also advocating use of HTML 5 to create Web video programming that can be combined with information from other parts of the Internet. In May it demonstrated a version of YouTube, which is built using Flash today, running on HTML 5.

Even Google's other competitors say it may be on to something. "Video on the Web is too important to be gated by any single company," says John Lilly, CEO of Mozilla, maker of the Firefox Web browser. As freely available Web technologies, including HTML 5, gain currency, demand for Flash may diminish. "That's a deep question" Adobe will need to reckon with, Lilly says.

Back in Los Angeles, Narayen told analysts that Adobe wants to be seen as the company that lets customers create documents, photos, illustrations, and video on the Web, then get as many people as possible to read and watch them. "Our mission is more relevant than ever before," he said. But Narayen, Lynch, and the rest of Adobe management will need to make a nearly pitch-perfect transition if they're to hold their much bigger competitors at bay.