Adobe CEO: We're off to a good start with subscriptions (Q&A)

Shantanu Narayen, chief executive of Adobe Systems, just took a big step through a difficult transition.

The company is moving from selling perpetual licenses to Photoshop, After Effects, Illustrator, and other members of the Creative Suite to selling the $50-per-month Creative Cloud subscription that grants access to the whole collection and to some online services. There's plenty of disgruntlement from customers who prefer the old sales approach, which now only works for the old CS6 incarnation of Adobe's software, but Adobe showed on Tuesday that there's significant support for the new way, too.

That support came in the form of 221,000 new paying subscribers to the Creative Cloud in its most recent quarter, which Adobe reported along with better-than-expected profitability. Adobe now has 700,000 Creative Cloud subscribers; its goals are to have 1.25 million by the end of 2013 and 4 million by the end of 2015.

Adobe's stock popped up 5 percent in after-hours trading Tuesday, but not everyone is so bullish. David Hilal, an analyst with FBR Capital Markets, said Wednesday he believes that investors pleased with the recurring revenue growth that the subscription levels imply are overlooking "tepid" overall revenue growth in the digital media business.

"As the company moves further through the transition, we believe this will become more apparent and will be disappointing for investors," he said.

But Adobe thinks the Creative Cloud will free it from having to artificially slow its product development. And it's clear that Adobe is committed to subscriptions. Narayen spoke about the shift with CNET's Stephen Shankland after the company's earnings were released Tuesday. Below is an edited transcript of the discussion.

Q: What do your quarter's results tell you about your shift to the Creative Cloud?
Narayen: The results overall say we're ahead of where we thought we would be when started the move to the Creative Cloud. If I look at the key goals we had of trying to move to the cloud, to be able to attract new customers, we're certainly attracting new customers as a result of the affordable pricing. We're hearing from customers that they like access to the new updates. [With the subscription, Adobe releases new features as they're done instead of waiting for a major release cycle to end.]

We're showing things like what we can do with [improving photos with] deblur in the cloud, or potentially to run Photoshop streaming on an iPad. In the big picture we've successfully migrated the ability for our product people to have rapid innovation. We integrated Behance [a social network for creative professionals]. Behance had the most number of signups and engagement in their history with one day of this new Creative Cloud application. The results tell us we're building a predictable revenue stream and a framework for the next-generation creator.

There is concern we've heard from some customers, whether they be from the photography community or [about] how they have continued access to their content after the subscription ends. We're very diligent as a company. We're very customer-focused, thinking through what we can do to help with that transition, but no company has done the kind of transition we have done. I would say we're well on our way to a very successful transition.

Two years ago, you looked like you were rocked back on your heels with all the changes going on -- Steve Jobs was criticizing you, the Web world was gleefully embracing Web-technology alternatives to Flash. But in May, you made this aggressive move exclusively to the Creative Cloud for new software. Have you moved from defense to offense?
Narayen: November 2011 was a pivotal point for the company when we announced what we were going to focus on strategically. We announced we would not be focusing on a couple product lines we had and really lining up the company's efforts around digital marketing and digital media. We're executing well against a strategy that's simple to understand.

From the standpoint of Adobe's business, what are the advantages of a subscription model, and how does that pay back customers in longer run?
Narayen: The first and fundamental part of the business is allowing product teams to innovate at a more rapid pace. At the end of day, innovation leads to better business because it leads to better customer solutions. With the traditional 18-month product cycle, an engineer could come up with great product idea and they'd have to wait for next version of that software to get that idea to market. Today, application stores are changing how you get your content delivered, with new devices emerging all the time.

The second huge advantage from business point of view is we're having a direct relationship with customers. On the Creative Cloud whether it's good, neutral, or [negative] feedback they want to give us, customers now have the ability to give us feedback in real time. We understand who is coming to Adobe.com and how they want to transact business with us.

The next generation of creatives are very comfortable with this approach of being able to pay for software as you use it. The world is moving increasingly toward subscription models being the norm on the Internet. If we innovate and attract new customers, it will lead to growth.

Does a predictable revenue stream make life easier for Adobe compared to the fits and starts of the upgrade model?
Narayen: I think that's a byproduct, honestly. The best part of the business is to be able to innovate at a rapid pace. What could be more important to a company? Apple comes out with the Retina display; we can have a version of Photoshop that runs with it. There's a new GPU [graphics processing unit] that Apple shows at WWDC; we can have a full version of Photoshop with filter effects optimized for that. That's what product people and engineers like to do. That's the biggest business advantage we have.

At your Max conference in May, you said you had an installed base of 10 million people. What fraction of them will go subscriptions?
Narayen: We hope to see 4 million by 2015. We like to understand what it would take to attract more customers. Those are the public targets we set.

So what customer types are you leaving behind? What's the 6 million you're leaving off the table?
Narayen: We don't want to leave a single customer behind. Even with previous Creative Suite products, there are people who choose not to do business with Adobe.

But who's not signing up for subscriptions? Casual users? Hobbyists?
Narayen: We segment our customers as creative pros who use it to make living, people at work who use it to make their jobs more productive, and hobbyists and people at home who enjoy digital creation. The Creative Cloud composition today mirrors fairly well, both for customer segmentation and geography, people who've subscribed to Creative Suite. This notion by moving to Creative Cloud we're intending to leave customers behind is false. In other words, the majority of the people who bought Creative Suite were creative pros, and that's true for the Creative Cloud. It's the same thing with at work and at home.

I wasn't trying to suggest you wanted to leave customers behind. But is it fair to say the folks who aren't happy with Creative Cloud are the ones who are most expendable from a business standpoint -- the ones would not upgrade frequently and who weren't actively engaged in the Adobe road map?
Narayen: Every customer is a customer we want to make the journey with us. We will work hard to demonstrate why the innovation is the better accomplished through the Creative Cloud.

When you talked about bringing disgruntled customers into to the Creative Cloud fold, is that just appealing to photographers and addressing the file-access issue? Or are there grander plans afoot -- for example pricing changes or maybe smaller sub-clouds, not the full package, that might be cheaper?
Narayen: David [Wadhwani, general manager of Adobe's digital media business,] is championing the outreach to the community. It is a little premature in terms of having plans finalized that I can share with you.

But would you call the changes tweaks or significant course corrections?
Narayen: I would categorize them as tweaks.

Two years ago, you acquired Web publishing companies like PhoneGap and TypeKit, but there's still a certain lack enthusiasm for your Web publishing and app development tools. Unlike with Flash, you no longer own the platform anymore, so the competition is a lot stronger. Are you up to scratch, or is there a lot more work to be done?
Narayen: At Max, we talked about tremendous progress we've made associated with our Web strategy, first with contributing to standards. We're taking an number of our desktop publishing technologies and making them available through WebKit [the browser engine used by Apple Safari and on which Chrome's Blink engine is based]. With our digital publishing solutions, a lot is delivered through HTML technology. We are contributing actively to the browsers.

When you look at the Edge set of tools [for interactive Web site development], we have millions of downloads. We have a family of tools, starting with Edge Animate. We have Muse as a mechanism for people to update their Web sites. I'm pleased with the amount of contributions our team has made, but we're not done yet.

It seems like the acquisition trend has shifted now: Behance, Ideacodes, Thumb Labs seem to be Creative Cloud-focused acquisitions. Can we expect the balance between packaged software and online services in the Creative Cloud to stay the same, or are online services going to become more important? Alternatively phrased, will the Creative Cloud grow into its "cloud" name?
Narayen: There's no question we'll be delivering more services. But when there's magic technology that needs to be embedded in our applications, we've done that. As we've invested more in video, [we have] been gaining market share with video products, Premiere and After Effects. We've been buying technologies to help make that video work better for our customers. We'll continue to innovate as well as acquire. We get great DNA with desktop products, mobile products, and services.

But what I'm trying to get at is whether the Creative Cloud subscription is going to move more toward online services than it currently is. Are we going to see a relative shift toward online services in the value delivered through Creative Cloud? I'm not trying to suggest you're abandoning packaged software.
Narayen: You will see more emphasis on services that extend the functionality in the areas of collaboration and tying together all these desktop and mobile applications, yes.

Are you on the same page with Apple now? There was that fractious period with the Flash wars and Steve Jobs.
Narayen: We were always aligned delivering great products on the Mac platform. There were business areas where we disagreed. With digital publishing, we're downloading millions of editions of Folio on iPad devices. With products like PhoneGap, we want to enable people to build great apps, whether they be HTML or native apps, for the iOS platforms. We showed at WWDC that we're supporting their graphics capabilities to provide greater functionality. It's always been a case where we're jointly focused on customers. We agreed to disagree, but that's all so behind us right now.

I recognize it's ancient history by Silicon Valley standards. Is it fair to say the upshot is that you're in effect reimplementing Flash with Web technologies?
Narayen: When we want to have great standards for people to express their creativity, if standards exist, we support them, and if standards don't exist, we create them. We're still pushing the envelope with Flash in what happens [in] gaming and high-definition video. We're pushing with HTML in publishing and animation and interactivity. Standards are a means to an end.

With the Creative Cloud shift, are you in effect upselling customers who otherwise wouldn't be upsold? Some things like Muse and Edge aren't available alone, so that's a good reason to upgrade, but there are a lot of photo editors out there who just aren't going to get into video editing and wouldn't buy Premiere Pro. Is this getting people to spend more money on software they're really not going to use?
Narayen: Absolutely not. We have point product offerings, and we will continue to innovate around point products. This is about enabling us to innovate at a faster pace and letting us deliver directly to customers through the cloud.

I recognize that you're innovating. What I was asking is whether this is getting customers to spend more money than they were spending before?
Narayen: If you look at the spectrum of customers, you'll find it is a lot cheaper for a lot of them. And for some it was an increase in money. We're trying to drive the next generation of creativity.

You were at Adobe for the transition from point products to the Creative Suite that bundled them together. You've said some customers complained about that, too. Is the Creative Cloud backlash worse this time around?
Narayen: What's common across all of them is that when we first introduced the offering, there were questions that came up. I don't know how to relatively measure it, but we successfully innovated against the Creative Suite agenda, and now everybody looks it and says that was absolutely the right product. If we do our job right, which we will, people will look at the Creative Cloud and say it was the right agenda for Adobe.