According to TechCrunch, Adobe has introduced Creative Cloud, its subscription service for getting all of its tools for designers, photographers, videographers, web developers, and audio professionals. The head of Creative Cloud stated that this service will be the only way to get access to Adobe’s tools.
Adobe seems to be following a trend of subscription-based services exemplified by Netflix, Inc. (NASDAQ:NFLX). Netflix, Inc. (NASDAQ:NFLX) can be used on any device, from a Google Android-based platform to Apple Inc. (NASDAQ:AAPL)’s iOS to Microsoft Corporation (NASDAQ:MSFT)’s Windows 8. This lets its users reach its services without worrying that they’re using the wrong kind of gadget or software.
At the time, investors and even analysts had a hard time comprehending why Netflix, Inc. (NASDAQ:NFLX) would move away from its rock-solid DVD rental business to pursue on-demand streaming. But now, the answers seem clear as day. Subscription-based software and services that live on the Internet — or in “the cloud,” as it’s known — are taking over the world. AT&T projects the cloud will be a $210 billion industry, with 74% of business applications web-based, by 2017.
Like Netflix, Inc. (NASDAQ:NFLX), Adobe’s new model maximizes the benefit of being a multi-platform solution. Creative Cloud can be used on both the Mac and Windows, meaning that Adobe Systems Incorporated (NASDAQ:ADBE) has made it easier for companies to adopt its software suite, regardless of the operating system employees use. Future growth opportunities may involve an Android version of Creative Cloud Solutions.
Adobe’s investment thesis remains strong
Adobe Systems Incorporated (NASDAQ:ADBE)’s adoption of a subscription-based business model has met with some reasonable success. In its 2013 first-quarter earnings release, Adobe reported a decline in product revenues from $808.52 million to $675.79 million, as customers switched from buying software to subscribing to it. But the company was able to grow its revenues from subscription to $224.26 million from $146.23 million year over year.
All in all, Adobe Systems Incorporated (NASDAQ:ADBE) saw merely a 3.64% decline decline in total revenue year over year, implying that the adoption of a subscription based business model had only a slightly negative effect on sales.
At first glance, analysts’ consensus that Adobe will report a 38.70% decline in earnings this year looks alarming. But the drop actually owes to the way Adobe Systems Incorporated (NASDAQ:ADBE) accounts for the money it brings in. It gets to record money from software sales immediately, but must spread out subscription revenue over a longer period of time.
That approach has its advantages; Adobe forgoes a short-term boost, but gets greater growth over the long haul. Rather than waiting three to five years between major software releases to bring in a tide of new money from customers, the company can enjoy a steady stream of subscription income every single month. Indeed, analysts predict that Adobe Systems Incorporated (NASDAQ:ADBE)’s earnings will actually grow 22.2% next year, and 10.50% on a compounded basis over the next five years.
Is Microsoft next?
That same potential for greater long-term earnings growth may look tempting to Microsoft Corporation (NASDAQ:MSFT), too. A cloud-based, cross-platform subscription service would make it easier for Microsoft’s customers to upgrade both their software and their hardware, since they wouldn’t have to worry about buying discs or downloads, or purchasing new machines that need new, expensive licenses to Microsoft Corporation (NASDAQ:MSFT)’s programs.
Microsoft Corporation (NASDAQ:MSFT) has already tested out a cloud-based business model through its successful Xbox Live subscription service. Console gamers’ accounts keep track of all their data, and store their online purchases.
But Microsoft Corporation (NASDAQ:MSFT) has had mixed feelings about adopting cloud technology across its business. From an accounting standpoint, the revenue recognition would hit Microsoft’s EPS growth figures hard. On the other hand, a subscription-based model will maximize profitability better than its current license-based business model.
I anticipate that Windows-based services like Microsoft Office Suite will move toward subscriptions. Office Suite shouldn’t have to be constantly upgraded with uninstalls and re-installs after each computer upgrade. A cloud-based service will eliminate that hassle. But Microsoft Corporation (NASDAQ:MSFT)’s operating systems shouldn’t fall under a subscription-based business model; no one will pay a monthly fee to keep using a computer they’ve already bought.
Conclusion Many Chief Financial Officers at the largest technology companies — Microsoft Corporation (NASDAQ:MSFT) likely included — will be watching the performance of Adobe Systems Incorporated (NASDAQ:ADBE) going forward. It’ll provide the best real-world case study of a software company’s ability to effectively transition from selling programs to selling services.
Investors should expect more such companies to adopt subscription-based business models. That shift will most likely lead to declines in year-over-year earnings over the short term. But if investors are patient enough, companies like Adobe Systems Incorporated (NASDAQ:ADBE) and Microsoft Corporation (NASDAQ:MSFT) will eventually figure out a way to maximize the profitability of a subscription-based business model for software licenses. When they do, their share prices could enjoy a sudden surge.
The article Microsoft Will Eventually Sell a Subscription-Based License originally appeared on Fool.com.
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