Good morning,
It is shaping up to be a big week on Stratechery, but first, some big news from last week.
On to the update:
Adobe Acquires Figma
From the Wall Street Journal:
Adobe Inc. agreed to buy collaboration-software company Figma for around $20 billion, using the biggest deal in its history to acquire a small-but-fast-growing rival that the tech giant hopes can give it access to a broader group of customers. Figma is relatively little known to the wider public but its cloud-based collaboration tools have gained a loyal following among software developers and product managers who build apps and other technology products. Adobe executives said they think the acquisition will enable them to tap into demand from such users in a way that is complementary to the base of designers who use its existing software tools…
But Figma is fetching a steep price from Adobe, which will pay for the deal using roughly half cash, half stock. The smaller company was valued at $10 billion in a funding round last year and has been expected to surpass annual recurring revenue of $400 million for 2022—about one-50th of its sale price. Adobe said Figma has gross profit margins of approximately 90% and positive operating cash flow.
Adobe, based in San Jose, Calif., unveiled the deal Thursday morning with its quarterly results, which it pulled forward from a planned afternoon announcement after The Wall Street Journal began inquiring about an acquisition Wednesday. Adobe reported fiscal third-quarter net income of $1.14 billion and revenue of $4.43 billion, which was up 13% year-over-year. It also issued fourth-quarter revenue guidance that fell below Wall Street expectations, citing foreign-exchange challenges tied to the run-up in the U.S. dollar…Adobe’s shares ended Thursday trading down nearly 17%, amid concern about the outlook and worry that the deal shows the company might be worried about being outflanked by some competitors. Its shares are down around 45% this year through Thursday, while the Nasdaq Composite Index is down around 26%.
To the extent that Adobe’s plummet in value was due to the reaction to this deal, then I think the market got it wrong: specifically, the market was wrong about Adobe’s previous valuation, because the reckoning implied by this deal has been coming for a while. Last fall I wrote after Adobe’s MAX keynote:
The only full on Article I’ve written about Adobe was way back in 2013 when the company cut off the old Creative Suite model, where customers could buy a perpetual license to a specific version of Adobe’s software, and pay for updates, in favor of the Creative Cloud model, where updates were free but the software required a subscription. Given that I’m an analyst, I was definitely more excited about this shift than many of Adobe’s customers at the time; it has certainly panned out from a financial perspective:
However, while Adobe successfully changed their business model, the product really wasn’t that different. Oh sure, there were new features, and a new option to save and sync your files to Adobe’s cloud, but the fundamental concept of standalone apps working on files remained; teams would have to go elsewhere to figure out how to collaborate and, thanks to Adobe’s dominance, they would drag Creative Cloud along with them.
Still, this left an opening for new web-based apps like Figma to start nibbling away at Adobe’s dominance: when working on things like UI design, collaboration is paramount, making the limitations of the web well worth whatever sacrifice in performance was entailed. Adobe was, in other words, being disrupted: new technologies were enabling new vectors of competition that Adobe, focused on providing ever more powerful features on its vector of dominance for its best customers, couldn’t or wouldn’t respond to.
In that update I was pleased to see that Adobe was “finally rousing itself to a response”, more deeply integrating the web into its products, previewing tools like Spaces and Canvas, and even offering Photoshop on the web. Still, that point about disruption remained: no matter what Adobe did the Creative Cloud suite of applications would always have their origins on the desktop, while Figma would be cloud native; the question was if Adobe could add web-native features like collaboration, built-in version control, etc. faster than Figma could develop the editing and creation capabilities that might render Adobe products completely unnecessary. This acquisition is an acknowledgment from Adobe that the competition has already been lost.
Figma’s Disruption
Here it is important to note that Figma’s most prominent victim to date has not been Adobe, but rather Sketch.
The explosion in apps led to a growing market for product design and development as designers needed to lay out a whole host of different app views, and developers needed to know what exactly the designers wanted them to build; Photoshop and Illustrator, which were primarily focused on the creation and editing of single files, were the completely wrong tools for the job. Sketch, which was released in 2010 as a macOS app (and is still macOS only, although it now includes the ability to view files on the web), completely took the category by storm (or, one could say, created the category). Adobe eventually responded with Adobe XD, but not until 2015, and the product is still in 3rd place — Sketch, though, is now only in 2nd.
Sketch was not a disruptive product: it was, like Adobe’s products, a desktop app; it just delivered a solution to an emerging product category that Adobe was slow to respond to. Figma, though, was something completely new: the company, which was founded in 2012, made a bet on the browser and spent a full four years building v1 of the product. This included writing the editor in C++, cross-compiling it to JavaScript using the asm.js subset that let it achieve desktop like control of memory and performance, and building its own rendering engine from scratch using WebGL — which had only been released in 2011. It was the epitome of leveraging new technologies to compete on a new vector, which in this case was collaboration.
Think about my brief description of this “product design and development” segment: multiple app views created by design and implemented by engineering imply at least two different people working on a project (a designer and a developer); in reality, the huge number of different views and increased functionality in apps meant that there were increasingly large teams on both sides. Sketch definitely made it easier to design an app in one place, but it did nothing to make it easier for teams to work on an app together; Figma, because it was native to the web, effectively got collaboration for “free” from the beginning.
Note that none of these developments affected Adobe’s core products; indeed, this is a screenshot from the page on Figma’s website where the company compares itself to Adobe XD:
Figma’s photo-editing tools are rudimentary and not remotely competitive with Photoshop; it’s vector editing tools are a bit more advanced but still nowhere near the capability of Illustrator. An app maker may use Figma to place a logo or photo in the application, but the actual creation of that logo or photo still happens in Adobe’s products. Sure, XD is getting killed by Figma, but no one ever subscribed to Creative Cloud for XD; you just used it because it was there.
Here is the problem, though: to the extent that Adobe’s products were being used as part of a Figma workflow was the extent to which Adobe was slowly but surely losing control of its long-term relevance. Figma could, for example, start investing much more heavily in its photo editing or illustration capabilities, rendering Adobe’s products increasingly unnecessary. What is more threatening is Figma’s platform capabilities: 3rd-party developers can build plugins for Figma that make it possible to easily add the sort of editing capabilities that Figma itself lacks, for example. The introduction to the company’s API states:
The Figma API supports read access and interactions with Figma files. This gives you the ability to view and extract any objects or layers, and their properties, so you can render them as images outside of Figma. You can then present your designs, connect them to other applications, or use them to expand on your vision. Future versions of the API will unlock even greater functionality around Files.
This is a world where Figma is the operating system for design, and applications like Photoshop and Illustrator are reduced to plugins, and increasingly commoditized. That, by extension, is exactly what Adobe is buying: control of the key integration point in the design pipeline, and, one would assume, a favored position for Adobe’s own apps in that pipeline.
The Figma OS
One of the most widespread responses to the news of this acquisition was to look back at Adobe’s 2005 acquisition of Macromedia in dismay. While the big prize in terms of Macromedia’s product suite was Flash (oops!), it was Fireworks, a combo bitmap and vector editor explicitly created for web design, that critics point to: the argument is that Adobe barely maintained Fireworks and let it quietly sunset in 2012 precisely because it was so much easier to use than Photoshop and Illustrator; the implication in the context of this acquisition is that Figma may suffer the same fate.
I am certain this is not the case, and not just because spending $20 billion to kill an app would be absurd. Rather, the reason why Adobe is both willing and has no choice but to spend so much is because of the point made above: Figma is set to be the “operating system for design”, which means that in the long run Adobe has to operate on Figma’s terms, not the other way around; to put it another way, Adobe is not only paying for long-run control of design but also its own independence. That alone is worth a whole bunch of money! What likely made the price even higher, though, is that in this view Figma has no need to sell; the company had pole position on the future of design, not because they were going to build a competitor to Photoshop or Illustrator, but because Figma was going to commoditize them.
Still, it’s a long ways from here to there: Figma may be taking in $400 million in revenue, but that means the purchase price was a 50x multiple — and that doesn’t include the $2 billion in Adobe stock options that are being offered to Figma’s employees (another sign that of course Adobe isn’t going to kill the product). It will be many years before Figma ever achieves that sort of valuation on its own — if ever (Spotify, for context, is a $19.3 billion company). Yes, Figma will gain some benefits from being a part of Adobe, including access to Adobe’s sales funnel and tighter integration with Adobe’s entire suite, but at the end of the day it seems to me that the biggest reason for Figma to sell was simply because Adobe made the number so big that it was all but impossible to say no.
The big question now is whether or not this deal will be challenged by antitrust regulators: on one hand, there is the precedent of Visa and Plaid, where the Justice Department sued to stop the acquisition of a startup that it argued presented a clear competitive threat; on the other hand, that was in the context of a major market (financial services) already crawling with regulators: creative tools are a relatively small market with no other regulatory restrictions.
Moreover, as I noted above, Figma isn’t competitive with Adobe’s core applications; it is competitive with XD, or rather was: nothing shows how badly Adobe dropped the ball in this space more than the fact that XD was built as a desktop application (because it was, after all, copying Sketch, not the as-yet-unreleased Figma). In other words, that isn’t a competition because Adobe already lost. At the same time, that doesn’t invalidate Figma’s threat to Adobe; rather, as I explained above, that threat is more about the overall value chain — the competition that is being eliminated here is the future Photoshop/Illustrator competitors that would have been built on Figma’s platform absent what I suspect will the clear favoring of Adobe’s tools.
What is interesting to consider is what happens if this deal is not allowed. Figma, as you would expect from the party with the negotiating advantage, comes out pretty well: the company gets a $1 billion breakup fee at an implied $20 billion valuation without having to actually raise money in a difficult fundraising environment. Still, it’s not all upside: it is human nature for Figma employees to already be buying their future yachts and biasing their product decisions to an Adobe future; if the deal doesn’t go through there could be both culture and product harm (particularly since I fully expect Adobe to fight this in court if necessary; that’s how strategically important Figma is to them). That, perhaps, means there is some upside for Adobe as well: $1 billion to sidetrack its would-be master is perhaps a better option than just being commoditized by a disruptor without a fight.
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