Related articles:

• Software and the Sexy but Dangerous Economics of Digital (pt 1 of 3)
• Digital Economics II: Why Pricing Is Getting Both Complicated and Critical. (Jeff’s Asia Tech Class – Podcast 53)
• How Digital Creates and Destroys Competitive Advantage. Digital Economics II. (Jeff’s Asia Tech Class – Podcast 55)

From the Concept Library, concepts for this article are:

• Standardization and Interconnection Network Effects
• Subscriptions, Cross-Selling and Integrated Bundling

From the Company Library, companies for this article are:

• Adobe Inc.

Photo by Markus Spiske on Unsplash

—–transcription below

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Welcome welcome everybody. My name is Jeff Towson and this is tech strategy and the topic for today Adobe ink and the power of old-school economics So I’m going a little bit off topic. This is obviously not a China company and it’s not an Asia company Although their products this is Adobe so PDF Adobe Illustrator Adobe Photoshop Premiere Pro all these sort of creativity tools That are pretty ubiquitous everywhere in the world But this is a Silicon Valley company, and it’s not just a Silicon Valley company, it’s kind of old school. I mean, this is 1982, 1983. This is, you know, the founders were hanging out with Steve Jobs and came up with the first desktop printer and laser printer. So, you know, that is kind of a world away from my normal sort of digital Asia, digital China topics. But as I was going through this, I just thought it was a great example of almost a pure breed. It’s not a platform business model. So many of the things I talk about with AI, platform business models, it doesn’t really have any of that. It’s just traditional software company that has been very, very successful, staggeringly successful. And I thought that was kind of a nice company to talk about a little bit and use it as a way to review and just sort of go through, look, the basics of software and digital are powerful in their own right. And that’s more than enough. Now on top of that, if you have a platform business model, that’s even better. But anyways, I thought this would be a good chance to talk about how they were so successful and the concepts that are important there. And yeah, so that’ll be the topic for today. And the two topics I wanted to talk about were standardization network effects and bundling and subscriptions. So those are both in the concept library. And that’ll be sort of the main. point for today is those two topics and I think Adobe is just a spectacular example of both of those. So that will be the topic. Now for those of you who are subscribers, I sent you an email basically about Adobe in the last day, so I’m going to kind of build off of that. And also coming in the next couple days, I’m going to send you something about SoYoung, because SoYoung, which is the… marketplace business model out of China that does, you know, they basically do marketplace for services for beauty treatments and things like that, a lot of plastic surgery. I wrote you a bit about them late last year as potentially interesting because the marketplace looked compelling but not totally clear. And there was a new short report that came out on them from Blue Orca a couple days ago, basically saying they’re faking a lot of their numbers and activity and revenue. So I’ll talk about that, but that’s pretty interesting. I like when these short reports come out about the companies I cover. You learn a lot from short reports. So anyways, I’ll be sending that out in the next day. And for those of you who aren’t subscribers, feel free to sign up. You can go over to jefftowson.com. There’s a free 30 day trial. See what you think. You know, get involved. There’s a lot going on here. Don’t miss out. And let’s see, last bit, my standard disclaimer here. that nothing in this podcast or in my writing or on my website is investment advice. The numbers and information from me and any guess may be incorrect. The views and opinions may be inaccurate or no longer relevant. Overall, investing is risky. This is not investment advice. Do your own research. And with that, let’s get into the topic. Now before I get into Adobe, I kind of wanted to, I guess, maybe do a little diversion and Talk about what we’re seeing. I’ve been struggling to sort of get a sense for, people call this the age of information, the age of digital. Digital data technology, AI, software, connectivity. There’s a lot kind of wrapped in there. And I’ve been sort of thinking about how to break this apart. And generally I’m looking at three buckets. All of this stuff. I’m bucket number one, I’m looking at software. Now that’s a type of digital. It’s a type of data technology. It’s stuff made of bits and bytes, ones and zeros, not atoms, very powerful. And I used to just kind of call that digital. And now I’m starting to break this into software. And software is a bit different because bucket number two would be AI. And again, that is also made of bits and bytes, data technology, things like that. But the economics are very, very different. And I’m starting to separate those two in my brain that look, software, a company like Adobe, that is a classical software company. It’s more like engineering, where someone designs the system, puts the whole machine together, and then it functions. So that’s a lot like engineering. AI is a lot more like science. We are gonna study what’s going on in the atmosphere. We’re gonna study what’s going on in nature, but we’re not designing the system. We are just reacting to a complex system that exists outside of us. And the economics of those are quite different. And a lot of times when we talk about how digital economics are really great, we’re usually talking about software economics. We’re not talking about AI economics. It’s just that the first generation, two, three generations of digital companies, we’re all… software companies. So that’s kind of how I’m breaking it in my mind is there’s software, there’s AI, and then the third one is connectivity. You know if you’re just making a video game that’s software engineering. You design the game, you make the rules, people play the game. It’s like building a theme park. It’s your world. AI is responding to an external world and trying to study it and react to it. Connectivity is just the increasing connections between all things. You know, it used to be, you know, things were kind of separate and then people had laptops and then one day, or PCs actually, and then one day the PCs started to connect to each other and suddenly you start getting the internet. And then people start to get accounts and suddenly everyone’s digitized and then Mark Zuckerberg says, let’s connect everyone to each other. And that’s Facebook. and then we put GPS in cars and they’re all independent and suddenly they’re all connected. And that’s Uber or Elon Musk or whatever you want. But it’s the connection between things that seems to be growing dramatically. And platform business models, they’re in the business of connections and interactions. They’re not in the business of building things on their own. So I’m starting to think of that as almost an entirely new bucket where some businesses are just fundamentally connectivity businesses. And platform business models are a type of that. But really anything based on a network would be that way. So anyways, those are sort of my three buckets. And I was going through some of the history of technology. And what really got my interest was, OK, this is the digital age, the information age, however you want to call it. Let’s look at the industrial age, 1820s, 1830s, 1840s. And we saw we could put things into similar buckets, but different, but we could also tease it apart the same way. And I’ve been reading up a bit about that. And you know, I’ve talked in the past about how the industrial age was about moving beyond the physical or animal ability to change our environment. When you start to harness power, mechanical force, you can start to bend things and lift things. horses and ox could do. And that’s how it began. And the argument is today we’re moving past the limits of our brains, that we can suddenly remember things on a phone or know things or manage things far beyond what our brains are capable of. In the same way that 150, 160 years ago, we learned to be able to do things physically far beyond what our bodies are capable of. So that’s why people call it the second machine age sometimes. But anyways. So you look back at sort of the Industrial Revolution, and that was one of the things that was going on, this use of physical power, which came from the steam engine. You heat the water, it produces steam, and it produces force, far beyond what a human or an animal could do. So you have force, but beyond that, it was the creation of various tools. winches, all the mechanical parts and modules you would find within a factory, all the pieces were finally in place and people started to put them together in combinations and build factories and other things. That’s not unlike what we’re seeing today where the digital components are in place and people starting to put them together in lots of combinations. And the analogy I’ve made probably a year ago to you was, you know, this is often called the Cambrian explosion where most all of the creatures on the earth emerged in a very small window of time. And the argument, which is not mine, I’m just paraphrasing, is all the biological components were finally in place. And once the last one that was needed was in place, mitochondria, DNA, protein synthesis, all of that, once the last one was available, you could start to put things together in all these combinations and make all these life forms. But it required all the pieces to be there. So the argument is, you know, the pieces there are now in place for information and digital. And in the 1830s, 1850s, all the pieces were in place for mass production for the first time. And people just went crazy, started creating factories for everything. Mass production is kind of an interesting idea. The whole industrial revolution, you know, mass production. Basically, the masses could start to own things and buy things. And prior to that, they never really could. You didn’t own things in the 1700s because creating anything, a table, a desk, lamps, mirrors, all of this was very, very expensive. So wealthy people owned stuff, but the masses did not. But once you started building these massive factories, then you had mass production. You could make things. It wasn’t just the money, but you couldn’t make them in volume anyways. But now you could make things in large volumes at low price. And you started to get mass production and mass consumption and so on. And everyone sort of talks about that and writes about it. And it’s very interesting. The part they don’t talk about, which is sort of the point here, is that was one component. Like software engineering is one component of the information age. But there were other components. And back then the other component I actually find really interesting is transportation. Okay, you’ve built a big factory. We’ve never had big factories before. First of all, you have to urbanize. You have to get people in one location. So cities started to develop much faster because we needed people in one place to staff the factories. Fine. You build the big factory, but then there’s a problem. We’re doing mass production, which means we need to get this stuff out to the masses who are located far away. These factories were physically distant from the markets they were trying to serve. And so transportation was sort of the other big category. Well, you could say there’s three or four categories, but the two big ones would be mass production and then the development of transportation systems to bridge the gap between where things were produced and where they were sold. And this is really cool. And I actually find this segment more useful because there was a couple booms and busts of companies that jumped in and everyone thought they were gonna be rockstar companies and then they got kind of wiped out. Because if you were moving things around, let’s say the United States, which is my background, people were moving on horses and stagecoaches. That’s how you moved people. But you couldn’t move cargo because the volume was too big and the cost would be too high. So you moved cargo on ships and you moved them along the coast and up the major rivers. Well, that doesn’t get you to the market. So the first big boom after the industrial revolution started was canal building. And there was this sort of wave of canal companies that were created. You know, I think, I don’t know, I looked up the number not too long, it was like 30 or 50 major canal companies that were all very capital intensive because you had to build these canals all through the country that you could transport goods to everywhere you needed to go, took a lot of capital. And so it’s sort of in parallel with the building of these canal companies. The capital markets really started to advance and you could start to raise large money and start to issue debt and equity and things like that. That didn’t really exist prior, but you needed all this money. You invested a ton of money. You built these canals and then the idea was big expenditure upfront, but then you get revenue over a long period of time in all these companies. There was a big boom in bus cycle in the 1830s around canal companies. And it turns out… So you could consider this operating infrastructure for mass production. And I’m gonna make a parallel because that’s exactly what Adobe is trying to do right now is to go into operating infrastructure for their business. So I’m sort of teeing this up. Anyways, the whole canal thing ended up not working because you still had to pull these things by animals, horses on the banks because they didn’t have steam engines back then that could move. trains or boats. And so there was this 10 year boom, and then basically a bust because someone had basically figured this doesn’t work. Let’s use all this new industrial technology have and learn to build a steam engine that can sit on a boat and power it or a train. And that’s when they started building the railroads, which went on for a long, long time. And this whole canal thing faded from history and all these companies died pretty quick. And it turned out the right solution was build railroads. And that’s what happened. So it’s kind of this interesting bit of history of a new technology, fine, mass production. That’s one bucket. Second bucket is transportation advancements, which started in canals but didn’t work, went to railroads. That seemed to be the solution for a long time. And then the third bucket would be the development of the financial markets to support all of this. So it was third of three buckets. Now compare that to the buckets I just said for the digital age. Software, connectivity. and AI. That’s kind of how I’ve been thinking about this. But I think that’s interesting because what looks like the solution may not end up being the solution. And Adobe is a company that I think was there early in bucket number one, which was software. They started to move into connectivity. I’ll talk about why that’s important. So they were sort of in bucket one mostly. They moved to bucket two. They’re not really in bucket three. they’re sort of moving towards infrastructure more than they have historically been. So anyways, that’s kind of how I think about it, but this idea of the rising and falling of these various components is interesting. Okay, that’s a little bit of a diversion, but I think the parallel is kind of fun to think about. Now for Adobe, the key concepts to think about here, network or standardization network effects and subscriptions and bundling. Those are kind of the two key concepts. Those are in my concept library. I think both are very important. The key takeaways for today. I’m trying to make this a little more digestible because I know, especially for the subscribers, I’ve been sending you a lot. So I’m starting to put key takeaways at the top. So even if you just read that, you’ll probably get the main point. Key takeaways here. Adobe’s a really good example of the strengths of just traditional old school software economics. That’s what they do. They have evolved over time, over multiple decades, but they’ve pretty much stayed within that lane. And they’re really building out creative tools to make videos, to make photos, to make documents. That’s where they’ve kind of been creative tools and infrastructure, and now they’re trying to expand to operating tools and infrastructure. So this is like going from, hey, we’ve been in the factory business forever. Let’s move into the transportation business. Let’s go from the factories to the railroads. They’re kind of doing the same thing right now. Takeaway number two, digital economics are incredibly attractive. Everyone loves them. We’ll talk about why. I’ve covered that many times. The weakness, of course, is you need a competitive barrier of some kind, because most, the rational evolution of most digital tools, mobile apps, is for them to be free. And most digital companies, most software companies don’t make any money. So you want the economics, but you also need a competitive barrier so that you can actually make some money here. And Adobe has both. So did Microsoft, so did many. But you look at your mobile phone. The vast majority of things on your mobile phone you’re not paying for. This is the land of free. And while that’s cool if you’re a consumer, it’s not awesome if you’re a business person. And Adobe has basically gotten there by standardization network effects and some switching costs. So, okay, those are the points, those are the lessons. Let me go into what we’re talking about here. Adobe, cool history. You know, it’s these same players you hear about all throughout time. This is 1970s. Couple men working at Xerox Palo Alto Research Park. And this is, you know, for those of you who know the history of Apple, this plays all throughout there. This is that Xerox Research Park and. you know young Steve Jobs would go hang out there and meet people and see what they were doing and you know he basically copied a lot of their stuff because they had done a ton of research but they weren’t commercializing anything and he just started commercializing it. So a lot of the things he’s credited for, you know the graphical user interface, the Macintosh, the laser printer, I think the mouse too. I mean he saw most of those at Research Park and then just built them and that became the Apple and the Macintosh and that’s pretty clever move. So, you know, there’s always these complaints from Steve Jobs and Apple that, you know, Microsoft Windows copied them, which they did. But then it’s like, yeah, but you copied Xerox PARC, so what are we talking about here? And now today it’s like, oh, these Chinese companies are copying at Silicon Valley companies. Like, Silicon Valley copies have been copying each other forever. This is totally, you know, if you’re not stealing anything, this is normal business behavior. So anyways, Palo Alto Research Park. John Warnock. Charles Geshke, G-E-S-C-H-K-E, were working there, and the senior guy was Charles. He’d been there about 10 years. And then John had come in later, around 1978, and they were working on what they call post-script page language, post-script page description language. This is a lot of the stuff that you create images on the screen, and you turn sort of code into a visual image, post-scripts. And then you can see it on the screen. That’s this kind of led to the graphical interfaces, where suddenly you weren’t looking at lines of code on your personal computer, which I can remember doing as a little kid. And then suddenly you could see it graphically. And then when you open a document, you can see it in Arial or this font or that font. So it’s sort of in between that code and visual. And then it turns out you need this if you’re gonna print. So suddenly what you can see on the screen, you can print out of your printer and it looks the same. So this sort of gives rise to the whole desktop publishing thing, which was a big thing in the 80s. Well, you know, they were doing this. They came up with a postscript while they were working at Xerox PARC, took it to their bosses, said, let’s do this. And they said, no, this isn’t commercializable, which seems to be the standard approach to everything at Xerox PARC. They leave. the two gentlemen, they go working in John Warnock’s garage in Los Altos and they start their company there and running behind his house is a creek which is called Adobe Creek and so they say let’s name our company Adobe and that becomes the company they start doing this post script page description language Steve Jobs shows up very, very quickly. Apparently they were like the first Silicon Valley company to be profitable in year one. So profitable right off the bat. And Steve Jobs shows up, young Steve Jobs in his 20s, and he wants to buy their company, I think offered $5 million. They say no, they go back and forth. Eventually they make some level of investment, Apple and Adobe, and basically Apple starts using this for their printer business. And there was also some font development and some other things, but people start using this so you can print from your computer to a dot matrix printer and then eventually laser printers. And within a couple of years, their Postscript basically becomes the standard and they’re licensing it to lots of software companies who are embedding this. So whatever they show in their software, you can print. And also lots of printer companies. So they just sort of become the standard interface and industry standard, profitable. And they sort of live in this space of design, creation, whether it’s documents, media, PowerPoint, publishing, that’s kind of their lane. And they just go sort of software product after software product, and it’s impressive. They start making a lot of digital fonts. They do Adobe Illustrator, where you can sort of create pictures and stuff, and then their big hit, their biggest hit to date would be Adobe Photoshop 1989. Suddenly that’s what everyone’s using to make photos. That’s their flagship product, Adobe Premiere Pro, which I’ve used for a while. That’s making videos, that’s 1991, and then Adobe Reader, Adobe Acrobat, 1993, which literally everybody has and uses in some format. Save things as a PDF. And so on and so on, and this is just the early 90s. And then they just keep going for decades. You know, you look at them today and they’ve got, they’ve done more than this, but the ones that they sort of sell today are about 20 plus software tools, all in the area of creativity, for creation, for making media, content, videos, photos, documents, video animation, visual effects, audio editing. So these were all creative tools. And I looked at sort of their, their latest tools in, you know, Adobe Reader, Photoshop, Premiere Pro, InDesign, Illustrator, After Effects, Lightroom, Premiere Rush. I mean, you can see there’s, a lot of these have been around for decades, because they’re just kind of widely used in the industry. And all of these are under the bucket of sort of creative tools. And if you look at their income statements and their filings, they sort of break their business into two. areas. One is creative tools like the ones I just mentioned, but then there’s another ones which they call experience products, which I don’t think is a very helpful term, but this is like bridging the gap and this is the difference between the factory and the railroads. I mean this is the different, I call it creativity tools and operating tools or creativity infrastructure and operating infrastructure. This is where, you know, for all these companies, individuals, businesses, advertising agencies who use these tools, which is pretty much everybody. Okay. You’ve built your, your media and your content and the digital world pretty much runs on media and content, right? Photos, advertisements, communication, content is in everything now. Well, how do you sort of, what are the operating requirements to do that? You might need distribution. You might need monetization. You might need to add the social aspects so that media as such is easy to share. There’s a sort of an operating infrastructure versus a creation infrastructure. And that’s pretty much what they’re doing. They’re moving into that second bucket. With some degree of success, it’s not obvious to me. Like a good comparison to this is Epic Games, which I’ve talked about before. Epic Games is a masterful combination Creation infrastructure and tools and operating infrastructure and tools You know they have all these you know the unreal engine that lets you create the Mandalorian and you know amazing video games Those are all creation tools but then they also have sort of the the gaming app stores and If you’re a designer of a video game, you can then put your you know Your new game you’ve created into the epic sort of marketplace and they will sell it for you and they will put advertising in it for you and you get a cut and they will add social features and they will add communication features where it can be played on any type of device, console, mobile, PC, and anyone who has an account and is playing it can chat with their friends. They can add all of that sort of operating infrastructure to what you’ve created. I think that distinction between creative tools and operating tools is a lot more obvious and Epic has done this masterfully. Well, that’s kind of where Adobe’s going, or at least they’re trying to go. And then you take a look at their economics, and I encourage you to do this. I’ll put the link in the show notes, and it’s like, oh my God, these are the prettiest financials I’ve ever seen. Like, this is like Microsoft in the 90s financials. It’s just, phew. The difference, of course, is Microsoft was always a platform business model. Nothing I’ve just talked about with Adobe is a platform. This is just old school software economics. No platform business models involved. And man, the financials are pretty. Their revenue just goes up and up and up. 2014, they had about $4 billion of revenue. 2018, $9 billion of revenue. It’s up above 10 to 11 now. It’s just a straight line up for decades. Most of their money comes from their creative tools, about 65%. That number is going down as they’re sort of building out more and more operating tools. Most of that’s from the US, 55-60%. Or at least the Americas. Okay, that’s nice, that’s pretty. Then you look at their gross profits. Above 80%, 84%. That’s insane. Only software and intellectual property, like if you own the rights to Iron Man or something. Like nobody makes 80 plus percent gross profits, but software, because your cost of goods are nothing. I mean, it’s software. You just hit Control C, Control V, and you’ve got a second copy to sell. Now they make most of their gross profit off their subscription products, which are all the ones I just mentioned. You buy a subscription to use Adobe Premiere, or maybe you buy the license. They do have another business, which is their support business. They’ll sell you the product, they’ll sell you a support package, you can call if you have an issue, things like that. The gross profits on that business are like 30% because it’s services, it’s human-based. So you mix those two together, you get 80 plus percent. And overall, pre-tax operating profits above 30%. And they really could do better than that if they wanted to. Yes, they’re making 30 plus percent operating profit, but that has a lot to do with the fact that they’re spending a… large amount of money on research and development and a large amount of money on sales and marketing. Their marketing, sales and marketing, spends about 30% of revenue. Their R&D spends about 70% of revenue. Now they’re doing that as a competitive strategy, which is smart. We’ll just stay in our lane of created tools and we will outspend everybody. And that’s smart. But it also sort of hides their true profitability because they could probably ramp that down significantly and that operating profit. pre-tax would be more than 30%. But they’re sort of just dominating their space. So I think they’re more profitable than it looks, and they’re already really profitable. So that’s kind of awesome. And then, I mean, it actually just gets better and better because you take a look at their balance sheet and their statement of cash flows, and it’s like, I mean, look at their business. They’re a subscription model. They used to be you buy a license, you download it, or they send you the disc. Now it’s a subscription model you pay monthly. But all your customers are paying upfront. You get paid upfront, and then when you have to spend the money to produce the product, to give it to them, well that doesn’t cost you any money because it’s a digital product. The marginal production cost is zero. The distribution cost is effectively zero. you get paid upfront and then you have no cost to deliver the goods. So you have this really strongly negative working capital of negative two to $3 billion in working capital. So when they grow, they can grow, you know, they really don’t need any capital to keep this thing going and to grow it dramatically. They can pretty much grow for free. So, you know, great working capital, negative working capital situation, very few fixed tangible assets. And then they have sort of a nice predictability of revenue. This is kind of the Netflix phenomenon. Like if you’re running a movie studio versus you’re running Netflix, even though your revenues might be the same, which they aren’t, but even if they were, there’s a difference in the Netflix revenue. The Netflix revenue are highly predictable because it’s a subscription model. So based on a predictable revenue, it’s easier for you to spend money upfront aggressively. to make shows as opposed to if you’re running a movie studio, you hope you’re gonna have money next year, but you don’t know for sure. Maybe your movies will tank, maybe they’ll be blockbuster. So it’s very hard to spend upfront on capital, I’m sorry, spend money aggressively upfront on content because yes, your revenues are big, but they’re unpredictable. So movie studios, it’s hard for them to just write big checks to create show after show after show like Netflix can do. Well. Adobe has the same thing. They’ve got such predictability in their revenue. They’ve got like a prepaid deferred revenue of three billion dollars per year. So they already know their money’s coming. They’ve been prepaid. So they can spend very aggressively on R&D and new initiatives the same way Netflix can do that in content versus a company that doesn’t have that like a movie studio. So that’s, yeah, even when you see on their balance sheet you’ll see a decent amount of debt. three to four billion dollars which is unusual for a software company unless they have a subscription model so that predictability of revenue is actually a pretty big strength. Anyways, financials are really, they’re as pretty as you get. These are classical software company economics and they’re just great. I’m so jealous when I read these. Okay, that’s the picture, but let me get into the strategy aspect because this is a strategy podcasting class. So what’s the concept stuff here that matters? What are the big strategy ideas that I think you should take away from this? Well, first of all, the profitability and economics I just described, that all comes from the nature of digital economics. And I’ve covered these before and I’ll put the links in the show notes. I’ve given you, there’s quite a few of them. There’s like… Digital Economics 1, Digital Economics 2, there’s podcasts. I’ve covered this quite a bit, but it’s worth just sort of covering it really quickly again. When you make things that are out of bits and bytes and not done by people and not physical goods, like a chair, the economics are different. And there’s about seven or eight economic phenomenon for digital goods that you just need to understand. And I put them in a list many times. They just gotta be in your vocabulary. Number one on the list, which everyone talks about, is zero marginal production costs. The first copy of your ebook cost a lot of time and effort to make, but the second copy cost zero because you just hit Control V and Control Z, I’m sorry, Control C and Control V, and now you’ve got two copies. The first copy of The Avengers, Age of Ultron, which I really like that one, $200 million to make the first copy. The second copy cost literally nothing. Control C, Control V. No other businesses like that. That is just weird and it’s really powerful. Number two thing, low distribution costs. Reaching the market in theory is not a problem. You just put it on a webpage, anyone can download it. You can email it, all of that costs nothing. Although that’s, people tend to say things are zero distribution costs. That’s not really true. It’s just that distribution has sort of morphed into a marketing cost. Getting it to a customer is easy. getting the customer’s attention is actually expensive. So yeah, you’re gonna distribute. In theory, you could put up your webpage and it costs nothing, but nobody’s gonna ever come to your webpage. They have to go through Google to find your webpage and Google search is gonna charge you. So you could consider that a distribution cost. You gotta put your book up on Amazon for people to buy it. Amazon’s gonna charge you 30%. So there are costs there. We just… They’re not really distribution, they’re kind of a mix of access and distribution. Next one, non-rival goods. You’ll hear this term, non-rival. It’s just an old economics term that no one cared about and now it’s become important in the digital world. Non-rival means multiple people can use your product at the same time. If I’m reading an e-book, you can also be reading an e-book. If I’m watching a video of Jordan Peterson on YouTube, you can be watching the same video. But if I’m eating an apple, you can’t eat that apple. That apple’s gone. If I’m in a seat on an airplane, that seat is gone. Most digital goods are non-rival. Next one, global scalability at very low cost. You know, it’s hard to sell books all over the world. You gotta print them, ship them, put them into stores on every street with staff and inventory. Going global, selling physical books is really difficult and slow and expensive. Going global selling ebooks is really easy, just put up a webpage and everyone can do it. So scalability at very low cost, that’s kind of a big thing. Next one, pricing and versioning. Because it’s software, if I’m selling a chair or a cup or a bag of coffee, I’m selling the same product to everybody and pricing is actually kind of difficult. But digital goods, you can make multiple versions. You can add features and take features away. You can make a free version that’s sort of a bare bones and give that one away for free. You can make a more robust one and charge for that. You can make a professional version that costs a lot more with a lot more features and charge more for that. You can segment your audience by creating different versions of the same thing, and that’s really easy to do with software. Bundling, which I’m gonna talk about, that’s one of the takeaways for today. It turns out, you know, if you want to sell shampoo, you can sell shampoo. You want to sell conditioner, you can sell conditioner, or you can wrap them together as one product, a bundle, and say, here’s a shampoo and conditioner package for this price, and you’ll see that in every drug store. That’s not a big deal in physical products. I mean, this idea of bundling has been around forever. It’s not that big a deal. People in the services business tend to bundle more. They’ll try and sell you a credit card and then they’ll try and sell you a credit card with something else. Or you go to a bank and they’ll try and bundle financial services products. Consulting firms will do this. You see it more in services. But it’s all over the place in digital goods because it’s really easy. Like you go onto Amazon Kindle and they’ll say, hey, you can buy product A, this book, or you can buy product B as well and get it together because it’s just software. You can give it away for free. Netflix is effectively a massive bundle. One price, all the movies, because they’re digital goods, it’s easy. Spotify is a bundle. A lot of subscription business models are bundles. And then there’s integration. Okay, so there’s some kind of key economic concepts to understand. You just kind of got to know them. But I mean, that’s why these old school… software companies like Adobe have such attractive economics. It’s following from those factors. You know, they develop their thing, the Adobe Illustrator, Adobe Photoshop, they spend some money to develop the software. Once they have it, they can give away copies at zero cost. So that’s that ridiculous gross profit and they can also grow very very easily because it’s just software. I mean they used in the 80s, you know, you used to sell this stuff on disks. So you had to have stores, you had to have consultants, you had to have resellers selling your stuff. And then it kind of went to downloads. So that problem went away. Nobody really buys stuff on discs anymore, although you can. But even that’s where it’s coming from. They have most of those interesting economic phenomenon in most of their products. Zero marginal production costs, they absolutely have that. Low distribution costs, they got that. Non-rival goods. They got that. Global scalability at low cost, got that. Versioning, I mean if you go on Adobe, you’ll be able to buy different versions of all of their products, whether you’re a student, a high-end professional, just trying out the free version, a basic one for a small business. They can do all of that, price them all differently, and you know, that’s kind of where their economic attractiveness comes from. However, The big but is, okay, that’s nice, then why do most software companies lose money or don’t make money if they have all of this? Well, because all that attractive economics also means the price is, the natural price for most software is zero. When you price something, you generally, in a physical product, pricing usually follows from the marginal production cost. If making the next Apple, cost you 20 cents, then you would price above that 25%. But I just got finished telling you that the marginal production cost of software is zero. So logically, the appropriate price is zero or very, very small. So you can’t price based on production costs, which is how it’s done for most things in business. And you could price versus competitors. Well, other people are selling this for this amount of money. So. I’ll have to just make it like that, and you sort of are a price taker from the market. Well, the barriers to entry are pretty small. Anyone can jump in and start coding in a garage, like these two guys did. So if you price based on competition, it also goes to zero. This is why all the apps on your phone don’t cost anything. The natural price for most software is zero. So. There’s always two sides to this. You want digital economics because it’s amazing, but you absolutely need a competitive barrier. If you don’t have a competitive barrier to stop what I just mentioned, you don’t wanna be in this business. And the competitive advantage barrier that most companies in Silicon Valley these days go for is network effects. That’s like their go-to. But there’s others. Switching costs can be a good one. And there’s, you know. Platform business models tend to be attractive because they have a lot of competitive advantages that you can get in there, as opposed to I’m just one of 50 companies making an app that lets you, I don’t know, tell the time. So platform business models has a lot more aspects, but even traditional software companies like Adobe, they have competitive barriers, and that’s really what Adobe has. Attractive digital economics and some strong barriers right from the start. And the one they had, which is one of the two concepts for today, is standardization network effect. I’ve actually called it standardization and interconnection network effect, which is a lot of verbiage. But I’ve said for a long time, like platform business models, you can get network effects, one-sided or two-sided. But you don’t need, depending how you define it, you don’t need a multi-sided platform to get a network effect. They usually go hand in hand, but not always. One of the ways you can get a network effect without having a multi-sided platform is when you’re creating a standard. And there’s lots of types of standard. There’s interface protocols that let one computer talk to another. But one of the most common ones back then in the 80s and 90s was this fight for file formats. Bill Gates used to talk about this a lot. Like if you ever read Bill Gates’ sort of comments in the 90s, he was talking about file formats all the time. We wanna be the file format for spreadsheets. That’s Excel. I mean, look at the end of any Excel file, you’ll have it’s.xcl, xcl. Word documents. We wanna be the file format for document editing and creation. So it’s.doc. PowerPoint.ppt. There was a fight to control and own the file formats. And… That’s basically a standardization and a network effect. So if you ever look at these, they’re kind of funny. Like if you look at where, like JPEGs, which is for photo, which is a compression file format, they kind of emerged from all over the place. Like there’s just random people who figured that out and maybe claimed a patent or two. JPEG, right, it actually stands for Joint Photographic Experts Group, But you can, you can kind of, I mean, it’s pretty obvious that there’s a network effect. What’s a network effect, right? Does more people buying, using your product make it better as a product? You know, if I go eat chicken, it doesn’t make the chicken you had just taste any better, right? But network effect, the more people on WeChat, the better it is for everyone. WeChat, you can call more people, the service actually is better. Okay. I mean, it’s pretty obvious. Like if you have a file format. like PDF, and that’s the one that Adobe got, is they created PDF. When you’re going to publish and share a document, not just create it, edit it, that’s a Word document, but when you’re gonna publish it and share it and print it and sign it and so on, and it can’t be changed, that’s.pdf, and that’s Adobe Reader and Acrobat, and PDF, like I looked it up, I wasn’t even sure what PDF stood for, it stands for Portable Document Format, PDF. Anyways, that’s the one they got. And the more people that use PDF, the valuable, if you’re using PDF, you have a reader, Adobe Reader or Adobe Acrobat, and I’m using it, the fact that you have it now makes it mine more valuable because I can send you a document and you can read it. And we’re all on the same standard and you can use yours and send it to me. And the more people that use this, the better it is for all of us. So it’s a pretty classical network effect. You could call it a one-sided network effect if you wanna think about it that way. And it’s not just helpful, hey it’s good, but it saves you a lot of money. If you’re learning to use a program like Adobe Acrobat, which has some functions in it, you save a lot of time and money because everyone just has to learn to use one tool. And when your new employees join your firm, you know they’ve probably learned to use Adobe Acrobat at their old firm so you don’t have to train them. But everyone was using 10 different types. We all have to learn a lot and relearn and train. That’s a lot of time and money, so there’s money savings there. People like to build add-ons to these. Like you can use this to sign a document, here’s an add-on. Like if you ever go in your browser, you can see all the add-ons you can add. Well, all of those software developers, they don’t wanna make 10 different versions of their add-on or complement. They wanna make one or maybe two, but that’s about it. And that saves them a lot of time and money. So there’s a lot of actual. cost savings in this apart from the fact that it’s just a better product when everyone uses it. So that’s a standardization network effect. I’ve started calling that like an interconnection network effect. That the value is really about the interaction between us, like sharing documents, as well as the standardization. Like since we all use the same one, we don’t have to learn 10. That saves you money. I think it’s actually two types of benefits there. But that’s just me being sort of little… maniacal about terminology, which I tend to do. But that’s how I think Adobe got so profitable early on. They had digital economics and then they had competitive advantages and standardization network effect was one of their big ones. So they started throwing off cash flow very, very early. They always had both and that’s really what you want. Let’s see, I’ll move on to the next topic. One last thing is freemium, which I don’t really want to go into this idea of like, hey, you give away the first version for it. Because it’s digital good, you can make multiple versions. versioning and you can make one of them for free. So you sign up for free, you can use Adobe Reader for free and then if you wanna upgrade you have to pay. And that’s a good product but it’s also very helpful for building a network effect because the network effect is based on usage. So if you can produce a low level version for free you’re gonna get a lot more adoption. So they sort of, one of the key ways they got to a network effect was offering a free version. It wasn’t just good sales, it got a lot of adoption early on. That’s how they captured a network effect. And then you can also stage up the versions and do various pricing. So it’s good for profitability, but it’s kind of key for getting the network effect as well. Okay, now the other sort of big idea concept for today, key concept for today is bundling. Bundling, subscriptions, cross-selling, and integrated bundling. And this was their other source of… of real strength that allowed them to put a barrier up so that their profitability didn’t get driven down to zero as they used a lot of bundling. And a lot of these traditional software companies did this and they still do this today. My favorite one, which I’ve talked to you before about was Microsoft, right? Like Bill Gates acquired Microsoft Word and Excel and PowerPoint. He bought two of them. I forget which ones. I think they did one in-house and then they bought the others. They were small companies. Like PowerPoint was a small company they bought. And okay, traditional software product. You can do versioning, all of that, fine. And in theory, you have a standardization network effect, doc,.xl, if you can get most of the market to use your product. So the other big lever Bill Gates did, because he was pretty much a ruthless businessman, was he did bundling, right? And back then, Microsoft Word was $500, Microsoft Excel was 500, Microsoft PowerPoint was 500. And they had competitors in all of those products. There were lots of other companies, not lots but several serious companies making document formats, another one doing Excel spreadsheet, another one doing like PowerPoint. There was multiple companies doing this. But Microsoft had all three, and most of the other companies had one. We’re the spreadsheet company. Okay, and what did Bill Gates do? He said, Okay, we’re going to call this Microsoft Office and we’ll bundle and you can get all three products for a thousand dollars, not fifteen hundred. So pull three products together, one price, that’s a bundle. And I mean that’s just a devastating move for the competitors. First of all, who isn’t going to buy the bundle? We’re all going to buy the bundle and it’s easy to bundle software because it’s just digital. You don’t, it’s not like shampoo and conditioner where you got to wrap it together with cellophane or plastic waste put it on the same disk doesn’t cost you anything In terms of distribution, but it also doesn’t cost you any money if you just give away PowerPoint for free Okay, maybe you’ve lost some revenue because you’re giving it away for free and not selling it on its own You’re just putting it in the bundle with Word and Excel So you lost some revenue, but it didn’t cost you any money didn’t have to roll it off the factory floor and eat the cost creating that extra version of it that’s the marginal reproduction cost of zero. Yeah, it’s no cost so you put that in there. So everyone’s gonna buy the bundle. Why would you buy them individually? You’re probably gonna buy the bundle. That’s gangster move and then their competitors they have to respond to this. They have to offer a bundle and most of them can’t because most of them are single source single-service companies. They didn’t have all three. So it’s kind of the first team, the first company that can create the suite of products and services. You’ve got to assemble the pieces first. The first company that can do that can then pull the bundle lever, and that’s pretty devastating for those who don’t have all three. And all those companies disappeared, and no one knows who they are anymore, and now everyone just uses Word, everyone uses Excel, everyone uses PowerPoint. I mean, Google’s in there a little bit with free tools, but. it pretty much wiped out the competitors. Anyways, you can see Adobe’s basically doing the same thing. Microsoft went after productivity tools. I mean, there’s a reason they call it Microsoft Office. This is what you use in the office. It’s a work productivity tool. And Adobe sort of went down a different path, said we’re gonna do creativity tools. You know, this is what you can use to make your photos. This is what you can make your videos. This is where you can add animation to your photos. Right, so they went sort of down the creativity path, but they did the same strategy. We’re gonna create a suite of tools as fast as possible. We’ll try and own the standards as much as possible, but once we get the suite of 20 plus creativity tools, then we’ll start to bundle. And it’s a pretty devastating move. Very hard to compete against that, but you gotta get the suite. So you can see a lot of their money in research and development. They are always trying to add new tools to their suite. because that lets you sort of bundle more than everyone else. It’s a pretty powerful move. It’s actually a problem for people like me who do subscriptions and podcasts. This is digital content, right? But it’s very niche and specialized. There’s a lot of podcasts out there, there’s a lot of subscription. People are starting to now bundle those together and say, hey, don’t do just podcast A, B, C, D, and E. buy our product which is 10 of the top 10 podcasts. And that will be one price. So they’re starting to do that now. A lot of newspapers are doing that now. They’re starting to bundle subscriptions and things like that. And it’s a pretty devastating move. The only counter strategy that works is kind of what I’m doing, which is you have to hyper specialize in one valuable thing, which is like, here, let me tell you about the strategic aspects of this company you might invest in. So I’m kind of immune from the bundle, but you’ll see it take down a lot of all the podcasts pretty soon, probably. And that’s what Spotify is, it’s a bundle of music. Netflix is a bundle of TV shows and movies, most of which are bad. And you’ll see the same thing with information, newsletters and things, they’ll start to bundle up. And I’m moving as far to one extreme as possible, which is, you know. There’s not that many people who do strategy thinking for digital companies coming out of China and Asia. I think I’m kind of the only person. So specialization is your competitive defense against bundling. Anyways, and content is actually like, if you’re doing in-depth content, not a utility, PowerPoint is a utility. If you’re doing content, you have a far greater ability to specialize than just a PowerPoint. a clock, a spreadsheet, a program that helps you edit videos. Those are more like utilities and functions as opposed to content, which is one of the strengths of content is you can hyper specialize fairly effectively. Okay, that’s most of what I wanted to talk about. I think that’s most of what they’re doing over at Adobe. Their expansion into operating tools, the same way Epic Games has done that, will give them some pretty powerful ways to bundle. So I think that’s a pretty good move as well. And interesting. Also they do some switching costs. Which a lot of software services, especially if you’re doing a subscription, they do that. But if you do too much, it kind of annoys people. Because they don’t like when they feel like, it’s hard to, you sign up and it’s hard to cancel. People don’t like that. So that’s not really one of their big levers. I think their biggest levers are, network effects and bundling. So anyways, those are the two ideas. Standardization, network effects, and bundling, subscription. People often call it cross-selling because that’s part of it, but it’s all the same thing. And you can find that in the Concept Library, and I’ve highlighted it in the show notes. As for me, I’m sitting in California. I’m in my parents’ home in the Bay Area. You can actually hear, maybe you can’t hear, but there are turkeys running around outside the window, sort of going through the trees here. You can hear them sort of gobbling. It’s a very strange sound. If you heard something weird in the background, those were turkeys running around. Anyways, it’s been a nice trip. I flew out of Thailand, got back to the USA, got my first COVID vaccine shot, which was a Pfizer one. I talked to a doctor friend. He kind of said, that’s probably the best one. It seems, according to him, it seems to be doing the best against the variants that are popping up. So I got my first shot. which was very anti-climactic, because I’ve been working on this since like January. You know, I’ve been emailing hospitals in Bangkok, when are you gonna get it? I’ve been looking at, because I can’t get on the road probably until I get a vaccine. And then I’ve been following all the regulatory stuff happening, and it’s been a real thing. And then when I finally got it, it was strangely anti-climactic, because I just showed up and they said, okay, go down to the Walgreens. So I said, okay. So I get in, drive down the road to sort of a truck stop. get off at a gas station, go behind the gas station, there’s a jack in the box, behind the jack in the box, there’s a Walgreens, I walk in the back, I’m the only one there, this dude comes out and just pops me in the arm and goes, there you go. It was strange, it was strangely, like after all this work and thought, it’s like, really? Like behind the gas station and the jack in the box, like yeah, it was no big deal at all. Anyways, no big side effects, just a little soreness in the arm. I’ve heard the second Pfizer one, which I’m supposed to get in two weeks. I hear that knocks you down pretty good. I’ve heard that from multiple people, like don’t plan to do anything the next day. Like you’re out. So I guess that one might be a little more, but it’s kind of nothing. Anyway, so that’s kind of what I’m doing and working on some stuff and trying to pull together my book on how to think about competitive… strength and defensibility in a digital age and really pull together, you know, what I’ve been talking about for now 81 podcasts over the last year or so and 600 and something articles. I’m trying to pull that together. I think I’m going to bounce down to Mexico, Playa del Carmen or Mexico City and just sort of crank that book out and get that. So that’s the plan. But it’s been a great week and having… fun with my family, seeing my parents and brother, family. I’ve got some nieces and nephews, so it’s nice. Anyways, that’s it, pretty much it for me. I hope everyone is doing well. I hope this is helpful as always. If you ever have any feedback, I really do appreciate that. I mean, don’t hesitate to send me a note, or send me an email, or LinkedIn, I’m really easy to reach on LinkedIn. I do get kinda a lot of inquiries, so just say that you’re a follower or a subscriber, and I will absolutely respond. If I don’t, it means I missed the email. So send me another one, because if it says, hey, I’m a subscriber, I always respond 100%. So anyways, I appreciate any feedback or companies you think we should talk about or things I’m missing. Anyways, and plus it’s nice to hear from people, because a lot of this is me talking to a microphone. And it is actually nice when I get to sit down in groups and talk with everyone personally. But that’s it. I hope you’re doing well. Take care, and I will talk to you next week. Bye bye.