Thursday, March 6, 2008

Adobe and Stock Investing ("The Wide Moat")

All the talk about Adobe's technology not being compatible with the iPhone made me wonder if its stock was still a good hold or buy. One key to investing is making sure you don't buy outdated manufacturers or companies that have products out of favor with consumers. Warren Buffett famously refused to invest in tech companies during the 2000 stock market boom/bubble, avoiding companies he did not understand because he could not calculate whether a particular technology would survive long-term.

Taking a look at the top 40 companies in Santa Clara County in 1982 and 2002, I recognized only 20% of the top revenue-generating companies on the 1982 list--and most non-stock-investors would only recognize three or four names. After Steve Jobs' comments at the Apple shareholder meeting, I became more curious about Adobe's product, especially because I own shares in both Adobe and Apple. I wondered whether Adobe would be one of those companies missing from the 2022 list. Mr. Buffett has a metric called a "wide moat." Basically, a wide moat is how secure a company's product is from competition/attack. Imagine being in a castle and having no moat. You will be invaded and possibly vanquished. But with a wide moat, attackers need to spend more time, energy, and resources to attack you and might avoid your territory. I asked one my friends, whom I've known since high school and who has always impressed me with his tech knowledge, whether Adobe had a wide moat. Here is his response:

PDF is an open international standard created by Adobe.

Anyone can create software that uses or reads PDF files. PDF is actually native to Macs. The imaging model of Mac OS X is PDF. The Preview application can display PDF files, as can version 2.0 and later of the Safari web browser. System-level support for PDF allows Mac OS X applications to create PDF documents automatically. When taking a screen shots under Mac OS X versions 10.0 through 10.3, the image is captured as a PDF; in 10.4 and 10.5 the default behavior is set to capture as a PNG file, though this behavior can be set back to PDF.

In other words, on a Mac virtually all applications can read and create PDF documents without downloading any software from Adobe.

Microsoft hates PDF and is trying to replace it with XPS, but they have been unsuccessful so far. Windows Vista comes with the tools necessary to create and read XPS documents. Some third party companies have created XPS tools for Macs and Linux systems. Thus, Adobe provides all PDF software for Windows systems.

So you might wonder then why do people buy Adobe PDF creation software for Windows and Macs? Yes, that's right, Mac users buy PDF creation software from Adobe too. The answer is that the PDF format is much like Microsoft Word. Over the many years of its existence, it has become a big fat pig of specifications and rules. The *only* software capable of reading and creating every feature with 100% accuracy is Adobe's software. The main reason for this is because Adobe adds new stuff to the PDF specification almost every year. For example, Adobe PDFs support DRM. Their DRM scheme was broken and thus Adobe added a new DRM scheme to the following year's specification. If you want to make 100% product you would need to implement both DRM schemes. However since only enterprise customers use the DRM feature and average-joe- computer user could care less, they don't need a reader with DRM support. Thus, most non-Adobe PDF software does not implement PDF DRM support.

PDF has many features of this sort that are only used by niche customers (e.g. enterprise). Enterprise customers have money and thus are willing to pay for these products. Windows users usually have no choice but to buy Adobe's software if they want to *create* PDF files. Mac OS X users can create basic PDF files for free, but if they want to use features like forms support then they too will have to buy Adobe's PDF creater.

In the same token, Google Docs lets you import Microsoft Word documents, but it doesn't support every feature of a Microsoft Word document. Often Google Docs users will import a Microsoft Word document only to discover the formatting is messed up in some way. So then those users go back to Microsoft Words for their documents.

BTW, Adobe's bread-and-butter product is not PDF, but Photoshop. Photoshop is the de facto standard for Digital Art. Although there's free alternatives like GIMP, Photoshop has huge following with a large investment in education and training. When you go to college to study Digital Art, you are taught Photoshop. Photoshop is the standard. Transitioning to GIMP from Photoshop is too hard. So, most people just end up buying Photoshop when they graduate (or download a pirated copy from the net). If your business deals with Digital Art like Apple, then you buy lots of copies of Photoshop.

There you have it. I am holding onto my Adobe shares. And for the record, I didn't think Mr. Jobs was trying to disrespect Adobe with his response to my question. I think he was just trying to say that no such product existed, and if anyone could create such a product, it would be a boon for the tech industry.

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