Last year Bruce Chizen, CEO of Adobe Systems, the software company best known for its portable document format (PDF) technology, spoke to Knowledge at Wharton in his San Jose, Calif., office. Responding to a question about competition, he said: “When I think about competitors, there’s only one I really worry about. And it’s one that happens to have $35 billion in revenues and $50 billion in the bank. And it happens to be in the software business. Microsoft is the competitor, and it’s the one that keeps me up at night.”

Chizen has now, apparently, found a remedy to relieve that particular cause of insomnia, though it’s still unclear whether the cure will make things easier for Adobe Systems or aggravate them further. This week (April 18), Adobe Systems announced its $3.4 billion acquisition of Macromedia, a San Francisco-based software firm whose Flash and Shockwave products are widely used to deliver video and animation on the Internet. The boards of both companies have already approved the merger; the deal is expected to be completed later this year, provided that regulators and shareholders of both companies sign off on it.

Assuming that happens, the new Adobe Systems will emerge as a powerful software company with an array of products including applications such Photoshop and Illustrator – which are commonly used in publishing content in the print and web worlds – as well as Macromedia’s Dreamweaver and ColdFusion products, which are essential elements to building web sites. Since both companies have products they have sought to build into platforms to deliver web-based content, their combined efforts will bring them head-to-head with Microsoft. At the same time, the merger raises several questions, including what the next steps should be for Adobe Systems and what it will take to ensure that the merger works.

Wharton legal studies professor Kevin Werbach says the merger makes a lot of sense for both firms. For Macromedia, it was unclear whether the company could have survived in the long run as an independent. While its business has been growing rapidly especially in non-PC gadgets such as cell phones and personal digital assistants — as Macromedia’s former CEO, Robert Burgess, explained in an interview with Knowledge at Wharton in October — Macromedia didn’t have the girth to compete with larger companies. From Adobe’s perspective, the deal works because Macromedia is likely to provide future growth opportunities. Kendall Whitehouse, senior director of information technology at Wharton, agrees. “It is a classic case of merging for strategic reasons.”

“Adobe has a broad product portfolio, but Macromedia provides a pathway to the future,” notes Werbach. “Adobe has a strong publishing position, but that’s being eaten away by the web. The PDF is a bridge from paper to the web that may not always be needed. Flash is in mobile phones and is the rich interface in Tivo boxes and airport kiosks.”

The Adobe-Macromedia deal represents the latest in a wave of software mergers. In recent months, Oracle has bought PeopleSoft and Retek; Symantec has acquired Veritas; and Computer Associates has taken over Concord Communications. Says Werbach: “Software will continue to consolidate. There’s only so much shelf space.”

Next Stop: Your Cell Phone

On a conference call with analysts, Chizen recently explained that much of the impetus for the deal revolved around targeting new markets such as mobile phones. “There is an explosion of digital information and a variety of ways to access it,” said Chizen. “Macromedia has done a wonderful job in the mobile space.” Macromedia recently signed deals with Nokia and NTT DoCoMo for its FlashLite version of software to deliver interactive content over mobile phones. Meanwhile, Adobe has collaborated with NTT DoCoMo to put PDF readers on cell phones.

Deirdre Woods, Wharton’s chief information officer, says the opportunity in the mobile telephone space is reason enough for the merger. “In the last four years the use of mobile devices has exploded,” she says. “Mobile devices are where the next technology innovations will be.” Independently, the two companies have carved out strong niches. Put Adobe and Macromedia together and you could have a dominant web content player as communications increasingly go wireless and technologies such as Flash and PDF are bundled together.

Werbach agrees. The mobile phone market could represent billions of dollars in revenues for the new Adobe over the next decade and the big race is to become a standard. “Mobile phones are becoming intelligent devices and content will need to be created for them,” says Werbach. If Flash becomes a mobile phone standard, Adobe could make money the way Qualcomm does by licensing its technology to phone makers, he adds.

Dan Hunter, a legal studies professor at Wharton, says the real challenge will be cutting the deals to make money off mobile Flash technology. “I don’t know if Adobe will have the clout to put its software on all mobile devices and monetize it,” he says.

“Telecom carriers are restrictive about their networks. We believe anticipated growth in the mobile segment was one of the primary reasons Adobe Systems and Macromedia decided to merge,” notes Steve Lidberg, an analyst with Pacific Crest. “As mobile phone carriers move closer to wide launches of next-generation networks in Europe and North America, handset manufacturers are increasing their offerings of multimedia-capable phones.”

According to Lidberg, Adobe Systems will be well positioned as the next generation networks are rolled out in the U.S. For instance, NTT DoCoMo has embedded Macromedia’s Flash in all 27 of its handsets, up from just three 18 months ago. NTT DoCoMo is also embedding Acrobat Reader in its handsets. “By combining their mobile product suites, Adobe and Macromedia will have a more compelling offering as they approach additional wireless carriers and handset manufacturers,” says Lidberg.

However, according to Werbach, the jury is still out on whether Adobe can become a de facto mobile phone standard. “There are so many different platforms in the mobile phone space,” he says. “If there is anything that’s a standard, it’s Java and Flash, but the challenge is finding ways to monetize that.”

Whitehouse notes that in addition to mobile computing, another key segment to watch is enterprise software. “Both Adobe and Macromedia have been striving to expand into enterprise application companies,” he says. “And although both have made significant strides in this area, I think they have both found this to be a challenging series of initiatives. If Adobe can combine its LiveCycle products with Macromedia’s enterprise architecture tools — such as ColdFusion, Flash Communications Server, and Flex — it will take big step forward in expanding the reach and the ease of deployment of these products. This type of ‘deep architecture’ integration will take a while to achieve, but it could have a significant impact on a key growth area for the combined company.”

Adobe vs. Microsoft

While Chizen argued in his recent conference call that the merger with Macromedia was about growth, Wharton experts point out that Adobe Systems may be playing defense, and that Adobe needed to bulk up to fend off a potential advance by Microsoft. According to Werbach, there are three major non-Microsoft platforms that are critical in web applications — Flash, PDF and Java. “This merger puts two of the three together,” says Werbach. “Clearly Microsoft is a huge competitive threat, as it is to any large software company.” Adds Hunter: “If you are ultimately going to go against Microsoft you have to be bigger. And to do that Adobe has to look to new markets. Flash can allow that.”

Whitehouse says that Adobe has been focused more and more on document management for corporations, which use PDFs as a form of digital record keeping. As Adobe pushes ahead, it will increasingly bump into Microsoft and its Office products. Meanwhile, Microsoft could develop products that compete with PDF and Flash and bundle them in with the software giant’s next operating system, codenamed “Longhorn.”

Woods sees Adobe’s acquisition of Macromedia as essential if the companies want to grow well beyond their current status. “It’s crucial to the viability of both that they pool resources,” says Woods. The risk? Adobe could wake up a sleeping giant. “The deal raises Adobe’s profile with Microsoft,” says Whitehouse. “Until now, both Adobe and Macromedia have been too small for Microsoft to be interested in them.”

Jay Vleeschhouwer, an analyst at Merrill Lynch, says it’s premature to be worried about Microsoft. “In our view the larger motivation has to do with underlying market and technology trends that will drive the use of design, development, and document applications. It remains to be seen if there will be any meaningful PDF-like or Flash-like technology in the new operating system.”

Easy Integration?

Of course, the success of mergers — especially those in the technology sector — resides in whether the companies can integrate well. On that front, experts at Wharton are optimistic. “The corporate cultures here are very similar,” says Whitehouse. “Both companies focus on creative types. There are some integration challenges, but for the most part product overlap is not an issue.” Werbach says there aren’t a lot of red flags with the merger. “Clearly both companies know each other well and they are in the same markets.”

A tally of the product lineup shows Macromedia brings Flash, DreamWeaver, and Freehand to the combined company with Adobe adding the Creative Suite (Photoshop, InDesign, Illustrator, and Golive) and Acrobat, along with new products focused on corporate workflow. The big challenge, says Vleeschhouwer, will be maintaining momentum in software bundles, volume licensing and direct sales.

Chizen and other Adobe executives were reluctant to discuss specific product plans, but Whitehouse says he expects to see more bundles. “As a user of both companies’ products it will be interesting to see what they put together,” he says. However, integration almost never goes as smoothly as projected on the day of the merger announcement. Werbach notes that a few wild-cards include the retention of Macromedia developers and how Adobe handles its newly acquired product lines. Integration, he notes, “is never as easy as it sounds.”