I first covered Xero, an SMB financial accounting solution, in a 2012 piece I wrote for ZDNet. Den Howlett’s enthusiasm about the New Zealand firm caught my attention and drove me to learn more about them.
In the years that passed, I got occasional news tidbits on Xero but I hadn’t really dived deeply into the company until last month’s Xerocon in Austin. While I thought the Xero I covered in 2012 had grown rapidly, the Xero I encountered last month dwarfed that. So, how is the growth going?
Xero in 2012
Five years ago, I saw a lot to like about the then six-year old Xero as it had gone from startup to publicly traded firm in a very short timeframe.
The 2012 Xero was also interesting as it had already acquired 100,000 subscribers for its SaaS accounting solution. It’s really hard to acquire new customers for any software firm, but, to gain this many in a mere 6 or so years is really impressive. Xero claimed in 2012 that it took it 5 years to get their first 50,000 customers but only 10 more months to double that.
So what Xero had done all those years ago was to create a three-prong strategy:
- Make the solution a hit with both end-customers and accountants
- Follow the crown
- Make the sales process painless
A solution for accountants and end-users – From the beginning, Xero possessed an accountant dashboard that allowed accountants/bookkeepers access into all of their clients’ data. Because this is a cloud solution, it helps third parties avoid the myriad of kludgy log-in mechanisms they would have had to go through when checking up on the various on-premises solutions of their clients. Today, Xero has 2 product lines: Xero and Xero HQ. The latter is the solution that accountants use. Each version has its own add-on solutions (via partners) with the HQ product possessing some additional benchmark and cross-client capabilities.
Follow the crown – Smart financial application developers know one key thing: many major accounting firms and disciplines originated within the United Kingdom. As such, the commonalities in accounting processes, principles, etc. are quite similar throughout Britain and its former colonies. This is why smart accounting software firms expand globally via this familiar route. English language and accounting practices are quite similar in England, Canada, United States, New Zealand, Australia, etc. Xero knew this, too, and today its largest markets are in New Zealand, Australia, United Kingdom and US/Canada. The follow the crown strategy puts a vendor in several of the world’s largest tech markets with minimal re-working of the core product.
Make the sales process painless – In October 2012, Xero had a very intuitive user interface (that required little to no training), a low friction sales process (which is key to success for a vendor so far away from major tech markets) and a free trial mechanism.
That was five years ago. Where is Xero today?
Customer/subscriber count is close to 1.2 million now – a 12X increase since 2012. The software is used by 8,800 accounting firms. That’s up from 4,600 in 2012. The last stat is interesting in that Xero got a 12X increase in customers with an approximate 2X growth in accounting firms promoting the Xero solution. That is leverage and shows what can happen when a partner channel gets behind a product.
Geographically, Xero now has customers in over 180 countries. What’s really interesting is that the software is still an English-language only solution. For the company to continue to grow in other parts of the world, it will need to add support for other languages (especially Spanish, French) and languages with double/triple byte characters.
With growth comes new (financial) responsibilities
Xero’s changing. Their massive growth over the last decade has required a lot of capital.
The company has raised approximately $325 million in equity funding over the years. The last round in 2013 raised some $180 million. Today, the firm has approximately $200 million in cash and is working through a growth strategy that shouldn’t require new capital. That cash is a combination of earnings, pre-paid subscription monies and paid-in-capital.
This kind of growth without requiring new capital is what all well-run cloud software companies achieve at some point in their growth evolution. The Rule of 40 (R40) that has garnered much attention from Silicon Valley types in recent years mathematically explains the way well-run companies are supposed to execute. Essentially, the R40 requires a company to add its cumulative annual growth rate (CAGR) to its profit margin. That total should equal 40 percentage points. Early stage firms might grow at a 50% rate and run unprofitably by a -10% margin. Established companies might grow at 25% per year but must also post a 15% profit margin to meet the R40 target. Venture capitalists don’t mind some operating losses when growth is outsized. But even venture capitalists won’t tolerate losses forever. At some point in a company’s future, they’ll need to (or be forced to) dial back the absolute growth rate and improve profitability. The R40 is the dictum to heed now.
Xero’s still growing well these days. They added over 300,000 new subscribers in the last year. While the absolute customer count and revenue dollar increases are still impressive, they likely decline over time on a percentage basis to meet R40 requirements. It’s simply what happens when you’re growing off of a large yet growing user base.
The new Xero is more focused on several SaaS metrics. For example, the company wants to reduce its customer acquisition costs (CAC), lower cost of sales, reduce opex costs and increase its lifetime customer value (LTCV). If the company can find more modules to cross-sell to existing customers, it can drive up LTCV often with minimal sales effort. Add-on/infill sales are great for software companies if they have the products to do so.
Xero’s numbers in Australia, New Zealand and the UK already suggest progress in these matters. However, the North American market will be another story as Xero is only now starting to make material progress in this market. New markets are often expensive ones for vendors to crack.
The U.S. and Canada market
Den Howlett recently posted a review of Xero’s challenges in the North American market. He’s absolutely right that the U.S./Canadian market is a different animal with an 800-lb. gorilla (i.e., QuickBooks/Intuit) in the way.
Accounting firms have been a huge key to Xero’s success outside North America. But, in North America, getting these firms to get behind Xero will be more challenging. The U.S. is a huge, geographically diverse market. Intacct (now owned by Sage) had a relationship with the AICPA but even that didn’t translate into monster business for them.
Tight relationships with commercial banks are also key to rapid market adoption for SMB solutions. But, as Den’s piece points out, there are thousands of banks in the U.S. – gaining critical mass with them may drive faster market adoption.
So, the challenge for Xero will be to grow in North America and other locales while bringing a new level of cost management into being in its more established markets.
Specific to the U.S. market, Xero opened its first U.S. office in San Francisco a few years ago. The company intends to open more sales and marketing offices in other parts of the country.
Xero now has a U.S. payroll solution and hopes this will drive further sales uptake. It also needed one to maintain competitive parity.
Expansion of its accounting and partner ecosystem will help drive additional uptake. One of the more interesting sound bites at Xerocon involved a Xero executive opining that U.S. businesses don’t interact with taxing and governmental entities as much as non-U.S. firms. Apparently, the need to report taxes collected on a quarterly basis (in VAT locales) drives more usage of accountants and accounting software in small businesses. But, in the U.S., more companies try to go it alone without accountants. That means channel partners alone won’t drive software adoption.
Xero will try to enhance its market presence/brand awareness in the U.S. We’ll have to watch this when it rolls out.
How Xero can grow
In the software industry, if you’re not growing, you’re dying. Typically, these are the growth options:
- Broaden the product line to increase average deal size for net-new customers and increase in-fill sales revenues. An expansion could be horizontal and/or vertical.
- Make the product viable in more geographies
- Enhance the existing modules’ functionality so that the software can serve more complex, up-market prospects
- Create a stripped-down, simpler product to sell to the low-end of the market
- Acquire another firm with complementary or tuck-in solutions
Most vendors can rarely pursue more than one strategy at a time as each approach often requires a lot of capital and management attention. In Xero’s case, product line extensions have been the order of the day. The functional footprint has grown beyond core accounting and will likely do so in the near future.
The slide above indicates that Xero will grow in several directions simultaneously. It wants to extend its product footprint into the front office. It wants to move up-market to serve larger firms and it intends to expand beyond English speaking markets. That’s a lot to bite off.
The machine learning growth is initially focused on robotic process automation (RPA). RPA will recognize, for example, a digital invoice of a supplier, remember prior accounting distribution encoding and automatically route invoices for appropriate approvals. RPA/machine learning is behind Xero’s goal of making its solutions smarter and freeing up end-users from the rote activities/tasks many accountants and end-users find so repetitive and tedious. As long as Xero stays focused on this aspect of machine learning, it will serve its end-users and accounting firms well.
Xero’s competitors have been distracted with lots of side adventures into other artificial intelligence and natural language processing (NLP) solutions. As a result, Xero’s competitors have built cute demonstrations of Alexa-like applications that are more empty-calorie dishes than real productivity tools. ERP competitors will use machine learning to power predictive analytics – the best of these will tie operational (e.g., shop floor) data to financial data. I’m not convinced this would or should be a top priority for Xero. RPA is the correct direction for Xero, right now.
Geographic expansion will be interesting to watch although we got no real guidance on what that will entail or when that will happen. At XeroCon Austin, there were a number of partner firms from South and Latin America. Xero has a number of customers in Spanish-speaking countries, too. I believe a Spanish-language version of the solution would be the next most appropriate functional change to make. A French version should follow.
The move to up-market customers will put Xero in competition with firms like NetSuite (now part of Oracle), Intacct (now part of Sage) and product lines of other application vendors like Infor, SAP and more. It’s a crowded and very competitive space. Moving up-market could be slow and expensive. Competitors won’t exactly roll out the welcome mat Xero.
On the flip-side, the competition has made it possible for Xero to successfully introduce a more up-market solution if it is easy to subscribe to and use. Sadly, too many established vendors have chosen to create extraordinarily complicated subscription terms, require drawn-out negotiations, developed lengthy obtuse contracts riddled with surprises (e.g., embedded URLs and huge price increases after the initial subscription term expires), and have solutions that aren’t particularly intuitive that combined, require large sales and implementation efforts.
If Xero can carry its simple sales approach, try-before-you-buy policy, intuitive user interface, etc. into the mid-market, it has a real chance as that space definitely needs a white-hat-wearing vendor.
But the mid-market is a confounding space. These are companies with champagne tastes and beer budgets. Like bigger firms, they have many integration challenges to overcome and they often require more sophisticated implementers with competencies in change management, program management, process re-engineering skills, integration capabilities and more. Bigger firms bring a degree of complexity that has not been part of Xero’s or its partners’ prior experience.
Other growth activities
To further Xero’s growth plans, the company has made a number of new executive hires with a focus on acquiring ever stronger players in key roles. I met some of the new executives at Xerocon.
The company intends to push sales hard in the U.S. and UK. While the company has a number of customers in each country, its overall penetration, especially in the U.S., is nowhere near Australian levels. Xero also wants to “Amplify network effects across the ecosystem and partner channel”. Xero has lots of accountancies using its solution and referring it to clients. But Xero also has a number of third-party software firms and banks that bring additional capability and functionality to the table. Several of the larger technology partners were present at Xerocon.
You can’t really throw stones at a vendor that’s delivered this kind of market success. It’s an enviable track record.
Future growth must be the focus of the company and its executives. Judging by the contents of their financial briefing documents, they’re focused on a number of the right metrics and actions.
My growth concerns are:
- Can the company grow in other countries with the same breathtaking speed that it achieved in Australia and New Zealand? I’m not so sure. Each country brings its own challenges and the products will need adaptations, too. The old playbook will mostly work but I suspect several new chapters are waiting to be written.
- Can the company go up-market, add products to its product line, expand into new geographies, hire more people, acquire more partners, face stiff local vendor competition and more all at the same time? That’s a mighty full platter.
- Can Xero really crack the code with U.S. and Canadian accountants? As someone who frequently speaks to accounting groups/crowds, I don’t think this will be a slam-dunk or a quick event. This profession has been slow to adopt new technologies and loves to study things for many years. Change and accounting are words that rarely appear in the same sentence.
- Can Xero get accountants to forego their current, comfortable relationships with other software products? Again, accounting is a profession that has changed ever so slightly over its 500+ years. Like a pair of broken-in shoes, accounting firms will likely stay the course with existing software solutions unless Xero provides a drop-dead easy value proposition.
What I’m not worried about re: growth includes:
- The culture of Xero – I like it. It’s a customer focused culture that is driven to make customers’ experiences along the value chain better.
- The attitude of their partners – I broke bread with a few Xero partners at the Xerocon event. They were, to the person, bullish on the solution. As a group, they are an energized bunch. They like the growth opportunities before them.
- The focus of their partners – Lots of SMB solutions partners of other vendors operate within a local geography (e.g., they only serve customers within 50 miles of their offices). But, the Xero partners I met with were vertically focused and not at all fazed by geographic distance. That’s a great thing for software buyers as they can get partners that really understand their business. Moreover, in one conversation I had with two partners from two different firms, I learned that they frequently pass leads to each other’s firms if the other firm is more suited to the prospect. That’s something you don’t often hear elsewhere.
The next 24-36 months will be ones to watch….
Image credit - Story slides via Xero, featured image via the author
Disclosure - Xero covered most of the author's travel costs for attending Xerocon