The state of SMB - a conversation with Gary Turner, MD Xero UK and EMEA

Profile picture for user gonzodaddy By Den Howlett November 18, 2020 Audio version
Summary:
Xero has high qualirty data with which to assess how the SMB economy is performing. What is Xero seeing and what does this mean for digitization?

Gary Turner Xero
Gary Turner, Xero MD UK & EMEA (screenshot from video call)

In this story, I am focusing on the UK since that is my home market and it is where Gary Turner, Xero MD UK, and EMEA is based.  Xero recently reported its fiscal 2021 half-year results. In the UK, revenue climbed a very respectable 38% to NZ$107.3 million (£57 million) on a subscriber count uplift of 19% to 638,000. Overall, Xero checked in with global revenue of NZ$409.6 million (£213.7 million) from 2.45 million subscribers. Both figures climbed 19% in aggregate. 

I've known Turner since his days at Pegasus, so that's about 20 years and I vividly recall his introduction to Xero UK in 2009. Xero is a company I have long admired as one that understands the importance of the professional accounting practice as a channel which, until Xero came along, was dominated by Sage. Also, since Xero offers a radically different approach to SMB accounting than the legacy vendors, it has had little trouble attracting forward-thinking professionals who see their role not so much as compliance assistants but as real-world advisors their clients. As a large SaaS solution provider, Xero has a large data set from which it can infer economic activity, and it was in that context I spoke with Turner. 

In common with everyone else I've spoken to since the COVID-19 pandemic struck, all bets were off in March and April as the UK's lockdown kicked in. Turner says:

Nobody knew what was going to happen. So back in March or April, it was completely pointless trying to anticipate anything. We operate based on pessimism rather than optimism. And so we put a freeze on headcount hiring, we stopped spending money on external advertising not so much from a cost management perspective, but because we felt it was insensitive to be promoting a product back in April and May where the messaging and the imagery wasn't representative of the reality that people were operating in. But we ended up better than we thought we were going to end up.

Turner shared that the volume of business passing through the Xero system showed the early pandemic impact as severe in New Zealand, where the borders were quickly shut and lockdown imposed but that there has been a relatively fast and sustained economic return. In the UK, the impact was felt a little later, but recovery has been much slower. 

Xero COVID impact data
(Xero SBI, AlphaBeta)

Based on our data, we think the UK's impact is hovering around minus nine to 10 percent year on year overall. Some segments have experienced real pain and drop off in the 30, 40, and 50 percent range. Hospitality is the obvious one. But then there have been some bright spots. We see people's spending habits changing, so we see support for local businesses rising significantly. That doesn't work for the larger cities, but outside of that, then yes, we have seen plenty of activity. It's not surprising given that with today's technology, you can spin up a website, commerce with something like Shopify, put a video out on YouTube all in a few days, and you're in business. But even before COVID, we saw the emergence of ghost kitchens popping up, and that's going to continue. 

That observation aligns with what I have seen locally, where local farmers have become retailers in a much wider selection than a small selection of locally grown vegetables, eggs, and milk. 

Whether that change is permanent is unknown. We know there is a preference for supporting local businesses, but we don't yet know if people will return to the large-scale supermarket in the numbers they were once the pandemic is over. In another example, a guy started offering a mobile tire changing service. He'd come to your house, change tires, and on to the next one. If you were stuck out of the way, then he'd come and get you back on the road for a premium. He started with a couple of vans for breakdowns. Now it's the biggest part of his business, and he's buying more vans. There are lots of stories like this. But there are also many stories of businesses that can't operate. There's no way to pivot. And of course, you don't hear them because there's no good news case study for those.

How is this reflected in the professional market? According to Turner, the accounting professionals with which they have the most success are thriving, taking on more people, and reporting more business. Turner thinks this is driven by the advisory nature of those practices, coupled with the fact that everyone requires help one way or the other. 

What does any of this mean for Xero's business? According to Turner, Xero has to replace 15-20% of its customers in any year to stand still. That's because the SMB market is especially vulnerable to failure while  some businesses grow out of Xero or switch to another provider. The company still sees growth because, as it says, everyone in business needs to maintain compliant records. But growth has slowed.

From March to September, we grew about 25,000. We would normally expect to double that. But with half our revenue coming from accounting practice recommendations, the accountants aren't going to be thinking about getting clients onto a platform like ours or swapping them over. They're busy helping clients navigate the rules for grants, payroll schemes, furlough, and the like.

Looking more long term, the UK government's plan to extend  the Making Tax Digital policies to include income and corporation taxes over the next few years make it mandatory for all but the smallest of business ventures to file returns online. 

MTD for VAT gave us a lift, and I am sure the next phases will do the same again. We have to make sure we are prepared. But the immediate future is a concern. We're coming into a period when deferred tax bills are due for settlement, and if people don't have the funds, then what? So far, the impact has been much softer than we expected, what with grants and subsidized loans, but those debts will come due at some point. I have heard talk that the government will give people more time to pay, but it doesn't avoid the fact that cash has to flow back to the government sooner or later. due;I think the prospect of a long term economic recession or volatility is something that we're all having to face.

As we closed out our conversation, I wanted to ask Turner about a topic that has come up in several discussions in the last few months. We have written extensively about Zoho as a firm that, while also focusing on the SMB market, has gained senior analysts' attention in the enterprise space. Xero is also entering those conversations. I wondered if Turner thinks that there is a place for Xero further up the food chain from its SMB focus, especially given its extensive ecosystem of partners with solutions ranging from HR to payroll, CRM, and beyond. He offered a small raising anecdote but before going so prefaced by saying:

You're not going to see us compete with a NetSuite anytime soon, but I know that where the conditions are relatively simple, requiring a straightforward GL and maybe consolidating with a spreadsheet, then sure, anecdotally I've heard that. I've been at a few dinners and sitting across from the CFO from a 100 million revenue business with multiple entities running SAP at the core. All the subsidiaries are on Xero. He's probably paying us three thousand a year and loving it. 

And with that, we were done. 

My take

Xero may not be on our typical reader's radar, but it should be. The innovative approach it took to basic book-keeping 12 years ago allowed it to stand apart from legacy vendors. Xero achieved this by asking  how can we make accounting easy for small business and then answering through a combination of bank feeds that import bank data directly into the book of record and then learning how each transaction should be categorized. That combination  removed two of the biggest challenges that novice book-keepers face. Over time, Xero has added functionality but always mindful of the need for simplicity. It is surprising how well the solution scales, but there are relatively low transaction volume limits as you'd expect.

The fact Xero aggregates enough data to provide representative insights into economic activity makes it especially valuable for people like myself who are thinking about how the enterprise software market is changing in the wake of the pandemic. The data points Xero provides offer important insights into what may happen next. To his credit, Turner is realistic enough to understand that even with great data, the volatile nature of the current economy makes planning a real challenge.