Xero expands into workforce management but accounting is still at the core

Phil Wainewright Profile picture for user pwainewright May 18, 2021 Audio mode
Summary:
Small business cloud accounting provider Xero reflects on a year of two halves and explains the rationale for acquiring workforce management provider Planday

People growing to the cloud graphic © jesussanz - Fotolia.com
(© jesussanz - Fotolia.com)

In the course of having some building works at home last summer, I was reminded how many small businesses still do their paperwork on spreadsheets, Word documents and email, before passing it across to their accountants to calculate company accounts, taxes and payroll. After ten years of doing my own business accounts in the cloud and working with an online accounting firm, I'd all but forgotten the regular pain of packaging up all my papers to physically pass them to my accountant. The impracticalities of this approach during last year's lockdowns must certainly have been a wake-up call for those businesses and accountants who still haven't made the move. As Gary Turner, Managing Director of UK & EMEA for cloud accounting software business Xero, sums up:

I think there's a degree of optionality that has gone and it's now a fundamental need ...

We heard lots of stories of accounting firms, who were already largely digital, who have thrived during the pandemic — who have been hiring people, who have been in a much better position to service their customers without disruption. But there have also been accountants that have struggled. They've had to very quickly catch up and update remote access or move to cloud products.

I think the pandemic has been the making of that argument for many accountants. I don't see pen and paper coming back, just because the pandemic is over.

That doesn't mean that the past year has been all plain sailing for Xero, which announced its full year results last week — Turner briefed analysts post-results. Founded in New Zealand and listed on the Australian stock market, its annual revenue for the year ended March 31st 2021 rose 18% to NZ$849 million (US$616 million). Annualized monthly recurring revenue for March is up 17% year-on-on-year — and at NZ$964 million, it's edging close to the NZ$1 billion milestone. But its earnings growth disappointed as EBITDA of NZ$191 million (US$138m) undershot analyst consensus estimates by 20%, reflecting the difficulties of a year in which global subscriber growth slowed.

Xero's total subscriber base now numbers 2.74 million, with healthy growth for new sign-ups in its home markets of 32% in New Zealand and 7% in Australia. But elsewhere there were falls in that rate, as business activity dropped due to pandemic lockdowns. In the US, new subscriber growth dropped 4%, while in the UK it was down 29% — although Turner points out that it was a year of two halves in the UK, with three times the number of new subscribers coming on board in the second half of the year compared to the first six months. Despite the slowing growth, the total number of UK subscribers was still up 17% on an annual basis, at 720,000.

Focusing on accountants

A big part of Xero's go-to-market strategy has focused on building the confidence of accountants and having them recommend Xero to their own clients. Adopting a new bookkeeping or accounting system is a choice that most small businesses won't do unless their accountant approves — or unless the business is ready to move to a new accountant that already works with Xero, which was my chosen route when I became a Xero subscriber more than a decade ago. This means that, as well as appealing to small business owners and finance directors, it must also offer a platform that accountants and bookkeepers find helpful as they file tax returns and prepare accounts for their clients. Xero arranged for Murat Kurt of UK firm Accountancy Assist to join last week's call and talk about his experience. He emphasized the value of automating routine bookkeeping, which has enabled the firm to add new services such as advising on credit finance and mortage applications. His verdict:

We're exploring extra advisory services. One of the biggest reasons is, because of Xero, I have more time now.

In recent years, Xero in the UK has benefitted from the Government's drive to encourage businesses to keep and file digital tax records, starting with VAT. Called Making Tax Digital, the initiative has forced small businesses to adopt digital bookkeeping and accounting. The company is now looking for similar results in South Africa, where it posted 40% growth in new subscribers during the year to reach a total of 175,000. It has been among the first in South Africa to offer e-filing for VAT, working with the South African Revenue Service. It has also launched direct bank API feeds with leading South African banks Nedbank and Investec, and has become the first cloud accounting firm to be added to the syllabus for accounting students at the University of Johannesburg.

Connected workforce management

Another strategy is to grow Xero as a platform for other activities outside of core accounting, which at the moment still brings in more than 90% of the company's revenue. In pursuit of that goal, last year was one of the company's busiest in terms of acquisitions. In October, Xero completed its acquisition of Waddle, an Australian company that provides invoice financing connected into online accounting software. This is an example of expansion into ancillary activities that leverage the financial data held in Xero, something that former CEO Rod Drury saw as a direction when I interviewed him five years ago.

Two further acquisitions were completed at the beginning of April. One is Tickstar, an e-invoicing business based in Sweden. The other is one of Xero's largest-ever, spending €183.5 million (NZ$305m, US$223m) to acquire Planday, a workforce management software provider out of Denmark, which has a significant presence in several European countries that Xero has not previously targeted, as well as the UK and US. Turner says that using digital tools to connect with workers and automate processes such as employee scheduling, time tracking and attendance is an emerging trend with similar potential to the digitization of core accounting, and provides a new vehicle for entering new markets. He explains:

We see this concept of a connected workforce and connected workforce management, which is in the cloud, providing mobile user experiences to the workforce — shift management, rota management — we think that's actually very potentially transformational ... It's happening right now and is applicable across a very large range of business types — obviously, retail, hospitality, but also things like healthcare, anywhere where people are being deployed and managed at scale.

The reason we acquired Planday, we think that's an immediate opportunity for us to enter new markets, without leading with invoices and VAT returns.

My take

Xero's progress has been impressive in the face of the stubborn inertia of the accounting profession and its small business clients. I was surprised to discover today that a colleague still hasn't switched to a cloud-based accounting platform, mainly because their bookkeeper and accountant aren't ready to make that move yet. Without a reason to move, small business owners will also feel they have more pressing priorities than switching to a different accounting package, for which they may end up paying more in annual subscription fees than they've spent on their traditional software license.

All the same, the time and effort that's wasted doing things the old way serves neither side well. Last year I sorted through old papers for a home office move and photographed the huge pile I used to send to my accountants for just one year of trading: 

It's such a relief that I no longer have to endure that annual rigmarole, which always made me run late despite the relative simplicity of that business. I dread to think what hoops I would have to jump through to deal with diginomica's accounts in the same way. Instead, we have a largely automated set of processes, based on Xero and two of its ecosystem partners, Dext and Flowrev, and we have moved to a monthly close, which typically takes about an hour to complete once all our supplier bills have come in.

Now Xero plans to expand into workforce management, which is another set of physical processes that are ripe for digitization, especially now that pretty much everyone of working age has a smartphone where they can install the app. I think this is a strategy that can work well, so long as it's sold alongside the accounting piece. But without that, I don't see much differentiation against other solutions that are more centered around distributed teamwork, such as Microsoft Teams and Workplace by Facebook. That limits the potential for Xero to expand in countries where it doesn't yet have an accounting or payroll offering. At the end of the day, I think Xero has to accept that, however slow the accountancy profession and its small business client base may be to move the cloud, there is no end run around that process. The company just has to buckle down and keep on plugging away until the last holdouts cave. It's never easy to cast off ingtrained habits, but once you do it there's no going back, and the pandemic has reinforced the arguments for making the move now.

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