Xero's half year report - firing on all cylinders

Profile picture for user gonzodaddy By Den Howlett November 26, 2013
Summary:
Xero has understood the value of building a platform for growth and not just another software. This is helping it bring new functionality while instilling confidence to expand aggressively.

Xero SF office view
Xero San Francisco Office view

Xero has just released a detailed half year report that indicates it is firing on all cylinders. Co-incidentally, I visited the company's San Francisco offices, meeting up with both Gary Turner, UK MD and Jamie Sutherland, US CEO.

Having raised a further NZ$180 million (USD 147 million) in October, Xero believes it is poised to grow the business substantially in all markets but the US market in particular. It has hired 100 people for that geography and fitted out downtown San Francisco offices capable of holding around 200. It is clear Xero is throwing a LOT of money at the US operation but then it has to in order to both attract the talent it wants while fueling the revenue engine in a market that totals some 36 million SMEs.

On to the numbers. It is a sure sign of a confident company that it talks in considerable detail about what it has achieved and where it is going. Here are some examples:

country growth xero

 

and...

xero ACMR growth

All figures are expressed in NZ$.

The acceleration in investment is clearly impacting the bottom line with a reported loss of NZ$17.1 million. However, with a war chest of NZ$230 million, Xero can go a long way before it runs out of cash. In talking to the company, two things emerged:

Investment barriers

They believe the entry cost for a global player in the SME SaaS/cloud accounting market is around NZ$200 million. This is a very high barrier to entry for any vendor that also impacts the incumbents that simply cannot afford to devote those resources without cannibalizing their own models. That's do-able if it can be explained in a coherent manner to the financial community. So far, we have not seen that although Intuit is having (yet another) foray into this domain with its beefed up QuickBooks Online offering.

Even if the Sage's and Intuits could muster the funding, they face three significant problems:

  1. Institutional DNA prevents them from placing this kind of bet
  2. Xero has aggressively built out a channel of partners who are doing things differently. They represent the future face of professional accountancy and do not look like the firms of old. It is hard to see how an incumbent could offer a proposition that will prove attractive to these new professionals.
  3. Xero has grasped the necessity of building its offering upon a platform for growth and expansion. None of the other players in the market has understood this. It is very difficult to build a platform that serves both end user organizations and professionals while holding the promise of limitless expansion, either through add-ons or new functionality.

The platform advantage

xero plarform

An example is the recent Files extension. This allows users to attach a document to an accounting record. Turner reckoned that when this was presented to a group of professional accountants in the UK, the audience gasped.

The potential is huge. Having the ability to attach a receipt (as example) to an expense record, or an order (to a sales invoice) opens up the potential to provide documented proofs for tax purposes. This in turn means Xero based accounts could be considered more reliable than those that have to rely upon paper based documents.

While rudimentary today (you have to manually upload), Xero is talking about adding in the ability to email documents. I can see numerous additional benefits as this functionality improves. What's more, it obviates then need for professionals and their clients to run Dropbox or Box accounts. And while Expensify might be a partner today, Files could be the cornerstone for rendering that partnership obsolete.

That illustrates the difference between building an application that can be consumed by others and an application platform. And in tomorrow's world, the platform wins.

Tipping points?

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Gary Turner - UK MD Xero

In a UK survey of 250 professional accountants commissioned by Xero, 45% of respondents said they had no plans to adopt cloud systems. 28% said they are using cloud already while 27% said they have plans to do so. The adopted figure is remarkably closely aligned to results from a survey conducted by ReallySimpleSystems that I am currently digesting which said 26.4% are using cloud accounting systems.

On a quick tot up, Turner and I concurred that the total UK uptake by those paying for cloud accounting now amounts to some 100,000 customers. It is still a drop in the ocean and given the both the addressable market and Xero's growth plans, there is still plenty of runway before the market tops out. Even then, Xero has plenty of options by which it can expand its offering and scoop up revenue that would otherwise go elsewhere.

Clear skies ahead?

Xero has put its foot firmly on the expansion gas having convinced investors that it will be the winner. In turn, the markets have rewarded the company with a monster valuation. However, there are some glaring holes and major challenges.

Multi-currency handling needs improvement. It is easy to get confused when reviewing bank reconciliations involving other currencies.

Reporting is not great. This has been an ongoing challenge the company continues to solve.

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Xero offices

While Xero makes a big deal out of bank feed support as the cornerstone upon which its ease of use is built, there is a long way to go, especially as the uK banking system in particular has a non-standards based approach to file formats.

We should not write off Intuit or Sage but I wouldn't bet with them at this point. Their reliance upon an incumbent profession which itself is being cannibalised by both software and new entrants is eroding their addressable market while improving Xero's chances. But what of others?

Kashflow is now part of Hg as is e-conomic. They're off the table for all practical purposes as IRIS tries to figure out how to integrate what looks like a hairball of acquisitions into a coherent offering.

That really only leaves FreeAgent as a significant independent operator. But they don't have the financial muscle with which to go toe to toe with Xero. Clearbooks is still playing in the weeds as is Crunch and others.

Add it all up and you'd be forgiven for thinking that the winner has already been decided. But then this is a very fast growing market and we could yet see changes in the running stakes as the story unfolds.

Disclosure: we are a Xero paying customer