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Behind the scenes at Xero's US beachhead

This week I swung by Xero's new head office in the US, where much of the company's surge in new spending is happening (in its interim result, which saw losses more than double to to $17.1 million in the half-year to September, Xero said its US operating costs* increased by $5.9 million to $8.6 million).

But before I get to that, let's go back, back in time, to the mists of 2012 when Xero was worth a mere half billion ...

Around this time last year I swung by Xero's San Francisco office - a.k.a. a couple of benches in one corner of the Kiwi Landing Pad co-work space.

There was enough space for a dozen or so staff; four were there when I dropped by.

I captured the snug office in two snaps:

The Kiwi Landing Pad made it fast, simple and easy for Xero to set up in the US, president Jamie Sutherland says.

But in February this year, as staff numbers hit 30, it was time for Xero to find it own space.

The company relocated from the Landing Pad in SoMa (South of Market St  - a trendy, transitional area with some hot tech companies, including LinkedIn and Twitter, but also some rough edges) to Jackson Street on the northern fringe of the Financial District. It's a grown-up neighbourhood, full of investment bankers and venture capitalists who feed off nearby Silicon Valley.

Early October, Xero outgrew Jackson St and moved a couple of blocks north to Green Street, which is where NBR dropped by this week.


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ABOVE: the building; BELOW: The entrance and mezzanine floor.

Xero has 25,000 square feet over three levels in its new building, which Mr Sutherland says its its first long-term lease in the city.

Today it houses 75 of Xero's 110 US staff.

The others are in satellite offices spread around the country. “In Denver we just built a customer support centre. We’ve got some IT Ops people there. In New York we’ve got a small development shop, and in Los Angeles a sales team," Sutherland says.

There are a couple of Kiwis doing tours of duty in the US, but the vast majority of the staff are locals.

Xero has just over 600 staff worldwide, most across its two Auckland and two Wellington offices. 

There are rows and rows of empty seats in the new office. Sutherland says the plan is to house 190 staff in building. He won't give a hiring timeframe.

Earlier this week, CEO Rod Drury told NBR that Xero will double its worldwide staff numbers to 1200 over the next 18 to 24 months.

The US would be one point of focus for the recruitment drive, Drury said. The company had just raised $180 million (taking total cash to $230 million). Investors didn't want Xero to keep the money in the bank, the CEO said. They wanted it spent on developing new products and winning new business.

ABOVE: Sutherland with members of the Xero's US payroll team. The Xero president says with different laws and regulations, with each state it's like developing a payroll system for another country. A state flag goes on the wall as payroll for each state is completed.

Like many local techs, Xero focuses product development in NZ, with offshore staff mainly sales-focused.

However, 25 staff in the San Francisco are dedicated to the key area of payroll. 

Earlier, Drury told NBR that Xero's lack of payroll functionality meant it was "fighting with one hand behind its back" in the US market - and analysts say Xero must do well in North America to justify its heady $4.5 billion market cap.

The first payroll features will go live in December, Sutherland says.

“This is the payroll team here. We close them off with the plants to keep the quiet,” Sutherland says as NBR approaches the team working on the key project, indicating a couple of token pot plants. His low-key, droll humour is closer to Kiwi sensibilities than American (Sutherland is Canadian. He came to Xero in December 2011 from rival Sage Software, where he was VP and GM for North America, working out of an office Vancouver).

ABOVE: A behind-the-scenes glimpse at some of the high-tech, interactive technology used to plan Mr Sutherland and team's recent US roadtrip.

Xero has so far followed a similar tack in the US to other markets, working social media, the press, accountants and other influencers; staging its own events, and schmoozing around others.

In Australia it recently kicked off its first ever round of "traditional" marketing.

"It's like radio, bus stop signs, print – more traditional things you wouldn’t expect from an online company," Sutherland says.

He sees the brand campaign as a way to reach small businesses who aren't being swayed by their accountant, and says the offline approach makes sense on a meat-and-potatoes level. "We know a lot of small businesses spend time listening to the radio whether they're a restaurant or they have their own office or they're in retail. At retail they often play it all day."

He won't put a cost on the campaign, but close followers of the company will note it had a wider increase in spending in Australia as operating costs for that market swelled by $5.1 million to $12.58 million, according to unaudited figures in the initerim report released this week.
 

ABOVE & BELOW: At the risk of this beginning to look like a real estate brochure with the owner in every shot, here's Sutherland on the roof of Xero's new building. There are views south to the Financial District, marked by the Transamerica Pyramid, and north to the stretch of San Francisco Bay where the America's Cup was raced.

Will the traditional marketing approach in Australia be followed in other markets?

"It's a good test for us. If it's successful there - and it's looking really good - then we'll consider it for other markets. But our regimen around this is that it gives the goals we want to achieve. Some of it is around aided and unaided awareness; the second piece would be converting companies," Sutherland says. Xero is comparing uplift in areas where it's running the campaign to areas where it's not.

It's possible, Sutherland says; the company is still assessing the impact of the Aussie campaign.

On the traditional marketing front, it was interesting to see Intuit running TV ads for its QuickBooks products, with payroll one of the highlighted features. Although Xero has a new-found taste for traditional media, its financial resources are modest relative to those of Intuit, which made $US858 million on $US4.12 billion revenue in its 2013 financial year. It has a $US20 billion market cap, 8000 staff and just over $US1 billion in the bank [UPDATE: Friday NZ time, Intuit reported its first quarter FY 2014 result. For the three months to October 31, it made a net loss of $US11 million on revenue that increased 11% to $US622 million. In the year-ago quarter Intuit had a $US19 net loss.]

ABOVE: Xero's SF office is hardly teeming with staff. In part that's because half the desks are set up for staff yet to be hired. But it's also because others are out sellng, or networking. This week, for example, Sutherland was in and out of Salesforce's giant Dreamforce conference.

There's been a rise in MYOB smack talk about Xero recently (admittedly with Xero giving its Aussie-based competitor plenty of space to land a punch as it proposed a price hike for some Australian users, then climbed down after a backlash).

“In the US market we’ve seen Intuit doing the same things," Sutherland says.

"They hosted an event over the top of XeroCon after we announced the dates of that, which might have been coincidental,” he says in a dry tone that indicates where he stands on that question.

(XeroCon San Francisco, staged during October to capitalise on the America's Cup, was the company's first major event for partners and accountants in the US.)

"And we see them doing more roadshow stuff that they haven’t done for some time. That’s what we’ve been doing; getting in front of accountants and showing them what’s going on," he adds.

"Then the whole redesign of their interface … We’ve talked to other vendors and they feel they’ve pulled best practices of what’s already on the market.

"It seems like we’re leading the charge and these guys are starting to catch up. But we know it’s hard to develop from a platform that was built over a decade ago and making that more conducive to web apps is not an easy endeavour. It’s about us introducing product faster and changing the product categories," he says.

"The stuff we’re introducing is stuff this industry hasn’t seen like Xero Files – drag and drop documents associated with transactions. Talking to customers, it seems very obvious for customers to have that, but know one else is doing document storage."

He reels off other features, Xero has but Intuit lacks – “things like multi-currency, expense claims and even the way we allow for unlimited users and they cap at five” (although it’s fair to say Xero is making a virtue of necessity with the latter; one suspects it would like to eventually be in a market position where it doesn’t have to offer companies unlimited users under a single subscrption).

Intuit is doing payroll. As mentioned above, Xero is going to start filling that feature gap in its US product from next month.

Meantime, Sutherland takes a jab at his rival's payroll feature, whom he notes has a payroll product by dint of its 2009 acquisition of PayCycle, which became Intuit Online Payroll, “But we hear the whole web services integration is not as seamless as it could be.” (Earlier, Drury offered the blunter verdict that QuickBooks Online was “very weak” in that area, and others.)

Sutherland and Drury are not neutral observers, of course, but the CEO also touts that Facebook/PayPal billionaire Peter Thiel recently upped his investment, again, after analysing Intuit's latest moves. And Xero has been getting good notices in the trade press, plus postive coverage from the likes of Fortune magazine and Bloomberg TV.

It needs it. There's a hill to climb. Intuit’s QuickBooks has a near-monopoly on the 29 million or so small businesses in the US – at least of those that use accounting software rather than Excel, an offline spreadsheet, or simply shovel a box of receipts in their accountant's direction. Intuit's latest SEC filing says it has 4.9 million small business customers worldwide (in Q2 FY2012 it had 5.1 million) - so it seems many in the wider small business community are ripe for the picking.**

ABOVE: Sutherland on Bloomberg TV. The Xero exec's rising media profile is good for the company per se, and reduces what sharemarket analysts call "key man risk"  (as in, what could happen to Xero's share price if you-know-who gets hit by a bus).

But in the cloud area, things are a lot more finely poised.

In its full-year result for the year to July 31, released August 21, Intuit said users of its cloud product, QuickBooks Online, increased 28% during its 2013 fourth quarter to 487,000 [UPDATE: On Friday NZT Inuit released results for the the three months to to October 31, 2013 - the first quarter of its 2014 financial year. QuickBooks Online subscribers increased 5.96% to 516,000 duriing the quarter].

Xero is not a million miles from that total. On October 4, it reported an 89% annual gain in paying customers to 211,300 ("paying" is the operative word here; Xero has a standing challenge to Intuit to break out revenue numbers for QuickBooks Online).

The flipside is that Intuit is strong on its home turf; Xero has fewer than 20,000 of its customers inside the US, while Intuit has only 37,000 of its QuickBooks subscribers outside the US. As it adds bodies, and the addition of payroll lets it fight with both fists, Xero will be hoping to improve that ratio.

ckeall@nbr.co.nz

* Actually its US and rest-of-world operating costs, but with figures for Xero's major markets of NZ, Australia and the UK reported separately, and no major drive elsewhere, it's essentially a US figure.

** Intuit's most impressive stats are for its tax software. For its 2013 full financial year, it reported 26.2 million users of its US TurboTax product (19.3 million web, 5.8 million desktop and 1.1 millon through a freebie electronic filing option). It also reported 1.9 millon Canadian TurboTax customers for the quarter.


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Comments and questions
14

This article would benefit from fact checking:

1. The new QBO is a complete overhaul and not over a decade old. Xero is seven years old and has major limitations.
2. The price hikes for many Australians remain.
3. Only the US edition of QBO does not offer multi-currency because small businesses there don't need it.
4. Not only does Intuit have payroll already for the entire US, they also acquired Prestwick Services, which helps the cash flow of small businesses.
5. July 31 is not the most recent quarter. Intuit's Q1 result show 516000 QBO users. Outside the US, subscribers increased by 80% in one quarter and are up to 37000.
6. What's the point of Xero files if they can cease their service just like they did with their personal finance offerings? It's also not correct that you couldn't store files with other cloud accounting programs. Saasu offers it and there are a lot of apps for it. It certainly doesn't give Xero the edge given their massive shortcomings.

Hi there, 
 
I'll leave Xero to speak on its own behalf (or not, Rod Drury has a policy of not responding to anonymous comments), but some counter-comment based on NBR's current and previous coverage:
 
1. Sutherland's broader point is that Intuit (like MYOB and Sage) have to split their focus between online and offline products. 
 
Maybe Intuit will make a completely successful transition to the cloud and continue to dominate the small business market; I don't know - let alone whether it will be the degree of success required to justify Xero's dizzying market cap (as I've written).
 
But in Australasia (against MYOB) and the UK (against Sage), the complications of tending to a legacy product at the same time as launching cloud meant the legacy players did have a more complicated, distracted life, giving Xero a foothold with accountants and customers that it successfully exploited to gain solid market share. It's the same scenario wit large in the US - although as NBR has noted many times, Intuit is more dominant in its home market, and has better financial resources than MYOB or Sage.
 
2. It was an embarrassing climb-down for Xero to abandon its $A11 a month increase in Australia for companies wanting more than one staff member on payroll (as NBR noted). I wouldn't call the $A1 to $A4 increase that remains for most customers a hike. Investors will be watching to see how Xero's experiment with new higher-end plans for larger Aussie customers goes (to the three plans available today, new $A70, $A80 and $A90 options will be added from December, offering payroll for 20, 50 or 100 employees respectively. As with Xero's foray into traditional marketing, it seems to be another case of Australia being used as a testbed).
 
3. Sutherland's focus is on the US market, where he's correct that QuickBooks Online lacks multicurrency support. Is it a key feature for the US? Customers will vote with their wallets.
 
4. Completely agree. As the article notes, payroll is a key feature, and a complicated one to add in the US market, where every state has different rules and regulation.
 
Intuit has payroll in the US. Xero doesn't. 
 
Rod Drury  says Xero is "fighting with one hand behind its back" without the feature (due to be rolled out next month, as noted in the article).
 
5. Thanks for the heads up on Intuit's latest quarterly result, which has been added to the article above (it was announced as I flew out).
 
Well done Intuit continuing to grow QuickBooks Online subs, particularly outside the US.
 
But no doubt Xero will seize on the fact the offshore growth was off a tiny base, and that total QuickBooks Online growth slowed from 28% in the previous quarter to 5.96%.
 
Xero earlier said it wants to see how many of those who registered for a QuickBooks Online free trial using their credit card subsequently paid up. Today (Nov 24), Rod Drury told NBR, "If they were all paid then why don’t they break out the QBO revenue?" Drury says Xero will address the issue further at an investor briefing on Tuesday.
 
With its latest results, Quicken says all its customer numbers listed are paid customers.
 
6. As NBR has reported on August 28, the $5 a month Xero Personal will be discontinued from November 14 next year, and Xero will take a $700,000 impairment.
 
Any time Xero or Intuit or any other software company discontinues a product, it has to weigh the impact it might have on its customers' perceptions about its commitment to other products. 
 
But this case, it was a New Zealand-specific product, launched in a marketing partnership with the NZ subsidiary of an Australian bank, so it's not something on US customers' radar.
 
Rod Drury told NBR that Xero Personal  (or BNZ Money Map, as it was known to Bank of NZ customers under the Xero-BNZ partnership that spawned the product) customers have never been included in its paid customer count.
 
re: Files - Sutherland wasn't commenting on the market as a whole, he was saying QuickBooks lacks a document storage feature like Xero Files, which is correct.
 
CK

Chris

Your comment
"But no doubt Xero will seize on the fact the offshore growth was off a tiny base, and that total QuickBooks Online growth slowed from 28% in the previous quarter to 5.96%"

It intrigues me considering Xero works off a tiny base locally, in Australia and also its US base.

Xero is just an overvalued pimple on a pig's arse compared to Intuit and yet you and Rod Drury continue to articulate a story as though you are in the big league.

Chris, you're sounding like a convert to Christianity the way you report on Xero.

There are two quite separate arguments here.
 
1. Is Xero a good technology company, poised for commercial success? On this score it seems to doing pretty well. It's created 600 high-value jobs, and counting; it's won a good share of the Australasian accounting market in absolute terms; and it's got a good share of the cloud market worldwide. It's a great NZ success story, and I'm happy to report on companies like Xero Orion Health, Wynyard, Mako and SLI as they expand into new markets and in the process add a little much-needed diversification to our milk powder economy.
 
Xero might succeed in the US market, and it might not - as noted in the article above, Intuit is a formidable competitor with financial resources way beyond those of regional foes like MYOB and Sage.
 

2. Can a $5 billion market cap be justified? I have no idea how Xero will perform on the share market in future. Factors in play go beyond success in creating great new software, and winning customers and making a profit (although of course that would help). Some investors are taking a punt that Inuit or another player will buy Xero. Others are hoping Xero will list on the Nasdaq, creating momentum on top of momentum.

Of course, Intuit could also push back more strongly, and simply attack Xero, Rod Drury could get hit by the aforementioned bus, or a new competitor could come along with a brighter idea, among other risks that NBR has mentioned along the way.

Rod Drury points out Peter Thiel - whose investment companies dominated the recent $180 million fundraising - is a sophisticated investor. But  a penny for Mr Thiel's thoughts as Xero's shares recently topped $40; when his most recent share purchase was announced on October 14, the US-based investor bought in at $18.15 - the market price at the time. 

As Drury has pointed out, he doesn't control Xero's share price - but his company has exploited it to raise $180 million on the cheap (by issuing a small percentage of new shares, which did not dilute the price - in fact quite the opposite).

I've covered opinions from analysts who say Xero is a buy, and those who say Xero is a sell. Read the latest roundup here.

Nice to see a well written and informed response to a snappily written post by someone who is clearly a QBO supporter who didn't read the article correctly, and chose only to respond on the implied negatives

Its nice that he replied but responding do anything the Doctor says is a waste of time. Most of his comments are in this vein and contain very little substance. Fine to take a contrary position, but perhaps you should support it with an argument rather than insults....

How come Dotcom gets criticized for "exporting jobs" but Drury gets a free pass?

Drury has a pretty clear strategy - most Xero jobs in Auckland or Wellington, but bodies on the ground in the US, UK, Australia and elsewhere for sales and sales support.

I'm not sure how NZ figures in Dotcom's music service plans (or his parallel movie site), given the Hong Kong ownership and Portuguese development. He's talked up local hosting before, but with Mega that element has been centred on a German provider.

Is Intuit's growth down to 6% from last quarter's 28% or up from 5% for the same period last year?

Can you please disclose how your trip was funded?

Quarter on quarter. My trip to San Francisco was was funded by an unrelated party. I visited Xero (and other NZ companies) while in town. None of the companies I visited invited me. I emailed them to say I was in SF and asked if I could drop by.

Hi Chris,

Just wondering (in the interests of full disclosure) whether you own shares in XRO?

Cheers

I don't own shares in Xero, or any other NZ tech company.

I've covered opinion from analysts who rate Xero a buy, and those who rate it a sell.

Hey, stop attacking Chris. I have seen many critical reviews by Chris on Xero. Just because more recent ones have been in a different vein doesn't mean anything other than he has considered the options and is reporting accordingly, in his opinion.

Disclosure: I do not own any Xero shares.

Enjoyed the article Chris. Really good to gain an insight into Xero's set up in the States and hear from Sutherland.