Thursday, August 21, 2014

Digital First: Xero Signals a Major Expansion Beyond Accounting

Sholto MacPherson for writes: Xero CEO Rod Drury slipped three jaw-dropping announcements into his “state of the union” address yesterday at Xero’s developers’ day in Australia.
  1. Xero will start adding features beyond the basic accounting stack to measuring business “in flight”.
  2. The “window has closed” for app developers to make horizontal applications. The only option is vertical.
  3. Developers can’t turn a profit selling business applications for $50 a month unless they plan to have millions of customers.
Drury spoke quickly, without notes, rapidly leaping from database shards to the mechanics of the Xero add-on ecosystem. It was difficult to digest the full significance of the three statements above until afterwards.
Going over my notes, these seem to have enormous implications. Please add your comment below if you agree or disagree.

1. “We want to be more involved in the business”

“We want to move away from just recording the transactions to be more involved the business,” Drury said to a room of about 200 people, and repeated the theme a little later. “The step before recording a job is managing it on the fly. Xero will be moving in there so make sure you can still add value.”
Xero has never hidden the fact that it was going to fill out features that it sees as part of the core accounting application. The most obvious is a proper quoting workflow, long-promised but never delivered.
However, Drury’s comments yesterday signalled that quotes is only the beginning. Xero has plans to add components covering inventory, time and billing, business intelligence and CRM. The caveat is that it will only invest in the basic steps in each of these areas, so there will be room for add-on partners to create highly featured or specialised programs to extend Xero.
Drury gave the example of recording time and goods into a job “so you can see exactly what’s going on when it’s in flight”. That sounds a lot like time-tracking and billing apps such as Harvest and Timely.
Drury’s advice – “make sure you can still add value” – becomes difficult to fulfil if Xero is doing the basics of time-tracking already. The developers of these applications have to ask, “What advanced features in time tracking will businesses pay more for?”
Xero will inevitably cannibalise a large part of their customer base and the remaining pie might not be enough to feed a software development company.
Quoting is another feature set that will struggle to “add value” worth paying for beyond the basics Xero will one day cover.
“We are getting very close to quotes. We are hoping the quoting providers will do more complex functionality such as connect to price lists,” Drury said.
There are still areas that will remain safe for developers. Xero’s efforts in CRM will never threaten a serious CRM program. ERP-style apps for larger businesses that use Xero as the accounting engine should still be able to convince customers they are worth buying.
These are both complex applications that require much higher investment costs and deeper industry knowledge, i.e. not a typical product built by a garage startup.

2. “The window has closed”

Drury very clearly warned away developers from building a single-feature app that appeals to every small business. “The window has closed for building horizontal applications,” Drury said.
Instead, developers need to build an app dedicated to a single industry, or perhaps two.
In the past Xero welcomed all-comers to its ecosystem with little interest in what tasks the add-on app performed. It was a numbers game. Now Xero is making an effort to define the ecosystem that it wants.
Drury spoke about a business intelligence dashboard that will be added to Xero in the coming months which will display KPIs on widgets from within Xero and also from add-on programs. A horizontal app is less likely to have useful KPIs than an app collecting key data for a particular industry.
One of the interesting stats that came out of developer day was that Xero had an attachment rate of 20 percent. Drury thought that was pretty good but when you do the numbers it’s not so brilliant. If you divide a fifth of Xero’s 330,000 customers (i.e. 66,000) by the 300+ apps in the ecosystem it’s only 200-odd customers each.
“At $50 a month that’s $10k per month turnover.  With that Xero couldn’t even wrap a tram,” said one developer.
Add-on developers are in a difficult position because accountants, bookkeepers and business owners regularly tell them that they can’t price their app more than the core accounting system. Even if it’s at $50 a month, an app can’t pay developers, hosting and security on a monthly revenue of $25,000.
Which led onto Drury’s next point…

3. “We think the add-ons are too cheap”

“We think the add-ons are too cheap. We want to see small businesses paying $199 or $299 a month for vertical software programs so you can make $10k-$20k per customer each year,” Drury said.
This is a pretty staggering statement. A quick poll of apps in the accounts and expenses category – the type of horizontal apps Drury warned against buildling – shows that the average price is roughly $50-$80 a month. Even the CRMs tend to be under $120 a month, unless they are billing per user.
Drury said Xero had spent $250 million to get to 330,000 customers, which shows the commitment required to make a global SaaS application.
That number includes an enormous marketing budget used to educate business owners about the viability of the cloud as a software channel (thanks Xero!). But listening to Drury talk about the complexity of the Xero database, the amount spent just on hosting it in multiple data centres with failover plans and ongoing security assessments, a big cloud app is not cheap to run.
Maybe that’s why MYOB is forging ahead with investments in the mid-market space. Accounting apps for small businesses might just be hugely expensive to run.
However, the advantage of selling a small business app is that you don’t need a very sophisticated sales team and the sales cycle should ideally be very short. Sign-ups should pretty much be DIY at $50 a month.
If you’re selling apps at $199 and up a month, that requires more sophisticated sales techniques such as value selling, managing longer sales cycles and – given the app will need to replace many processes to justify its cost – a longer and more expensive implementation. And then there’s the cost of training and change management.
This business model is a big change for many developers because it requires human capital. Developers traditionally rely on their coding skills and own time to build an app. Getting to a proof of concept, finding customers and making sales is a much bigger task selling apps at that price.
These statements beg the question – how much does Xero rely on its developers? Probably not as much as it once did. As Xero builds out more features it will be able to increase its own price and ramp up market share.
The ideal Xero developer is an industry insider who has written the perfect app for real estate agents, manufacturers, dairy farmers, and so on.
The marketing value of add-ons is minimal in the wider market, but tie-ins with industry vertical apps could help Xero into bigger businesses.
The best way for developers to reduce the risk is to connect their application to multiple accounting programs. One developer at Xerocon compared the risks associated with sticking with one vendor to Australian farmers selling produce to the Coles or Woolworths duopoly. “If you only sell to one or two accounting vendors, then you have already lost.”
Sholto Macpherson - Editor and Publisher
Sholto is a journalist, presenter and public speaker with 14 years’ experience writing about IT for enterprise and consumer audiences. Digital First was formerly named from its launch in June 2011 until 28 July, 2014.


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