{audio:0:10:16} I was looking at the recent Xero numbers. Their [monthly] churn rate, on the latest deck.

{audio:0:10:39} When you annualize that, 1.13%, that’s probably about 13% a year, for annualized. On average, you’re looking at about seven to eight years, in terms of the lifetime that the customer is going to stay with you. That’s a pretty sticky customer, in a SaaS business, seven or eight years. To answer your question, in terms of how they did that, first of all, it comes back to having a great product. Xero have got a great product, FreeAgent have got a great product and, ultimately, if your customer is finding value and finding your product easy to use and, in both of those, with financial accounting software, pretty central to the way that they run their business, then making that product into what I call a killer app, which is a business-critical app that a small business owner has to go into and use on almost a daily basis, essentially, that’s how you create the stickiness. You create the stickiness and, therefore, low churn rates, by making sure that you are maximizing customer engagement, by making it a meaningful, central part of their day-to-day business environment.

{audio:0:12:01} The first way to get those churn rates is to make a great product and make it as engaging and sticky as possible, as a business-critical app. It then comes down to things like reliability. Obviously, in a SaaS environment, your software and your data is being held in the cloud and that is maintained and the uptime is very much in the control of the service provider, either Xero, or maybe Amazon Web Services, where the data and the software is being hosted. Ultimately, you want to make sure that when you want access to your software and your data that, first of all, it’s reliable access, so the uptime of the service of there. Secondly, and crucially nowadays, that your data is really, really secure, as well. Security and credibility around security is really important, in a SaaS environment.

{audio:0:12:57} Then the third element, as well has having a great product and having good uptime and good, reliable service, is then the support tools around that. In terms of minimizing churn, if a customer needs help, we live in an instantaneous environment nowadays. Whether you want to see what’s on TV tonight, or whether you want to see what’s on at the cinema or if you want to find out the football scores, people go their mobile phones. There’s a demand for instantaneous access to knowledge and access to information. Therefore, the way that you can also retain your customers and get those good churn rates, that Xero and FreeAgent have got, it’s about giving access to your customers, to that information, ASAP, on demand almost, so that they feel as if they are getting good service and they feel as though Xero and FreeAgent are good businesses to deal with.

{audio:0:14:00} How different is that, really, from what Sage might be offering, for the equivalent customer, in this space?

{audio:0:14:06} To be fair to Sage, they are transitioning to that type of service now, but it probably took them a lot longer to do that than it probably should have done. I guess, when you compare how the Sage service used to be and still is, to a certain extent, the access to the updates to the software was, again, very different. I know that, now, things have transitioned in the Sage business, as well, to have cloud-based software, but a lot of their software is still, what I would call, hybrid cloud, which is where you’ve got the data synching in the cloud but, actually, there’s still an implementation of the software, on the local PCs and server. Sage 50cloud is a good example of that. They’re not fully cloud, in my view, in the true and purest sense. But when you look at the way they also used to do their customer help, for example, it used to revolve, very much, around a helpline. You would have a number to call the helpdesk and then a human would answer the phone and try and answer your query. They still offer that, but they offer some of the digital services, as well, such as online knowledge bases and video learning and that type of thing.

{audio:0:15:28} They’re definitely transitioning, but they were probably very slow, compared to the true cloud providers, like Xero and FreeAgent. But Sage have had some customers for 10, 12, 15 years. They’ve got a fairly loyal customer base and a lot of their customers are used to phoning that helpline and, therefore, probably aren’t transitioning to more of the digital, online, on demand type services, as quickly as some of the true cloud providers, like Xero.

{audio:0:16:05} Then customers get a bit frustrated, because they’re hanging on phone lines, listening to music. To be fair to Sage, they are going through that transition process and they are starting to bring more and more digital, online, on demand services, but in my view, I still believe that they are behind the true cloud players.

{audio:0:16:29} Could you just bring that to life for us, a little more, especially on this point of customer service and the experience that I would get with a Xero or with FreeAgent, versus Sage, if I’m trying to solve a problem, today.

{audio:0:16:47} There’s various elements and various channels to customer service or help, as I call it. I guess the way that FreeAgent and Xero do it is very much by having online knowledge bases. You can go to the customer extranet areas of their websites and type in what problem you are having and it will return knowledge base articles to try and answer the question for you, in that manner. Obviously, using webchat technology, as well, is quite common now, certainly for FreeAgent. We have also got something that we call Ruby the Robot. Ruby the Robot is actually a webchat where you type your issue in and then it goes off and searches the knowledge base and returns the information for you, as opposed to having to search the knowledge base yourself.

{audio:0:17:45} So there’s that type of technology which is available, certainly at FreeAgent and Xero. At FreeAgent, we recognize that certain customers still want to talk to a human and we are one of the few providers that offers, in the cloud space, a telephone helpline, as well. Sometimes, you do need that as a backup, to be able to service the more complex customer requirements. It’s not that the telephone is dead, but it’s just not people’s first choice of getting customer help and answering their queries.

{audio:0:18:20} Again, some of those features are available to Sage’s customers. Webchat, for example, and access to knowledge base articles. I think that what most Sage customers would probably do is to default to the telephone service first and then, potentially use the other elements as a backup, as opposed to Xero and FreeAgent customers going the digital route first and then using the telephone as a backup. It comes back to that philosophy and psychology of your users.

{audio:0:18:58} Having set the scene, with some fundamentals on the SaaS business models and the industry, as a way to get into the next part of our conversation on accounting software in the SMB space, in the UK, could we start with looking at the recent Xero numbers, where over the last year, in the UK, they’ve grown their revenue by over 50%. Could we get into that story and how exactly, in your view, they’ve done that, in what is a reasonably mature market?

{audio:0:19:40} You say it’s a mature market. Actually, when you look at profile of the market, there’s about 5.7 million businesses in the UK, according to ONS. It may not be the exact number, but it’s round about that figure. I guess, when Xero entered the market, back in the UK, in about 2009, but they probably didn’t make any major headway into the market until probably 2012. That was still only eight years ago. At that stage, of the 5.7 million businesses in the UK, Sage had a huge amount of market share, particularly in those SMBs, SMEs, which make up the majority of those 5.7 million businesses. Probably only about one million of those 5.7 million, back in 2012, had actually used computerized financial accounting systems and, predominantly, it was the Sage systems, at that point.

{audio:0:20:48} At that time, it wasn’t a particularly mature market. There were probably about 4.5 to 4.7 million businesses that were using Excel spreadsheets and paper-based systems which, at the end of the year, they would send to an accountant – the old, what I call, shoeboxes of receipts and bank statements – and the accountant would have done the majority of the work, to product the end-of-year tax return and the end-of-year company accounts. It wasn’t actually that much of a mature market, when Xero entered it. It was probably quite a closed market, in terms of the fact that Sage was the incumbent provider and were the dominant player in the UK. In terms of making that initial headway, the way that Xero did it was by having a great product; having a different product, in the respect that the data was in the cloud. It was very much a true cloud system which, initially, was probably a bit of an issue, back in 2012, even. It was only eight years ago but now we think about our data and software in the cloud as normal.

{audio:0:22:01} Back then, it wasn’t that normal and people still had a lot of concerns about data security; accountants, in particular. The accountancy profession had a lot of issues around data security. At Xero, what we had to do was, really, to educate the market. We had to educate the market about the benefits of having the accounting software and the business data in the cloud, both for the benefit of the end-user businesses, but also to the accountants themselves. What Xero were very, very good at was that they identified, back in 2012, that actually, the accountants were crucial to their growth. Accountants are seen as trusted advisors to the end-user businesses and, therefore, if Xero got the accountants on-side, and got the accountants educated and knowledgeable about the benefits of having financial accounting systems in the cloud, then they would influence their customers and, essentially, create a sales channel or a wider sales team, of all the accountancy practices in the UK, to sell the virtues of Xero, on Xero’s behalf. That, essentially, was pretty much the model.

{audio:0:23:15} That was a very different model to the likes of Intuit, for example, or Sage, to a lesser extent, in terms of the fact that they had a much more direct model. They were selling direct to end users, which meant that the cost to acquire those end users was relatively high, because it depends on brand awareness, advertising, even direct marketing, at that point, because you’re actually going to each one of the end users and trying to get them to buy your software.

{audio:0:23:44} Xero took a very different approach and they got the accountants on-side and, essentially, got the accountants selling and recommending Xero, on behalf of Xero. Those two elements were pretty key to Xero’s success, initially, in the UK. First of all, having a great product and, secondly, having a very good strategy of how to get to those end-user businesses, via the accountants. Those were probably the two crucial bits of early strategy in the UK, that Xero had and they’ve built their current success on the back of those two things.

{audio:0:24:22} They’re now eating into the installed bases of the incumbent, to a meaningful degree?

{audio:0:24:27} Yes, absolutely. Yes, they are eating into the incumbent user base of Sage, in particular, but also, they have had a large amount of success in attacking that white space market, as I call it. Those 4.5 million businesses who were not using Sage; they were using Excel or they were using paper-based systems. That was the low-hanging fruit. The other thing which also helped Xero to attack that white space, was actually the pricing strategy under a SaaS-based model. Traditionally, Sage would have sold a product on a perpetual license base, for an initial price of anything from £400 upwards which, for a small business, is not an insignificant investment. For Sage 50, £400 was the entry point. Xero came in and said, well, we’re not going to charge a perpetual license; you just have to pay £30 per month. Therefore, that lowered the price barrier of entry, for a lot of small businesses in the UK which, again, was a differentiator between them and Sage, at the time, back in 2012.

{audio:0:25:46} As you were saying, that dimension of white space is crucial. As the business grows, with this expectation that it is, increasingly, eating into the installed base of the incumbent, how, as an incumbent, to put ourselves in Sage’s position, do I deal with this threat and retain my installed base?

{audio:0:26:12} It’s very difficult. Sage have been going through their challenges for the last eight years, really. The way that Sage approached it, initially, was by trying to develop their own cloud solutions, very quickly. They did that relatively quickly; probably slower than they should have done. Their first pure cloud product was the Sage One, as it was then called. It’s now called Sage Business Cloud Financials and Accounting. They quickly tried to get an equivalent to Xero, out in the market and probably brought that product to market too quickly. There was a race to get something out and although I wouldn’t say not fit for purpose, because that would be a bit harsh but, certainly, it was very much behind Xero, in times of the like-for-like functionality and, therefore, struggled to gain traction in the UK market, versus Xero.

{audio:0:27:20} So the first thing that Sage did was to try to bring out its own cloud solution. The second thing which, to be fair, Sage have been quite clever on, is that their main installed base in the UK was on a product called Sage 50; it still is on a product called Sage 50. That’s the quite clever bit that they did, in terms of defense mechanism. Although Sage 50 isn’t a true cloud product, they brought out a cloud version of it, called Sage 50c. That allowed people to have the benefit of putting their data in the cloud but, actually, still have the robustness and the software that they were used to, in terms of layout, by staying on Sage 50.

{audio:0:28:09} What that meant, in practical terms, is that yes, you still had to have a piece of Sage 50 installed on your PC, but with the data synching to the cloud, you could go home and have another installed piece of Sage software on your home PC, that still accessed the same data, centrally. You could work at home or you could work in the office. So it was a bit more portable, but you still had to have a copy of Sage 50 on whatever machine you were using, to log into your data. That was another of their defense mechanisms, to protect their existing Sage 50 user base, by developing a hybrid cloud version of Sage, as I call it. I think that that has helped them defend that against Xero, to a certain extent. But ultimately, it’s not a true cloud product and, therefore, over time, their base will continue to be eroded, unless they migrate that base onto a true cloud version.

{audio:0:29:17} Typical Sage, is that they brought out new modules, as well. Things like RTI around payroll, in 2014 or 2015. They made sure that their existing software was compliant but continued development on the cloud solutions, in parallel.

{audio:0:29:43} From a product strategy perspective, they’ve also made a number of acquisitions and seem to be broadening their offering. How much of an advantage does that give them, do you think, in retaining customers and in acquiring new customers, in offering this suite of solutions, versus a more focused player?

{audio:0:30:01} It’s a good point you make there. One of the ways that they have defended against Xero is by going out into those other solutions, like HR solutions, CRM solutions, that type of thing. I think that’s been a good strategy because, essentially, they’ve been saying, to get all this extra functionality, you don’t necessarily need to move your core financial information, your core financial database. I think that’s been a good strategy. It’s also enabled them to generate extra revenues, because normally, Sage would charge extra for those modules. That’s certainly contributed towards the organic growth figures that they’ve had in the last three, four, five years, by acquiring those pieces of software and then cross-selling and upselling their existing customers onto those products.

{audio:0:30:53} I think, from a retention perspective, they have used that acquisition of software strategy, to retain their existing customers and that’s been one of the ways that they’ve done that. I think where Sage are continuing to struggle is actually in the new customer acquisition space, certainly in the SME sector. A bit less so in the mid-market sector, because they’ve got a good, new cloud product in that mid-market sector, as a result of one of their acquisitions, Sage Intacct, which is a US SaaS-based product, which Sage purchased three or four years ago. That is a good product in the mid-market and that’s enabled them to acquire new customers in the mid-market and their customer acquisition has been a bit better in that space.

{audio:0:31:39} But in the SME space, they’ve still struggled to acquire new customers. Their revenue growth has been more a strategy of retaining existing customers and upselling and cross-selling them onto these other products, which they’ve acquired, rather than going out and acquiring tens of thousands of new customers a year, like Xero are doing, in the UK.

{audio:0:32:04} How big would you estimate the SME space is, in terms of market size? How do you like to look at it?

{audio:0:32:14} I tend to look at it in terms of the customer numbers. I’ve already mentioned that there’s about 5.7 million businesses in the UK; probably about five million of them are in the SME space, just because of the profile of UK businesses. In terms of market size, of number of businesses, it’s about five million. In terms of revenue, it’s difficult to estimate. I’m sure there are probably studies out there which will give you a better answer than I can give you. I would say that it’s in the 500 to 800 million type size, maybe even a bit more, actually.

{audio:0:32:56} Having operated in that space for a while, how do you like to segment those five million businesses, in terms of broader categories?

{audio:0:33:05} There’s a few ways you can do that and, actually, as part of one of the initiatives that the government introduced last year, Making Tax Digital, meant that all VAT-registered businesses in the UK had to do their VAT submissions online. That was legislation that was brought in last year, by HMRC, in the UK. One of segmenting those customers is VAT-registered businesses versus non-VAT-registered businesses. Again, the majority are actually are in the non-VAT-registered space, because something like 75% of those five million businesses actually don’t have any employees at all. They are IT consultants, gardeners, dog walkers, mobile hairdressers, builders, electricians, who have no employees and, therefore, that’s another way that you can segment it. So VAT-registered and non-VAT-registered, limited companies versus sole traders or, typically, on size of turnover or, the way that I tend to do it, is on employee numbers. I think employee numbers is probably a better indication of the size of businesses and complexity of businesses, rather than, necessarily, turnover.

You could have a property development company that is turning over millions and millions of pounds, but is actually only employing five people. Therefore, they are not a particularly complex business; it’s just that their invoice values are quite high. As opposed to an engineering business, which has got 20, 30, 40 employees, who many only have an annual turnover of two, three, four million, but has got quite complex business needs, from a financial accounting perspective, because they’ve got lots more transactions. Each one of those transactions, in terms of servicing their customers, is a lot more complex.

{audio:0:35:03} Yet another way that you could profile the SME base in the UK is based on vertical industry types and SIC codes. Service-based businesses versus retail versus manufacturing versus distribution. There’s a number of ways that you can slice and dice it and people do it in very different ways, to be honest.

{audio:0:35:26} Maybe towards the upper end of the SMB space, how do you see the market structure evolving?

{audio:0:35:40} It’s the most competitive, in the respect that it is the most mature bit of the market, I think it’s fair to say. For the top end of the SME space and the bottom end of the mid-market space, or even into the mid-market space, the majority of businesses there will already have some type of financial accounting software or business solution. Firstly, because of the size and complexity of those businesses and, secondly, because of the compliance requirements around Making Tax Digital, filing of final accounts, etc. That is the most competitive, in terms of the fact that a lot of those customers are probably very sticky, because they’ve had systems in place for quite a long time. They’re probably quite loyal to their incumbent provider and, therefore, trying to win one of those businesses or acquire one of those mature businesses, is actually quite difficult for a software supplier. You have to leverage the incumbent supplier out and that’s quite a painful process, sometimes, for the small business itself, to actually go through that change process of a change in software suppliers.

{audio:0:36:57} I think the real battleground is for that white space, that I mentioned previously. By definition, they’re not using any software and, therefore, they’re fair game and open season, to acquire as a new customer. Therefore, in terms of the number of providers, such as Sage, Xero, Intuit, FreeAgent, going after those businesses, we’re all going after that white space, because it is the low-hanging fruit. So the most competitive part of the market, in terms of winning new customers, is actually in that white space. You then start to get into, not only functionality type scenarios or comparisons, but it also becomes very price sensitive. It’s about the software suppliers trying to generate market share by making it really attractive, from a price perspective, to get those white space customers on board.

{audio:0:38:04} Is it harder to move down market or upmarket, as a vendor?

{audio:0:38:14} I think, as a vendor, it is actually harder to move down market. The reason for that is because, once you have built a piece of software for a certain part of the market, such as the mid-market, taking complexity out of that product is actually harder than building complexity into a fairly simple product. Let me give you an example. If you were using a product like one of the Sage products in the mid-market, like Sage 100 or Sage 200, that is built for a relatively complex business, who probably needs to analyze expenses and profit and loss, via departments and cost centers. It has probably got some quite detailed authorization processes around bill payments; it may need one or two bits of authorization to go through there. It probably has quite a detailed stock system, with bin numbers or things like that. It may have multiple price lists, for multiple customers. All that complexity is built into that mid-market product.

{audio:0:39:28} If you then strip that down and think about what a landscape gardener needs, they need the ability to raise a very simple invoice to a customer, for the work they do; they need to be able to capture their expenses and they need to be able to pay their suppliers for their materials and they need to keep on top of the cash flow. That is a very simple product, compared to a mid-market product with all those authorization levels, those cost centers, those departments.

{audio:0:40:09} The other reason why it’s easier to go upmarket is because, nowadays, you don’t necessarily have to build the functionality yourself. What FreeAgent and Xero have done very well, is actually built an API, which allows their software to connect to other specialist software areas, such as stock systems or ecommerce systems or payments systems. Those ecosystems, of what we call add-on partners, basically broaden the functionality of products like Xero and FreeAgent, without Xero and FreeAgent having to build that functionality themselves. That’s another powerful way that the likes of Xero can go upmarket, because they can use those add-on partners as an extension of functionality of their software, to appeal to those more complex businesses. Whereas the traditional mid-market suppliers have to build all that functionality in themselves, because they haven’t got god APIs and are not use to embracing this wider ecosystem, essentially.

{audio:0:41:16} How does a business, like Xero or FreeAgent, look at whether to build something, versus partner, in terms of product strategy?

{audio:0:41:27} I think it comes down to customer demand and customer feedback, in your target market. That gives you an indication of how core that functionality is, to your target market. For example, in FreeAgent, if we are getting asked for some additional specific reports that our customers want, then depending on the number of requests that we get for that and the feedback mechanisms from our customer surveys and things like that, as well as our support statistics and the analysis of that data, if we felt that it was a report that needed writing that was going to be for the general benefit of the majority of our customer base, then we would build that ourselves. That’s very different from one-off requests from customers that say, it would be great if we could this or report on that. If you’re only getting infrequent requests for stuff, then that would indicate that you are probably better partnering, rather than building yourself.

{audio:0:42:41} What you don’t want to do is become a bespoke software house, for two or three different customers, who demand certain things. You have to build your software to appeal to you core target market.

{audio:0:42:59} On the subject of pricing and really to bring that to where we are today, in the context of the current market and in the SMB space, what’s happening to pricing, in the crisis, or as we go through a crisis?

{audio:0:43:16} In terms of the Covid crisis, specifically, I think I mentioned before that these products are fairly business critical and, therefore, they are very sticky, from an existing customer perspective. Unfortunately, we are going to see some business failure, in the next few months. I think that’s inevitable. Therefore, software providers, like Xero and FreeAgent, are going to lose customers, due to business failure. But the ones that remain in business are going to be pretty stable and will continue to pay their monthly subscription fees. I think what we’ve seen, in the Covid scenario and the current climate is, it’s difficult to acquire new customers. We are still acquiring customers, but not at the same rate as we did, pre-Covid. That’s partly because some businesses aren’t even trading at the moment. If you’re not trading, why would you look for a new piece of financial accounting software?

{audio:0:44:19} I think that’s just a natural thing that is happening, that growth rates, across all providers, will slow down. I think the main battleground and where pricing will become interesting is when businesses do start to get back to work and some degree of normality does come back. At that point, the one thing that the Covid crisis has probably taught a lot of businesses is that they do, actually, need to be more on top of their finances and they do need to get more control over their businesses, just in case, God forbid, another Covid crisis comes again, in two, three, four, five years.

{audio:0:44:59} Therefore, what I anticipate will happen is, some good special offers, in September or October time – it’s probably a bit insensitive to do this at the current time and in the current climate – some initial offers for businesses to come on board, with Xero and Sage and Intuit and FreeAgent, whereby there could be six months discount, at 40% discount, on each subscription. I think there will be a bit of – a race to the bottom is probably not quite the right term – but there will be some good promotional offers out there, to try and gain that market share of people who are coming back in, post-Covid. But also for some of the start-ups which, a bit like a phoenix from the flames, there will be a resurgence in the start-up businesses, post-Covid. Businesses which have failed will tend to have serial entrepreneurs and they will start up a new business, post-Covid. Or people will like working from home, being masters of their own destiny and may like the idea of starting their own business. They will be, again, gold dust and key targets for the providers, to get traction and gain market share.

{audio:0:46:26} I think you will see, in some areas, some very aggressive and interesting pricing offers, initially, with a view to gaining that market share. But then, undoubtedly, once those offers come to an end, everyone will be then trying to work out how they can monetize those new customers, by upselling and cross-selling them onto different or complementary products and services.

{audio:0:47:02} As you mentioned, pricing is this huge question right now. I picked up, recently, an offer from QuickBooks – 60% off for six months. That looks pretty aggressive. Could you help us understand how a business, like Xero or FreeAgent, would look at making it about more than just price? Perhaps starting with how Xero did that, in the past.

{audio:0:47:34} Let’s take the Xero versus Intuit scenario, because I think that is quite a good comparison. Intuit, typically, in the last three or four years, in the UK, have grown market share by throwing a lot of money at above the line advertising. You’ve probably seen then be quite prevalent on TV adverts, etc. Also, by aggressively pricing their software, encouraging end users with the sort of offer you mentioned, but also with accountants, in terms of bundling products. It’s not unheard of, in the accountants’ channel, for Intuit to offer 50 licenses for £1 each, to accountants. You can’t get much cheaper than £1 per month, really.

{audio:0:48:21} So they’ve gone down the aggressive pricing route and that is all about gaining market share, gaining traction and then monetizing the customers that you’ve acquired, by either, unfortunately, price increases in the future or by selling them other products and services which are complementary to their core software.

{audio:0:48:44} I think Xero have taken a slightly different approach, where they position themselves, very much, as a premium product. Whilst they did a few offers, certainly in the early days, they didn’t do many offers. It was, pretty much, this is the price; we believe we’re the best product in the market. In terms of your specific question about adding value, it was all about adding efficiencies into business processes, when Xero first came into the UK. That was by using things like connecting bank feeds, from your bank, into your financial accounting software, so that you didn’t have to actually rekey every single transaction into the software. The bank feed took your bank transactions, they were already posted into Xero and all you then had to do was analyze each of the transactions, rather than typing in every single one of them.

{audio:0:49:33} In terms of value, certainly with the accountants, Xero very much went down the efficiency route.  They also went down the route of, particularly with their relationship with the accountants, around how they could add value into the accountant’s business. The way that they demonstrated that was by saying to the accountants, well, instead of waiting for access to your client’s data, at the end of the year, with their permission, you can log into their data at any time that you wish to, because the data is in the cloud. What that means, you can start to do more frequent monthly management accounts, for example, and show value to your customers by showing them their profitability and giving them business advice on a monthly basis, rather than on an annual basis. Because you are offering them a better service, you can charge them for that and you can feel more valued that  the advice you’re giving them is helping them to grow the business, rather than just to remain compliant and do the tax return and VAT return on time.

{audio:0:50:36} So Xero went down the route of, that’s the value that we can add to you, as an accountant and also the value that we can add to your customer’s business. Because you’re more on top of the finances, you’re being more efficient in terms of your business processes. I don’t think Intuit went as hard, on that message, as Xero did. Therefore, Intuit chose the above the line campaign, plus the aggressive pricing, which was quite a different strategy, from Xero’s.

{audio:0:51:08} How do you see that shaking out, over time?

{audio:0:51:11} Xero have still got very impressive growth rates, as have Intuit. As Xero have become more mature, in the UK market, they have had to be a little more price aggressive, to maintain those growth rates, both in terms of offers to direct end users, but also to accountants. I’m certainly seeing that Xero are putting more and more attractive pricing together, for accountants, on behalf of their clients. They’re not getting totally sucked into that price war, but they’ve certainly been tempted by it slightly, shall we say. They have succumbed to it, to a limited extent. I think the other thing that we’re seeing with Xero, at the moment, is that having got quite a lot of traction in the UK market, with about 600,000 end user customers and subscriptions, they are now starting to try and increase the ARPU, the average revenue per unit, in those customers, by developing new modules and charging extra for those modules.

{audio:0:52:25} An example would be expenses. They’ve got a new expense management tool, which they are charging extra for. They’re charging extra for the ability to make payments to suppliers directly from within Xero, via a third party, called TransferWise. That’s a transactional pricing mechanism. They charge extra for project functionality. They are starting to build these extra modules, which will be applicable to some of their customers, but not to all of them and they’re trying to push up the average price per unit and, therefore, their overall revenue, by increasing the average revenue per customer.

{audio:0:53:07} How sustainable do you think Intuit’s playbook is, in a country like the UK, today?

{audio:0:53:16} The one thing that Intuit have done, through their brand, is QuickBooks. Again, a lot of above the line advertising, and I’ve got a rough idea of what that’s cost them, but I’m not going to divulge it, because it’s probably confidential. They’re really going around brand awareness, from an end-user perspective. What we’re finding is, a lot of accountants in practice, who I deal with a lot, have got end users who are coming to them saying, I’ve signed up or I’ve subscribed to QuickBooks, because I’ve seen the advert on the television and it looked quite nice. Some of the accountants are thinking, if they like Intuit and QuickBooks then they are quite pleased about that. But if they are a Xero or a FreeAgent fan, then the accountant is probably thinking, why did you do that; I’d much rather that you subscribed to FreeAgent. Why didn’t you come and ask me? That’s just a preference and a personal choice.

{audio:0:54:13} In terms of Intuit’s strategy, I think they are definitely going down the above the line, building the brand, building the market awareness. I guess, trying to go down the route of probably what happened in the eighties and nineties, with IT managers. There was a famous phrase, you’ll never get sacked for buying IBM. That was very much a brand loyalty and brand awareness thing. I think Intuit are trying to do the same, in terms of their above the line spend, in the UK.

{audio:0:54:47} How that will play out and how successful it will be, we’ll see. Intuit have got quite a track record for price increases. I think, when they do start to try and fully monetize those customers that they’ve acquired and try and increase that ARPU, average price per unit, from those existing customers, that will be quite a crunch point for Intuit. It will really test the brand and the customer loyalty. Depending on how aggressive those price increases are, will very much depend on how much retention and churn they can avoid.

{audio:0:55:29} Taking things from Xero’s position, in that context, if they’ve been focusing on really driving and creating value for the accountant channel and also driving this innovation, trying to price a little bit higher, some might argue that that’s a little more sustainable?

{audio:0:55:54} They have done a good job of winning over the hearts and minds of the accountants.

{audio:0:56:02} Could you help us understand how much that really matters?

{audio:0:56:06} It matters from the perspective that the accountants are seen as trusted advisors, to their end-user businesses. Again, a lot of end-user businesses trust their accountant more than their bank manager, in terms of advice. That’s been proven in various surveys. If the accountant is saying to their customer, we really want you to use Xero or we want you to continue to use Xero, then the end user will listen to that advice from the accountant. Why does the accountant want their customers to continue to use Xero? As well as educating the accountants, Xero have done a very good job, like I think we have at FreeAgent, of making tools available to accountants, to help them in their day to day management of their clients, from a financial accounting perspective.

{audio:0:57:09} What I mean by that is things like, they have brought out what I call, final accounts, corporation tax, personal tax software. Say the accountant’s ultimate aim is to produce financial accounts and compliant accounts and file those online, on a timely basis, plus all the relevant tax returns. If Xero are making tools available, to help the accountant do that in an as efficient way as possible, by taking the data that the end user client is entering and, essentially, the accountant not having to rekey that information in. They can amend it slightly, but then take it through to product a full set of final accounts, that whole end to end process, from the accountant’s perspective, is pretty streamline and pretty seamless. Ultimately, time is money, to an accountant. Traditionally, accountants have charged on the basis of the amount of time it takes to do the work. If they can halve the time, to process the client’s transactions and process the tax returns, that’s obviously going to improve their margins. Therefore, they’re going to be a fan of Xero, rather than Intuit, because Xero is helping them to make more money.

{audio:0:58:23} If they are then suggesting to their clients that they really need to stay on Xero as it’s a great product, that is what I mean by winning the hearts and minds of the accountants. Ultimately, it comes down to efficiency and the service which Xero helps the accountants to offer to their end users.

{audio:1:05:12} My last question for today is on customer-centricity. Of course, it’s something that everyone talks about; it’s very easy to make claims. How do you really build that, from the ground up and how have you experienced that, at Xero?

{audio:1:05:31} There’s various ways of doing it. Again, you have to have a good core product or service. Because, without a good core product or service, customer-centricity doesn’t really matter. You’re not going to attract customers if you got a poor product or service. Making sure that those products and services are world-class and market leading is really crucial. I think there are softer elements around that, in terms of how you generate that customer culture and customer experience and excel at that. I’ll use Xero as an example; they built a customer community that people wanted to be part of. Therefore, in terms of customer-centricity, they did a lot of social media activity; they encouraged a lot of customer feedback, in a very open and social environment, whereas Sage were a little bit more of a closed shop around that sort of customer feedback.

{audio:1:06:44} I think the whole, being seen as a thought leader, in the industry that you’re in, is really important. That comes around getting a lot of content out there, a lot of thought leadership type stuff. Maybe not the typical accountancy stuff that you would expect but, again, getting content out there about how small businesses can improve their profitability; nothing to do with the software, really, just about helping small businesses. The Covid scenario is a really good example. At FreeAgent, yes, we’re a software as a service business; we provide financial accounting software. But we also provided multiple bits of content around advising our end users how they could access the CBIL loans, for example, or making them aware that they could defer their VAT payments. Even tips like, you’re transitioning to working from, what are some good best working practices for a business that is working from home. It’s not necessarily just about software. It’s about creating that holistic experience. That customer-centricity that you mentioned, comes from creating that sense of belonging to a community and belonging to a business and having really close touchpoints with the business. Not necessarily just about the software, but about all the other bits which go around that.

{audio:1:08:25} So really, this focus on community?

{audio:1:08:28} Yes. Again, at FreeAgent, as Xero do, for our accounting partners, we hold regular conferences, regular round table events. Those have all become online, in the last 12 months. Making the customers feel that they have actually got some input into product roadmaps, for example and that we’re actually listening to them. Not just paying lip service, but actually listening to them and getting their views, allowing them to vote on product features and then delivering on those product features and making sure that if we don’t take on board a customer feature, explaining the reason why. Normally, the customer understands why you’re not doing that. It’s about engagement with the customer, not just from a software perspective, but from a wider, social, face to face, whatever means people use now, to interact with the customers.

{audio:1:09:25} Nick, is there a question you wished I’d asked you today, that I did not ask?

{audio:1:09:41} Maybe around the business model, such as customer acquisition costs and lifetime value in the cloud services, is probably something that would be of interest to certain people who might be watching this sort of content. Because it’s a very different business model, I suppose, under a SaaS and cloud environment, under the subscription model, than it is in that perpetual business model.

{audio:1:10:15} I suppose, when you’re in a cloud environment and a SaaS and subscription model, probably the key KPIs and leading indicators are really around the lifetime value of a customer. I use that Sage example, where you’re getting £400 up front, on the old perpetual license model and you could, pretty much, account for that in your P&L for this financial year. In a subscription model, you can only account for the months of subscription which you collect in the year, which are obviously a lot less. Therefore, you don’t necessarily at the revenue you are going to get from a customer just this year; you look at the revenue of the lifetime of the customer. That typically is, as we’ve mentioned with Xero’s churn rate, over a seven or eight year period.

{audio:1:11:06} So you have to think a lot more long term, is what I’m probably trying to say, when you’re looking at the value of customers. It’s not immediate value, necessarily. It’s the value over the longevity and the lifetime of the customer, which you need to be very aware of. You need to compare that to the cost to acquire a customer. One of the metrics that is common in a SaaS environment is comparing the lifetime value of the customer, versus the cost to acquire a customer and looking at those ratios. Typically, if it costs you £1,000 to acquire a customer, in terms of your sales and marketing costs, and the lifetime value of your customer is £2,500, over a five-year period, then actually that’s still really good business, because your CAC to lifetime value is 2.5.

{audio:1:11:58} The overriding thing about a SaaS and subscription model is thinking about the longevity of the customer. Customer retention is really important, to make sure you are maximizing that lifetime value. It’s much more of a long-term play rather than just selling perpetual licenses, in the current year. In hindsight, do I wish you’d asked me that question? That was probably a bit of a boring question for me to answer.

{audio:1:12:25} Very important and foundational. Very briefly, what is a great ratio of CAC to LTV, in the space that you’re operating in?  What does that look like for the SMB space?

{audio:1:12:38} A good indicator is probably between two and four. Obviously, if you’re below one, then it’s costing you more to acquire the customer than you are getting from them, over the course of the lifetime. You’re probably in registered charity status if you’ve got a CAC to LTV of less than one. Typically, between two and four is seen as good. Clearly, the higher it is, the better. However, it can get too high in a SaaS business, particularly in a volume end of the SaaS business, that Xero and Intuit and FreeAgent are in.

{audio:1:13:06} If you’re over four or five, your business could be accused of, are you aggressively going after customers, in terms of market share and volume, quickly enough. If you’re at four, five, six, then at a time in the maturity curve where you’re trying to get market penetration and acquire market volume, then probably a CAC to LTV of five or six is too high. You’d expect that at the other end of the maturity curve. But when you are in a customer acquisition mode, probably two to four is where I would suggest where you need to be. Maybe two to three, actually, because it shows you are aggressively going after market share, whilst still be aware, obviously, that you have to look at the profitability of a customer, over their lifetime.

UK SMB Accounting Software: Xero vs Sage vs Intuit

How Xero successfully drove down customer acquisition costs by focusing on adding value to the accountant channel

Why it is harder to move down-market than up-market as software a vendor

Comparison of Xero vs Intuit pricing and go-to-market strategy in the UK market

How Xero creates value for accountants and helps them make more money

How to benchmark at CAC/LTV ratios for fast growing SaaS businesses in the SMB market

UK SMB Accounting Software: Xero vs Sage vs Intuit

Current VP Sales at FreeAgent & Former VP Sales at Xero

inpractise.com/articles/uk-smb-accounting-xero-sage-intuit

Why is this interview interesting?

Executive Bio

Nick Longden

Current VP Sales at FreeAgent & Former VP Sales at Xero

Interview Transcript

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