Share Investor Q & A: Xero CEO Rod Drury

Additional information added on 30.4.15

Reading this over just 5 years latter its surprising to read how much of it is relevant today.

From the concerns from others about the large amounts of money it would cost to run the company, $65 million Rod points out it cost MYOB at the time, now it cost over that figure to run Xero - to the fact that Rod gave up on running the company at a profit in 2011 to concentrate on growing the company.

Of particular interest are the parts on customer churn and cost control.

Darren


Xero Ltd [XRO.NZX] is an online software company that specializes in accounting for small business. It listed almost 2 years ago to raise NZ$15 million to enable the company to grow and raised a further NZ$29 million in 2009. Its results for the full-year to March 31 2010 are a loss of NZ$8.5 million, nearly $2 million more than last year. 


Comment on Interview & Feedback for Rod Drury 

It has thus far reached just over 17000 customers but has yet to manage to push into profit. 

Management say break even could be in 2011. 

The company has products that seem to find favour with the customers it does have and users of Xero are enthusiastic to the point of idolization of their products. 

To those outside the software business or indeed the company, Xero seems like a hard business to understand. What does it do? who runs it, will it ever make money? 

I certainly don't understand the business and growing income and customers without making a profit is foreign to most investors. 

With this in mind I thought it might be a good idea to go right to the horses mouth and fire some questions to Xero founder and CEO Rod Drury. 

Most questions are from me but some have been submitted by Share Investor readers. 


The Q & A 

 

Share Investor - What was the primary reason you decided to found Xero and why list on the NZX when the money raised was only comparatively small and could have been found privately? 

Rod Drury - That’s two big questions. 

We wanted to do Xero because we saw the consumer Internet was taking off with lots of innovation yet small businesses were still locked into pretty poor desktop software. Doing the books in our own businesses was just too hard. As we got into we saw that the consumer Internet, which must be the worlds biggest market is hard to directly monetize – often companies go to an advertising based model. However small businesses will pay a reasonable amount of money if you provide value. So the small business market we believe is the largest monetizable opportunity out there. The problem is it is so fragmented. The Internet allows us to solve that.

We sold AfterMail with 25 staff. It wasn’t enough to do things properly. I didn’t want to do that again. So with Xero the model was 50 people from the start so we could build a global business with a full team. Develop, Test, QA, Customer Care, Marketing, Billing, Sales etc. When the server runs the business you need to build a full business. Say that costs 500k a month. We knew that getting people to change their accounting software would be hard and also the minimum required feature set is large and it would take a while to build all the features the incumbents had. Also, rather than getting paid all up front you get a small monthly fee. So we needed at least 3 years cash which might be around $15m. We could not have raised that in a VC round in NZ. If we had of raised Venture Capital money in the US then we may have had a valuation of 18m with VC’s driving us to an early trade sale. At the time, after AfterMail, TradeMe and 42 Belowwe believed there was an opportunity to fund a business like this properly. In addition to the funding requirements we also knew that for people to entrust us with their financial data and long term viability we had to have credibility and being listed on the NZX.

Xero as a start up as a public company in NZ was the only way to do it. It also provides us with a number of competitive advantages. It is fundamental to our strategy.

SI - How is the company performing compared to your projections when you first started and has growth and or profitability stalled over the current economic slowdown and if so have you seen any indication of recovery ? 

RD -The challenge with doing our type of business is that we can control costs and product but its very hard in the early days to predict what adoption will be like and therefore what the revenue will be. I think the financial crisis may have helped as people put a focus on daily cashflow. The Global Financial Crisis was much worse in the UK than NZ and Australia. Overall though we are delighted with where we are at. Having tripled revenues and reached over 17,000 customers is fantastic. I still remember the chase to get the first 100, then 1000. 

SI - What are you doing to contain costs considering the current economic environment and the focus by other businesses on this important factor? 

RD - Our main cost is people. But we have enough cash that we have been able to build up our team. We have always had a culture of good cost control.

SI - When do you expect Xero to turn a profit, based on figures in your 31 March 2010 update to the market? 

RD - At our AGM last year we predicted monthly break even in Calender 2011. That is still our plan

SI - In terms of all important margins how are they tracking and how do they compare with your competitors? 

RD - As we are still in investment phase we are focusing on executing our plan within our cost budgets, recruiting and growing partners (which builds a scalable way to attract customers), customers, revenue. As the plan progresses over the next few years we will focus more on margin. It hard to determine a direct competitors and margin. The large companies we are targeting on on completely different business models. The last numbers I saw for MYOB was they spend $AU65m on staff per annum so we are a much lower cost operator. 

SI - Will your company pay a dividend from sustainable future profits or reinvest in the business? 

RD - I would certainly like Xero to pay dividends eventually but we are still in an investment phase. It is still early days and the market is taking off. 

SI - Do you think the Xero stock price accurately reflects the value of the company at present or do you think there is alot of expectation built into the share price? 

RD - The stock price is not something we think about too much as we are a low liquidity stock. I think people are seeing we are executing well, communicating openly and they are starting to understand the size of the opportunity. It’s also obvious that a lot of risk has been taken out of the business. We have been able to raise enough cash, our winning of webby awards last year and this year show we can write world class software, the near 1000 accounting partners show traction in the industry as well as customer and revenue growth. 

SI - How big is your shareholding in Xero and how important to you is it that you and other Xero directors have a financial interest in the company as an added incentive to do better?

RD - The founders, directors and staff have a big stake in the company as you can see in our annual report. We are very motivated for Xero to do well. We are living this 24x7 and really enjoying it. (Rod has a holding of just over 24 million shares, the largest Xero shareholder - Share Investor)

SI - Do you own shares in other listed companies or have stakes in private businesses? 

RD - I’ve done a few angel investments and do have other shares in private companies.

SI - What percentage of customer churn do you have and is it above or below sector standard? 

RD - We have low levels of churn. Less than the death rate of businesses (which we hope means that businesses that at on Xero are better!). I think this is because accounting is quite sticky once you commit and by the time we count a customer they have trialled the software and running their business on it. 

SI - How many customers do you expect to have in five years and an estimate of revenue and profit projections for those customers? 

RD - We haven’t put out any projections. Not because we are hiding anything, just that it is really hard to know. We do want to build a significant business though and be one of the key global players in this space. 

SI - The sector in which you operate is very competitive and fast developing, why is what you are doing different and if it is will it keep you ahead of the pack? 

RD - Actually the SaaS accounting software isn’t that competitive. The incumbants haven’t launched a competitive product yet (and we’re 3 years in). Smaller companies we track have fairly thin offerings because it take time to write a full accounting package and they have much smaller teams. As we have strong capital backing we are able to do things properly and take a long term view. It is still very early days in the SaaS accounting space.

SI - What's to stop any current competitor or start-up operating a similar business model to Xero? 

RD - It’s very expensive and is a difficult to do significant SaaS busineses out of cashflow. It is much harder now to raise money. Also it takes a while to get traction which we now have.    
     

SI - You seem to have a small band of loyal and devoted users within the software industry, why do you think that is and do you think that will translate into mainstream customers? 

RD - Actually I think at 17,000 customers and many more users we have much more than a small band or loyal users. We have a wide and diverse fan base. This is very important because accounting software is very much a word of mouth sale.

SI -You seem to have strong brand recognition in New Zealand, how is Xero going in foreign territories? 

RD -  NZ has been a great first market because we were able to leverage our profile and being listed to create a brand. That has allowed us to develop the product with great feedback. The opportunity is leveraging the traction in NZ into the much larger markets we are operating in. The approach to market that has worked in NZ we are now rolling out in the UK and Australia and that is looking good but there’s much more to do. 

Reader Question - Hi Rod, are Asian versions(non-English) of your products in the pipeline? 

RD - Not in the short term, we haven’t conquered the English speaking markets yet, but we have designed the platform for other languages in the future.

SI -Are your customers new to accounting software or do they come from competitors products? 

RD - It’s a real mix. Our initial market research showed that 60% of small businesses used Excel. So we are very often the first accounting system. We are converting a lot from MYOB and Banklink.

SI - As a user of accounting products why would a consumer choose yours over your competitors? 

RD - Begin your journey at Xero.com. Xero is really easy to use and will save you hours of time each month. 

Reader Question - when I looked at this I couldn't believe with all the HYPE it doesn't have inventory management - will this come? 

RD - We are planning to do Stock in the coming year. As I have said Accounting has a broad minimum feature set. Stock often is tied up with Point of Sale or Warehousing and may not suit a web application so we prioritized it after other features. Our research showed it was the least used feature of desktop software. We’re designing Stock now and hope to get it released this coming year. In the meantime we are also looking for other SaaS based Stock systems to link Xero to. 

SI - Your competitors take an interest in copy done on Xero -I know this because they all read what I have to write about your company - with this in mind how have you responded to your competition and have you found the MYOBs, Quickens, Sages and SAPs of this world are taking you seriously as a competitor? 

RD - I haven’t been watching SAP that closely, we don’t see them in the small business space but yes MYOB, Intuit and Sage follow us very closely. We know them well. Our hypothesis was always that it would be tough for them to transfer from a Windows desktop model to SaaS and that has been proved to be correct. I’d expect them to do acquistions over the next few years but it’s hard to see who they would buy. Again if we were a private company we’d be positioning for a take out. As a public company we can capture the opportunity ourselves. 

SI - How are you different from the aforementioned competition in terms of product offering, price and service? 

RD - Check out Xero.com 

SI - Is Xero capable of footing it with the big boys, especially as the company gains some sort of scale in terms of customer base and revenue size? 

RD - Yes. Our team is first class across the board. 

Reader Question - Will the American version of Xero be launched this year? and are there new features on the road-map that will increase ARPU? (like the multicurrency release) 

RD - Yes we have a lot of US customers now and have good feedback for a few things we need to do. The timing is really due to focus. We want to get the UK and Australia countries to a certain point before we open another front. 

SI - How crucial is cracking the United States to your future growth and profitability? 

RD -  We can build a signficicant company in just NZ and Australia, but it would be very exciting to crack the US as well. The US does have a big influence on the rest of the world so we would also get additional benefits globally. 

SI - With the question above in mind, do you see Xero coming back to the market and or its shareholders for more capital to grow your business? 

RD - At this stage we have enough cash to execute our current plan. But at some stage we have to address our lack of liquidity which may provide other reasons to diversify the shareholding. 

Reader Question 

On paying customers: How do Rod and the board of Xero reconcile the following? 

MARKET RELEASE Xero exceeds 10,000 customer milestone 23 July 2009 In advance of the Xero Annual Meeting this afternoon Xero wishes to provide the market with a short update of the Company’s progress. Xero has now exceeded 10,000 paying customers, which amounts to ten-fold growth since March 2008. Crossing this threshold two years after the IPO (read the 2007 Xero Prospectus for detail) is a significant milestone and positions Xero as one of the leading online accounting software providers in the world. 

There were a number of similar releases plus the annual report and audited accounts that clearly states that the customer numbers are "paying customers". An assertion that was made repeatedly in various interviews and blog posts that the customers were paying customers. With this excerpt from the latest announcement on 1 April 2010, that said: 

In the UK, the sales efforts were re-configured to focus on Xero implementation by accountants and to encourage adoption among key individuals within practices. This follows commitments from a number of sizeable UK accounting firms for large up-front orders without actual implementation. The re-focus on implementation is working. Xero has excluded those unimplemented customers from its customer count to more closely align the timing of revenue. 

What does that really mean? Rod clarifies and confirms that the previous numbers were not paying customers on the Xero website. 

RD - We have trialled a number of sales models in each territory as we worked out the best approach for each market. In the UK we had a number of larger firms committing to orders but not following through with implementation. This was a useful lesson as we reconfigured the team to assist with implementation which has proved to be a better approach. The delay in implementation delayed revenue so we now count customers as they implemented which more closely aligns revenue. 
  
SI - Was the intention of yourself and the Xero board to build the company up as a brand with the express purpose of selling, along the lines of say 42 Below? 

RD -  No. Having sold businesses before, this time we want to grow a long term business. The market is really just starting and with accelerators like iPads, Google's up comingChrome operating system we think that things are only just getting exciting. 

SI - What are the biggest commercial threats to your businesses in terms of competition and is your reaction to this competition likely to be aggressive or reactive in nature?

RD -  We’re more scared of a well funded new SaaS competitor like us than the incumbents. Haven’t seen one yet. Our biggest risk is losing customers data so we ensure that we cover that risk with the appropriate risk management strategies. We’re also worried about ensuring that broadband investment takes place which is why we are such advocates. 

SI - What are your biggest challenges as the company expands? 

RD - Getting talented people in New Zealand. For example we probably constrained most by Quality Assurance people. It’s really hard to find great product testers in New Zealand. 

SI - You contribute to a blog on the Xero website and of course your business is web based, how important is the internet to the business to spread the Xero brand and business and will you start to use more traditional forms of media and or advertising as you grow? 

RD - Accounting software is a referral model, so the social media can be used to accelerate that. We continue to test different approaches. Traditional media can be very expensive so we tend to piggyback on our partners spend for that which is why we have built marketing partnerships with banks and telecommunications carriers. It seems to be good for building brand but is very expensive. The social media side is working pretty well for us. 

SI - You are a small company now, how will you keep your strong company culture and customer service when you hopefully get allot bigger?

RD - Xero is fairly distributed as our sales teams operate out of several areas on many time zones so we build culture online. Yammer is a great way for everyone to know what’s going on and feel part of the discussion. Our senior team are all passionate about technology and improving productivity so a lot of what I do is keep reinforcing the vision so we can align with that. Doing quick release cycles reinforces a culture of innovation and execution but it is something we think about a lot. 

SI - Who is your favourite New Zealand business mentors/leader/s and why?

RD - I think Rob Fyfe is classy. He is a leader that gets marketing and has built a great culture of innovation. I like working with Sam Morgan because he is so smart and really challenges me. I like working with Mark Weldon at the NZX because he is also super smart and thinks strategically. Rob Cameron is also someone I like to watch operate.

Reader Question - I have a concern about focus at Xero at the moment. I am concerned about maintaining focus on building the best online accounting system for the SME market. I believe there is a significant opportunity here, but that there is still a lot to do to maintain Xero’s position as a leading SME accounting solution. For example, reporting is still very rudimentary, there is no stock control, the functionality in a number of the modules is quite basic, etc… I have been concerned with the amount of time being spent on building Xero Personal which is a completely different target market. I understand that for many SMEs there is a fine line between personal accounting and their business accounting, but I think that providing a solution to solve this for small business owners doesn’t require all the Xero Personal features. E.g. maybe it just requires an add-on to the Expense Claim module to allow expenses to be pulled out of a personal credit-card statement, etc… I am still a Xero investor as well as customer, and I find a number of the features of the product extremely innovative. My only concern is that they do not divide their focus between two very different markets. (please explain or elaborate on these points if you could - SI comment) 

RD -I’ve already commented on Stock but a big focus of the product right now is accountant features so we become the tool they recommend. We have some big features coming for annual accounts and reporting over the next few months.I was concerned that people would think that we were losing focus on doing Xero Personal. There are some important strategic reasons for doing Personal which I don’t want to go into publicly. Be rest assured that we are very focused on small businesses and say no to a lot of things.

SI - What company or companies do you admire the most(apart from Xero)that you don't have a financial interest in and why?

RD - Atlassian out of Australia have cracked a good business model in the Enterprise space and love their customers. Apple for their strategy. They think long term and put in place building blocks that lead to long term value though I think their emerging culture of secrecy and aggrogance is wrong. I enjoyed Richard Branson's latest book, Business Stripped Bare: Adventures of A Global Entrepreneur, that explained what the Virgin Brand promise is.

Reader Question -Does Xero have any future plans of going into any other fields of cloud computing beyond accounting or personal finance? If so can you elaborate?

RD - Nope. The opportunity is significant enough.

SI - Are there any particular books or periodicals that you have read that you would recommend to Share Investor readers in your business sector or business/investing in general?

RD - My favourite blogs is TechMeme. That gives a good picture of the tech scene. And Whale Oil of course.

SI - In my investing experience I have found the level of business leadership in New Zealand wanting – with a few very notable exceptions - when it comes to making good long-term decisions based on sound business skills, the basic understanding of running a business and accountability when it comes to making mistakes and this is often reflected in businesses hiring from an overseas talent pool. What are your views on how we can get better shareholder representation in the boardroom?

RD - I agree with you the NZ talent pool is very thin. For our part we’re trying to share our experiences so that others will follow in our foot steps and we’ll see other companies and experience develop. In Xero’s case the non executive directors are shareholder representatives.

Reader Question - Does Xero have any intention of implementing stock/inventory control? If so can you give a time frame when this feature will be implemented?

RD - Yes. In this coming year. (Discussed earlier.)

SI - Where do you see yourself and the business you lead over the next five years? 

RD - I would still like to be running Xero, the global leader in small business software and one of the most admired software companies in the world. The profile of Xero and the newPacific Fibre cable has attracted significant inward investment making New Zealand a global player in the Internet economy. Five new internet companies list on the New Zealand sharemarket.


Q  A end. 

*Please note - On Interview Questions: Because of the nature of this Q & A, it means the subject cannot be probed further on each question asked. I would imagine though that Rod would entertain follow-ups in the comments section below.


About Rod Drury - Provided by Xero

A recipient of New Zealand’s most prestigious hi-tech award the Tait Flying Kiwi in 2009, Rod is renowned for entrepreneurial skills in the technology sector. In early 2006 prior to setting up Xero, Rod sold his award-winning email archiving software company, Aftermail, to USA publicly listed company, Quest Software.In 1995 Rod developed one of New Zealand's first Microsoft development companies, Glazier Systems, which was acquired by Advantage Group in 1999 and continues today as Intergen. In 2000, Rod co-founded Boston based Context Connect, which holds several mobile directory patents.

In the late 1980s to early 1990s Rod worked primarily for Ernst & Young, as well as spending several years working on telecommunication billing systems both in New Zealand and the USA.

Throughout his career Rod has maintained a close relationship with Microsoft and was selected as New Zealand's first representative on the prestigious Microsoft Developer Network (MSDN) Regional Director programme, holding the role from 1997 to 2000. Rod achieved Microsoft Most Valuable Professional status for his work in the early days of Active Server Pages.

Rod is a director on the board of the New Zealand Stock Exchange and also sits on the New Zealand Trade & Enterprise Beachhead Advisory Board. Previously he was on the board of TradeMe and SQL Services.

In 2008 Rod was conferred as an Honorary Fellow of the New Zealand Computer Society (HFNZCS) recognising his achievements, ongoing advocacy, and willingness to assist others in the industry

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