Xero is upbeat about its latest year-end financials announced earlier today. It turned in an 83 percent increase in operating revenue. Xero says the increase was held back by the strong New Zealand dollar; measured in last year’s terms the growth was 92 percent.

At the same time the company’s net loss has more than doubled in the last year thanks to the costs of expanding and breaking in to the US market.

Xero says it now has twice as many employees and $210 million in cash to fund further growth.

All this reminds me of the late 1990s when I was busy covering the dotcom boom in Australia.

At that time companies would boast about their ‘cash burn’ rate. This is a jargon term for when cash flows out of a business faster than it comes in. During the dotcom boom, cash burn was often seen as a necessary evil as companies raced to pick up customers.

This is why Xero’s story sounds familiar – at least in part.

In the dotcom boom, the goal was for companies to evolve from picking up customers into a profitable state, either by hitting a critical mass or by convincing those customers to buy more products or services. Many failed because the cost of acquiring a customer was greater than the customer’s worth. Older readers will remember the dotcom boom ended in a crash.

While there are some similarities — Xero is burning cash to acquire customers — there’s a major difference between it and the dotcom era companies. Xero’s customers pay a sizable subscription each month. Most customers go on paying those fees for month after month. I’ve paid Xero more than $50 a month for the last three years. Even allowing for churn, at Xero an acquired customer is a valuable asset.

The problem comes if the marginal cost of acquiring each new customer increases. That’s the fear.

Picking up customers in New Zealand is one thing, Xero entered a relatively uncompetitive market with a compelling, albeit expensive, proposition. Much the same happened in Australia.

However, in the last year Xero’s rivals have rallied. From this point acquiring new customers gets harder. It almost certainly gets harder as Xero tries to expand in the US and the UK. Those markets are more competitive. Intuit is the market leader and a tough nut to crack.

I’m no expert on this, but I suspect Xero is also under price pressure. Three years ago when I signed up it looked expensive, but the product was so much better than the alternatives. MYOB has sharpened its product and sharpened its pencil — the MYOB product closest to my needs costs less than half the price of a Xero subscription. That’s worth investigating.

Dotcom companies would use customer acquisition to attract fresh rounds of investment until the people putting up funds realised there was no light at the end of the tunnel. Xero has revenue and access to patient investors with deep pockets, but if the cost of finding each new account in the US or UK rises too high, things could get ugly. At that stage there’s an option to wind back and become a regional champion.

Xero is a smart operator and so are the people financing the company. My gut feeling is the management have what it takes to deal with Intuit and other competitors. Long term I suspect Xero will share the spoils with the US incumbent while squeezing out the remaining minnows. But for now, if I was an investor, I’d be keeping a close eye on the cost of acquiring each new customer.

 

One thought on “Xero upbeat as losses double

  1. Agreed. In fact, my observation is that a similar thing is happening in the security space. Huge volumes of cash as being invested. It feels a lot like that bubble is re-inflating with many start ups receiving a lot of VC.

Comments are closed.

%d bloggers like this: