I have been considering Xero, a provider of online accounting software, and whether this is a disruptive innovation for the SME accounting software market. Please see my overview of Clayton Christiansen’s book An Innovator’s Dilemma for a distinction between a disruptive and sustaining innovation and why disruptive innovations can significantly alter the market structure.
The SME accounting market to date has been desktop-computer installed software, with the major competitors being MYOB (NZ and Australia), Sage (UK), and Intuit (USA). Each of these companies offers small companies a choice between basic cash-book software, single-user double-entry systems, and higher-priced client/server multi-user systems. Xero is a radically different offering, since instead of installed desktop software it is a SaaS (Software as a Service) accounting solution. A SaaS solution offers customers benefits that are not possible with installed software: frequent and automatic software upgrades; accessibility from any machine running any OS; offsite backup at all times; distributed multi-user with unlimited users located anywhere with an Internet connection; and a monthly fee instead of an upfront capital expense. Xero has further leveraged these SaaS advantages and have provided some innovative features such as:
- Seamless integration with your bank for automatic bank reconciliation.
- Various user roles, including special access for your accountant to log directly into your live accounts.
- Seamless integration with other third party web services through the Xero network, such as Payroll, Project-Management, or Time-tracking.
- A cut-down interface to access your accounts from an iPhone or Windows-CE device!
So Xero is definitely a discontinuous and radical break from the existing desktop accounting software. It would be intuitive to assume that Xero is a disruptive innovation. However, as defined in An Innovator’s Dilemma, the distinction between a disruptive innovation and a sustaining innovation is not based on the actual technology but on how the market values the improvement. If the improvement is in the dimension that the main market already values, then it is a sustaining innovation. If the improvement is actually a degradation in performance in the dimension that the main market values, though has other benefits that a fringe or new customer’s value, then it is a potential disruptive innovation. To evaluate whether Xero is a disruptive innovation we need to consider the SME accounting market and what the dimensions of product performance are.
In my opinion, the must-have small-business requirements are invoicing, compliance with GST/VAT and end-of-year filing, and the ability to produce standard management reports. The various SME accounting offerings then compete in the dimensions of ease of use, feature set, and reliability. These are the dimensions that the main market values.
Xero is a product that improves ease-of-use, provides innovative new features, and increases reliability. Xero provides integrated and automatic bank reconciliation which greatly increases ease of use. It provides enhanced features such as iPhone interfaces, and improves reliability for the customer with its automatic upgrades and offsite backup. Therefore Xero is improving SME accounting along the dimensions valued by the main market customers.
In the customer acquisition data provided by Xero recently it was interesting to note that nearly 50% of customers were not previously using an accounting system – instead either no-system, a spreadsheet, or just pen-and-paper. This could indicate that Xero is providing a product to an under-served market that values the new features of a SaaS product. In my opinion Xero is a high-margin product that provides enough standard functionality to cater to the main market, and provides benefits that are in the dimensions that the main market values. Therefore I conclude that Xero is a sustaining innovation.
With sustaining innovations, Clayton Christiansen has found that the leading and dominant firms recognise the value of the technology, invest in it, and are able to master and lead with the new technology. This would lead to a prediction that Xero will face significant competition in the near future from the existing incumbents such as MYOB, Sage, or Intuit. In trying to predict what this means for Xero, I think there are a number of other factors to consider: first-mover advantage; network externalities (Metcalf’s law); and switching costs. I think some of these could be significant factors for Xero, though better addressed in separate blog entries!
Disclosure: I am a Xero shareholder and one of many delighted Xero customers!