Kashflow, Xero, Zappos, Zoho : nuances and ethics

Earlier today I read an extract from Tony Hsieh, co-founder Zappos upcoming book on why they built something before taking venture funding, what happened when they did take money and what forced them into the arms of Amazon. It’s instructive for the different perspectives you see on why entrepreneurs do what they do and what happens when the money men move in:

Zappos sells shoes and apparel online, but what distinguished us from our competitors was that we’d put our company culture above all else. We’d bet that by being good to our employees — for instance, by paying for 100 percent of health care premiums, spending heavily on personal development, and giving customer service reps more freedom than at a typical call center — we would be able to offer better service than our competitors…

…Some board members had always viewed our company culture as a pet project — “Tony’s social experiments,” they called it. I disagreed. I believe that getting the culture right is the most important thing a company can do. But the board took the conventional view — namely, that a business should focus on profitability first and then use the profits to do nice things for its employees. The board’s attitude was that my “social experiments” might make for good PR but that they didn’t move the overall business forward…

…Out of nowhere, Jeff [Bezos, CEO Amazon] said, “Did you know that people are very bad at predicting what will make them happy?” Those were the exact words on my next slide. I put it up and said, “Yes, but apparently you are very good at predicting PowerPoint slides.” After that moment, things got comfortable…

…I realized that there were similarities between our companies, too. Amazon wants to do what is best for its customers — even, it seemed to me, at the expense of short-term financial performance. Zappos has the same goal. We just have a different philosophy about how to do it.

Later I read Zoho’s Sridhar talking about Why we haven’t taken venture capital and harking back to the Zappos story:

As a founder, I have no interest in exit or liquidity. I am in business to run a business, not to run away from it. Or as Warren Buffet puts it:  Our favorite holding period is forever.

Now that brings up a philosophical point: what is the purpose of a business? Milton Friedman is unambiguous: The Social Responsibility of Business is to Increase its Profits . From the perspective of a financial investor, by which term I mean anyone investing other people’s money, Professor Friedman would be absolutely right; profit maximization is the dharma of the financial investor…

…You can even say that a good part of the reason we exist is to perform those interesting experiments. It is as much a voyage of discovery as a journey for profit. We believe in paying our own way, so we have a certain internal discipline about our experimentation. We certainly believe those experiments are good for our business, on the whole, and in some unspecified long term horizon. But we cannot be sure, indeed no one can be sure, of the outcome, nor the timeliness of the outcome, which is crucial for a financial investor. The seeds we plant may end up bearing fruit for someone else. We just look at it as building good karma in the world.

Finally, I will mention in passing that there is a Zen paradox about business: too much focus on profit will destroy profit. Now try saying that in a board meeting!

Then I got to thinking about how Xero has raised a lot of money the last few years as it runs ever faster to build out a credible SaaS accounting solution and compared that to Kashflow’s single inward investment.

Conventional wisdom would have you believe that it is pretty darned hard to build a large company without a lot of cash. In the UK we’re used to borrowing to finance expansion and that has nearly always been based upon fixed asset backing, usually in the form of bricks and mortar. I did a lot of that work in the late 80′s and early 90′s for owner/managed businesses that were looking to do something sustainable rather than sell out. That was our preferred route. It’s a viable strategy provided you have something tangible to collateralize, the returns are sufficiently attractive and you have at least a 7 year time horizon in mind.

Unfortunately, software companies are not like that. Neither are many of the emerging knowledge based businesses. They have intellectual property but that has no meaningful value you can collateralize in the conventional sense. Investors are, therefore placing bets on what might win, hoping to catch the next Google. Depending on who you listen to the win loss rate is something like 1:10, 1:20. That inevitably leads to the kind of tensions that Tony describes and which Sridhar is trying to avoid. In fairness and what Sridhar doesn’t tell you is that Zoho can afford to be privately financed because of the other paid stuff the company’s parent undertakes. [See Zoli's comment about structure.]

Xero on the other hand has had a deliberate policy of burning its way through capital in order to achieve market position. So far, it has been careful to select investors that understand its core market and is under no pressure to return a profit. Kashflow meanwhile only took one tranche of investment from Lord Young in the early days and has worked its way towards profitability. Kashflow CEO Duane Jackson is of the view that it can grow well without taking further capital. He’s young enough to be comfortable with that but it leaves open the question whether Kashflow can become a leader or whether its funding strategy will leave it an also ran – albeit a profitable one. Making profit from software isn’t hard, making sustainable profit is much tougher. Evidence to date suggests Xero’s strategy is winning. It is adding customers at a much faster rate than Kashflow. That’s because it has the money to get out and market in ways that Kashflow cannot. In turn that means Xero has a better chance to be viewed as sustainable even while it continues to burn cash. That has an invisible but braking effect on Kashflow.

The UK SaaS market is sufficiently large enough for any of half a dozen players to emerge as powerhouses. Unfortunately, history tells us that sooner or later, the market gets consolidated. It took roughly 15 years for that to happen in the UK with names like TAS, Cedar, OpenAccounts and Exchequer getting swept up into the arms of larger, vendors that were well backed. Today there are almost no independents left of any appreciable size. I see that as a signal for re-invention. It is one of many reasons why the SaaS market is so vibrant and why I find it so interesting. The question is – who’s right and what would you advise?

Umair Haque fervently believes that 20th century models of doing business are unsustainable. He takes a deliberately extreme view that often talks to zombie economics. Guess who he points fingers at: beancounters. I admire Umair’s guts but sometimes find his arguments short on detail. His latest post about ethical capitalism reflects something of what Sridhar is attempting and which Tony is still trying to build. My sense is that most professionals will default to one of two positions: 1. do what the client wants 2. appeal to greed over sustainable value. 1 and 2 often go hand in hand but does it have to be that way?

I like to think of the example of the Co-Operative Bank. Last week it proudly announced that:

The Co-Operative Bank turned away £100m of business last year because it did not meet the organisation’s ethical requirements. Twenty financial opportunities failed to meet the Co-op’s standards on human rights and the weapons trade, while 16 companies were excluded by guidelines on environmental impact and four by rules on animal welfare, says the bank’s annual ethical audit, out this week. Requests for finance for two new British coal mines were among those vetoed.

Meanwhile, total lending by the Co-op soared to £8.3bn, with an extra £800m loaned to British businesses. More than half of commercial deposits, and a quarter of loans and overdrafts, were to companies with “a distinct ethical, environmental or co-operative purpose”, the bank said.

It has a history that goes back to 1867 – 143 years. As you can see from the graphic, it remains profitable. Now think about all those banks that have evaporated in the last few years.

Capital has a proven track record of helping build large businesses. It just doesn’t have the same track record for building companies that are sustainable. A big part of that comes in the way a company stamps out its ethical position or s Zappos might say ‘doing good in the world.’ I take the view that whatever ‘capital’ wants, its dedication to the Milton Friedman model has to change. If that happens then success may be longer coming and investments more carefully thought through but results will be more sustainable. In the meantime, it will be interesting to see if the mood among those who provide capital changes sufficiently to persuade Duane Jackson that it is time for a rethink. It will also be interesting to watch how professionals adjust to this way of thinking.

Tagged as: Accounting, Amazon.com, Business, Financial services, google, KashFlow, Milton Friedman, Tony Hsieh, venture capital, xero, Zappos