Intuit: An Operating System for Small Businesses

Sector

TechnologyVertical SoftwareFinancial Software

Background

John Feeley is Deputy CIO and a Portfolio Manager at Findlay Park. We cover the scope of Intuit's various offerings, how they have fought off significant competition, and the key drivers behind Intuit's dominant financial position.

Cover

Date

October 5, 2022

Episode Number

77

Key Learnings & Lessons for Investors

1. Consumer-Centric Approach is Pivotal: Intuit's success underscores the importance of being attuned to consumer needs. Their products, beginning with Quicken, prioritized ease of use over feature-rich complexity, setting them apart from competitors. For investors, businesses that prioritize customer feedback and continually refine their offerings based on this feedback are more likely to sustain and grow. For instance, Intuit's realization that half of Quicken's users were businesses led to the development of QuickBooks, revealing the value of listening to the market.
2. Defensive Moats Matter: Intuit's ability to defend its territory against tech giants like Microsoft, even when faced with acquisition attempts, highlights the significance of building and maintaining defensive moats around one's business. From an investment standpoint, companies that have layered moats and prioritize continuous innovation are less vulnerable to external threats and provide more reliable long-term returns. The fact that Intuit's market cap has grown from the $1.5 billion acquisition attempt by Microsoft to its current $120 billion is a testament to this.
3. The Power of Incumbency and Trust: As observed with Intuit, being an incumbent in a space characterized by complexity and high stakes (like tax filing) can be a significant competitive advantage. Users prioritize trust, especially when financial implications are involved. For instance, even with a well-known brand like Credit Karma backing a free tax filing offering, they only achieved about 2% market share. This highlights the importance of brand trust, especially in sectors where users require high confidence.
4. Complexity as a Moat: Intuit's success in the tax preparation realm underscores the value of mastering complexity. The U.S. tax code's intricacies and the continual changes serve as a barrier to entry for potential competitors. Even governmental bodies have found it challenging to create competing solutions due to the inherent complexities. As a lesson for investors, businesses that master complex domains and weave them into their value proposition can carve out defensible niches, making them solid long-term investments.
5. Consistency in Growth Amidst External Challenges: Intuit's ability to achieve consistent revenue growth, even during financial downturns like the 2008 crisis, underscores the resilience of its business model. For investors, it's essential to recognize companies that can navigate external challenges successfully, as they often indicate a strong market position and robust operational efficiency.
6. Evolution and Adaptability: Intuit's transition from primarily solving problems via software to now becoming an expert-driven platform showcases the company's adaptability. The shift towards offering services like TurboTax Live represents Intuit's response to changing market demands while ensuring profitability. You have to find these shifts but with profitability!
7. The Power of Culture in Sustaining Growth: Intuit's emphasis on consumer empathy and consistent management practices, like hosting board meetings inside the customer contact center. For instance, despite being predominantly a U.S. firm, Intuit has consistently ranked among the top places to work in India, outperforming other tech giants with a larger presence in the region.
8. Strategic Flexibility in M&A Decisions: Intuit's M&A journey offers a lesson in the importance of strategic flexibility. While the acquisition of companies like Rock Financial was influenced by the tech boom of the late '90s, the company later recognized the need to refocus on its core competencies.
9. Serving Latent Market Needs Can Be Transformative: Intuit's recognition of the unmet need for a CRM tool among its QuickBooks users and its subsequent acquisition of Mailchimp underscores the importance of listening to customer behaviors and adapting offerings accordingly.
10. Regulatory and Policy Changes Require Proactive Management: While policy changes can pose threats, they can also be opportunities if managed proactively. Intuit's approach to potential tax code simplification exemplifies this. Instead of viewing it as a threat, they've anticipated the potential shift towards DIY solutions.
11. Beware of Stock-Based Compensation Pitfalls: Many SaaS companies offer attractive switching barriers and high returns, but these advantages can be eroded by stock-based compensations for engineers and salespeople. Intuit stands out as they don't rely heavily on salespeople, avoiding the intense competition for talent in that segment.

Key Takeaways & Business Model

1. Intuit's Extensive Business Model: Intuit has positioned itself as a dominant player in the personal, prosumer, and professional accounting software industry. With significant brands under its umbrella such as TurboTax, QuickBooks, Credit Karma (which includes Mint), and Mailchimp, the company generated approximately $13 billion in revenue last year and currently boasts a market cap of around $120 billion. The main segments of their business, consumer tax and small business software, account for roughly 80% of the total revenue. Their recent acquisitions of Credit Karma and Mailchimp, however, signify their intent to expand and diversify their service offerings.
2. The Roots of Intuit's Success: The company's founder, Scott Cook, drew inspiration from his days at Procter & Gamble. This led to the development of Quicken, a user-friendly personal finance tool that eliminated complexities seen in competitor products. Over the years, Intuit expanded into the small business accounting and consumer tax spaces, fending off competitive threats from giants like Microsoft, and emerged stronger. Their resilience can be attributed to their unwavering focus on customer delight, consistent feedback loops, and a deep sense of paranoia about being overtaken, ensuring they remain innovative and ahead of the curve.
3. Intuit's Multi-Faceted Revenue Model: Intuit's diverse suite of products has allowed it to tap into different revenue streams. TurboTax primarily follows a transactional software model, with an average revenue per customer of around $60. QuickBooks operates largely on a SaaS model, with a median monthly price of about $70 for its core offering. Additionally, Mailchimp operates on a freemium model, charging users between $11 and $300 monthly based on usage. Lastly, Credit Karma, with its 100 million members, uses an ad-supported model, offering valuable consumer insights to advertisers.
4. Network Effects and Barrier to Entry: Intuit's dominance, especially in its QuickBooks offering, has established it as a standard in the small business accounting space, akin to how Microsoft Office is perceived in the productivity space. The company's collaboration with accountants and open API platform further strengthens its position. For instance, 40% of QuickBooks users integrate third-party applications, creating a barrier for new entrants. This dominant position has been further exemplified by Intuit's size advantage over Xero in North America.
5. Robust Financial Performance: Intuit reported revenues close to $13 billion for the year ended July, showcasing consistent growth every year since 1998 (excluding 2015 due to an accounting change). The company even managed a 4% YoY growth during the financial crisis. For the past year, Intuit has achieved a growth rate of 24%, surpassing its initial guidance by 8 percentage points. The organic growth forecast for the upcoming year ranges between 14% and 16%. Intuit's gross profit margin stands at around 80%, with a GAAP operating margin of 21%, which can be adjusted to approximately 25% when considering non-cash amortizations related to deals.
6. Operational Efficiency and Margin Considerations: Intuit invests significantly in R&D, with an R&D to sales ratio of 18%, ensuring continued innovation. Their sales and marketing expense account for 27% of GAAP expenses, mainly due to their annual heavy marketing campaigns leading up to tax season. The free cash flow conversion is notably higher than GAAP net income, with a significant portion attributed to stock-based compensation. This metric has seen an upward trend recently due to new acquisitions and Intuit's transition into a higher-growth company. However, management anticipates leverage on stock-based compensation, forecasting it to stabilize or decrease as a percentage of revenue. Intuit's operational principle of growing revenue faster than expenses further reinforces their financial strength. I have my own views around SBC.
7. Intuit's Culture and Management: Intuit's culture has been a major source of its competitive advantage. This is exemplified by their rigorous focus on consumer empathy, with practices like managers and engineers talking directly to customers for 12 hours a month. Notably, even Microsoft recognized the value of Intuit's culture in the 1990s, with Bill Gates praising it.
8. Intuit's M&A Strategy: Historically, Intuit made acquisitions based on the prevailing trends of the era, leading to ventures like Rocket Financial. However, under Brad Smith's leadership, there was a refocus on core competencies, leading to divestitures like Quicken and Rocket Financial. More recently, their acquisition of Credit Karma aligns with their long-held vision of offering free personal finance services, monetized by an ad-driven model. This acquisition also allows them to leverage vast consumer data, making the service even more valuable.
9. Rationale Behind Mailchimp Acquisition: Intuit's acquisition of Mailchimp aims to address a latent need among small businesses: a Customer Relationship Management (CRM) tool. With approximately 4 billion customer records stored in QuickBooks, businesses have been using the accounting software as an impromptu CRM. Mailchimp complements this by providing dedicated CRM functionalities and assisting businesses in customer acquisition early in their lifecycle. Furthermore, Mailchimp's strong international presence, with a 50-50 revenue split between domestic and international markets, offers Intuit an opportunity to broaden its global footprint, particularly since Intuit garners only 8% of its revenue internationally
10. Tax Simplification Impact: Intuit's business, particularly its tax preparation segment, stands to be influenced by potential simplification in the tax code. However, the company believes a more straightforward tax system would actually increase the adoption of lighter, DIY solutions. The multifaceted U.S. tax system, with variations across states and numerous deductions, makes radical simplification a challenging endeavor.
11. Low Digital Penetration Presents Growth Opportunities: Intuit's success is anchored in the digital transformation of essential yet cumbersome tasks such as tax filings and accounting. Their current market penetration is still low, offering vast growth potential. Examples include:
• Their share of U.S. tax dollars is only in the mid-teens.
• They've onboarded 6 million businesses for their accounting products, which is less than 10% of the potential market.
• $2 trillion worth of invoices are processed on Intuit's platform, but they only charge for $120 billion, indicating a mid-single-digit penetration.
12. High-Value Products to Counteract Churn: Intuit has introduced premium products to address customer churn and enhance lifetime value. These offerings not only help retain customers but also position Intuit at a higher price point, boosting revenue.
• TurboTax Live, for instance, is priced at almost double the cost of the DIY filing option.
• QuickBooks Advanced, priced 3x the base QuickBooks, caters to businesses that have outgrown the standard offering but don't yet require more expensive, sophisticated software.

Transcript