Should You be Considering a Merger, Sale or Acquisition?

Before jumping into a merger or sale, you should stop and think about the consequences and whether it makes sense from the viewpoint of them offering a better quality or a broader range of services to your clients and/or whether it will improve your long-term profitability or survival prospects through internal efficiencies from scale. 

Let’s consider the issue of the quality and range of services first.

If two firms that offer the same suite of services to clients merge you end up with a bigger firm, but not one that offers a better breadth or quality of services.  In these circumstances, clients are no better off than they were before the merger and often they feel that they are actually worse off.

For clients to be better off after a merger one or both of two things must happen.  They must either see a reduction in their fees through greater efficiencies being passed on to them (which is so unusual I’d suggest it never happens) or they must have the opportunity to have access to services that were unavailable to them previously.

Typically, a merger of the same type of firms creates little, if any, value for either their clients or the partners and employees of the two entities.  Furthermore, the difficulty in integrating different cultures and dealing with ‘top dog’ ego issues, not to mention getting uniformity in the way things are done in the practice, adds to the pain.

For a merger to make economic sense the condition precedent is that the two firms should have some different skill sets that, when made available to the combined group of clients, present an opportunity to create value that would otherwise not be created when they are operated as independent businesses.

I have heard suggestions that economic efficiencies will be achieved by getting bigger, but the evidence runs counter to this.  The fundamental economics of this industry are such that there is little evidence of scale economies.  In fact, the evidence is that there appear to be diseconomies of scale.

Accounting businesses buy the same inputs and pay much the same prices for them.  Productivity is also more or less the same across the board, so you don’t have to be a rocket scientist to conclude that relative cost structure is going to be the same as a consequence.

Inter-firm comparison data also indicates that prices charged for services offered by firms of different sizes are also more or less the same when measured based on average fee per hour.  To the extent that larger firms achieve slightly higher average profit per partner than small firms is because they tend to have a higher partner to team member ratio. It is also important to note that there is some strong evidence from inter-firm comparison studies that (excluding the mega-firms) the most profitable firms are those with about 3 partners and about 20 team members.

If a more highly leveraged firm acquires a lower leveraged firm the only way it will maintain its profitability will be to retire some partners, charge higher fees or generate more revenue either through improved productivity or by hiring more people accompanied by more effective marketing and sales.  These matters should be at the top of the agenda in any merger (or acquisition) discussions.

We hear a lot of talk from firms that are in the process of buying accounting practices that they will engineer revenue growth through cross-selling additional services to the acquired client base.  In the main, the services they are talking about revolve primarily around financial planning, insurance and the like.  I’ll believe that when I see it.

I have great difficulty coming to terms with the observation that if accountants are not cross-selling now why will they all of a sudden start doing that simply because they have been acquired by another company.  Accountants have had the opportunity to build seriously good financial planning businesses during the past 20 years but few of them have stepped up to the plate and done it.  And even those who have offered those services most of them have been mediocre at best.

The principals of financial planning businesses that I have spoken to repeatedly tell me that amongst their accounting firm associates, 80-90% of the business that is written can be attributed to 10-20% of their associated firms.

SMEs typically prefer to work with advisors who understand them and who will work with them over the long haul.  Large firms are always changing the people who are responsible for managing client relationships which negatively impacts their ability to win client loyalty.  An extraordinarily strong case can be made for the argument that if there are small and medium sized businesses there will be a similar size distribution of professional service firms.

If smaller independently owned firms can deliver all the services that their larger competitors offer either directly themselves or, more likely through alliances, they will thrive in this environment and will carve out, and in my view retain, a very profitable business.

The key here can be found in the words “are able to deliver all the services that their larger competitors can offer.”  One way to do that is to align your firm with a network that gives you access to a broader range of services so that you can position yourself as a multi-disciplinary firm.  In the future, I believe the most viable form of structure for professional service firms will be through formal networks.  To put that another way, if you are not in a network you might find yourself competing against one. 

And if you are in a network you had better avail yourself of all the benefits that offers because simply offering your clients what you have provided them in the past will not cut it.

We also believe that business value in the accounting profession in the future will not be based on arbitrary rule-of-thumb measures such as a revenue multiple but instead will have regard to earnings and other valuable assets such as access to network intellectual property, average revenue and profit per person and per client and, of course, local and global brand equity.

Independently owned and operated firms that are members of a strong network will have all the firepower they need without any of the disadvantages of being part of a large enterprise and we believe that their owners will see much greater value growth in the future without any loss of effective control. 

Importantly, the firm of the future will be able to attract and retain quality employees because of the brand equity it enjoys and the opportunity it offers for growth and development.  Talented young professionals are not going to want to go to work for a corporation where the layers of management are deep and the prospect for an equity play is a long way off.  In contrast a small nimble, client focused, profitable and aggressive local firm with global reach is an extremely attractive alternative in my view.

It is obvious that my considered personal view is that you should not sell out to a consolidator.  I’d add to that the suggestion that if you are considering merging with another firm do so only if you believe that you really have a shared vision and can achieve a cultural integration that will work for both groups. 

Most firms that merge find this extremely hard to achieve and I doubt that will change.  When professional firms get together there are rarely any significant scale economies achieved and if there are, they tend to be lost in the bureaucracy that typically associated with a bigger entity.

Going Forward

Everyone in the profession at this time is faced with many decisions.  It is a difficult time because no-one really knows what lies ahead. 

Entire industries, not to mention firms, are likely to be wiped out in the next decade.  This has happened before when major shifts in technology have occurred.  I am optimistic about the future of the accounting profession, but I fear for many of its present constituents.  The future will be characterized by strong alliances and curious relationships.  Businesses (including accounting firms) will find themselves working with their direct competitors as well as competing against them. 

Relationships with clients will be different and there will be constant pressure on firms to deliver value or risk losing their clients.  The same applies to their people.  The traditional command and control structures that worked in the past will not longer be acceptable.  Accounting businesses will need to be organized along corporate lines rather than traditional partnerships and will embrace a diverse range of talents only some of which will be in the core compliance and accounting areas.

Cloud technology offers the accounting profession an opportunity to create significant value for its clients.  They will be able to operate with little traction and enjoy high levels of efficiency.  Their own survival and that of their clients’ will increasingly depend on the quality of the information (and importantly, their understanding of its significance) they have access to and given that accountants have traditionally owned the business information franchise they will be the logical people to go to for assistance.

The questions you might want to ask yourself now are as follows.

If I were starting an accounting business today:

  • What clients would I target?
  • What services would I offer those clients?
  • How would I service those clients and specifically how would I deploy technology in my service model?
  • What type of people would I hire?
  • What alliances would I form?

Having asked and answered those questions you might then ask yourself: why not set about creating such a firm now even if it means trashing a lot of what you already have.  As Geoffrey Moore reminds us in “Living on the Fault Line: Managing for Shareholder Value in the Age of the Internet” (page 11), “It is in the gestation phase that market leaders and followers are determined—more or less permanently.”

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