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The top 100… does size really matter?

March 31st, 2012

About this time every year I wait anxiously for my copy of Accounting Today’s Top 100 US accounting firms – well, perhaps I’m not that excited about it but I certainly find it interesting that we seem to place so much store on revenue as a measure of success. This year’s report (as is always the case I might add) is interesting so I thought I’d make a few observations.

Now, when I went to business school I was taught that the purpose of a businesses was to create a customer. That made sense on many levels that I will not go into here.  But I did want to point out that unless I was sleeping in class I did not hear the Professor say the purpose of a business was to generate a lot of revenue.  What she did say was that the only indicator of a successful business strategy was a net profit (perhaps expressed as ROIC) that was superior to competitors in the industry.

She went on to say that there is no evidence to support the proposition that size (of revenue) correlates with net profit–again as reflected by ROIC.  So wouldn’t it be interesting to know what the net profit for the top 100 firms was?  I totally understand why that information is never likely to be published although I suspect all of the firms in the various size cohorts would be able to make a pretty good guess about what their near rivals are making given the similarity o their business model and the wide availability of revenue and head count data.  I should also add that if net profit data was available it would be close to useless information from a competitive point of view although it would give some firms boasting rights and others, of course, cause for commiseration.  So t’s probably best kept quiet.

Based on the information contained in the Top 100 survey I’ve taken the liberty to “play” with some numbers and excels’ sort capability to attempt to get a sense of whether size counts.  Here’s my logic — and I fully accept that it could very easily be contested– but I’ll share it anyway.  Based on my experience with this industry, the most profitable firms (which I define in terms of net profit per partner) tend to have the highest revenue per professional (ratio 1 – a broad metric for revenue productivity in the form of both price and/or volume) and the highest ratio of professionals per partner (ratio 2 – a metric that reflects people leverage).  These two ratios when multiplied result in revenue per partner which correlates highly with net profit per partner.

So, with that in mind, I did a sort on all100 firms on ratio 1 and then after that sort, I did a sort on the top 20 of those firms on the basis of ratio 2.   I then posit (I don’t what that word means but my friend Ron Baker uses it so I think it adds credibility to the analysis) the resulting order of firms reflects their relative profitability.

One of the things I found interesting is that of the top 20 firms (by my presumption of profitability), only 7 (35%) of the 20 where in the original top 2o sorted by their revenue.  In other words there is a long tail evident here.  Further, the top 20 (by profitability) accounted for 78% of the total revenue for the entire top 100 firms but the Big 4 accounted for 95% of that revenue meaning that the other 16 firms in the group that I suspect are the most profitable firms in the Top 100, only spoke for 4% of the $44.84 billion revenue attributed to the entire Top 100.

Based on data that I do have a lot more detail of I now but even in relation to the Top 100 firms, I have a strong gut feeling that, except for the mega firms, size really does not matter.  What I think is far more important is to have a superior strategy that results in a superior net profit.  I don’t believe that is the case at either the big end of town or the other end.  If a business has a superior strategy it will earn higher-than-average industry profit.  My guess is this probably only applies to a handful of firms in the Top 100.  In saying that I’m not suggesting all of them are not profitable, they clearly are but I suspect they’re all implementing more or less the same strategy and are therefore getting more or less the same result.  Pure strategists would say these firms have a strategy based on simply competing “to be the best” which over time results in “competitive convergence” where they all look alike, behave alike and yield much the same profit.

There’s at least one exceptional firm

When reading the Top 100 my eye was caught by a table showing the top tax firms headed of course by H&R Block.  I especially noticed a tax-only firm based in Texas called Ryan.  This firm does not practice as a CPA firm but does $23.5 million — not a small firm by any means.  I went to their website www.ryan.com and noticed that the firm was founded in 1991 with fees if $156k.  If you do the sums, you’ll discover they have experienced a compound annual growth rate over the past 20 years of 44%.  THAT is impressive and while I’m not suggesting it’s unique it is certainly not common.

What I really want to emphasize about Ryan is the value in having and executing a superior strategy.  In their own words their strategy is: “While tax services are only a sideline at the national accounting firms, it’s all we do.”  They don’t try to be all things to all people but rather do one thing extraordinarily well.  I’ll bet that firm has an industry-leading bottom line.  Chasing revenue for the sake of getting bigger rarely if ever results in a bigger bottom line, the only “bigger” it seems to cause is problems!

This will be one of the issues I’ll be focusing on in the Principa Practice Development Challenge later this year.

 

  1. April 7th, 2012 at 22:41 | #1

    I wasn’t arguing for any particular services being offered. I was just saying that for some people the pursuit of revenue growth seems to be a more important indicator of “success” than profit. I believe that is wrong. The data does shows that larger firms are more profitable on average. BUT, within size cohorts (measured by a revenue range) there is also a range of profitability outcomes. There are some firms that I know of that are a fraction of the size of the top 100 firms an yet they are generating a profit per partner that is several times higher than many (and i suspect most) of the top 100.

    My advice to clients in general business and in the profession is focus on profit first (but never lose sight of cash of course), revenue will then take care of itself. Now with all that said, I also happen to believe very strongly that BD services offer by far the richest source of value that an accounting form can offer. They are the ONE service that when properly positioned and executed offer a sustainable competitive advantage that is simply impossible to get from traditional compliance services. But that’s another story.

  2. April 6th, 2012 at 15:23 | #2

    These were interesting statistics Ric and thank you for posting them. All that said, how does one promote the argument that accounting firms (in general) should offer some sort of BD services to their clients.

    I’d be interested seeing feedback from ‘dyed in the wool’ tax practitioners on this!

  3. March 31st, 2012 at 10:25 | #3

    Great post, Ric – I agree with you 100%
    Revenue per person and per professional really is the best indicator of profitability
    In todays modern practice, I believe that number of professionals per partner is not so important as practices embrace a team ownership culture. This metric seems contrary to modern business practice
    Cheers
    Chris

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