Accounting

Big Six and medium-sized firms of accountants are still in the same business as each other, just, but in many ways are poles apart. This polarisation was underlined last month when Smith Industries announced it would recommend to shareholders that Price Waterhouse should take over the audit from Clark Whitehill. This means that every FTSE 100 company is now audited by a Big Six firm. And in truth it is a smaller group than that. In the UK a Big Four of Price Waterhouse, Ernst & Young, Coopers & Lybrand and KPMG has left Deloitte & Touche and Arthur Andersen some distance behind.

The domination by the big firms of the UK’s quoted sector has been shifting downwards, the grip that the medium-sized firms have on smaller quoted companies is slowly being loosened by intense competition from their bigger brethren. This shift has so far suited big companies and their shareholders.

Finance directors of multinationals have managed to reduce the cost of that statutory nuisance, the audit, and at the same time have half a dozen eager competitors falling over themselves to provide other services ranging from actuaries to business process re-engineering. Analysts and shareholders have the comfort of a big name on the audit report which means that everything is alright: and if it is not there is presumably a nice deep pocket to sue.

The result of this market domination is that the battle between the medium-sized firms and the big firms for the quoted company sector is effectively over, and in truth, has been for several years. Last month’s switch from Clark Whitehill to PW was just the official surrender. The audit market in top quoted companies is effectively shut to new entrants. The big firms will win some audits and lose some audits but, in the absence of a mega-merger between firms, winner and loser trends will emerge only very slowly.

FDs of multinationals are right to choose the global professional services firms. They need and expect the same standard of audit service in New Mexico as they do in Manchester. Over the past 10 or 15 years the big firms have worked hard at stitching together global networks which have eliminated technical and procedural differences as much as possible. A big firm may disappear behind separate legal entities in times of crisis but in effect it is now one commercial entity. In stark contrast, the loose federations and networks put together – and sometimes hastily abandoned – has, internationally, at least, been the undoing of the middle tier.

Their inability to overcome the cultural and accountancy differences meant that they were never going to be able to service mega-corporation whose plants and operating units stretch across the world.

The war for winning the UK quoted sector audit market may be finished, but the battle for the middle market is just warming up. While the FD of a multinational has little option over its audit firm, the finance director of a smaller quoted company or a private plc is spoilt for choice.

By volume the vast majority of audits are doled out by small and medium-sized companies with a turnover range of #1m to #130m. The choice of audit firms for this size of organisation runs into dozens. It is the FDs and their fellow board members in the mid-corporate sector who, over the next decade or so, will decide the shape of the accountancy services market and the fate and fortune of thousands of partners and staff in the medium-sized accountancy sector.

The logic that forces multinational companies into the arms of multinational professional services firms does not work for the mid-corporate market.

Admittedly if the company is reasonably go-ahead it may export to Europe or beyond, it may even have appointed agents in its main export markets, but it is unlikely to have an office or a production unit anywhere outside the UK. So medium-sized firms don’t need their auditor or tax advisor to have a global network.

If the big firms can’t sell FDs global network, they can try selling them price. Lowballing of course, never did, does not and never would exist. That is the official line from professional firms and we all know – including them – that it is rubbish. But the glory days of lowballing may be over. The economy is in better shape than the height of audit price cutting in the late 80s/early 90s and the culture of corporate governance and the, albeit half-hearted, disapproval of the professional institutes has made it slightly more difficult to lowball. But no doubt some big firms will lowball in the mid-corporate sector and medium-sized firms will have to respond.

If medium-sized firms do not want to fight on price they could try fighting back on service. Most mid-corporates are owner managed or family run businesses.

While they may have brought in outside expertise in areas where they are lacking, such as finance, their corporate culture will tend to make them more loyal to the bankers, lawyers and accountants who have served them over the years. While having a big name firm may impress the chums at the golf club, it still makes commercial sense to be able to do business with the partner of a medium-sized firm who knows the business, rather than some shadowy partner in a big firm whose huge portfolio of clients means he or she meets individual clients once a year to clear any outstanding points on the audit and try to raise the fees. Big firms say they are changing their structure and their methodologies to make partners more “client facing”, whether they succeed or not remains to be seen.

The big firms have one other major difficulty in kicking middle firms out of the mid-corporates and that is market perception. In some ways the big boys are victims of their own success. They set out their stall to serve the top end and now everyone thinks that they only want to serve the top end. In fact, a big firm is likely to have more medium-sized clients that a medium-sized firm. But big firms are being told by mid-corporates that they “don’t understand their business”. Whether they can persuade the world that they can be friendly to mega-corporations and at the same time cuddle up to the FDs of smaller company remains to be seen. The middle-sized firms should have long ago learned not to underestimate the determination and ruthlessness of the big ones. Equally, the big firms should remember the demise of the middle tier has been long predicted and for them there is nowhere else to go.

Peter Williams is a freelance journalist.