Big 4 firms have traditionally aimed high. But now that they’re turning their attention to the middle market, just where does that leave mid-tier firms?
Something’s in the air.
First Big 4 firm Deloitte swooped on the Melbourne office of mid-tier firm BDO. Not long after it scooped up the Sydney business of Horwarths, also a mid-tier firm. And at the end of 2006 the remaining BDO and Horwarths networks in Australia announced a merger. What gives?
The big end of town is booming, awash with mergers and acquisitions, regulatory changes and private-equity deals in the offing. So why is there now such a sharp focus on mid-market and entrepreneurial companies? Call it forward thinking. These companies may well be minnows in the natural life cycle of companies, but they very soon could be the ASX 200 members of tomorrow.
The consolidation in the Australian public practice market is also due partly because size, scale and reach are the real differentiators between the larger accountancy firms. The idea has long been to be big, but also to offer every speciality item – the supermarket approach to business. Deloitte, the smallest of the four in Australia, is plainly looking to bulk up its offering.
Before the acquisitions, it had an annual revenue of about $500m, making it about one-third smaller than its next competitor. Next year it expects to bring in about $660m worth of business. This is one of the drivers behind the firm’s recent acquisitions. But it also signalled a focused assault on the mid-market client sector, which is becoming a sharp focus for the Big 4 firms, and not just in Australia.
Horwarths Sydney, already a powerful player in the NSW middle market, particularly in the motor vehicle and hospitality sectors, was a rich prize for Deloitte.
‘Our goal has always been to be the firm of choice for middle-market clients both in New South Wales and Australia,’ said Deloitte CEO Giam Swiegers at the time.
Horwarth Sydney managing director Michael Stibbard was in agreement. ‘The merger with Deloitte allows us to build on our current industry leadership and specialist expertise,’ he said.
This merger represents just part of a Deloitte global strategy to target the middle market. ‘Late last year and this year the global strategies were focused on leading up to 2010,’ says David Murray, partner in growth solutions. ‘And one of those strategies was to enhance the position of the firm in the middle market globally.
‘At the same time we were thinking about this in Australia, and put together our own middle-market strategy. Not just for growth solutions but across the entire firm. We are acting very much in tandem with what the international firm is aiming to do.’
Robert Quant is national chairman of Grant Thornton. ‘Deloitte was so far behind the other big three. They were in no man’s land,’ he says. ‘And they’ve decided strategically that they need to get bigger, and in doing so they have taken a strategy where they have cherry-picked a couple of second-tier firms out of a relatively unstable network.’
Luckily for Deloitte, the partners in BDO Melbourne and Horwath Sydney didn’t share in their federated firm’s values. They jumped ship and took the money, leaving their parent groups in the lurch. The remainder of BDO was painted into a corner, with the remainder of Horwath making them ideal marriage partners.
The combined entity is now number five in size, with 140 partners and fees of $140m. Next in size is PKF (which has also flirted with mergers) with 114 partners and an income of $130m.
BDO chairman, Russell Heywood-Smith, says the strategy behind this merger was to place the firm into the next league, putting it into ‘a space of its own neither Big 4 nor mid-tier’. Heywood-Smith says there are no initial plans to change the way the yet-to-be-named firm operates as a federation of offices. But in the longer term, issues about the firm’s structure and governance will be addressed.
Grant Thornton’s Quant says the merger between his competitors was one of necessity. ‘I don’t see they had an alternative,’ he says. ‘The Horwath network didn’t have a strong international network. BDO just couldn’t find a replacement for Melbourne. And that’s the issue that any federation has. It needs to value firstly its clients to make sure it does everything for them, but secondly its members, and not to take them for granted.’
While the market conditions have been good for the larger accountancy firms, with a flurry of activity at the top end, attention is now turning to the potentially lucrative mid-market and fast- growing companies. (The Big 4 firms report growth rates of about 10 per cent a year; their small competitors say they are growing at rates of nearly 20 per cent.)
It’s clear everyone is still looking for new opportunities. ‘The increase in the number of M & A transactions, private equity deals, the resources boom, offshore growth by clients is really at the top end of town,’ says Joseph Carrozzi, PricewaterhouseCoopers’ national managing partner (markets). ‘That growth is very, very strong. While the last three or four years have been characterised by regulation-based activity – that’s companies complying with IFRS and Sarbanes-Oxley [and the like] – the next three to four years are probably more likely to be characterised by growth, expansion, M&A and private equity.’
Mark Pickering, a former Big 4 partner, now consults to accountancy firms through his business consultancy Pickering Byrnes. ‘At different times,’ he says, ‘the firms have gone through ideas such as, ‘We’re not in the small end’ and, ‘We are only going to focus on the top end’.’
Pickering says there has been a shift in thinking over the past five years and all of the Big 4 emphasise they are strong in the middle-market area. ‘If we look at the way that the firms are positioned, they are definitely positioning on the growth [side of the business],’ he says. ‘Ernst & Young, for example, sponsors the Entrepreneur of the Year Award. They are after fast-growing companies, not just middle market. The goal is to pick up the ones that are the next [ASX] 200.’
Globally, Ernst & Young has been sponsoring the Entrepreneur of the Year award for 20 years in the US. In Australia its sponsorship of the awards is moving into its sixth year.
Ernst & Young partner Patrick Winter explains the general attraction to the mid-market. ‘Statistically, 50 per cent of the ASX 200 will turn over every five years,’ he says. ‘But [mid-sized business] is the fastest-growing area of the firm globally. And globally, we have a strategic growth-markets focus. In Australia, we’ve seen exceptional amounts of growth in this area over the last three to four years for our firm. We are very focused on not just firm revenue growth, it’s [about] replenishment strategy. These are companies of the future for us to create relationships with.’
Graeme Matthews, national managing partner of KPMG’s middle market advisory practice, says the mid-market client base accounts for about half of the firm’s revenues.
Though KPMG targets entrepreneurial companies, it is seeing action in the family business sector, where Baby Boomer business owners are looking at their options. ‘We are seeing a lot of intergenerational change,’ Matthews says. ‘And the trend is there are more families that are looking to exit via a sale rather than through an intergenerational transfer.
‘If you look at the age of the typical family business operator, they are in their 50s and 60s. There is a family business bubble coming up. The firm is helping family companies to ensure they have the right systems, strategies and people in place so they are operationally sound at exit.’
One driver of change for the Big 4 is the Sarbanes-Oxley Act. All firms must avoid conflicts when working for US-based companies and subsidiaries. What this means in reality is that conflicting work has been shuffled between the Big 4. Deloitte for example, although being the smallest of the Big 4, works for 86 of the top 100 ASX listed companies. Figures are similar for the other big firms.
This may be why the four are now casting covetous eyes on the lucrative middle market. ‘On Sarbanes-Oxley there are two major points to note,’ PricewaterhouseCoopers’ Carrozzi says. ‘The first one is the Big 4 are increasingly working together because of the independence issues.
‘If there are audit issues with a PWC client, it is quite common that we work very effectively with KPMG or Ernst & Young and where they provide acquisitions, valuations, and other work that is inconsistent with an auditor relationship. That is a maturing of the Big 4 and their relationships with each other … and I think that is to the benefit of the industry.’
Says KPMG’s Matthews: ‘Rather than Sarbanes-Oxley and independence rules creating a more open playing field. The reality is that the Big 4 have worked [together] on the client relationships.’
If the mid-tier are to grab some of this lucrative work it might be through their international networks.
In the US Grant Thornton is successfully mopping up Sarbanes-Oxley work, claims Robert Quant. The US firm has about 800 staff in that area of practice, although there is yet to be much impact in Australia. ‘We’re doing probably less than half a million dollars in fees in that area at present,’ he says.
‘The issue of Sarbanes-Oxley had a lot of initial work in terms of systems review. The ongoing reviews are somewhat less [of a workload]. It’s an opportunity and it’s one we are geared to deal with, but it really relies upon the US firm. That drives most of those [Sarbanes-Oxley] opportunities for us here. They are a clear number five in that market.
‘I don’t think there have been too many second-tier or third-tier firms in Australia that have been winning major pieces of audit work. They just don’t have the depth of skills or investment in training that is required. And I don’t think it is something they would deny.’
Tough at the top
High brass at top firms talk about the Big 4.
‘The Big 4 are working increasingly together because of the independence issues’ – Joseph Carrozzi, managing partner (markets)PricewaterhouseCoopers.
‘I don’t think there have been too many second-tier or third-tier firms … winning major pieces of audit work …’ – Robert Quant, national chairman Grant Thornton.
‘… one of [our] strategies was to enhance … the firm in the middle market’ – David Murray, partner in growth solutions, Deloitte.
‘These are companies of the future for us to create relationships with’ – Patrick Winter, partner Ernst & Young.
‘The strategy … was to put the firm into a space of its own’ – Russell Heywood-Smith, national chairman BDO.
Reference: February 2007, volume 77:01, p. 36-40
Food & Drink. Travel. Est. 2005