Via Accounting Today : Ninety percent of the accounting industry is tied to compliance services in areas such as accounting, audit and tax, but don’t look there for encouraging signs of industry performance.
“If you look at those Level 1 services over the next decade, it’s a slow death,” says consultant Allan Koltin, who has been called the industry’s biggest deal broker. “A Level 1 service is a service a client doesn’t want but needs. A Level 2 service is a service a client both wants and needs, and hence, will pay value for.”
He expects growth in Level 1 services to range from zero to no more than 3 percent in the next 10 years as technology continues to replace more of what accountants do when providing these types of services, and as clients look for the cheapest options because they need but don’t want them. “You can’t be in a business that only grows 0 to 3 percent, because your payroll and operating costs are going to grow much faster than that.”
Instead, it will be services that involve advisory, consulting, wealth management and performing outsourcing functions (such as CFO duties) that offer the most opportunity for accounting firms during the next 10 years. These are the services offered by trusted advisors because it is these services that clients need and, more importantly, are willing to pay for, Koltin says.
Helping with Business/Financial Problems—Whatever They May Be
To illustrate the point, consider Koltin’s relationship with an accounting firm that serves Koltin’s consultancy, based in Chicago’s home of Cook County.
“There are 3,000 CPA firms in Cook County, and every one of them can do a financial statement or tax return,” he says. Clients don’t really want these services, but they need them in order to get a loan or comply with tax laws. “It’s logical that I might as well take the cheapest one I can find, because it’s a service I don’t want but I have to have. We call this a commodity!”
But Koltin hasn’t done that, because his CPA is a trusted advisor. “The partner on the account comes to my office once a month, and we spend 10 minutes talking about the financial statement. We spend the other 3 hours and 50 minutes talking about any business challenge or financial problem that I’m having in my business and sometimes in my personal life.”
“What I like about this person and the firm is the mentality of ‘we’re in the business of helping our clients with their business and financial problems, whatever they may be.’ ”
“There’s no audit checklist; there’s no agreed-upon procedures. It’s a blank pad of paper or iPad, and it’s almost like a resident psychologist: ‘Hey Allan, tell me how the month was. What’s your game plan for the next month? What things that we’ve been talking about are continuing to be a problem, and how do we reach a decision to do something?’ A lot of times we’re not talking about accounting, taxes or audits—it’s all business coaching and advice.”
Instead, they’re discussing service areas that may be underperforming or discussing how to balance finite resources and finite time.
“So when another accounting firm calls me up and says they can do a cheaper audit or tax return, I’m not moving for $10,000; I’m probably not moving even if it’s $20,000 less, because I value the trusted advisor relationship that I have with my CPA firm and I don’t know that I can get that business coaching and advice elsewhere.”
It is these types of relationships and services that represent the best revenue-growth opportunities for accounting firms.
Level 2, 3 and 4 Services
Aside from Level 1, or compliance services, here’s how Koltin sees growth rates breaking down over the next decade among the various levels of services provided by accounting firms:
Level 2 services: 5 percent to 10 percent growth. These are services that clients want and need and will pay value for—services that many firms can do in-house, such as estate planning and tax solutions (like helping with international tax, SALT and transfer pricing issues), business valuations, feasibility studies and budgeting.
Level 3 services: 10 percent to 20 percent growth. These include advisory work, consulting and outsourcing services, such as CFO work, and accounting firms often need to partner with a third-party expert or hire that expertise in house.
Level 4 services: 20 percent to 200 percent growth. These services focus on wealth management: helping the client accumulate, protect and grow their wealth. “The legendary story goes that a firm resigned from the $100,000 audit so they could represent the client in the sale of their business,” Koltin says. “The client gets $50 million, and $40 million of that gets parked with the CPA firm’s asset management, and that annuity is worth five to 10 times what the audit was bringing in.”
“Accounting firms are starting to get religion and understand that Level 1 is dying, and they’re quickly migrating into Level 2, 3 and 4,” Koltin says. “It reminds me of the old adage: If the railroad industry knew they were in the transportation business, they would still be around today.”
The railroad industry became entrenched in doing what they knew and what they always did, whereas the transportation industry offered more advanced forms of service that were valued by the customer, who became more willing to pay greater fees, Koltin says. Accounting firms that only do what they’ve always done and what they’re most comfortable with—Level 1 services—will lose out to firms offering more advanced forms of services—Levels 2, 3 and 4—that are of more value to the client.
Impact on Dealmaking
The expected growth in Level 2, 3 and 4 services is also affecting industry consolidation, says Koltin, who in addition to his consultancy, also advises CPA firms on mergers and acquisitions.
About half of deal activity is related to succession activity or older partners looking to unlock goodwill value built up by the firm, but the other half is strategic.
Many firms are looking to build out product lines for the future but recognize that building those organically could take years and a lot of capital, accompanied by uncertainty and risk, so they choose to merge with a larger firm that already has the playbook. There’s also a tremendous trend of local firms rolling up into regional firms, regional firms rolling up into mega-regionals, mega-regionals into nationals and nationals into global firms. As a result, Koltin expects industry consolidation to continue apace.
“Today, firms with no succession issues are doing upstream mergers because strategically, it makes sense,” Koltin says. “They realize it’s good for their people, partners and clients.”
Mary Ellen Biery is a research specialist at Sageworks, a financial information company that provides financial analysis and valuation applications to accounting firms.