December 15, 2023

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Failing to plan for failure 

I’ve been watching accounting firms merge left and right for a long time now, and so far as I’m aware, virtually all of these deals go off without a hitch. Part of the reason they go off without a hitch, I think, is that a lot of people have a lot at stake getting that merger to happen. In many cases, these deals come up because a lot of accounting firm partners would like to retire, and the best way for many of them to cash in is to sell their firm to a bigger firm. If they don’t sell, then they don’t cash in. And then what? Keep working? 

In other circumstances, firms can join up together, pool their resources, get bigger, and compete for more lucrative work and more prestigious clients. This kind of deal isn’t about succession planning but about succeeding on an even bigger scale. The largest firms like to think that they can do all things for all businesses, but the truth is they can’t. There’s plenty of work to go around, and the second and third-tier firms are competing pretty fiercely for that work.

Still, it’s a risky thing, tying up with another firm. The partners selling might not get the money they want; the partners that aren’t retiring have to navigate a bunch of new partners that they don’t really know. Employees at the acquired firm are now working somewhere they didn’t choose, and so on. Plus, how does anyone even know if the merger is successful? Especially with the scaling-up mergers, just because your firm is now BIGGER, doesn’t mean the merger was a success. You can’t really trust the management to be on the level about that. It was their job to get the merger done, and so, of course, they will say it was a success. 

But are the partners better off? Are the employees? Are the clients? There isn’t a ton of accountability in these situations since the firm’s owners would have to hold themselves accountable, and as a species—humans, accountants, whatever—we haven’t been great at doing that.

Anyway, mergers are risky and not to be entered into lightly. EY wanted to do a deal in the opposite direction—spinning a business off—but it’s two sides of the same coin. EY wanted to split its audit and consulting businesses into separate firms because the conflicts of interest were cramping everybody’s style. (But probably mainly the consultants’ style.) EY management repeatedly said it would be great for everyone and that it was pretty much a done deal.

Until it wasn’t. Long story made short: They couldn’t figure out how to split the lucrative tax work, the retired US partners didn’t like the deal really at all, and so they lobbied some key executives, and that was that. No deal. The whole ordeal was exhaustively covered from the moment EY announced it was a thing until it wasn’t a thing, and now we’re all covering the messy aftermath, too.

A big part of that aftermath is the firm dealing with the fact that it spent a lot of money trying to make this deal happen— $600 million—only to have it fail. Now, I should probably tell you that the firm claims that pursuing the merger actually saved them $400 million by not doing or delaying other projects, but that seems like cold comfort when you consider: 1) You still squandered $200 million, and 2) the big deal that everyone was talking about FAILED.

So, yes, money. But also, namely, people. Thousands of EY’s people have been shown the door, the firm has pushed back start dates for new hires, and now, just this week, the Wall Street Journal reported a greater-than-usual number of partners were informed that their services are no longer needed: 

Ernst & Young is laying off dozens of partners across all U.S. businesses, a deeper round of partner cuts than usual as the Big Four accounting firm faces slowing demand for certain services and seeks to cut costs following its failed plan to break up the firm. 

The cuts are largely concentrated on the advisory side of the U.S. operation, affecting more than 10% of partners in consulting and about 4% in strategy and transactions, but they touch the audit and tax arms as well, people familiar with the matter said. That would equate to more than 100 partners in consulting and over 30 partners in strategy and transactions at both junior and senior levels.

Look, obviously, I don’t know for a fact that EY leadership didn’t plan for the possibility that their spinoff would fail in spectacular fashion for all the world to see. But if you followed that story, you definitely got the impression that failure was never an option. They believed, at least publicly, that their vision would ultimately prevail. They convinced a lot of people to believe, too.

Most people will tell you that the end of a year or the beginning of a new one is a good time to reflect, think, look ahead, etc. One thing that I’m sure of is that in the year ahead, more accounting firms will merge with or acquire other firms, and precisely NONE of the leaders involved in those deals will think that their deal will be the one that falls apart. Or, at the very least, they won’t let others think that they think that their deal will be the one that falls apart. 

But a few of them will, and everyone will be—act?—surprised. And I get it, no one wants to plan for failure; it just seems better to be prepared for it than to be caught off guard. Because if you’re not prepared for it, then there are likely to be unintended consequences, and those consequences will not be pretty.     

Evolving accounting firms

The other thing that’s becoming increasingly apparent, as the Journal article points out, is that as consulting becomes a bigger share of firms’ revenue, more of these services become “nice to have” instead of “have to have”: 

Consulting demand tends to weaken or surge depending on the economy, whereas audit is a generally steady business line because of the reporting requirements for public companies. As consulting contributes to a growing share of these firms’ revenues compared with audit, the overall professional-services industry has grown more cyclical.

Historically, accounting firms have been recession-proof. Clients need audit and tax services in good times, bad times, and horrifying times—including the pandemic. A non-cyclical business is great when times are tough, but it’s probably a little frustrating in heady times when everyone seems to be having a lot more fun than you. It takes a certain type of person to run a tried and true successful business quietly and not get caught up in the hype.

Still, technology has played a role here. Legacy services like audit and tax are increasingly vulnerable to automation, which is part of the reason that organizations like the AICPA have been harping on accounting firms for years to build out their consulting work (or “advisory,” if you must). Before the pandemic, many firms invested heavily in developing those services and have enjoyed plenty of success.

Then, like many things, the pandemic accelerated the offering of non-audit, non-tax work, which resulted in accounting firms making a lot more money from consulting. But when all the pandemic-related work dried up, a lot of people were asking, “Well, now what will accounting firms do?” (Full disclosure: I was one of those people.)

What the EY situation shows is that firms that went all in—or, let’s say, 50% in—on consulting work will have to reckon with the ebbs and flows of economic conditions more than they used to. I could be wrong, but the evolved accounting firm, one that’s increasingly tied to consulting work, may end up being less recession-proof. And that may be something that some accounting firms haven’t completely thought through.

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Caleb Newquist Caleb is Editor-at-Large at Gusto. In 2009, he became the founding editor of Going Concern, the one-of-a-kind voice on the accounting profession, serving in the role for 9 years. Prior to Going Concern, Caleb worked as a CPA for nearly 6 years in New York and Denver. He lives in Denver with his wife, two daughters, and two cats.

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