This article was first published in the May 2016 UK edition of Accounting and Business magazine.

The rapid growth of new business is normally a cause for unrestrained celebration, but soaring consulting revenues are a reason for concern at the Big Four.

‘We have been down this road before and it is fraught with tensions,’ says Jim Peterson, who was in-house legal counsel for Arthur Andersen for 18 years and the author of Count Down: The Past, Present and Uncertain Future of the Big Four Accounting Firms. ‘The surge in consulting or advisory services in the 1990s was a bugbear for regulators, who feared it would conflict with the crucial role these firms play in validating corporate accounts. It also led to ruptures within the major professional services firms as two distinct cultures clashed.’

In the early 2000s, the consulting units at the large professional services firms were either sold off or split out. The Big Four seem to be fast reaching this point again. Over recent years, the firms have been two-speed businesses, with slow growth in audit but runaway acceleration in consulting.

The stagnation in audit revenues is attributable to a couple of factors. Fiona Czerniawska, managing director of research firm Source Information Services, says: ‘The Big Four have already locked up a dominant audit market share, so growth is very slow and volumes do not change very much.’

Only two of the FTSE 100 companies are not already audited by a Big Four firm: Sports Direct, which stuck with its mid-sized auditor Grant Thornton after being elevated to the index in 2013; and Randgold Resources, which has used BDO since 2007. This dominance is also global. As of the end of 2014, the Big Four audited 95% of the world’s 500 largest companies.

The mandatory rotation of auditors imposed by regulators around the world (including an EU-wide regulation) to prevent too cosy a relationship developing between a business and its auditor is setting a further challenge to revenue growth. Rotation puts pressure on audit firms to reduce fees, the bidding process is costly, and auditing a company for the first time is more resource-intensive than working again for a familiar client. However, the increasing automation of the audit itself, such as the use of data analytics, is reducing costs and should help offset some of the fee pressure (see AB February 2015).

The contrast with the fortunes of the consulting business could scarcely be starker. ‘The public importance of auditing is still as crucial as it ever was,’ says Stella Fearnley, professor of accounting at Bournemouth University. ‘But recently, consulting has become a more exciting business by far.’ After a decade of frantic growth, revenues from advisory are now larger than for auditing for all the Big Four UK firms. In the 10 years to end-2014, for example, advisory revenue at EY increased by 225% from £0.3bn to £0.9bn, according to Source. Over the same period, audit, which represented a higher share of revenue in 2004 with £0.4bn, expanded by a more modest 46%. Advisory revenues are up by 188% at PwC, and 205% at both KPMG and Deloitte. The same pattern can be seen in other main markets.

Technology the driver

So what is behind this growth? The economic bounce-back of many rich nations in the years after the 2008 financial crisis is only part of the answer, says Czerniawska. ‘The key driver has been improvements in technology and a determination by companies to make best use of them,’ she says. ‘Globally, 45% of the growth in consulting in 2014 came from digital transformation, helping companies change the way they work in response to these new technological capabilities.’

From traditional retailers expanding their online offerings, to financial technology businesses challenging other financial services providers to change the way they operate, to the increasing digitisation of government services, it seems that everyone needs help with digital.

This environment is creating such an abundance of opportunities that most consultancies are growing. ‘There is enough food for everybody to eat here,’ says Czerniawska. Yet the advisory operations of the Big Four have been doing even better recently than the independent consulting firms, she says. ‘This is partly because of the high rates of growth in demand from the financial services businesses – a sector in which they have traditionally had a strong position.’

The banks have required more help to cope with intensifying and changing financial regulation. They have needed advice not only on the implications of the shifting rules, but also on changing their systems to ensure they are compliant and calculate appropriate compensation when they have made mistakes. The fact that the Big Four have audited these financial entities has given them a bridgehead to sell this kind of service.

In response to this surge in demand, the Big Four have been buying up a range of consultancies with different specialities, as well as developing their own internally. Some have been really big deals: in 2013 the purchase of Booz added 3,000 staff in 57 countries to PwC’s offering, renamed Strategy&. ‘This kind of large deal has been the tip of the iceberg,’ says Czerniawska. ‘They are trying to be strong across the board in consultancy, from IT to strategy.’

Yet the land-grab has also revived old controversies. ‘We are slipping back,’ said Arthur Levitt, the former chair of the Securities and Exchange Commission, in response to the PwC deal. ‘As the accounting profession becomes more committed to consulting, their audit activities have got to be questioned.’

Internal and external pressures

Peterson believes that pressures will come from regulators and the firms themselves. ‘Through the 1990s we saw increasing concern among regulators that fast-growing consulting abridged the notion of an independent audit,’ he says. ‘Whether this was right or wrong, there was a sense that selling advisory services to companies would make it harder for accountancy firms to assure the integrity of corporate accounts.’ That led politicians and regulators to restrict the operations of professional services firms.

Such limitations exacerbated internal tensions that had been building within the firms. ‘In Arthur Andersen, which was one of the trailblazers in developing its advisory businesses, internal tensions led to a breakdown of the model. There were escalating conflicts over compensation, since consulting partners could often end up bringing in more money and wanted that to be reflected in their pay,’ says Peterson.

As profits surged in advisory, Arthur Andersen consultants increasingly resented the need to make transfer payments to the accounting business. The International Chamber of Commerce was brought in to arbitrate and ultimately granted Andersen Consulting its independence in 2000. But the consulting business was prohibited from using the Andersen name and required to pay US$1.2bn in past payments. The independent advisory operation became Accenture, now the world’s largest IT and services consulting business. As of early April 2016 the company had a market capitalisation of US$75bn.

The split was accompanied by similar moves in other major rivals. Ernst & Young, now EY, sold its consulting service to CapGemini in 2000. PwC Consulting was spun off in 2002 and later absorbed into IBM for a sale price of US$3.9bn. At KPMG, the consulting business was split out in 2000 and listed independently in 2001, changing its name to BearingPoint. The exception was Deloitte, whose far smaller consulting practice was not seen as viable at the time.

‘The question is whether this will happen again,’ says Peterson, ‘or whether the businesses will be able to remain cohesive and work together.’

Despite these potential tensions, there are still advantages for the Big Four in continuing with both business lines. ‘It would be a natural instinct for chief executives at these firms to ask what is the point of holding a nearly zero-growth business,’ says Czerniawska. ‘Still, the answer is not so obvious. After the Enron collapse, audit margins expanded sharply, and advisory is vulnerable during economic downturns.’ We can’t eliminate the chance that this will happen again, she adds. Audit can provide some protection against cyclicality.

But in the event that the firms do divide, it may well be the audit functions that will be spun off this time.

Fernando Florez, journalist