Caught in the middle

Intheblack, Feb 2007 by Charles, Ed

BIG FOUR 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 Four 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 midmarket 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 Four 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 Four 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 Four 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."