"We've been pleased with PricewaterhouseCoopers' work [as our auditor and consultant]," said Henry Schacht, chairman of Lucent's board, to shareholders recently. "However, we have had another look at our policies and we have decided not to use PricewaterhouseCoopers [PwC] for consulting work [anymore]."
Since the collapse of Enron in late 2001 unveiled an unhealthy relationship between the auditing and consulting functions of the energy giant's outside accountant, Andersen, major companies have been rushing to ban their financial auditors from also providing them with IT and other consulting services. Apple Computer, for example, has said it wants KMPG to end any consulting assignments with the company, while Disney has said its accountant, PwC, will no longer be eligible for IT consulting work.
"I think we're just at the beginning of this process," says Jason Brueschke, a senior analyst at investment bank Robertson Stephens. Companies feel "compelled" to do something, if only to insure themselves against future problems. After the Enron scandal, directors and auditors "will find themselves increasingly liable to lawsuits" if there are any auditing problems, says Brueschke, and boards do not want to take risks.
The suggestion is that auditors can take advantage of their position of knowledge in order to win and control consulting contracts. "The audit relationship creates warm calls for them," says John McCain, president of e-solutions at IT services giant EDS.
It is a situation that has concerned financial authorities for some time. During 2000, the US Securities and Exchange Commission (SEC) launched a probe into the whole question of whether independent auditors should be allowed to sell consulting services to their clients. But after hefty lobbying and reassurances from the big accounting firms, the SEC stopped short of forcing companies to separate the two business practices.
Now, with billions of dollars worth of consulting business under threat, those firms – Andersen, PwC, KPMG, Ernst & Young, and Deloitte & Touche – are either stressing the fact that they have already spun off their consulting divisions or have announced their intention to do so.
These moves – coupled with the cancellation or suspension of consulting contracts – suggests the IT services industry is set for a period of upheaval. "These developments will lead to a long term, permanent change in the IT services industry," says EDS's McCain. He suggests that the accounting services firms' consulting practices were all born out of the auditors' close relationships with their clients, and have traditionally been seen as natural extensions of their businesses. Once separated, they will "lose some of that leverage for sure", he adds.
The case of Lucent is perhaps typical. "[Last year] we made the decision to reduce the amount of consulting services we were purchasing from PwC," says Michelle Davidson, a Lucent spokesperson. And even though PwC Consulting will file for an initial public offering this spring and possibly be a completely separate entity by summer, "Lucent didn't want to wait for them to do so," she says.
Lucent's commitment to the consulting services of its auditor were not insignificant. In 2001 alone, the company spent $44 million on auditing services with PwC, and a further $27 million on consulting services.
So where will such large contracts end up? According to Brueschke, companies such as Cap Gemini Ernst & Young, Accenture and IBM Global Services look to be the winners in this situation. They are all global enough and large enough to handle the requirements of multinationals without any conflict of interest. Though it is difficult to quantify the benefits such companies will receive, McCain believes the current situation is "a tremendous opportunity", saying that "dialogues are already under way" with several companies seeking to switch IT consultancies.
Over the next five years, Robertson Stephens' Brueschke believes that the IT services companies best equipped to succeed will be those who are either large and global, with more than 50,000 employees, or small, niche consultancies with low overheads. For those in between, "margins will erode", he says. Even consultancies such as KPMG Consulting, with 10,000 employees and a strong brand name, may not have what it takes. Without their auditing parents, many of the divested consulting arms will simply lack the required global footprint, says Brueschke – or indeed the global foot in the door.