Implications and Attitudes As the Andersen's Split under the ICC Ruling: Consulting To Go for a Name Change

  • Written By: R. Krause
  • Published On: August 2000



Implications and Attitudes As the Andersen's Split under the ICC Ruling: Consulting To Go for a Name Change
E. Robins - August 31, 2000

Event Summary

Andersen Consulting was set up in 1989 to more effectively split technology consulting from the tax and audit accounting component. Andersen Worldwide (AWSC) was intended to coordinate the activities of the two firms, and ensure they did not cross paths, AWSC was a follow on from the Andersen Worldwide Organization which had been in existence since 1977 to coordinate the Tax / Audit division of Arthur Andersen with its management and IT consulting arm, MICD (Management and Information Consulting Division).

Early on contentious problems arose between the two business units, since salaries had to be kept on par across the organization. This led to either salaries in MICD being kept below market value (resulting in a massive exodus of personnel to competing firms) or to creating unacceptable inequities within the company. The issue, among others , led to an agreement called the Member Firm InterFirm Agreements or MFIFA and the creation of Andersen Consulting. Andersen Consulting and Arthur Andersen were to operate in different, complementary spheres with a minimum of overlap between their respective lines of business - management and technology consulting in the case of Andersen Consulting, tax and audit accounting for Arthur Andersen.

Since then, Andersen Consulting charged that AWSC and Arthur Andersen had not lived up to their side of the bargain. Indeed, Arthur Andersen has continued to build up its Business Consulting practice, from which it is experiencing much of its growth, at times coming into direct competition with Andersen Consulting. Since Andersen Consulting, the more profitable group, under MFIFA, had to provide up to 15% of its revenues for distribution to Arthur Andersen (the less profitable arm of the two), it amounted to Andersen Consulting paying to support its own competition.

Key to the development of the internal competing business units was the fact that overlap management was initially left to lower level managers who were closest to the clients and the marketplace. This left executive direction and the power of the AWSC weak in enforcing non-competitive rules. Various attempts to resolve the problems among the business units were attempted, but each time thwarted by the independent partnership nature of the organization.

This has given Andersen Consulting the leeway to separate from Arthur Andersen and Andersen Worldwide. In December 1997, following several years of reconciliation attempts, Andersen Consulting applied to the International Chamber of Commerce (ICC) Court of International Arbitration in Paris to settle the dispute. The final judgment was delivered on August 7, with both sides claiming (ridiculously) victory. In fact, it is clear from the judgment that Arthur Andersen and Andersen Worldwide in particular, roundly lost this one.

Given the increasingly integrated business environment, it was inevitable that the issues surrounding these two business units would come to a head, which it did in December 1997. The tax audit arm must become compromised when it is combined with a business consulting practice / technology-management-consulting arm. But the way Andersen had structured its partnership arrangement (more political than sense at the time) was doomed to internal competition from the start: tax and audit system and management consultancy were and are becoming more tied to technological wizardry which is blurring the boundaries of services required by clients.

The division of tax and audit versus technology/management consulting is likely imminent for most of the partnerships, one way or another, as we predicted after Ernst & Young split its technology consultancy and sold it to Cap Gemini (see Meiosis, Mitosis: Cap Gemini's Mating with Ernst & Young), and PwC (PriceWaterhouseCoopers) agreed to some separation of its internal divisions after the SEC ruled on findings that PwC employees had investments in their client businesses.

Arthur Andersen may have some explaining to do with the SEC as to how it intends to operate its arms independently. It seems Arthur Andersen partners don't get the difference nor understand today's business models - i.e., having a technology-partner where you need one and sticking to your core business where you are good.

Over the years Arthur Andersen has attempted to obtain skill sets through acquisition, much to the chagrin of Andersen Consulting. Andersen Consulting has openly claimed that Arthur Andersen has engaged in business integration consulting assignments similar to Andersen Consulting and contrary to the statements it made to the SEC. And as for the SEC, it already has a very hard time in knowing how and where the lines should be drawn to avoid conflict of interests in these firms.

This is particularly difficult when, in Arthur Andersen 's case, the company's employees are given a stake in the outcome of client companies, and Arthur Andersen has set up a $500M venture capital fund to invest in its clients! We believe the SEC made a mistake in 1990, when it took Arthur Andersen at its word and did not issue at least some operational guidelines. It seems Arthur Andersen used the decision from SEC to begin its internal, then external, competitive track against Andersen Consulting.

Both Arthur Andersen and Andersen Consulting claim victory - for Arthur Andersen this is more a pyrrhic victory, if anything. Jim Wadia, worldwide managing partner for Arthur Andersen, has resigned, presumably over the decision. Andersen Consulting had offered to settle prior to going to the ICC with a much larger sum than the $1.2B Arthur Andersen finally got. The $1.2B consisted of $400M in transfer payments under MFIFA, and an outstanding $830M was being held in escrow. It also lost all common intellectual property rights to Andersen Consulting, except for old technology dating to the time prior to December 1997, which consisted of general ledger and payroll technology. Both these items can be obtained from other sources such as from several ERP vendors.

The ICC ruling effectively has created a new Andersen Consulting, free of any hindrances from its mother accounting/audit firm. However, Arthur Andersen also gained something it had been seeking all along - the freedom to compete openly with Andersen Consulting and spread its wings from under the control of Andersen Worldwide (not that Andersen Worldwide had any real control particularly since the SEC ruling in 1990 gave a free hand to the Andersen companies after it would 'take no action' on the separated companies).

Andersen Consulting must change its name by December 31, 2000 - something it was thinking of doing anyway. (You are probably already confused with the names in just getting through this article!) According to Jim Murphy, Marketing Head of Andersen Consulting, the cost is about $100M in terms of broadcasting its new identity. As it is, the name "Andersen Consulting" belies the more IT focused company's real role in building e-businesses.

In Joe Forehand's (Andersen Consulting's CEO) words, "The name we view as a small price in this (arbitration decision), it is fairly insignificant in the overall scheme of things. In building our brand it is largely about the significant client base we have worked the 65,000 people who show up in offices over 48 countries and intellectual property which we keep - all of this are the essence of what we have created we do not have any concerns about moving to a new name, new identity to identify us."

Market Impact

Like other legacy (that is, those consulting houses with roots prior to 1990) consultancies of their genre, the Andersens, have been changing rapidly. The joint Arthur Andersen / Andersen Consulting path has been, however, less clear due to internal conflicts and competing interests, much of which is market driven.

For Andersen Consulting, since Global Managing Partner and CEO Joe Forehand took the helm at the beginning of November 1999 (see our article "The Empires Strike Back - Part I: The Big Guys Spin On A Dime"), Andersen Consulting has been very busy developing a new management structure, and new policies, trying to recreate itself to meet the new economy. By comparison, Arthur Andersen has a lot of catching up to do in this area, but its large resources will no doubt begin to play a noticeable part in the creation and implementation of e-businesses.

The continuing break up of the consulting partnerships into separate technology consulting and tax/audit companies enables the technology consultant firms to more clearly focus on their business, and should in theory liberate them from any limiting obligations. This is true of Andersen Consulting, but not Arthur Andersen. However, the presence of these two large behemoths released completely in the marketplace is going to increase competition with just about every serious Digital Business Service Provider (DBSP). This should translate into more aggressive marketing and consulting practices, putting pressure on the smaller consultancies in the mid- to high-end marketplaces, and also with those partnerships that have as yet stuck it out - namely mainly PwC, and Deloitte.

As Arthur Andersen is intending to be a two-headed beast, it presents an issue for the SEC, and until clear and strong actions are taken, the marketplace should be aware of the dangers this represents. The consequences of ignoring this can result in major issues for the consulting organization (see for example "Heads Roll at Consulting Giant in Wake of SEC Investigation" by our analyst Steve McVey). Compromising the independence of any audit processes is not something that should be encouraged, and may give cause for some consideration, as the SEC is likely to rule shortly to ban these joint services. On July 26, Arthur Andersen, Deloitte & Touche, and KPMG issued a desperate plea to the SEC not to rule against their ability to deliver technology consulting services. In their defense they state:

"that we oppose any regulatory ban on services that is not grounded in evidence or supported by facts, and where the consequences have not been fully considered The Commission is rushing to judgment by means of a process that is fundamentally flawed and without any factual justification. Moreover, we are very concerned that the proposal will undermine audit quality and have a number of other unintended consequences that will injure investors." (reference: July 26, 2000 - " STATEMENT BY Arthur Andersen, LLP; Deloitte & Touche, LLP; and KPMG, LLP regarding proposed SEC rulemaking on auditor services"

We do not think this position is particularly tenable, partly because it lacks specifics, and because in today's world, big need not do everything. In fact, Arthur Andersen itself has partnered with service providers such as ProsoftTraining.com to provide JAVA training services for Arthur Andersen, hence the concept is there, and should be extended to increase arms length activities. Following Ernst & Young's example would also not be a bad idea. They should learn to utilize these directions rather than sticking with the 'go it alone and do everything' approach. Even IBM has partnered where it lacks the technological capabilities and/or faces too much uphill work for market penetration.

Further, the breakup shows that attempts to coordinate two practices are at best extremely difficult, if not in the end impossible. Andersen Worldwide, according to the arbitrators report, failed to coordinate the practices of the two firms, and this led to Andersen Consulting being able to claim that the obligations among the parties had been undermined, opening the gate for the management and technology consultant to go to arbitration and formalize the break.

(Author's note: Arthur Andersen interprets this differently, saying the arbitrator cleared them of all issues related to their obligations under MFIFA. Andersen Worldwide was roundly criticized, and became the whipping post. Given the worldwide nature of such organizations, and multiple divisions among the branches of these firms, such events should not be surprising.)

The rapidly expanding marketplace will soften any impact for other service providers, particularly those playing in the lower mid and lower market levels, at least for the next 12 months. If there is a slow down - due to economic changes or simply a lack of bodies - these giants may well play a stabilizing role.

Vendor Recommendations

Vendors on two levels are affected from this decision. First, legacy tax and auditing companies cannot expect to retain Chinese walls for long in their organizations between tax /audit and management / technology wings. The politics and market pressures make it tempting for business units to go their own way, rather than lose a piece of the action to another business unit. Arthur Andersen started small, saying it would only service small businesses that Andersen Consulting would not have been interested in: trouble is, when does 'small' stop? In the end, these companies should separate. The tax and audit companies need to align themselves with independent technology partners, rather than continue into compromising territories.

Secondly, for smaller service providers, it emphasizes the need that as the large international organizations branch from their mother companies, they must build out internationally and/or find their unique niches in the marketplace. Their impact will be cushioned somewhat by the rapid expansion of the marketplace, but the competition for business - and bodies - is going to increase. However, the large consulting houses can be great training grounds for your next crop of experienced workers. Arthur Andersen may do a service in this respect yet. (It is a point to note that the ownership of the St. Charles training grounds that both "Andersen" organizations share was not clearly delineated by the arbitrator's ruling, and this has yet to be worked out.)

User Recommendations

For the users this may mean they should take a fresh look at these 'emerging' super consultancies. Powered by new ideas, freed from obligations, and including investment arms as well as technology development wings with very large resources, will mean they could have a formidable impact on the market in 12-18 months from now in the high-end market in particular.

Given the blurring of requiring technology and management consulting solutions and audit processes, there is an issue that the user should consider: the independence factor. Make sure your service provider meets SEC requirements, otherwise down the road it could lead to difficulties.

The user should consider these companies for their depth of technology and business resources. However, it may be an expensive ticket, and a large organization may not be your cup of tea. Further, bear in mind that Andersen Consulting is more the Fortune 500 company's companion, and you need solid financing to work with them.

On the other hand, Andersen Consulting can provide venture capital and take equity compensation through its venture capital arm AC Ventures where it has about $200M to invest over the next year, and already has had significant throughput at its 24 worldwide Dot-Com Launch Centres. Arthur Andersen is more focused on providing traditionally oriented business services in the new e-business environment, though it can assist in finding financing.

The distinctions between Arthur Andersen and Andersen Consulting are, however, apparent.

Arthur Andersen is focusing in the lower to mid- markets, with an emphasis on the mid-market. Its business practice is still centered on management consultancy and tax / audit regime, and is still weak in the technology sector. However, Arthur Andersen is hiring recruits with a composition something like 65% new / raw technologists (programmers, network engineers etc.), and 35% in the business development area (mostly experienced personnel). It has catching up to do in the marketplace if it hopes to be a serious player against Andersen Consulting. Andersen Consulting, in turn, intends to hire 16,000 over the next year.

Andersen Consulting, on the other hand, with more of a focus on the mid and high-end markets, has obvious strengths in technology implementations, and driving e-businesses through from scratch at its 24 dot-com launch centers. In terms of technology partners and technologists, it is a leap ahead in the e-business building marketplace to Arthur Andersen.

Arthur Andersen has some 77,000 employees spread around 84 countries, and has about $7B in revenues. We estimate it should add about another 6,000 people - mainly technologists - to its retinue over the next year.

Andersen Consulting has 65,000 people in 48 countries, and earned $8.9B in revenues last year. See our recent article"The Empires Strike Back - Part I: The Big Guys Spin On A Dime") for other details on Andersen Consulting's offerings. Andersen Consulting plans to build out as well.

Billings per capita show the significance of moving into a management and technology-based rather than audit-based tax industry. The value proposition is incomparable to clients, as figure1. indicates. The return we estimate is an extra 51% per capita on the business consulting/IT side. Part of the additional value is derived from the fact that engagements in technology typically run over $500,000, while those for a tax audit process are much lower.

Figure 1. Estimated per capita returns for core businesses practices of each of the Andersen companies.

In 1997 for example, 54% of billings for Andersen Consulting came from engagements exceeding $500,000, while for Arthur Andersen, 82% of it income was derived from engagements below $500,000. Hence the sizes of projects each is used to - and their nature - are quite different. For the next year or so, as Arthur Andersen ramps up in the technology sector, users may want to bear this in mind if desiring to select between the two Andersen's.

Both companies have venture capital programs. It remains to be seen what SEC makes of Arthur Andersen 's venture capital and employee incentive programs.

 
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