Meiosis, Mitosis: Cap Gemini's Mating with Ernst & Young

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Meiosis, Mitosis: Cap Gemini's Mating with Ernst & Young
E. Robins - April 5th, 2000

Event Summary

Cap Gemini wants Ernst & Young's management consultancy, and in all likelihood (about 90%), the partners of Ernst & Young are willing. The whole affair has been long in the making. Ernst & Young, like its cohorts Andersen, KPMG, and Pricewaterhouse, suffers from the malady known as SEC rules on conflict of interest. Its auditing wing can never quite be distinguishable from its interests in management consulting wing. The SEC has threatened legal action against at least one of the major consulting firms if the practice doesn't stop.. The SEC is also upset that some partners have (un)wittingly invested in companies that other partners are contractually engaged with.

It is perhaps ironic when you consider the origins of the major management consulting practices were from the advent of computers back in the 50's and 60's. Computers freed accountants from the drudgery of number crunching, resulting in more time to review what the numbers actually meant for their clients' businesses.

Market Impact

Cap Gemini's move will take it into the leagues of the major management consulting firms, with a staff numbering on completion of the deal at around 60,000. More than that, however, it makes Cap Gemini a world player, rather than what it has been in the past - somewhat relegated to the corridors of Europe. This causes a re-evaluation of Cap Gemini's position in the world.

Cisco, for example, is re-examining a proposed partnering arrangement with Cap Gemini, since originally this was meant to fill a partnering hole in Europe.

Like many partnering arrangements of today, it is hard to predict what your partner is going to do, and write the necessary terms into the contract. This merely emphasizes the situation.

However, prior to this deal going through, the implications are interesting from a number of perspectives.

  1. From limited Partnership to Public Corporation For Partners in Ernst & Young, the move from being part of a well heeled respected large limited partnership to a public company - with the name Cap Gemini - competing in a market against the Scient's, Viant's, Whitman-Harts - must entail significant management changes, and psychological readjustment.

  2. Change in marketing culture for the partners. Traditionally, accounting-like partnerships meant leads for management consulting - a dangerous recipe that forced a semi-divorce of one part of the business from the other early on. Conflict of interests in cases of large and multinational companies is not easy to avoid. The question will however, be interesting as to what the SEC will think of this separation: after all will Ernst & Young accounting and auditing services provide leads to the new Cap Gemini through the new (old) boys system? How does SEC deal with that - and will it need to?

  3. Change in bonus remuneration. Many Ernst & Young partners receive large bonuses at the end of the year. In this deal they are provided with stock options and shares over a period of four years (to retain loyalty, of course), These options and shares, subject to a fickle stock market, are not necessarily dependent on the earning capacity of the company. Remuneration in Ernst & Young also benefited from the accounting side. Hence remuneration of staff, and charges to clients, are generally higher in this and other comparable large consulting companies.

  4. Partners must feel they can hang in for four years. The partners in these large consulting companies are not necessarily the risk-takers. Looking at an uncertain stock-option value may make some reconsider where they should be spending their time, particularly when compared to high-flying dot-coms. They have four options - hang in for four years and take the cash risk, depart for safer shores in another legacy consulting company, set something up on their own, or find a dot-com where the return on the risk is much higher (then, so is the risk - however, research in this area shows that most people underestimate risk, which is just as well, otherwise, I suppose, as a species we'd never move forward).

  5. Ernst &Young Partners will turn into VP's. The problem is the prospect of having a VP providing services rather than a solutions or project manager. This makes a disparity between the functions of the new VP's and those at Cap Gemini. It will be interesting to see how this plays out, but we suspect Cap Gemini employees may be looking at their own titles before long.

  6. Disparities in billing of expertise of Ernst & Young partners against Cap Gemini personnel. While the name of Ernst & Young rings synonymous with the other consulting houses where $700 an hour up can be commanded for the more senior consultants, it is hard to see this charge rate coming out of Cap Gemini which must compete in the marketplace with rates in the $125 - $450 per hour level. We believe it will not be long before some Ernst & Young partners find themselves at loose ends - in or out of the job. Simply put, why use an Ernst & Young partner (now a Cap Gemini VP) when you can use a cheaper Cap Geminian project manager of equivalent capability and increase your margins - or at least be competitive?

  7. Catalysis by e-business. Both Cap Gemini and Ernst & Young see e-business from at least two perspectives: (a) it is the major growth business and (b) it is effecting a culture and business change throughout their organizations. It would not be the first time that e-business is used as the catalyst to unite two merging firms.

The merger is not likely to upset any major balance of power in the market place in the immediate future, but it will mean that Cap Gemini and Ernst & Young clients are going to have to look carefully at what Cap Gemini cost structures are going to be after this merger. This could add pressures to increase costs for developing e-businesses by Digital Business Service Providers (DBSPs). As an indication of the difference between the two companies, a rough measure of revenue generated per employee indicates that Ernst & Young charges are generally over 20% higher than Cap Gemini employees. Since the Ernst & Young figure also includes lower costing accountants (there are no published breakdown figures for Ernst & Young), it can be expected that the Ernst & Young technical arm probably is higher than this.

This split and new marriage may not be typical of what will happen to the consulting wings of the other members of the major consulting firms with auditing wings. It may add impetus to the division of some. However, they may wait until they see what the SEC says about this change, and how it plays out in the real world.

Further down the road, it is more likely is that the other consulting divisions will go into meiosis (splitting off the management consulting business), and - it would not surprise us - if one or two could consequently go public. We believe Pricewaterhouse is the most likely candidate to go this route given its position with the SEC. Separating completely has many advantages for both sides of the business: separating for a start generally increases the value of the two pieces.

For the consulting arm, it would enable them to get more fully into the lucrative dot-com market, restructure their cultures, and bring new blood in for the new economy. As well, SEC rule limitations would be less stringent. The big problem will be hanging on to highly skilled personnel who may find themselves priced out of the market due to their seniority. They could decide to strike out on their own or seek safer havens. Severance payments may be the kick some will need to start out on their own, adding to the birth rate of new companies - and with their contacts (one would suspect) have the ability to succeed. All this should potentially lead to more business vigor. The Cap Gemini move may well accelerate the marketplace in this direction.

In the U.S., Cap Gemini's presence will suddenly take on an enhanced position. As evidenced by the Cisco reconsideration of Cap Gemini's position in this market, it is clear the impact will be significant. It also means that a European based company is now among the major U.S. DBSP players, and you can bet their focus will be in the digital business sector. It is an instrument which will unite them and about which the new organization will mostly be built.

One other interesting note is that Cap Gemini has been losing its edge in the U.S. Its U.S.revenues were actually down in 1999 from 1998 while its workforce remained practically static. It would seem Cap Gemini has some internal challenges to overcome, and linking with Ernst & Young can only add to the issues. Hence, we expect it may take some time before Cap Gemini truly expands outside of its revenue malaise in the US market. It's big growth regions are in Europe and Asia (where in the latter case, admittedly, it has a small contingent of about 400 staff).

User Recommendations

If you have a consulting relationship with any of the major consulting firms, nothing is likely to happen for a while so no action need be taken. These companies certainly deliver the goods according to our own research and user stories, but they are generally more expensive, largely because their name is synonymous with high quality service. In the case of Ernst & Young, however, the issue will come to a head after the partners vote at the end of this month. The merger is likely to complete later this year after the SEC has given its blessing (90% probability).

For users of Ernst & Young services - or Cap Gemini - be prepared for possible changes in pricing structures. Also remember that the name of Cap Gemini can be enhanced by the name of Ernst & Young (probability 90%) - or, maybe vice-versa. Whatever the direction, certainly Cap Gemini's presence will be felt more in the U.S. marketplace than elsewhere.

We believe there will be a marginal increase in competition for the dot-com market and to a lesser extent the B&M's. However, given the current demand for services, charge rates will still increase (80% probability).

The upward pressure of increasing seniority, blending of rates of senior and junior employees, and the tight labor market all point to an upward trend, particularly in merged companies of the Cap Gemini/Ernst & Young genre. The most senior people from these companies will most likely be looking at creating something on their own within the next few years as they price themselves out of the market.

If you are caught in one of these meiotic or mitosis situations, look carefully in case your service should suffer. You may see team changes you may not want. Make sure the team you are shown will be hanging around to complete your contract.

Remember: losing and gaining genes will always breed a new organism.


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