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.
- 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.
- 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?
- 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.
- 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).
- 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.
- 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?
- 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.