Note: Fred Fink, is the co-author of this blog.
The business model of professional services firms—whether lawyers, accountants, doctors, architects, management consultants, or others who deploy specialized “white collar” expertise to serve clients, usually with some degree of fiduciary responsibility—is based on sharing of expertise between practitioners. Experienced practitioners transfer their knowledge and experience to junior practitioners and supervise and mentor them in serving clients. A partner who charges $300 an hour might supervise junior personnel who charge $80 an hour: this is the model that generates efficient services to clients, profits for professional services firms and good income for its members--especially the senior ones.
Over time knowledge in a professional services sector tends to be become commoditized. A case in point: consulting services to implement SAP and other enterprise resource planning (ERP) tools. In the years around 2000 there was more demand for these services than practitioners trained to deliver them. Big 4 accounting firms and other practitioners who specialized in this kind of work could typically charge about $300 an hour for their services. Over time knowledge of best practices for how to implement ERP consulting has come to be more widespread and firms transferred much of the lower level work to lower cost countries like India. The result? Rates for ERP implementation work have come down to under $100 an hour.
Such cannibalization is facilitated by technology. Accounting firms used to be able to charge by the hour for juniors to add and cross check i.e. “tick and tie” numbers. Now much of that work is automated. The overarching principle is that anything that is primarily rules-based can be automated.
Another case in point illuminates this key trend in the evolution of professional services: the sector of professional services that reviews companies’ state and local tax payments to find overpayment and file refund claims. Practices of big firms and standalone firms that perform these reviews are generally paid a percentage of the refunds they generate.
This sector is now being disrupted by a new firm, CypherTax. CypherTax, which is a client of Newport Board Group, saw the potential for a collaboration tool that could be layered on top of the ERP packages that capture tax expense information and their account coding. The opportunity to disrupt the state/local tax review industry starts with the human error that can occur when accountants enter into an ERP system a product or service that the company has purchased. At this point they must decide whether the company owes state and/or local tax on it. The criteria are typically the cost center that the purchase is coded to and the purpose for which it was bought.
Compounding the normal rate of human error in coding of costs is the widespread move of corporate shared services departments to India. These are high volume operations where management monitors employee activity down to the number of key strokes required to enter an invoice. Coding a purchase correctly as to whether it is taxable requires knowledge of the context of the purchase, which is often lacking when Account Payable personnel are remote from the company’s operations. If the purchase in question is a prototype chip, for example, the accountant coding it may not know whether and how it is to be used in manufacturing—and therefore whether it is taxable. The problem is exacerbated by the fact that, with automation of the Payables function, errors as to whether a particular item should be taxable or not tend to get replicated.
CypherTax saw opportunity in the fact that seeing aggregated tax data in summary, interpretive form (especially graphs) is the best way to spot problems. The CypherTax tool set helps to look at cost centers and effective tax rates by jurisdiction so that analysts can question, for example, why the effective rate for a manufacturing cost center is high for a particular jurisdiction.
CypherTax in effect flips the traditional, bottom up model of doing state and local tax reviews. It facilitates filtering aggregated data to identify and assess possible errors, along with the likely cause of the problem. It allows for month-end analysis and execution of corrective processes, with validation that amounts due have been properly adjusted.
CypherTax’s automated, granular approach to finding over and under payment of state and local taxes has other benefits. Sales and use tax is connected to other issues. A company may find it is erroneously paying tax on machinery and equipment because it hasn’t provided documentation to vendors as to whether they are a reseller or a manufacturer. This in turn can highlight the need to provide recycling and disposal documentation to vendors. The system has the ability to identify anomalies in results that should typically be relatively standardized.
Won’t such an automated approach reduce the amount of work that service providers can charge for? Yes, to some degree. But the net impact of using the system is to help clients solve an important problem: identifying coding errors and their causes such as inadequate training and supervision. Firms using CypherTax should be able to charge more for getting at the root of the problem--and preventing problems from recurring. It enables expensive client problems to be fixed with a less expensive resource. Higher cost resources are freed up from doing routine tax reviews to performing higher value consulting. It’s less about reducing professional services firm headcount than shifting people to new roles in which they can create more value—and charge for it.
The same kind of disruption, powered by technology and new business models, that is overturning incumbents in industries across the economy now aims to transform professional services firms of all kinds. Those that embrace innovation have a chance to profit from it. Those who ignore it do so at their peril.
About the Expert
Fred has been successful both as an executive and an entrepreneur. As founder and CEO of Optical Resources Group, a consolidator in the wholesale optical laboratory industry, Fred led completion of 12 acquisitions in 18 months and was responsible for raising $30 million in equity capital and $55 million in senior debt. The company was sold in an all cash deal for over 14 times pro forma EBITDA. More background on Fred's experience as a business leader and advisor and information about how to contact him is available here.
About the Expert
Mark Rosenman has had leadership roles in knowledge management at top global firms McKinsey and KPMG and at entrepreneurial firms Tatum LLC and Newport Board Group, where he is currently Chief Knowledge Officer. He was a main architect of McKinsey’s first firm-wide document portal and of standards for publishing internal documents. He has extensive experience building line management consensus for content policies and processes. Click here to learn more about Mark Rosenman or contact him.
