It seems like most regional and small accounting firms do not see how fast their business models could disintegrate in the next three to five years. Many of these firms are heavily concentrated in audit and tax compliance activities. The audits and returns need to get done. However, neither of these services drive revenue, decrease expenses, or reduce risk for clients. In other words, they are not accretive to the value of the client's business.
I have discussed this point with many accountants who believe that the value of their client's business is not their responsibility and they are not obligated to find someone that can help clients drive the value of their business and prepare for the due diligence process. If we assume that a client is five years out from a sales transaction, this view could pose great harm to clients.
During this time, the accounting firm could prepare five perfect audits and five perfect tax returns and that helps due diligence to an extent. However, the audit reports and tax returns do not impact the valuation of the business. The sales price of the client's business will determine the quality of their retirement and their legacy because the business value generally represents 85% of their net worth. Yet, the compliance based regional and small accounting firms heavily prioritize compliance over services designed to drive business value during this critical period. Clients are facing AI premiums or discounts based on their ability to deploy AI and they need to be highly differentiated as boomer exits dramatically increase the supply of businesses for sale.
The impact of these compliance service models used to only impact the clients. In the next three to five years, it will have a major impact on the firms themselves. Compliance fees are going to compress gradually in a series of stages that will ultimately drive the value of the firm down significantly. AI and technology improvements will create so much efficiency that the billable hour model will collapse and firm profits will drop significantly. Everyone in the firm will be working harder and making less money even if they can fill capacity gaps with more clients or perfectly timed personnel reductions to preserve profits. Headcount has to decrease proportionately each year to offset additional fee compression as AI and technology continue to drive more efficiencies.
The only way to avoid this fate is to make a hard turn into business advisory services that reward outcomes instead of effort, that are based on productized platforms instead of people performing services, and that are billed on a subscription basis rather than a project basis. The analysis below focuses on the stages that firms will move through. Firms have to move as quickly as possible to stage 5 but this will not happen overnight. It will take 18-36 months to achieve on a very aggressive timeline that assumes the ability to execute the largest change management transformation ever.
Stage 1 — Tool Curiosity
The firm starts using ChatGPT and compliance productivity tools.
Professionals are discovering ways to speed up research using the LLM's.
AI implementation involves a series of tools with no coherent AI strategy.
This stage feels safe because AI disruption is not impacting profits.
However, there is an invisible layer of firms that are beginning to create permanent sustainable competitive advantages with budding stage 5 advisory practices.
Stage 2 — Workflow Assistance
The firm is more efficient because documents are imported electronically, computations are automized, tax research is faster, and the first drafts of memos are produced by AI.
There is a feeling that the firm is becoming more efficient which is a good thing in business.
Firms now have too much capacity when they had too little capacity five years ago.
They need to start reducing headcount now.
The remaining staff are forced to absorb salary reductions because there is too much supply in the market.
The problem is that the efficiency gains that seemed great are compressing fees because everyone has excess capacity and it needs to be reduced.
Stage 3 — Production Transformation
The entire compliance process with the exception of partner reviews is automated.
AI efficiencies and reduced outsourcing margins are compressing fees further.
The speed of completing audits and tax returns compresses fees even more.
Turnaround time is now three days instead of three weeks.
Clients notice the increased delivery speed and demand further fee increases. Excess capacity needs to be reduced further.
Stage 4 — Economic Repricing
The compliance heavy business structure fails.
No firm can bill based on traditional hourly models.
The only way to increase client volume is to reduce fees.
The partners are working harder and earning far less.
A change of scenery begins to look very appealing.
The only way to merge up is from a position of extreme weakness.
Stage 5 — Model Reinvention
The firm needs to rapidly move into business advisory models.
Firms need to pivot to marketing positioning and narratives that focus on outcomes.
Firms need to deliver on the promises of outcomes
The delivery methods need to move from people providing services to systems providing products.
Firms need to implement subscription models instead of project billing.
Firms have the ability to move to stage 5 and prosper if they commit to a fundamental change in their business model and they complete an extraordinary change management process based on partners all moving in the same direction. The process takes time and requires incremental gains every day as opposed to dramatic change overnight. The reality is that the process cannot begin until April 16th. However, it cannot wait until November 1st.