Big Four Firms Report Tremendous 2007 Results

The Big4.com 2007 Firms Performance Analysis

The Big Four accounting firms had a banner year in 2007 with double-digit revenue growth on the heels of strong performances in 2006 and 2005. KPMG had the highest annual growth rate among the firms with 17.4%, followed by Deloitte at 15.5%, Ernst and Young at 15% and PricewaterhouseCoopers bringing up the rear at 14.4%. Despite this relatively slower growth, PwC remains the planet’s largest accounting firm with 2007 revenues of $25.2 billion, ahead of Deloitte at $23.1 billion, E&Y at $21.1 billion with KPMG being relatively the smallest firm at $19.8 billion.

Combined, the Big Four firms had an astounding total revenue of $89.2 billion. If the firms were to continue this level of performance, the combined total would exceed a hundred billion dollars in 2008.

The depreciating US dollar in 2007 was also a key contributor to this performance, as all the Big Four firms report in US$ but earn much of their revenues in Europe and Asia, where local currencies appreciated strongly against the dollar. In terms of local currencies, growth was a little subdued. Combined Big Four revenues grew 11.7% from $77.1 billion in 2006 to $86.1 billion in 2007. Thus foreign exchange effects contributed a full 4% points or $3 billion to the combined firms revenue.

These spectacular growth patterns are seen usually in much smaller companies, and that huge $20 billion professional service companies are able to achieve double-digit back-to-back growth rates is testimony to their global reach and ability to capitalize on the need for financial services by all of the world’s economies. Big Four firms leveraged well global mega trends of stringent financial reporting (Sarbanes Oxley, internal audit), strong IPO listings (and subsequent audit work), complex M&A deals (due diligence, assurance), growing tax complexity, emerging economies, globalization, private equity buyouts, and risk management.

Service Line Performance

In terms of service lines, Advisory and Consulting services for all four firms combined grew the fastest at 21.7% from $18.0 billion to $21.9 billion. Ernst and Young reported a terrific 29% growth in this service line. All other firms grew close to 20% in 2007.
The Tax service line services for all four firms combined grew at 18.4% from $17.6 billion to $20.8 billion. KPMG’s Tax service line (ironically) grew the fastest at 20%, and Deloitte grew the slowest at 16.5%.

Audit or Assurance service line grew at the slowest relative pace. For all four firms combined, revenues grew 12.9% from $42.1 billion to $47.5 billion. This service line is the largest contributor to revenue and was likely held back by the sheer size of the practice. Ernst and Young again was the winner in this category with a revenue growth of 16%. PwC’s Assurance service line grew only 10.2%, the slowest in this category, and the lowest growth rate among all service lines and across all firms.

Owing to its high growth the Advisory service line became a larger contributor of total revenues to the Big Four firms. For all Big Four firms combined, the share of the Advisory service line of the total revenue grew from 23.1% in 2006 to 24.3% in 2007. This share gain of 1.2% came at the expense of Tax and Audit. Advisory services now contribute almost one-quarter of Big Four firm revenues, though there is disparity among the firms. In Deloitte and Touche, Advisory and Deloitte Consulting were 31% of total revenues in 2007, and in KPMG Advisory Services were 32% of total revenues. For E&Y, Advisory services were only 12% of total revenues in 2007.

Tax service line also marginally improved its contribution share. For all Big Four firms combined, the share of the Tax service line of the total revenue grew from 22.6% in 2006 to 22.9% in 2007.

Audit, owing to its slower growth, lost a lot of its contribution to the total. For all Big Four firms combined, the share of the Audit service line of the total revenue actually dropped from 54.3% to 52.8%, a share decrease of 1.5%. If such growth patterns were to continue in the service lines, Audit could well drop to less than 50% of total revenues in just a couple of years. Already in KPMG and Deloitte, Audit is less than 50% of total revenues.

Geographical Performance

As in previous years, the Big Four firms reported the strongest growth in Asia, helped by underlying strength in China, India and Southeast Asia. Europe turned in surprisingly good numbers while the mature market of the Americas had the slowest growth rate.

While Asia remains the smallest geographical segment, it grew by 22.2% from 2006 to 2007. Ernst and Young’s Asia segment grew by a spectacular 27%. Even Deloitte, with the slowest growth among the firms reported a 17.2% growth rate. Owing to its high growth rate, Asia’s share of total revenues for all the firms improved by 1% from 12% in 2006 to 13% in 2007, at the expense of the Americas.

Many firms reported more than 30% annual growth in the BRIC (Brazil, Russia, India and China) economies, reflecting the strong economic momentum in these countries.

Europe is the largest region by far for all the firms. On a combined basis, Europe had strong growth of 19.2% from $34.7 billion in 2006 to $41.4 billion in 2007. KPMG grew by 20.9% in Europe, while the slowest grower Deloitte reported a 12.6% growth rate. The combined Big Four European revenues in 2007 was $41.4 billion, a full 46% of the total combined revenue and increasing from 45% in 2006. For KPMG, Europe is already 54% of total revenues, contributing to more than half its total revenues. Surprisingly, the European region in 2007 raced ahead of Americas on a combined basis, widening its lead to almost $5 billion. By contrast, in 2006, combined European revenues was only $1.4 billion more than the Americas.

Despite being domiciled in the Americas, the home region for all the Big Four firms grew the slowest and also lost its leading share in terms of revenues. On a combined basis, Americas had only moderate growth of 10.3% from $33.3 billion in 2006 to $36.7 billion in 2007. Deloitte grew by 11.9% in Americas, while the slowest grower PwC did not even make the 10% mark, reporting only a 9.1% growth rate. The combined Big Four American revenues fell a full 2% points from 43% of the total combined revenue in 2006 to 41%. KPMG, which is heavily Europe-based, only produced 33% of its total revenues from the Americas. Even the PwC behemoth had only 38% of total revenues from Americas.

On a combined basis, the Americas are nearly $5 billion in revenue behind the biggest region, Europe, and this gap appears to be widening rather quickly. This geographic size and growth disparity, especially in the Americas, is sure to pose some interesting questions to the currently-US-centric Big Four firms about their future center-point and constitution of their top leadership.

People

The Big Four firms on a combined basis employed 546,690 partners, professionals and administrative staff in 2007, increasing their employment 9% from 501,736 in 2006. The Big Four firms now have more than half-a-million employees by far! Assuming a 10% attrition rate in 2007, the Big Four firms would have hired 96,000 personnel in 2007, almost 400 each business day of the year.

The partner count increased from 30,429 in 2006 to 32,009 in 2007, an addition of only 1,580 partners. PwC reported the smallest growth in its partner ranks by only 3.6% from 8,280 to 8,578, only 298 new partners were added in 2007. It certainly appears that the partner ranks are tightly controlled, only 6% of these half-a-million employees could be termed as partners and owners of these lucrative businesses.

Total combined professionals across all the firms were 409,579 in 2007 increasing 10.5% from 370,716 in 2006, as the Big Four firms bulked up by hiring non-partner professionals. Here again, PwC despite its large size had the least number of new hires, up only 4.3% from 2006 to 2007.

Total combined administrative staff across all the firms were 105,102 in 2007 increasing moderately 4.5% from 100,591 in 2006. Here again, PwC despite its large size actually appeared to have shrunk its administrative staff, which fell by 0.7% from 2006 to 2007.

Ernst and Young’s total personnel grew from 114,279 to 130,000 a whopping increase of 13.8%, which means that this firm hired the highest total number of employees in 2007. However, Ernst and Young does not appear to report the breakdown of these by ranks. Our estimate for Ernst indicates that its partner ranks grew by 7.1% and professional staff grew by 16.4%. It seems that Ernst was certainly more active than the other firms in the labor marketplace and more likely to extend offers.

Revenues per partner for the Big Four firms also increased substantially as partner ranks increased much slower than revenues. Each partner sold on the average $2.81 million in 2007, up 10.8% from $2.54 million in 2006. Each partner also appears to have managed a larger pyramid, leading 16.5 professionals in 2006 and 17.2 professionals in 2007. It certainly looks like partners are enjoying a growing share of the pie, but have to sell more and manage more to make their numbers work

Summary

All Big Four firms turned in tremendous growth performances in 2007, with KPMG being the overall winner in terms of annual % growth, and PwC continuing to maintain its position as the size leader. Deloitte has a solid position behind PwC and marginally higher growth rates, which would indicate that the gap could shrink over time. Ernst and Young crossed over the $20 billion mark in 2007, while KPMG remains shy of this level this year.

Forex was a large contributor to growth this year, and could hurt overall results in US dollar terms were to strengthen in the coming months. Asia and Europe continue to power ahead, some of the growth is certainly due to appreciating currencies, but that is not to take away from solid underlying growth. Action seems to be moving away from the Americas, and this is certainly going to have interesting effect on the firms in the future.

Ernst and Young was clearly adding aggressively to its personnel base, while PwC seemed to be adding relatively the fewest number of people, despite its large size. The Big Four continue to monitor their partner ranks, keeping this august club small and certainly well compensated.

All told, these were results to be proud of, and these large firms have to think through the challenges and opportunities that lie ahead in 2008 and how they can repeat such tremendous results in the coming years.


Reporting

The Big Four firms certainly need to learn something from their audit clients. For the most part, firms’ reporting of their own numbers left much to be desired in terms of transparency, ease of use and detail. For one, no firm reported profitability, though this is quite understandable given their private ownership. While the division across service lines was quite clean, each firm had its own specific way it looked at the world. There was just no consistency in reporting by well-defined geographic regions.

In this set, we thought that PricewaterhouseCoopers provided the most information. Numbers were well presented, easy to read and detailed in terms of financial performance, service line performance and personnel.

We put Ernst and Young in last place in terms of reporting their numbers. Its 2007 press release was vague, and could not be analyzed without physical reference to the 2006 annual review. Further, months after reporting results, the 2007 annual review was still not available on their website of http://www.ey.com/. Also, Ernst and Young did not provide the breakdown of personnel by partner, professional and administrative – we believe this is fairly relevant reporting and remain mystified by its absence.


Disclaimer

Though we believe our numbers and analysis are correct, we do not guarantee their accuracy. This analysis should not be used for any investment or presentation purposes.

We had to make some minor adjustments and changes to uniformly analyze our data. For example, we exercised judgment in selecting appropriate sub-regions to comprise a region. We also had to estimate Ernst and Young’s personnel breakdown using averages of the other three firms.

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