Your Firm's Business Model Deserves Careful Thought
IMGCAP(1)][IMGCAP(2)]Many CPA firms have been expanding rapidly, both organically and through mergers and acquisitions. This has included significant geographic expansion beyond the firms’ core locations. It has also included expanding into new areas such as IT-related advisory services.
Firms that have not expanded think seriously about the need to expand and whether they can remain independent if they don’t. As firms have grown, several different business models have emerged, each with distinct advantages and critical success factors. Comparing these models and weighing their respective strengths and weaknesses with your firm’s growth and governance needs should be a key aspect of your strategic planning.
The Centralized Business Model
Under a centralized approach, the firm is housed in a single office. Often the firm is committing to deep market penetration in a particular geography, generally a major metropolitan area. Most firms began with centralized business models, often moving to a different business model over time.
Advantages of the centralized model:
• Since all partners and staff are in a single office where face-to-face discussions are possible, it is easier to manage the firm. Also, because, all partners have in-person access to the firm’s managing partner and executive committee members a collegial atmosphere between leadership and other partners is more likely.
• Areas of practice specialization that the firm should target are easier to identify based on the industries that are strong in the firm’s geographic location and the services that clients need in the geographic location. Collaboration among partners is strongly facilitated by their physical presence in the same office.
• Since the firm’s office is in close proximity to clients and prospects, spending time with them, professionally and socially, is convenient. This can have a major positive impact on client relationships, especially where difficult issues need to be addressed.
• Mobility of staff among practice groups is free of geographic constraints. This can be a powerful advantage because all of the firm’s specialties will be available as options for staff as their careers progress.
These advantages can be powerful.
There are also some key success factors that are needed to support the centralized model:
• The firm needs to be in a market large enough to support growth without geographic expansion.
• The firm’s location needs to be desirable for attracting and retaining talent.
• The firm needs to be more active in acquiring talent than firms that are growing rapidly through geographic expansion to maintain its position in the market.
As they grow, many firms move away from this model, usually as a way to grow rapidly through acquisitions. Given the added challenges of managing a firm with multiple locations, it’s worth asking a key question before committing to this change: “Would we be better off working harder to grow our client base in our existing location?”
A related question is: “By emphasizing acquisitions, are we de-emphasizing organic growth which drops to the bottom line more quickly?”
Firms will answer these questions differently, and there is no one right set of answers. But these issues deserve careful thought before moving away from the centralized model.
The Locally Integrated Business Model
Under this model, firms establish satellite offices in areas close to the firm’s central office. A good example of this is where a New York City firm establishes additional offices in the New York suburbs, some of which may be out-of-state—i.e., New Jersey and Connecticut.
Here are the advantages of the locally integrated model:
• Partners can become active in local business communities where they live.
• It enables the firm to be in close proximity to clients who are located in the suburbs.
• It may open up new industry markets for the firm, such as pharmaceutical companies in New Jersey for a New York City-based firm.
• It may open up new markets for acquiring other firms, and these suburban markets may be less competitive from an acquisition standpoint.
• Offices close to home make commuting easier, which can be a draw for female professionals raising children in the suburbs.
• In certain specialties such as real estate, being “local” can help with referral relationships, such as from local banks and lawyers.
• Firms that are first contemplating multiple offices are often more comfortable starting this journey with a few offices in their “backyard” where managing the firm across multiple offices can be learned at close range.
These can be meaningful advantages.
There are also some key success factors that need to support the locally integrated model:
• Careful thought needs to be given to firm governance to ensure the overall industry and service line practice structure is deployed successfully in all locations over time.
• The firm’s overhead structure needs to support the opening of new local offices, taking into account the cost and utilization of office space and support staff in all locations.
• Competition in the local office’s markets may require a different billing rate structure for clients of these offices.
• Giving partners the choice of working in a satellite office can potentially hurt business results, if partners who “play big” with major main-office clients spend time in satellite offices for personal reasons.
There is presently a proliferation of firms that have adopted this model. The key is to think carefully about risks and rewards before committing to this approach. The answers can differ substantially from firm to firm, depending on many factors.
The Regionally Integrated Model
Firms that take this approach establish offices in major cities in a given geographic area. A good example of this is where a Houston firm establishes additional offices in Dallas, Tulsa and New Orleans—locations that are not within commuting distance of Houston.
Here are the advantages of the regionally integrated model:
• This approach can make firms attractive to clients with multiple locations—e.g., regional banks or retailers.
• This model greatly expands the number of acquisition targets that are geographically friendly and can be folded into existing offices.
• The firm will be close to more universities, expanding the potential for local recruiting.
• The firm will have access to more channel partners such as banks and law firms.
• This approach can open the door to mergers with other firms adopting this model in other regions, setting the stage for becoming a national firm.
• It may position the firm to expand its client base into new industries—e.g., high tech or manufacturing.
• This approach may bring some countercyclical geographic diversification.
• This approach can allow for shared support function costs.
These can be meaningful advantages.
There are also some key success factors that need to support the regionally integrated model:
• It will take work to become “one firm” with a consistent culture. The culture that emerges is unlikely to be that of the original firm that drove the expansion. Some firms readily accept this result. Others struggle over how to make the new offices part of the “mother ship.” We can’t overemphasize how critical it is to consider this issue before taking the regional expansion plunge.
• It will take careful planning to make firm governance work properly. Each office will want to be represented on the firm’s executive committee, and the members of the executive committee need to put the firm first, rather than thinking locally. Sometimes, when firms adopt this model, they consider using a nominating committee to appoint executive committee members to de-politicize firm governance.
• Partner compensation, a sensitive issue in any firm, will need extra care. There are some well-known examples where offices split from larger firms over the issue of partner compensation. Once partners in an office determine they would be far more profitable as a separate firm, these problems can arise.
There are many examples of successful firms that use the regionally integrated business model. It has distinct advantages. But don’t underestimate the challenges that can arise where firms adopt this model in the name of growth without thinking through and addressing the potential pitfalls.
The Nationally Integrated Model
Firms that take this approach establish offices in major cities in each region of the country: the Northeast, Mid-Atlantic, Southeast, Midwest, Southwest and Pacific Northwest. A good example of this is where a New York firm establishes additional offices in Washington, D.C., Atlanta, Chicago, Dallas and Los Angeles. In many cases, these offices will also have satellite offices—e.g., an Orange County office as a satellite of the Los Angeles office.
The advantages of the nationally integrated model:
• This approach can make firms attractive to clients who have or intend to develop a strong national presence. As one managing partner recently told us: “We have a nice thing going as a Mid-Atlantic firm, but our clients are expanding geographically and asking about our growth plans. So, we also need to expand geographically. I guess this was inevitable once we expanded our focus from the middle market to larger clients.”
• This model can be a powerful recruiting tool in two respects. First, there will be easy local access to many more universities. Second, the firm can offer candidates geographic mobility now and in the future. This can be important for two-earner families as well as for other reasons such as the need to move close to an aging parent.
• A nationally integrated firm will have broader access to larger channel partners, such as banks and law firms that also have a national footprint.
• Firms that reach a certain size and geographic scope are harder to acquire and more likely to be the acquirer in M&A transactions.
• It may position the firm to expand its client base into new industries—e.g. high tech, energy, aerospace, pharmaceuticals and entertainment.
• This approach may bring some countercyclical diversification inasmuch as economic weakness tends to impact different industries and geographies differently.
• This model can support centralized internal services such as technology and support functions.
These can be meaningful advantages.
There are also some key success factors that need to support the nationally integrated model:
• It will take work to become “one firm” with a consistent culture. In fact, certain cultural differences will need to be embraced for the firm to be successful. To put it another way: what works in New York may not work the same way in Los Angeles or Dallas. It’s important to appreciate these substantial differences and limit the “core” cultural values that you need to be universal. Some firms readily accept this change. Others struggle with how to make the new offices clones of the “flagship office.” It is critical to consider this issue before committing to a national expansion strategy.
• It will take more work to make firm governance function properly. Each region of the country will need to be properly represented on the firm’s executive committee, and the members of the executive committee need to put the firm first, rather than thinking regionally. Often, when firms adopt this model, they consider using a nominating committee to appoint executive committee members to de-politicize firm governance.
• Firms using this model feel different. Local and regional firms boast that their leadership teams know all of their partners well. Under this model, that is unlikely to continue. So be prepared for leaders to rely on each other to represent their partners at leadership team meetings.
• Working across multiple times zones can also present a challenge. Fewer in-person meetings are inevitable. Firms that take this approach generally have in-person executive committee meetings once per quarter.
• Partner compensation, a sensitive issue in any firm, will need extra attention. There are likely to be cost-of-living differences in different regions, and many firms reflect these in partner compensation levels. We can think of a few firms where partners in markets other than New York and California feel cheated because the New York and California partners are paid more both because they have more profitable practices and because of the cost of living.
There are good examples of successful firms that use the nationally integrated business model. It has distinct advantages. It also takes extra work to manage the firm, and there are substantial risks unless key issues are recognized and addressed, both before moving to this model and as they arise over time.
The Federated Model
Firms that take this approach establish federated relationships with other firms in different major U.S. cities, typically located in different regions of the country from the founding firm. For example, a Chicago firm could establish federated relationships with firms in Washington, D.C., New York, Atlanta, Miami, Dallas and Los Angeles. In some cases, member firms of the federation also have satellite offices—e.g., a Long Island office as a satellite of a New York City firm.
There are many possible variations of this model. At one extreme, all members of the federation are independent firms who go to market under a common brand, share resources and refer business to each other. At the other end of the spectrum, there is a national governing body that oversees the federated firm, and there is at least some degree of profit-sharing among partners based on national profitability. Under all variations of the model, the members of the federation retain a high degree of autonomy respecting day-to-day governance, partner admissions and culture.
Here are the advantages of the federated model:
• This approach can make firms attractive to clients with a strong national presence. As a senior member of a firm using the federated model nationally, recently said to us, “This approach allows us to play bigger than we are. We’ve been part of a successful global consortium of firms for years. We decided to take the same approach in the U.S. and it’s working well.”
• The model is relatively easy to adopt because the member firms are able to retain their autonomy.
• Member firm autonomy also makes firm governance easy because issues such as partner income allocation, leadership style, target culture and partner admission decisions can be made locally by the member firms.
• This model can be a strong recruiting tool because it facilitates local access to many more universities. Also, if the member firms collaborate on campus recruiting, this model can offer candidates the opportunity to choose among several practice offices, which can be a very powerful recruiting advantage.
• The federation will have access to larger channel partners such as banks and law firms because it has a “presence” in more locations.
• Firms that use this model successfully have a better chance of remaining independent by being “buyers” rather than “sellers.”
• It may position the member firms to expand their client bases into new industries—e.g. high tech, energy, aerospace, pharmaceuticals and entertainment.
These are meaningful advantages.
There are also some key success factors that help firms use this model effectively:
• To make this model worth adopting, the member firms will need to agree on a name for the federation and collaborate to build a brand around the name.
• The separate cultures and reward metrics of the member firms can make it difficult to collaborate successfully on client opportunities. For this reason, firms that adopt this model often move to some type of partial revenue sharing after a trial period of a few years.
• Partners from different member firms are far less likely to know each other well than if they were in a single firm. In response to this challenge, it is not unusual for firms using a federated model to hold annual partner meetings together so the partners can get to know each other better and share ideas, opportunities and experiences.
• Governance under this model requires careful planning. There are many aspects to this, but the key success principle is to achieve clarity about who has the right to make decisions when issues arise between two member firms.
• Working under this model can make it difficult to share infrastructure investments, particularly initially. Ultimately, firms that succeed under this structure move to share services to leverage economies of scale. One area that will need particular attention is human resources. Conventional processes and technology will require a degree of content standardization across the federation for which it may take time to gain the support of the member firms. A similar issue presents itself for financial processes and systems where common platforms are easy to achieve, yet member firms may want to keep certain financial information private.
There are good examples of successful firms that use the federated business model. It has some distinct advantages, particularly ease of adoption. It also takes work to manage, and there are substantial risks unless key issues are recognized and addressed both before moving to this model and as they arise over time.
As you look at the different business models, you will be able to consider where your firm is today, whether you have leveraged the advantages of your business model and how effectively you have addressed the critical success factors that underlie successful use of the model. You will also be able to think critically about the implications of changing your business model before beginning to take that step.
Carolyn K. Carlson is the president of StangerCarlson LLC. Richard Stanger is the CEO of StangerCarlson LLC. You can reach them at firstname.lastname@example.org and email@example.com, or (646) 797-4000.