Competition: playing low-ball

The Big Four say they welcome the idea of more audit choice for large
companies. But do they mean what they say? After all, the concept of greater
audit choice for big business implies that the top firms would lose audits,
market share and profit.

In this debate, the subject of low-balling has always been the elephant in
the corner: something that is really obvious, but which has never been properly
discussed.

Priced out the market

The ultimate purpose of predatory pricing is to sell goods or services at
artificially low prices with the intent of driving competitors out of the
market, or to create a barrier to entry into the market for potential new
competitors. The predatory pricer then has fewer competitors or even a monopoly,
allowing it to raise prices above the level that the market would otherwise
bear. Audit choice and low-balling are two sides of the same coin.

It is not in the interest of any of the major players to open up the question
of predatory pricing. The Big Four audit firms don’t want to discuss it, nor do
finance directors. So the audit trail on low-balling goes cold. While some
accept low-balling as an absolute fact of life, others deny that it ever
happens.

Certainly, the documented evidence on low-balling is rare, but every few
years there is a low-balling tale or accusation from someone who ought to know.
And this keeps alive the idea that absence of evidence does not equate to
evidence of absence.

The latest explosion came from Jeremy Newman, managing partner of BDO Stoy
Hayward, who is leading a sustained assault on the Big Four. A clearly
exasperated Newman has put into the public domain the story of a due diligence
job for which his firm quoted. Despite the fact that the maximum fee level BDO
asked for was a third of the initial price of the company’s auditors, the work
eventually ended up being performed by the incumbent for around 10% more than
BDO’s top quote.

It is tempting to dismiss the tale as an example of a canny FD using a
different supplier as a stick with which to beat the incumbent – and presumably
favoured auditor – into providing the service at a more reasonable price. Or is
it, as Newman suggests, predatory pricing designed to force out his firm from
competing in certain segments of the marketplace?

Under attack

Significantly, Newman also claims that the Big Four firms are increasingly
targeting BDO clients – and presumably the other mid-tier firms – by promising
significantly reduced fees, which the incumbent is forced to at least match, or
risk losing the work.

Even smaller firms feel the threat of low-balling. These independents find
their biggest clients – significant private companies, but not quoted entities –
are regularly targeted by the Big Four.

One way in which the incidence of low-balling could decrease would be if
clients made it clear that being the auditor gave a professional firm no
advantage when it came to bidding and winning other work. The downside of that
step is, why should FDs bother? It’s convenient to work with professionals who
know your business.

Jeremy Newman chose to release his tale about low-balling at a time when the
Financial Reporting Council is consulting on audit concentration.

Part of the recommendations of the Market Participants Group should have an
impact on the possibility of low-balling. For instance, the recommendation that
audit firms disclose the financial results of their work on statutory audits and
directly related services on a comparable basis should ensure relevant
information emerges over time about audit firms’ current pricing policies.

The question at the heart of the debate on increasing choice in the audit
market is how hard the Big Four firms are prepared to fight to hold on to their
market share. All the evidence suggests the answer to that question is easy:
very hard indeed.

This is an edited version of an article that first appeared in Financial
Director magazine