Questions to Address Before Expanding a Business Practice
More than a ‘Swashbuckler’ Approach
- An assault on a new market segment can be exhilarating. Indeed,
what CPA would pass up an opportunity to swoop into a sea of competitors
and plunder their clients?
passion, however, can lead to catastrophe if a firm doesn’t
soberly assess its chances of success before launching a new practice
venture. Many promising new initiatives have failed, not because
a firm’s lust for competition was found to be wanting, but
rather because some fundamental detail of business planning was
overlooked or poorly implemented.
of this article is not to discourage “swashbuckler”
accounting firms from launching assaults on new markets. Rather,
its purpose is to present operational questions that can help
pinpoint hidden dangers so business planners can be prepared.
swashbucklers may blanch at the prospect of methodically poring
over volume estimates, cost analyses, and return-on- investment
calculations. Nevertheless, if such mundane activities reveal
a single “nuts and bolts” problem that can disrupt
an initiative, that time may prove to be a wise investment.
1A. Identify key competitive advantages.
1. Will the
firm be able to retain an ideal mix of client service professionals?
2. Can the firm give its professionals what they need to perform
3. Will the professionals’ work lead to increased client
activity and satisfaction?
4. Will the increased client activity and satisfaction help the
firm achieve its fiscal goals?
firms must be very specific in defining the requirements of each
of its professional positions. Valuation specialists, for instance,
may simply need to maintain their requisite credentials. Eldercare
advisors, however, may need the right temperament to interact
effectively with seniors and their family members.
also think carefully about matching the business model with their
business goals. A valuation practice specializing in divorce cases,
for instance, may do less to attract entrepreneurial clients to
a middle-market CPA firm than a personal financial planning practice.
On the other hand, a personal financial planning practice may
do less to support the growth of audit division revenues than
an information systems consulting practice.
1B. Present statistical evidence that supports the firm’s
5. What is
the firm’s primary fiscal goal?
6. What specific competitive advantages will the firm rely on
to achieve that goal?
7. What statistical evidence supports the firm’s competitive
8. Has the firm placed appropriate emphasis on these advantages
in its business model?
A firm might
establish its primary fiscal goal to be “reducing audit
client defections by 50% by providing value-added consulting services.”
If, however, statistical evidence indicates that continuous contact
with clients throughout the year discourages client defections,
then the fiscal goal might be easily achieved by simply interacting
with client employees frequently at conferences and community
events. In other words, consulting services may neither be required
nor desired by clients.
evidence may also reveal fatal conflicts of interest that could
doom the venture. If an important referral source perceives the
new service as a competitive threat, or if a number of audit clients
are concerned that the growth of consulting services would distract
the firm from focusing on its core assurance function, survey
data—or perhaps just simple feedback—from such sources
may convince the firm to find some other path to growth.
1C. Confirm that these advantages will yield profits at various
levels of volume.
9. What are
the firm’s plausible low, moderate, and high levels of engagement
10. If the low-volume scenario yields a loss, can the firm afford
it? For how long?
11. If the moderate-volume scenario yields a profit, is it sufficient
to offset the risk of a loss?
12. Considering the costs of rapid growth, is the high-volume
scenario truly achievable?
business plans present profit projections for a single “most
likely” volume scenario. A good risk manager prefers to
review projections across multiple scenarios; for practice expansion
initiatives, a minimum of three scenarios is often advisable.
services generate significant fixed costs due to professional
liability insurance, membership fees, marketing expenses, and
other business requirements. Thus, the firm must assess the profits
it expects at moderate volumes in comparison to the losses expected
at low volumes, considering the risk that such moderate volumes
may never in fact be achieved.
some practice expansion initiatives do not grow to high levels
of volume without expending additional resources to take business
away from deeper-pocketed competitors. Accounting firms should
assess whether such high volumes of business can ever be achieved
and maintained profitably.
2A. Determine the firm’s maximum capacity of client service
“inventories” must be available in order to conduct
14. How much inventory does the firm need to meet its engagement
15. What constraints will prevent the firm from maintaining these
16. Considering these constraints, what is the firm’s maximum
For an example
of what “inventory” means in this context, a litigation-support
practice may need to maintain a roster of specialists who can
travel to client sites on short notice; their contracts may be
treated as “direct material inventories” if the firm
must prepay for service hours to secure their availability.
a firm planning to enter the eldercare business may need a roster
of social workers to interact with clients. With three such advisors
under contract, a CPA firm might be able to address the clinical
needs of up to 600 eldercare clients. If only two advisors are
available, the maximum client roster might be reduced to 400.
firms track their staff utilization levels in a “pipeline”
format of engagements that are “works in progress”
or “finished goods.” Such inventories should also
be considered at this stage of the planning process.
2B. Determine the potential market demand for the firm’s
17. How much
demand already exists within the firm’s current client base?
18. How much additional demand can the firm generate from its
current marketing activities?
19. How much additional demand can the firm generate from new
20. Considering these marketing activities, what is the likely
total level of client demand?
firms can survey current clients to establish a base level of
demand for new services. In addition, by exploiting advertising
opportunities in firm publications, sponsored community events,
and other current marketing activities, firms should be able to
identify new client opportunities. New practice ventures also
introduce a firm to new trade associations, conferences, and publications.
Firms should investigate these opportunities thoroughly when assessing
market demand, given that unexplored sources of business may be
2C. Reconcile capacity with demand while maintaining service quality.
the firm’s maximum service capacity fall short of client
demand? By how much?
22. Can the firm increase its maximum service capacity safely
23. What quality management practices can the firm implement to
address liability risk?
24. What is the firm’s single best estimate of likely service
If a firm
is reluctant to dedicate significant resources to a new practice
initiative until client demand is self-evident, it might consider
contingency plans. For instance, it can use temporary employees,
outsourcing arrangements, and other short-term solutions to raise
service capacity to the level of market demand.
though, may necessitate strengthening internal oversight functions
in order to ensure service quality. Total quality management (TQM)
principles have been applied to practice monitoring functions
for years. TQM refers to specific practices that can help prevent
problems, test for technical errors, and ameliorate in-house and
client-based service failures. These functions may be costly to
implement, but nevertheless necessary to an expanded support service
A firm that
fails to increase capacity safely to meet client demand may become
a victim of its own success. Even if a firm generates a lot of
new business, a single failure to serve a client because of staffing
shortages or poor oversight practices can destroy the relationship.
3A. Compute costs per period by matching them against revenues.
25. How much
will the firm spend on direct client-service functions per period?
26. How much of these expenditures will be accrued for completed
27. How much of these expenditures will be accrued for billed
28. After matching these expenditures with revenues, what profits
will be earned per period?
pipeline of consulting activity involves the application of staff
resources to client engagements before engagements can be completed,
and the presentation of engagement deliverables before completed
engagements can be billed. Accounting firms rely on staff-utilization
data to monitor the first function, and on client cost-sheet data
to monitor the second function.
projects often feature unusual terms for “completion”
and “billing.” For example, certain projects may call
for retainer-style billing, in which case services may be billed
before they are performed and completed. Other projects may require
reports to be approved by the board before bills can be issued,
in which case services may not be billed until well after engagements
3B. Establish special policies for costly client or project niches.
29. Are certain
services more costly to produce and distribute than others?
30. Are certain clients more costly to serve than others?
31. What cost drivers most influence these differences?
32. Can these differences be minimized, absorbed, or passed along?
advisory practice may find it far more costly to analyze complex
hedge-fund derivative investments than direct equity investments.
Similarly, an eldercare practice may find it far more costly to
provide care-oversight functions for Alzheimer’s seniors
than for physically frail seniors.
A firm should
identify and assess the cost drivers that produce such differences
from a risk-management perspective. For example, if a lack of
qualified staff is driving such cost differences, then staff-sharing
joint ventures with other firms may be worth consideration. On
the other hand, if a lack of qualified staff can be addressed
only through reliance on costly independent contractors, the benefits
of the new line of business may not outweigh the risks.
alone should not deter a firm from entering new lines of business.
They can be managed via oversight activities, justified by ancillary
service revenues, ameliorated through flexible progress billing
practices, or passed along within higher fee structures.
3C. Establish risk management systems for exceptionally risky
of the firm’s cost drivers may be the most unpredictable?
34. From a cost perspective, what is the worst-case scenario for
35. If this scenario ever occurs, will the firm be aware of the
36. If this scenario ever occurs, will the firm be prepared to
implement risk response activities?
may be justified in dropping an attractive practice expansion
opportunity if the probability of incurring a significant loss
is high, or if the cost of a relatively improbable loss is potentially
an actuarial advisory practice may be unduly risky if losing clients
because of a shortage of qualified staff at some time in the future
is highly probable. Likewise, a tax-shelter practice may be too
risky if even the low probability of being targeted by investigators
for tax fraud would threaten the firm’s existence.
if a professional liability company believes that a new service
is unreasonably risky, it may increase premiums to the extent
of making the new service unprofitable. If an insurer opts to
carve out the service from coverage instead (e.g., when daycare
oversight activities are carved out from eldercare policies),
then a firm must consider self-insuring against potential risks.
A good risk
manager should identify specific cost drivers, assess the attendant
risks of loss, then consider risk response and internal control
systems that can mitigate those losses. These elements should
all be incorporated into the practice expansion plan.
4A. Consider a discount-off-standard fee strategy.
will be the firm’s revenues, variable and fixed costs, and
38. How many clients will the firm need to serve to produce its
39. Will the firm’s volume growth lead to sufficient earnings
40. Will the firm be able to use price discounts to attract new
margins on a standard-fee basis, a firm should consider a variety
of short-term, growth-oriented discounting options. For example,
an absorption-cost discounting strategy would involve establishing
a discounted fee structure that would generate sufficient revenues
to cover staffing and overhead costs but would not generate profits.
A more aggressive, variable-cost discounting strategy would involve
a fee structure that would generate sufficient revenues to cover
staffing costs but would not cover overhead or generate profits.
competitive markets, some firms decide to set fees very aggressively
when starting up operations, but shift to more profitable fee
levels as volume builds toward the target profit level. Before
implementing such price increases, however, a firm should consider
how clients would react.
4B. Consider the competitive implications of a fee strategy.
41. Do competitors
price their services rationally?
42. How might competitors react if the firm implements an aggressive
43. Is a destructive price war with competitors avoidable?
44. Should the firm charge standard fees for some services, and
discounted fees for others?
may respond emotionally, perhaps even irrationally, when faced
with the prospect of losing clients to a new, fee-slashing competitor.
Accounting firms should identify these competitors, then consider
their likely behavior when planning a new venture. Because timing
is everything, a firm may wish to consider introducing discounts
at a time when its chief competitors are least prepared to respond
may not be accounting firms. For example, law firms may compete
for tax-advisory clients, whereas software companies may compete
for information technology clients. Because these businesses have
very different pricing models than accounting firms, responding
to their challenges may require developing creative discounting
4C. Consider offering extremely deep discounts to specific clients.
45. Do any
prospective clients already have special relationships with the
46. Will the firm benefit from developing special relationships
with new clients?
47. Do legal issues affect the fee strategy?
48. Do tax issues affect the fee strategy?
A new litigation-consulting
practice may need to offer discounted fees to law firms that are
partnering with the organization’s existing mergers-and-acquisitions
practice. Likewise, a new actuarial-consulting practice may need
to offer discounts to longstanding audit clients.
taxes and franchise fees are imposed in certain markets, accounting
firms may need to offer deep discounts to clients in those markets.
Such discounts can be risky if clients in different markets discreetly
compare notes on their consulting fees. Without such discounts,
however, the effective cost of the accounting firm’s services
may exceed their perceived benefits.
markets, regulatory constraints may also require consideration.
If a firm is considering expansion into a state that bans CPA
firms from accepting certain forms of sales commissions, or restricts
their ability to hire attorneys, investment advisors, or other
professionals, then the firm may need to increase its fee levels
for permitted services to adjust for these opportunity costs.
In such circumstances, significant premiums (as opposed to deep
discounts) may need to be imposed.
5A. Assess the impact of cash flows on value.
cash balances remain at acceptable levels throughout the start-up
50. Will operating, financing, and investing cash flows be balanced?
51. Will profits be earned on an accrual basis as well as on a
52. Are these conclusions highly sensitive to changes in future
In a typical
start-up scenario, accrual-basis income, operating cash flows,
and investing cash flows are all negative in the early stages
of growth, while financing cash flows are positive. Then, after
the breakeven point is achieved, income and operating cash flows
turn positive, while financing cash flows turn negative.
can make or break a business plan from a cash-flow valuation perspective.
If there is a risk that financiers may need to be repaid before
the breakeven point is reached, the new initiative may fail. Similarly,
the initiative may fail if there is a risk that the breakeven
point may be reached in terms of income while operating cash flows
lines of business muddle through years of mediocre performance,
draining funds, and managerial attention from more worthwhile
activities. To avoid such scenarios, accounting firms should not
hesitate to drop such ventures when they fail to achieve minimum
standards of success.
5B. Design a risk-management system that optimizes value.
53. How will
the professional evaluation function reflect residual-income standards?
54. How will the performance incentive plan reflect economic value-added
55. How will the firm’s growth plans reflect return-on-equity
56. Will the firm’s risk-management system protect these
residual income (RI) equals the difference between actual income
and minimum required income; furthermore, minimum required income
equals the minimum required return on investment (ROI) times the
capital required for start-up purposes. Thus, conceptually, RI
represents the extent to which profits actually exceed minimum
requirements. If a new practice slips into negative RI, its managing
partners may be placed on probation, replaced, or dismissed.
cannot be taken lightly. The dismissal of a partner because of
failure in a poorly conceived venture inevitably drains a firm
of valuable talent. The reassignment of a partner from an existing
line of service to a new one likewise deprives existing clients
of that partner’s expertise. Thus, the minimum requirements
that define the RI standards must not be set too low; rather,
they must be established at a level that compensates for these
prospective or actual losses.
value added (EVA) is similar to residual income, but it employs
an average return statistic (usually the weighted average cost
of capital) in place of a minimum return statistic, and it employs
net assets in place of capital. Thus, conceptually, EVA represents
the extent to which actual profits exceed average expected profits.
When a new practice generates positive EVA, its managing partners
should be rewarded.
return on equity (ROE) equals profits divided by equity; it can
be disaggregated into three components: asset growth (assets divided
by equity) times sales growth (billing revenue divided by assets)
times profitability growth (profits divided by billing revenue).
When developing a new practice, accounting firms often focus on
asset growth initially, then sales growth later, and finally profitability
firm should design its employee and operations management systems,
including professional review, compensation, oversight, and internal
control systems, with an emphasis on these fiscal performance
outcome measurement standards. Furthermore, risk-management systems
should be designed with an emphasis on maintaining a consistently
high set of RI, EVA, and ROE measurements.
5C. Develop a continuous quality improvement system that maintains
57. Has the
firm’s original business model survived the planning process?
58. How will the firm measure each relationship within the firm’s
59. How will the firm analyze and report these key measurement
60. How will the firm ensure the continuous improvement of its
A firm must
think broadly about any inherent contradictions between the five
sections of this business-planning model that may lead to failure.
For instance, if a CPA firm is planning to introduce a financial
advisory practice for elderly clients with significant investment
assets (as defined under “Business Model”), its communication
processes (as described under “Volume” and “Cost”)
should not emphasize Internet modalities if these clients are
A firm should
develop quantitative and qualitative performance indicators to
manage each key relationship of the business model. In addition,
the managing partner should review all indicators; employee indicators
should be shared with the director of human resources; infrastructural
indicators should be shared with the director of information systems;
and client indicators should be shared with the director of marketing.
remember that new ventures must find a home within the existing
family of products and services that are maintained by accounting
firms. Although certain events may be beyond the control of new
practice partners, understanding how such events could impact
the value of the firm is very important. For example, even though
a financial investment advisory practice may enjoy initial success
by recommending successful investments to its clients, the firm’s
overall value may diminish if those investments unexpectedly sour
and the clients lose faith in all of the firm’s business
question-and-answer format is designed to reflect the rational
line of thought that accountants follow when thinking through
business plans. Certain topics covered by this approach are not
included in the planning guidelines published by the Big Four
and other professional organizations, yet are fundamental tools
of management planning and accounting.
when planning new initiatives, accountants should ask the following:
- How will
the new practice actually operate and succeed on a day-to-day
basis? This is addressed under “Business Model.”
- Is the
managing partner prepared to deal with inevitable, but hopefully
infrequent, service glitches and staffing shortages? This is
addressed under “Volume.”
- Are engagement
partners prepared to deal with unexpected, but perhaps inevitable,
variations in labor costs by modifying their recruitment and
retention plans? This is addressed under “Cost.”
- Are engagement
partners willing and able to slash fees in order to respond
to the aggressive actions of competitors? This is addressed
client service and administrative support professionals at every
level of the firm support its commitment to quality? This issue
is addressed under “Investment Value.”
above produces answers to management questions that accountants
will likely need to ask while contemplating new growth opportunities.
Any individuals developing a practice expansion plan should ask
themselves the questions above during the planning process.
here to view a Sidebar.
Kraten, PhD, CPA, is founder and president of Enterprise
Management Corporation, Milford, Conn., and an assistant professor
at Suffolk University, Boston, Mass.