KPMG is questioned over 2017 audit of Bargain Booze-owner Conviviality ©Mark RIchardson/Alamy Stock Photo
KPMG is questioned over 2017 audit of Bargain Booze-owner Conviviality ©Mark RIchardson/Alamy Stock Photo

Is the audit services market working?

7 September 2018

A series of high-profile failures mean questions are once again being asked about the continued dominance of the Big Four accountancy firms.

A cosy club incapable of providing the degree of independent challenge needed.” As indictments go, the verdict of a group of MPs on the ‘Big Four’ accountancy firms (Deloitte, EY, KPMG and PwC) in the wake of the collapse of Carillion is pretty damning. Having all worked for Carillion at some point – KPMG was the firm’s auditor for 19 years – questions are now being raised about the performance of the world’s largest audit firms, and their dominance in the market. 

Rachel Reeves, chair of the Department for Business, Energy & Industrial Strategy (BEIS) committee investigating Carillion’s demise, labelled the relationship between auditors and large organisations “parasitical” and called on the Competition and Markets Authority (CMA) to explore breaking up the Big Four firms “to help increase competition and deal with conflicts of interest”. The MPs’ report suggested making businesses run competitive tenders for their auditing services more regularly, breaking up the auditing arms of the Big Four, or making them separate their auditing and non-audit functions (for example consultancy).

It’s not the first time such concerns have been raised, or such solutions mooted. Back in 2012, accounting watchdog the Financial Reporting Council (FRC) amended the UK’s Corporate Governance Code, introducing a ‘comply or explain’ requirement for FTSE 350 companies to put their external audit out to tender at least once every 10 years. 

Then in 2014 the CMA issued regulation, following a review of the market, making it mandatory for listed firms to retender audit services. Subsequent 2016 EU legislation introduced a requirement for all public interest entities to conduct a tender at least every 10 years and rotate auditors after a maximum of 20 years. These rules contain specific additional requirements for tender processes, such as not precluding the participation of non-Big Four firms. 

However, such enforcement doesn’t appear to have had much effect. The market remains as closed as ever, tendering little more than a merry-go-round. The Big Four are even more entrenched in the FTSE 350 than they were a few years ago. In 2015, they audited 95% of the UK’s largest listed firms. Today it’s 98%. 

Guy Strafford, executive vice president of market engagement at Proxima, refers to audit tendering as “an abyss of hell” – and he’s only half joking. “The problem is that the market remains oligopolistic,’ he says. “It’s sufficiently small that one [of the Big Four] can influence the behaviour of the others.”

He adds that the competition process is “much more complicated” because of the myriad consulting relationships between the Big Four firms and large corporates – relationships that are more prestigious and, sometimes, more lucrative. With FRC rules preventing auditors also providing non-audit services during the audit period, the temptation is there to fudge a bid and hold onto consulting services instead. Strafford says he has seen examples, “ways of making sure the bid isn’t great to keep [the] consulting [work]”. 

The complexity of the process means the structure around running an audit tender is appreciated in listed organisations, and procurement has been getting more involved, he says. However, some of the CPOs SM spoke to questioned the value procurement can really add, given how closed the market is – and how closed-minded many audit committees are when it comes to considering other options. 

“You face enormous obstacles from an audit committee’s predisposition to what they regard as a ‘fit and proper’ company,” says one FTSE 100 financial services CPO. “It always ends up being the Big Four; even established names like Grant Thornton and BDO aren’t considered good enough. There’s a lot of prejudice, and that’s hard for procurement to cut through.” 

Freshfields Bruckhaus Deringer CPO David Ford, who ran an audit tender in a previous role at GSK, concurs: “The audit committee would laugh you out of the room if you suggested anyone outside of the Big Four.”

Arguments for the continued dominance of four firms include the fact that only they have the scale of resource, experience and expertise to manage truly global audits across multinational corporations. But as the above CPOs identify, entrenched cultural prejudices – that old boys’ network – are also a major factor. According to 2017 research from industry magazine Accountancy, 61 of the FTSE 100’s audit committee chairs roles are held by alumni of the Big Four firms. “It’s very incestuous,” says Ford.

Perhaps it’s hardly surprising then that earlier this year Grant Thornton, the well-respected second tier accountancy firm, announced its decision to pull out of the FTSE 350 audit market, citing Big Four dominance. Chief executive Sacha Romanovitch told The Financial Times the firm was fed up with coming “a glorious second place”. Since mandatory audit rotation came into force in June 2016, Grant Thornton has only won two tenders – and each attempt reportedly costs it around £300,000. The financial services CPO sympathises: “I would love to see the ROI [of bidding] for the tier two suppliers. They never win the big contracts. It must be soul destroying.”

He adds that for procurement too “it’s a pretty thankless job”, but mandatory tendering for large corporates means “to make the process meaningful, the easiest thing to do is to involve procurement”. 

This can bring benefits to the function and individuals, even if procurement’s role is mainly “doing a lot of the grunt work”, says Ford. “The positive for procurement is it does raise your profile, no question. You’re having one-to-one conversations with the CFO, which does a huge amount for your credibility and reputation within the organisation.”

Christine Lithgow Smith is a former CPO who now runs her own consultancy. In a former role, she led the procurement process for tendering audit services in an international, regulated organisation, working directly with the CFO and the audit committee. 

While she admits she was “a bit flummoxed” at discovering “zero appetite beyond the Big Four”, persuading all the firms to engage in bidding via a kick-off meeting uncovered unexpected innovation around reporting. “If quality isn’t a differentiator, it’s about innovation and price,” she says, adding that as digitisation increases, “there’s a huge amount that should be automated, and firms should be bringing their prices down”. 

After an eight-month process (“watch out for firms using back door tactics – they will”), the organisation changed auditor, supported by its shareholders, put in place better processes, and achieved a 30% cost reduction. 

“Don’t be phased by the terminology,” advises Lithgow Smith. “Audit services aren’t that different, just more complicated because you need those senior relationships. Think about how you can ensure better service.”

The level of services these firms provide is increasingly being questioned. “People talk about the Big Four having those great reputations, but look at their actions and how they behave,” says Lithgow Smith. “There are ethical issues.”

Aside from Carillion, KPMG is being investigated by the FRC over its audit of Conviviality, the owner of retail chain Bargain Booze that went into administration in April. In June, the FRC announced a probe into Deloitte’s auditing of construction supplies distributor SIG. And in the regulator’s quality review of the Big Four’s audit processes, the FRC found an overall “fall in quality”, with “an unacceptable deterioration in quality” at KPMG in particular, where 50% of the firm’s FTSE 350 audits required more than limited improvements. 

For Alan Day of consultancy State of Flux, this decline in quality at least partly represents an opportunity for better supplier relationship management. “Clearly these guys aren’t as an industry improving things, so how do we as procurement drive that improvement? I heard a case recently, of the audit at a big bank, where [Big Four] employees were told to be on site even though they weren’t doing any work, so they could charge the client their hourly rate. This is an industry stuck in the dark ages, not improving its accuracy ratings. As procurement, we not only have an opportunity, we have an obligation.”

While refuting some of these accusations, the Big Four have largely welcomed further reviews and increased competition. But ultimately for now at least the market for audit services remains, in the words of the financial services CPO, a “Gordian knot” for procurement to get through. “If you were able to take it out of the hands of the usual suppliers, you could get a more open competition,” he says. “But there would have to be regulatory change to break that up.” Whether that change will be forthcoming in the post-Carillion world, who can say?    

Proxima’s Guy Strafford and Richard James on how to extract value and create competitive tension in a limited market

1. Understand what you really want
Cost is unlikely to be differentiating. Service quality, relationships, insight and value-added services will affect how decisions are made. Challenge bidders to focus on experience and understanding your market.
2. Consider the big picture
Explore auditors outside the Big Four for parts of audit such as subsidiaries. Consider how to challenge consulting relationships.

3. Sell yourself
Providers choose where to invest their best people and resources, so market yourself as attractive.

4. Take your time
The tender process can be managed quickly as decision-making is board level. But speed should not supersede planning. Questions should focus on service differentiators; decision-makers must make themselves available to the process.
5. Get real
Your auditors will get to see everything about the business so there is little point withholding information during the tender process. Sharing current practices, areas of focus and feedback from previous processes will improve the quality of the bidders’ responses.

The Big Four under the spotlight in 2018

24 January Government launches inquiry into the collapse of Carillion

16 May MPs publish a scathing report accusing the Big Four of being complicit in Carillion’s demise

13 June PwC is hit with a record £6.5m fine from the FRC over its audit of retailer BHS two years before its collapse

18 June FRC releases review that reveals declining audit quality standards across the Big Four, singling out KPMG for criticism

28 June The FRC opens a probe into Deloitte’s auditing of construction supplies distributor SIG

3 July FRC launches investigation into KPMG’s audit of Bargain Booze-owners Conviviality, which went into administration in April

20 August KPMG fined £3m over its audit of fashion retailer Ted Baker



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