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Divesting Clients Wisely
Co-Editors:
Editor’s Note: Mr. Holub is a former chair of the AICPA Tax Division’s Tax Practice Management Committee. Mr. Porter is the chair of the AICPA Tax Division’s Tax Practice Improvement Committee. Mr. Eckelkamp is a member of that Committee. For information about this column, contact Mr. Holub at (813) 222-8555 or stevenh@apcpa.com, or Mr. Eckelkamp at (314) 849-7555 or joe@eckelkampandassociates.com.
Most CPAs agree it is in everyone’s best interests to match clients with CPA firms that are best suited to the clients’ specific needs. However, that fit can change over time, which can lead to divesting. Wise client “de-selection,” or divesting, requires combining several key concepts and creating alliances with other service providers. This column discusses how firms seeking to narrow their client base and firms seeking to add clients can create value, as well as add value to their clients—all at the same time. The 80/20 Principle The Pareto Principle’s impact on CPA firms is a frequent topic of discussion. Put simply, the principle states that 80% of a firm’s revenues come from the top 20% of its clients; see Kotch, The 80/20 Principle: The Secret to Success by Achieving More with Less (Doubleday, 1998). And further, a different 20% of clients usually produces 80% of a firm’s problems. Some have even used the Pareto Principle as a basis to postulate that the bottom tier of clients may actually reduce a firm’s profits. The value of strategic alliances with other professional service providers is another frequent topic. Often, the discussion deals with firm specialization, niche development and/or combining firms with complimentary skills to serve a broader market. It rarely deals with alliances among firms situated in similar market niches offering similar services. Combining the Pareto Principle with the concept of strategic alliances, CPA firms can create value and build strong relationships with colleagues as a foundation for future cooperation and, possibly, for succession planning. Moreover, they would be able to accept clients with less concern about whether the clients will still be attractive in the future. This strategy also permits smaller firms to create a “feeder” relationship with larger firms. This can help the smaller firms grow steadily and more predictably. Divestiture Instead of Firing As professionals, CPAs have a responsibility to provide their clients with quality service. When this is no longer possible, it is time to divest. Divesting can be beneficial to clients and CPAs alike for the very reasons the Pareto Principle identifies. It usually occurs when clients no longer fit the CPA’s target market. Often, the firm’s growth or reduction in client services drives the decision, usually making it unfair to both the client and the CPA to allow a poor fit to continue. Divestiture’s basic premise assumes it is better to find a new home for clients rather than just jettisoning them. It helps avoid making the client feel rejected, and rewards the divesting firm for having attracted and served the client. It helps the profession’s overall image by reinforcing the notion that CPAs look for what is best for their clients, as fewer clients are left to fend for themselves. It is often emphasized that the best way to “fire” clients is to deliver the message professionally in a way that does not anger them. However, no matter how great the effort, the message the client receives is negative. Divestiture differs from firing clients by more closely resembling a partial sale of a practice. This is true precisely because a divesting firm truly is selling off a small part of its business. The divesting firm transfers clients that are not a good fit for the CPA to another firm that is seeking that kind of client, and then it typically receives a portion of the new firm’s first year’s billings. Making arrangements in advance with another CPA to take over the divested clients is clearly the best approach. If done properly, divestiture also allows the firm terminating the relationship to be paid for its past investment in building the relationship. And because the divesting firm may have tried unsuccessfully to price the client into leaving the firm, it allows a small firm to achieve pricing it might otherwise not be able to achieve. Lastly, it eliminates the guilt many practitioners feel when deciding not to continue to serve a particular client; the practitioner is recommending what he or she considers to be an excellent solution to the client’s needs. The arrangement between the CPA firms can be as formal or informal as the parties wish, but the disclosures to clients must be handled carefully. Otherwise, the transfer is unlikely to occur, client confidentiality issues can surface and the message to the client remains the same as if the client were fired. The Process If divestiture is handled properly, the risks to the acquiring and divesting firms are small. The risk is small to the divesting firm because the CPA has already decided the divested clients are not clients it wants to retain; the firm was prepared to let them go. Any compensation the divesting firm receives as a result of the transfer is a “bonus” compared to simply terminating the client relationship. And since the divesting firm has already decided not to serve the client any longer, the acquiring firm can be less concerned with noncompete issues. Further, the successor firm typically only pays on successfully collecting for its first year of work. Compensation typically is one-third to two-thirds of first-year fees, with 50% being most common. Finally, both firms can distance themselves from the other firm if necessary, because the arrangement is officially just a referral with a “finder’s fee” attached to it. Successful divestitures share several attributes. The first is that the divesting firm built a relationship in advance with a CPA firm it trusts and that trusts it. The new firm must also be a firm that wants to grow by adding new clients. Ideally, the acquiring firm is smaller and/or newer than the divesting firm. It is best if the divesting firm has worked closely enough with the successor CPA to know he or she is a good fit for the divested clients. This is a key element in making clients comfortable with the change. A message that often works well is, “[New CPA] has worked with us on a lot of projects over the past [__ years/months] and we have high regard for the work [he/she] has done while working with us. We believe [he/she] offers the quality you are used to and [he/she] will honor our price structure.” For divestiture to work well, several conditions should exist. Among the more important ones are: Client service issues:
Firm-to-firm issues:
Additional Observations Divestiture and firing are not mutually exclusive. A practitioner can fire some clients and divest others; it is just harder to explain to the fired clients why they were in that group. Further, although this column has focused on developing a strategic relationship with a smaller firm, there is no reason why this concept could not be implemented with more than one firm. Multi-sourcing, while perhaps diluting the relationship with the one smaller firm, may provide greater opportunity for finding a “better fit” based on a particular client’s needs. While the divestiture concept is most often used by comparatively small firms that are, perhaps, one order of magnitude different in size, nothing prevents larger firms from applying the practice. A small local firm can develop this sort of “feeder” approach with one of the large international CPA firms. What makes this particular arrangement work is that the small firm shares a core competency with the large firm that is not commonly found in small CPA firms. When a client is not willing or able to pay the rates commanded by the large firms, the large firm knows the client has already decided to leave and steers them toward the local firm because they know the competency is there. As the trickle down effect of Sarbanes-Oxley and other economic mega-trends continue to be felt throughout the profession, divestiture also offers a great opportunity for small firms with unique skills to “move up the food chain,” achieve recognition for the expertise they possess and charge appropriately for that expertise. As noted earlier, because most firms’ first reaction in the case of less attractive clients is simply to price the client into leaving, honoring the existing fees should be attractive to the acquiring firm, especially if the clients are coming from a larger firm. And honoring the old firm’s pricing (or even bettering it slightly) is usually received positively by clients moving to the new firm. Communicating a small (5%–10%) fee reduction when clients are notified often has a large positive impact on conversion rates. A good candidate for receiving divested clients is a subcontractor or a practitioner just starting out, which the firm has previously used for peak seasonal staffing needs. Another alternative is someone with an office in the same building. This is often easier for clients; they simply return to a different address in the same building. Although this column focuses on divesting clients by working with strategic partners for the benefit of all concerned, client transfers between larger and smaller firms can go both directions. If clients grow beyond a small firm’s capacity to service them properly or need assistance in areas in which a small firm does not have expertise, there can be an understanding that both firms will use their best efforts to encourage the client to transfer some work to the larger firm under the same sort of divestiture approach. Divestiture will not work in every situation. Client conversion rates differ significantly, based on a number of factors, some of which are beyond one firm’s or the other’s control. Examples of other issues that can affect the outcome are geographic compatibility and branding, or “touch and feel” service issues. A Final Suggestion Trade publications often refer to CPAs as clients’ “most trusted advisers.” As such, CPAs are in a unique position to deliver the message discussed here. An analogy that often helps in these situations deals with another highly trusted adviser, the medical doctor. When clients are uncomfortable about the divestiture process, consider saying something like, “Just like a doctor, we see what is affecting our ‘patients’ and try to prescribe the right solution. Sometimes that means needing to see another doctor; sometimes it’s just going around the corner to the pharmacy; and sometimes it’s a procedure we can do here in the office. We just want our ‘patients’ to get the right treatment and I honestly believe you will be happier in the long run with this new ‘doctor.’” It is amazing how effective this analogy can be. Conclusion Before firing clients, firms should give serious consideration to alternatives, one of which is divestiture. Divestiture offers many advantages over firing clients. These advantages accrue to clients, firms seeking to grow and firms seeking to narrow the focus of client service efforts. It can be a “win” for all of the affected parties. However, while divestiture is almost always preferable for the parties involved, sometimes firing clients cannot be avoided. Now that the 2005 “busy season” is over, practitioners should evaluate both the source of future growth and what, if any, clients the firm would not accept today if they were not already clients. The Pareto Principle’s 80/20 relationship is nearly universal and its applicability to CPA firms is clear. The benefits of applying it properly can accrue to clients, the CPAs involved and the profession as a whole, by ensuring clients are served by the firms most interested in, and capable of, serving them well. |
