So the firms make money from offering these services, and we should presume that the clients also receive benefits

So the firms make money from offering these services, and we should presume that the clients also receive benefits

Our estimate was that’s about 20 cents, so about 20 cents of every dollar of revenue is gross margin before partner compensation back to the audit firms.

Now, the reason I mention that is I think when we think about the value added by these services we want to think about the profit produced not only to the firms that provides the services but to the clients themselves.

And I’m sure you could all do a rough calculation, if you figured that a client hires a firm expecting they’ll roughly split the surplus that’s going to be generated by the job, how much money that might be.

I have to say that when we look at the growth ofnon-audit services there’s, sort of, two things that can come to one’s mind. One is, “Oh my god, these firms are doing so many other things.” The other is, “Look at the value being added in the economy as these services grow.” I tend to think of the latter.

The key thing with value added by these services, though, I think is the economies of scope that are or are not present with the audit function. That’s really why we’re here. The real question is not how much value can you add by consulting, but how much of that value is driven by a tie with auditing.

That’s really the key issue and certainly, I think, should be the key issue behind the Commission’s thinking in terms of barring accounting firms from delivering non-audit services to their audit clients.

The only thing I can have here is some intuition

What are these economies of scope I’m talking about? Well, they’re the values of the synergies that are generated by bundling services. I’ll tell you now that as far as I know there’s no systematic evidence as to the magnitude of these economies, just none that I know of.

One is I would observe that firms have been very successful incubators. These firms have generated not only a lot of revenue but a lot of different services that they’ve been able to find a niche for, and that, to me, indicates thatthere’s some type of comparative advantage that the firms have in the market for non-audit services. That suggests an economy of scope.

The other thing I’d like to point out is I’d like to think about the experience with Arthur Andersen in particular. When Arthur Andersen — when Andersen Consulting and Arthur Andersen split, as I recall, it left Arthur Andersen, the audit part, with virtually no non-audit services — I’m not talking about taxes — no non-audit services.

The evidence that I’ve seen suggests that Arthur Andersen audits has, sort of, completely — or has re-grown that non-audit services business to the point where it’s the virtual equal of their audit practice now.

You can think of this like a star fish. You can cut off the arm, but it grew back. If there weren’t some powerful economies of scope operating between their audit practice and non-audit services, how were they able to start from zero not that many years ago and re-grow a substantial presence in non-audit services?

I think that that again speaks to economies of scope. I personally would like to have some real evidence as to their magnitude.

Now, if you think about it, how were they able to do that?

We don’t know whether the firms have a very smallcomparative advantage in the area and that’s why they’re able to really just take advantage of that, or whether their comparative advantage in offering non-audit services is really very large, and that’s why it seems to be so easy for them to market these services.