KPMG's Brave Leap into the Cold

The first Big Five consulting firm to sell shares is wrestling with wrenching change

Eighteen months ago, KPMG Consulting (KCIN ) was securely tethered to the accounting arm of KPMG LLP and mired in the inbred atmosphere of a Big Five consulting firm. Hundreds of partners ran their parts of the business as separate fiefdoms, all under the sheltering canopy of KPMG. No more. The consultants split from the accountants in January, 2000, and went public a year later, becoming the first of the Big Five firms--but not the last--to transform itself from a private partnership into a public company.

These days, investors, clients, and competitors are watching closely as KPMG Consulting, based in McLean, Va., struggles with wrenching cultural changes. Transformations large and small are visible everywhere in the $2.4 billion company. The massive mahogany desks and expansive offices once occupied by KPMG's venerated partners have given way to cookie-cutter work spaces, pint-size offices, and managing directors. Gone are the days when a client could wait indefinitely to pay. And directors who don't make their cash-flow numbers can expect a call from CEO Randolph C. Blazer. "As a partnership, if you don't get to the numbers, you don't get to the numbers," says Blazer. "In a public context, part of our reward is appreciation of the stock price, and you're not going to get that unless you're hitting the numbers you said you were going to hit."

Hitting those performance targets is about to get a lot harder. KPMG Consulting's bread-and-butter business, the integration of big-company computer systems, is showing distinct signs of a slowdown. Results in its first post-partnership quarter--$42.2 million in operating profits on $751 million in revenues in the three months ended Mar. 30--were respectable, but clients canceled or delayed $180 million worth of contracts in the quarter, and analysts predict that business will be sluggish over the next six months. Already, shares are trading at about $17, 30% off their high. "I've never seen a tougher environment," says F. Mark D'Annolfo, the chief of the computer-services consulting group at Deutsche Bank Alex. Brown.

That's not what KPMG's senior partners had in mind two years ago when they first kicked around the idea of an initial public offering. The Securities & Exchange Commission was pressuring the Big Five firms to set their consultants free, arguing that having auditors and consultants under the same corporate roof posed an irreconcilable conflict of interest. Besides, back then, business was booming and expectations for KPMG'S consulting arm, with its 36% compound annual growth rate, were particularly high. Partners saw a chance to use newly minted stock to acquire KPMG operations in Europe and issue options to lure talent.

KPMG execs got their first taste of the rigors of life as a public company when they met with the sales force of lead underwriter Morgan Stanley Dean Witter & Co. (MWD ) in January, and again two days later, at a meeting with potential investors in Frankfurt. No one, they found, cared a whit about the "story" of KPMG Consulting and its fabled 131-year history as a white-shoe firm. All they cared about were the financials. It was an eye-opener. Says Chief Financial Officer Bob Lamb: "This firm never talked about compensation and tax rates. We're doing that now."

UNDER SCRUTINY. That emphasis on financial performance has led to some painful choices. KPMG Consulting has already laid off 800 of its 10,000 employees in the past 16 months, for which it will take a $15 million to $20 million charge. Dan Johnson, an executive vice-president who keeps a Wall Street sign in his office in the company's headquarters, recently fired another 25 consultants working on government projects. Why? The work wasn't profitable enough. "You have to move quicker," Johnson says. "You can't wait." Even harsher measures could be on the way. A former partner says KPMG Consulting will have to rid itself of the last remnants of the old regime: dozens of highly paid, underperforming partners. Blazer says many have already departed, both voluntarily and involuntarily, and that the issue will continue to be addressed.

Those who are left have had to adapt to an environment in which the focus is firmly on the numbers. Instead of measuring profitability once a year--standard operating procedure in the partnership--the company now monitors financials constantly. Every Friday, Senior Vice-President Kenneth C. Taormina grills his sales force on every would-be client: "I go through every single deal [asking] `What do we need to get it done?"' Even the office kitty that partners dipped into freely for morale-building activities such as staff dinners is now under scrutiny. "There's a lot more emphasis on measuring things that we wouldn't have measured before," says Managing Director Darryl B. Moody.

And these days, most former partners, who once had full access to KPMG's financial data, now find out how the company is doing at the same time as outside investors. Many of the 630 managing directors asked Blazer to declare them corporate insiders--with restrictions on trading stock--in order to retain their old access to the financials. Blazer refused, saying there were just too many.

Rivals are watching KPMG Consulting's metamorphosis for what may be in store for them. And with good reason: Two similar experiments in public ownership--Arthur D. Little Inc. in the 1960s and Booz, Allen & Hamilton Inc. in the 1970s--ended with both firms eventually reverting to private ownership. Today, four Big Five firms have sold consulting units or announced plans to do so. Accenture (formerly Andersen Consulting) plans a $1 billion IPO. PricewaterhouseCoopers, which tried to sell its consulting arm to Hewlett-Packard Co. (HWP ) last fall, may follow.

Will KPMG manage to thrive as a public concern? Even with the dismal business outlook over the short term, the company has considerable strengths. With 2,500 clients and an enviable retention rate, it has been shielded from the wild revenue fluctuations that turn off investors, despite deriving half its revenues from e-commerce. A solid public-services practice, which brings in a third of its revenue, and joint-marketing agreements with Cisco Systems (CSCO ), Oracle (ORCL ), and Microsoft (MSFT ) also go a long way toward providing predictable growth. And clients say they like the new KPMG Consulting. Says Ed Mulvey, vice-president for strategy and e-business at Honeywell International Inc.'s aerospace-services unit: "You definitely sense the enthusiasm of people having a piece of the business."

As the first of the Big Five consulting partnerships to go public, KPMG Consulting is clearly the canary in the coal mine. But Blazer is confident that despite a soft business outlook and the changes wrought by public ownership, his firm will thrive. If it does, look for other big consultants to start flocking to the public markets, too.

By Louis Lavelle in McLean, Va.

    Before it's here, it's on the Bloomberg Terminal.