Transcription
In December 2024, the Australian government hired the world's largest corporate firm to give them advice on how to fix one of the country's most pressing issues, an automated welfare system which penalized the nation's most vulnerable. And after a rigorous 7-month brainstorm and $290,000 in fees, the results were back. However, there was just one issue. All the hard work that Deloitte had been doing had been done by AI. The report included fake references, fake quotes from a fake court hearing, and even a citation to trusted academic work, all of which didn't exist.
While this might seem like a somewhat extreme example, these firms have been getting away with dressing up obvious advice and solutions behind extreme price tags for decades. That is, until the last couple of years.
The accounting giant PwC is facing an existential crisis. Revelations that its senior partners misused confidential government information to help multinational tech companies avoid tax has rocked the firm to its foundations.
Round after round of layoffs are starting to puncture these big companies. But while the problem is most acute with the Big Four, the same problems are showing up across pretty much the entire corporate world. Bloated firms that have gotten away with overcharging for decades are seeing their business model begin to fall apart. And while you might think that the industry is just another victim of the AI revolution, while in part that's true, there's actually a lot more going on here. Over the past few decades, corporate America has hollowed out its competition. But doing that comes with its own risks, and firms are only now just starting to pay the price.
Okay, so pretty much anyone who's worked a corporate job knows that these companies can be a bit of a joke these days. In 2014, in what should have been a routine audit, PwC managed to overstate Tesco's projected quarterly profit by 250 million pounds, almost 30% higher than what they actually brought in. And events like these aren't a simple one-off. Time and time again, these companies have made massive mistakes on what should be fairly basic, if lengthy tasks.
However, there was actually a time when these kind of American corporations were the envy of the world for the high quality of work that they would do. The 1970s saw the birth of the modern era of multinational corporations. After conquering America in the decades prior, companies like IBM, Coca-Cola, and Ford began building operations that spread to every corner of the globe. But that presented a unique challenge. How do you keep track of money moving through dozens of countries at once when every single one of those branches operates under a completely different tax code and a different set of accounting rules?
Ideally, you'd have one trusted, independent outsider who could come in and check the books the same way everywhere, no matter which country you're operating in, which is what gave rise to these. Originally known as the Big Eight, they were firms which specialized in verifying companies' financial statements. They sat at the very heart of corporate America, helping run the biggest organizations in the Western world. By the late 1980s, the Big Eight together controlled about 98% of all public company audits.
But gradually, as time went on, firms that couldn't keep pace with their bigger rivals got absorbed by them. So by the start of the 2000s, only five of the big original eight were left. Now, in theory, it's not anything unusual for the worst-performing firms to go extinct. After all, that happens all the time to smaller corporations in history. But problems start to emerge when new firms aren't able to come into the market at all. And in a sector like financial auditing, that's exceptionally difficult.
Imagine you're running a multinational corporation that sells cars across Europe, and it comes to that time of the year again, and you need to do an annual audit. You're presented with two options: a new startup audit firm that nobody has ever heard of, or one of the same multinational auditing firm who's been checking your books for decades and probably does the same for all your competitors and most of the governments of Europe. On the balance of probability, you're probably going to go with the latter. After all, this isn't really the kind of thing that you want to take a risk on. The point is, it's a world built on reputation and that's exceptionally difficult to build from scratch.
So, over the last couple of decades, we've seen this same effect of consolidation play out across all sorts of industries in corporate America. Three credit rating agencies, S&P, Moody's and Fitch, collectively control about 96% of the global ratings market, a dominance they've held for over a century. And it's the same for strategy consulting. McKinsey, BCG and Bain dominate not because nobody else can do the analysis, but because we hired McKinsey is a much easier sentence to say in a board meeting than we hired a firm that nobody has ever heard of. Law, finance, asset management, private equity, all of these industries are increasingly dominated by a smaller and smaller number of firms. And in practice, that means these companies can get away with offering worse and worse services because they know that their buyers don't really have any sort of alternative.
Now, big corporations across all sorts of industries have been getting away with charging huge prices for sub-par services simply because they control enough of the market. And the same thing has been happening to your SIM card, especially when you go abroad, which is where the sponsor of today's video, Saylite, comes in. Saylite is an eSIM app that works in over 200 destinations. It gives you instant mobile access the moment you land. No physical SIM card needed, no airport vendors and my personal favorite, no fumbling around with kiosks. Pick your plan before you travel and the second you touch down, it activates and connects automatically. You get affordable data plans in multiple destinations without the expensive roaming fees carriers love to sting you with. Every plan you buy also earns you credit towards your next one. And don't be that person hunting for airport Wi-Fi while you figure out the bus. Turn on Saylite security features to keep your location private. Download now and use code invisible game to get a 15% discount on Sayle data plans. Download the Sayle app or go to sayle.com/invisiblegame.
Now, let's get back to the video. As the quality of the services which a lot of the country relies on continues to decline, something is eventually going to go badly wrong. And in 2001, that's exactly what happened. By the late 1990s, Enron was one of the most admired companies in America, an energy trading giant worth tens of billions of dollars on paper, and its auditor was Arthur Andersen, one of the Big Five. And the relationship between these two companies was extremely lucrative. In the year 2000 alone, Andersen earned $25 million in audit fees and an additional $27 million in consulting fees, both from Enron.
However, behind the scenes, Enron was quietly hiding roughly $20 billion in debt off its balance sheet using a web of shell companies built specifically to make Enron look far more profitable than it really was. Of course, spotting that kind of manipulation was exactly what Arthur Andersen was getting paid for. They just completely failed. And when that came out, it cost the company so much that just 9 months down the line, they completely collapsed.
The trouble is, rather than learning the lesson from this that corporate America had become uncompetitive and needed to be broken up, the opposite ended up happening. Today, those four remaining audit companies audit every major organization in the Western world. Of the 500 biggest corporations in America, 498 are audited by these companies. And when a firm picked which company they're going to go with, it takes them an average of 23 years to change once. This is BCE Inc., Canada's largest telecommunications company, and it's been audited by Deloitte for 144 years.
Now, that might sound like a recipe for subpar service, and in many ways it is. But as long as these firms could maintain the illusion of prestige, it just about works. The problem is, after decades of charging millions for orders that aren't even accurate, people do eventually start to notice. In 2022, regulators found that 43% of EY's orders had what they called a deficiency. Essentially meaning that the auditor didn't even gather enough evidence to actually support the opinion it was signing off on. The following year, they were forced to walk away from 84 audit clients, giving up $215 million in fees. And it's not just them, either. Regulators found that the average deficiency rate across all Big Four firms more than doubled in just 2 years, from 12% in 2020 to 26% by 2022.
Given that, it's hardly surprising that firms are increasingly choosing to bring in what they call in-house, or moving these services out to smaller firms. And this isn't just an audit story. It's the same pattern playing out right across the corporate world. These giant firms spent decades building themselves into effective monopolies on the back of the idea that what they did was so prestigious that nobody would ever seriously challenge them. However, the problem is, once they became safe, the quality began to quietly slip year after year, until eventually the firms that were supposed to be the kind of gold standard in the industry are now the ones that are rubbish and don't even do the job they're paid for.
Now, it's important to remember that a big part of why these firms were able to dominate for so long wasn't just their reputation, but the scale of cheap, high-quality labor that they could attract. For decades, the best graduates from the best universities funneled straight into some version of accounting, law, or finance almost by default. At Harvard, roughly 57% of the class of 2022 went straight into finance, consulting, or technology. And that made it insanely hard for smaller firms to compete with them, as their name brands just didn't have the same CV attraction for fresh grads.
But, ever since the introduction of AI, that advantage has been massively eroded. The very same tasks which gave these massive firms a competitive edge are exactly the kind of work that AI massively speeds up. Data extraction, pattern matching, document review. The actual grunt work that used to require armies of junior staff can now be done faster and cheaper by software supervised by a smaller and smaller team. And perhaps most critically, none of this groundbreaking technology is exclusive to the old corporate giants, which massively reduces the barrier to entry to compete in the market.
Okay, so the sudden introduction of AI, along with the fact that the services the Big Four were providing just weren't that good, has meant that the companies have been bleeding clients for years now. But there's actually an even bigger threat to these companies which might bring them down even sooner. Government antitrust.
Starting in the 1980s, what was then the Big Eight realized something very important. Given how good their reputations had become, they didn't just need to sell an actual service. Instead, they could simply sell advice. That's what gave the rise to corporate management consultancies as we all know and love today. Deloitte Consulting, PwC Strategy, EY Parthenon, and KPMG Advisory. They all almost exist as a branch of these original auditing firms. By 2023, the Big Four were pulling in 95 billion dollars from advisory services alone. More than the 66 billion that they made from audit and assurance combined.
But it also presents a bit of a problem. Remember, the job of an auditing company is to independently verify that a company's financial statements are accurate. At the same time, the job of a consultancy is to try and improve how that same company runs. In effect, you've got the exact same company doing the job and then evaluating how good a job it's done. It's like marking your own homework. This creates massive incentives for the auditing side of the business to sign off on the books a little too generously in order to make them seem like the consultant's advice is working better than actually is. And at the same time, the people doing the audits get access to a huge amount of confidential information, much of which would be extremely profitable for consultants to quietly use to win new business or advise clients' competitors.
Of course, doing so would be totally illegal. And in theories, these companies all have its strict internal Chinese walls to prevent this from happening. But as you might have expected, they aren't particularly effective. In 2013, the Australian Treasury hired a PwC partner named Peter Collins to help advise on new laws designed to stop multinational companies from dodging tax. He signed three separate confidentiality agreements, but he then shared that very same confidential government information with at least 53 PwC partners who used it to help clients, including Google, get ahead of a law PwC itself had helped designed.
This kind of thing has been going on for decades across the Western world. And once a firm becomes successful enough to expand into several branches of the same industry, the temptation to use information it shouldn't really have to boost its position in both directions becomes almost impossible to resist. But it does seem like governments might just be starting to notice. Following the Australian PwC scandal, the company was forced to sell off its entire government consulting business for just $1. And in the UK, from 2024, all four firms had to operationally separate their UK audit practices from the rest of the business. Even the US, known for being the poster child of free market capitalism, has had Senate considering a breakup.
For these businesses, getting split up this way would be totally detrimental for one key reason. Both sides of the business rely on each other. Consulting is clearly the main profitable arm, and in 2023, the Big Four alone generated $95 billion from advisory compared to $66 billion from audit. But it only exists in its current form because of the credibility and client access that auditing has built up over a century. If you cut those things out from each other, chances are that both sides would end up doing a lot worse.
And even if Western governments don't get involved, the quality of consulting services has dropped so much that it might not really matter. Take a look at this slide from 2016. It's a key deliverable which McKinsey would have charged thousands of dollars for. And for the money, they get words like this: "Develop value-creating partnerships. Build a clear mission. Develop strategies to create a sustainable-related opportunities." These words are the output of millions of dollars, and it's not like they actually mean anything. But with a fancy graph and a complimentary color tone, it seems like the advice must be valuable.
Of course, you can only play that game for so long. By 2024, only 13% of businesses felt that consultants were actually doing more good than harm. Slowly but surely, firms and governments alike are beginning to cut contracts with these companies. And once the branch of the business that was propping up the entire operation starts shrinking, that puts the entire operation under massive pressure.
Okay, so all of this raises an important question. What actually ends up filling the space they leave behind? The most obvious option is that large companies simply stop outsourcing this work altogether. If the main value the Big Four provided was cheap, high-quality labor to do data extraction and document review, and AI can now do most of that work internally. And then a company doesn't really need to pay millions of dollars to a consultancy just to get an outsider's opinion on something its own staff could generate in an afternoon.
At the same time, it's also very possible that we see a wave of smaller boutique firms start to compete seriously for the first time in decades. AI is quickly closing the gap in output quality between a firm with 300,000 employees and a firm with 30, meaning that the size of your head count stops being the advantage it used to be.
And the third, perhaps most disruptive possibility, is that the work stops requiring a firm at all. Historically, one of the reasons you needed a firm, rather than a single expert, was that any serious piece of consulting or audit work required more labor than one person could physically produce in a reasonable time frame, which is why these companies were built around armies of junior staff supporting a smaller number of partners. If AI can now do the bulk of that supporting work, then a single experienced professional, someone who spent 15 years inside one of these firms and understands exactly what clients are paying for, could possibly deliver the same output on their own without needing hundreds of junior employees behind them. This would create an entirely new category of competitor that doesn't really resemble a firm at all, made up of independent consultants who can undercut the Big Four dramatically on price simply because they don't have the overhead of a firm to support.
Of course, none of these outcomes are mutually exclusive, and it's entirely possible that all three end up happening at once, chipping away at the Big Four from different directions simultaneously. What does seem fairly clear, though, is that the model which dominated corporate America for the better part of a century is no longer guaranteed.