Thursday, 19 February 2009

BearingPoint (ex-KPMG) is bankrupt

Ed Kless at VeraSage points out that BearingPoint has filed for Chapter 11 protection, wiping out shareholders equity.

VeraSage campaigns for a switch from hourly-based to value pricing (mainly among accountants) and so Ed asks how BearingPoint could possibly have lost money on hourly contracts, unless most of its consultants were sitting around doing nothing for months on end.

However, even though BearingPoint came out of KPMG, I doubt they were charging on an hourly rate for most projects. In my experience consulting and IT firms are much more likely to use fixed-price agreements than accountants.

A number of such firms have made serious losses on these agreements in recent years - IT projects of course being notorious for going over budget. I would expect that this is the reason for BearingPoint's problems. While government IT projects used to be notorious for going over budget at the taxpayer's expense, they are now getting just as bad a reputation for causing losses on the supplier's side.

I certainly don't believe this is a strong argument against fixed-price agreements - in my own software firm we almost exclusively use fixed or value pricing - but it does highlight that pricing is an area where these companies seem to make some expensive mistakes.

I'm sure most firms make a profit on the majority of their engagements; but IT projects in particular are highly asymmetric. If you fix a price of $1 million for a project, the highest profit you can make on it is $1 million. But the loss you can make is, in principle, unlimited. Inevitably a large loss will occasionally happen, and can wipe out the profits from many other projects.

This makes it incumbent on consultants to become good estimators. There is a certain amount of research on this in the software field, but I think not enough. At any rate there is still no universally accepted method.

Many consultants will accept hourly rates when they can get away with it, specifically in order to avoid such problems. Others will write their fixed-price specifications skilfully and therefore be able to charge more when circumstances change. Others will get themselves stuck with too-loose specs and lose money on changes.

I don't know whether the greater acceptance of fixed price agreements among the IT sector is because they see the opportunity for greater profit, because of a better understanding of how to profit from intellectual property, because of a greater attachment to 'a logical way to do business' or because clients have got wise to IT overruns and put greater pressure on suppliers to fix their prices. Probably a combination of the above. I'm sure both the consultants and the accountants have things to learn from each other.

3 comments:

Jim said...

It was not fix priced contracts. BearingPoint went down because it grossly overpaid, with borrowed money, for non-US operations. Then it custom build an new accounting system, shut off the old system, and the new system did not work.

Then the CEO had the auditors do a 100% of revenue audit (audits normally involve relatively small samples). The audit ultimately cost a few hundred million.

There were no audited financials for more than three years. That triggered a declaration of default on debt. About $30 million bought off the debt holders to withdraw the default. The company borrowed $60 million to pay bonuses.

The core business was great. The corporate operations were run poorly. The core business was severely damaged over the past two years. Bankruptcy does not help, and it may be too late to keep the ship afloat.

Jim said...

It was not fix priced contracts. BearingPoint went down because it grossly overpaid, with borrowed money, for non-US operations. Then it custom build an new accounting system, shut of the old when, and the new system did not work.

Then the CEO had the auditors do a 100% of revenue audit (audits normally involve relatively small samples). The audit ultimately cost a few hundred million.

There were no audited financials for more than three years. That triggered a declaration of default on debt. About $30 million bought off the debt holders to withdraw the default. The company borrowed $60 million to pay bonuses.

The core business was great, but severely damaged over the past two years. Bankruptcy does not help, and it may be too late to keep the ship afloat.

Leigh Caldwell said...

Interesting! Thanks for the info Jim. Always sad to see when a good operation is brought down by finance; but I guess more operations are created through finance than destroyed by it.