Research supports value of IT consults in post-SOX age

In the wake of spectacular corporate collapses, the Sarbanes-Oxley Act established new rules on a scale not seen since those meant to ameliorate the economic calamities of the 1930s. But three experts at the W. P. Carey School of Business argue that although many of the law's provisions are sound, it may overreach in others. The researchers disagree with the common perception that the pre-SOX consulting fees paid by companies to their auditing firms were actually veiled bribes or leverage to ensure positive audit opinions. They also concluded that, despite growing skepticism, businesses believe that information technology is more than a simple commodity and can indeed produce value and competitive advantage.

Coming on the heels of spectacular corporate collapses, the Sarbanes-Oxley Act (SOX) established new rules on a scale not seen since those meant to ameliorate the economic calamities of the 1930s. In a new study, however, three professors at the W. P. Carey School of Business argue that although many of the law's provisions are sound, it may overreach in some areas.

In addition, the researchers concluded that despite growing skepticism, businesses believe that information technology (IT) is more than a simple commodity and can indeed produce value and competitive advantage.

In new research published in the April issue of the Journal of the Association for Information Systems, information systems professors Govind Iyer and Sury Ravindran and accountancy professor Philip M. J. Reckers argue against the common perception that the pre-SOX consulting fees paid by companies to their auditing firms were actually veiled bribes, or leverage to ensure positive audit opinions.

Reckers says the flurry of accounting scandals that have dominated headlines in the past few years bred distrust — among the public and ultimately law makers — for the companies which had paid huge consulting fees to the same accounting firms they hired to audit their numbers. As the thinking went, a client could in essence pay for a good accounting review under the pretext of purchasing the consulting options offered by the accounting firms.

It appeared to be an easy carrots-and-sticks equation: Give our company a good audit review and we'll start writing checks for services we may not even need; but issue a less than favorable review and lose those contracts. The way to eliminate impropriety? Amputate consulting services from audit firms.

Familiarity breeds improvement

Government regulators reasoned that forcing corporations to engage an accounting firm for auditing and a separate company for consulting would eliminate the motivation to grease palms and at the same time introduce more competition — and thus better service and prices.

But this line of thought did not factor in the basic reason why accounting firms offered consulting in the first place — and why clients bought it from them, even when there were other options. The accounting firms gain an intimate familiarity with their clients' businesses while doing audits. From this holistic vantage point arguably they would have unique insights as to what companies might need to do in order to improve.

"Sometimes the person who can give you the best advice is somebody intimately linked with you, which is your auditor," says Iyer. "There's nothing sinister in letting an auditor do some consulting; there are valid reasons why firms would go to the auditor for consulting."

Drawing on a wealth of new information from 2001 made available in the wake of Sarbanes-Oxley, the research team looked at IT consulting services, including projects such as the installation or fine-tuning of enterprise-wide IT systems from the likes of SAP, PeopleSoft and Oracle.

The team used public data such as profit margins and turnover ratios to organize companies into a matrix that showed whether they were selling goods or services quickly and whether the margin on their offerings was high or low. The best position for a company was to be a high-turnover, high-margin business such as Microsoft, Intel or Dell, while the worst was to be a the low-turnover, low-margin enterprise like some traditional department store chains.

In a final pool of 230 companies, the data show those that performed the worst in terms of earnings metrics (those that were low-turnover, low-margin) were the ones most likely to seek help in the form of IT consulting — presumably to improve their financial performance and please stakeholders. Comparisons were made controlling for variables such as each company's industry, available cash, and how other companies in the industry utilized IT consulting.

Companies reach out for help

How much a company spent on IT consulting did not, however, preclude taking other measures which might have ranged from launching a new advertising campaign to shifting production, restructuring divisions or downsizing. Rather than being unscrupulous in their contracting for value-added services, companies indeed acted rationally — trying to, in effect, right their ship.

"There's a reason why companies invest in consulting services — because they need it," says Reckers. "They're not just doing it to get an opinion that makes them look good. They need help to make them factually good." The researchers also see a deeper, more relevant message for today's companies in this research in an atmosphere where Sarbanes-Oxley has mostly eliminated the debate as to whether accounting companies can offer consulting services to their audit clients.

That message is that companies, in seeking out IT as a solution to their issues, appear to hold a different opinion about the value of IT from the "IT doesn't matter" philosophy that has been gaining ground over the past three years. This idea is attributed to Nicholas G. Carr who proposed the idea of IT as a commodity in a 2003 article in the Harvard Business Review.

On his Web site, Carr explains his thinking: "IT infrastructure is indeed essential to competitiveness, particularly at the regional and industry level. My point, however, is that it is no longer a source of advantage at the firm level — it doesn't enable individual companies to distinguish themselves in a meaningful way from their competitors.

Essential to competitiveness but inconsequential to strategic advantage: that's why IT is best viewed [and managed] as a commodity." Carr might argue that the companies in Iyer, Ravindran and Reckers’ study were wasting their money when they plunked down cash for IT insight. But were they indeed foolish with their funds? Ravindran says no.

"Firms are not stupid," he says. "These companies are rational. They are not foolish. They do this because they are lacking in performance in this area or that area, and they see this as a way of building up some assets that would allow them to deliver sustained value to their stakeholders."

'IT does matter'

By proxy the market agrees. Estimates place the worldwide market for consulting services at $100 billion — up from less than $10 billion only a decade ago — and worldwide IT spending is expected to increase at a compound annual rate of 6 percent from 2004 through 2008 to $1.2 trillion.

Interpreting their research, the three authors say these companies believed — and rightly so — that there is indeed value in IT. Even if a company has the same hardware and software as its competitors, it's how the software is used that creates value. Of course, consultants are engaged to determine how IT can be used for strategic advantage and companies which bought consulting services were likely of this mind.

"We can confidently say that companies believe that IT does matter," says Ravindran. Why else would they — when faced with unimpressive financial results, unhappy shareholders and limited resources — decide to dedicate substantial resources to IT when there are so many other options? "They could do any number of things — why would they do this?" Ravindran asks.

Because a logical organization directs its resources where it believes there is a significant return, he replies. The next step in the research will further examine not if, but how IT matters to an organization. The three plan to look at how the consulting services affected companies' bottom lines, whether the pricey advice helped meet stated objectives, and which industries, projects or types of consulting are the best candidates to net a worthwhile return.

Bottom line:

• Consulting services offered by auditing firms pre-Sarbanes Oxley have been painted as little more than bribes for buying a rosier audit, but a new study of 230 companies shows the ones most likely to seek these services actually needed them — were trying to right their ships.
• An "IT doesn't matter" philosophy has been gaining ground over the past three years, suggesting that IT is a commodity, and not a source of strategic advantage. Companies, however, seem to disagree. The worldwide market for consulting services at $100 billion — up from less than $10 billion only a decade ago — and worldwide IT spending is expected to increase at a compound annual rate of 6 percent from 2004 through 2008 to $1.2 trillion.
• The value of IT is in its deft application. It's not whether a company has the same hardware and software as its competitors, it's how the software is used that creates value.