Qiang Guo is a researcher specializing in auditing and the structure of the audit market. An important example of his line of research is the article “Switching Costs and Market Power in Auditing: Evidence from a Structural Approach”, published in the leading international journal The Accounting Review. It is co-authored with Christopher Koch (Johannes Gutenberg University Mainz) and Aiyong Zhu (Southwestern University of Finance and Economics). You can find the full article in English here: https://doi.org/10.2308/tar-2022-0416
About the Costs of Changing Auditors
Changing auditors can be expensive. Switching costs can take several forms. First, there are transaction costs, such as those associated with selecting a new auditor or terminating the existing engagement. Second, there are learning costs, as the new auditor must become familiar with the client’s business, internal processes, and accounting systems. Third, there are compatibility costs, which arise when the client’s systems or procedures must be adapted to the new auditor’s technology or audit approach. Finally, there may be psychological switching costs, reflecting a preference for the status quo or concerns about the risks and uncertainties of changing auditors.
Switching costs play a central role in both the customer experience and the audit firm’s competitive situation. Therefore, it is useful for both clients and audit firms to gain insight into the effects of switching costs before changing auditors.
The audit market
Qiang Guo's research shows that switching costs are pivotal in the structure of the audit market. It also shows that switching costs often lead to a mismatch between firm and client, and that many clients would switch to another audit firm if it were not for switching costs. They are a barrier to companies switching audit firms. However, insight into the challenges potential clients experience can help the audit industry develop products and communication strategies that guide clients through the process.
Switching costs make the market less dynamic
Switching costs are often a considerable expense for a company, and according to Qiang Guo's research, they are also the main reason for the rather low turnover rate in the audit sector. He believes that if legislators reduced or eliminated switching costs, it would contribute to a more dynamic audit market.
This paper is the first to quantify the magnitude of switching costs, estimating them at approximately USD 682 million to 1.185 billion per year, corresponding to 14.2%–24.0% of total audit fees. The research shows that Big 4 clients typically refrain from switching to non-Big 4 to avoid loss of utility, while non-Big 4 clients often refrain from switching to Big 4 due to high switching costs.
From a policy perspective, the results imply that regulatory interventions aimed at increasing market mobility, especially to strengthen the position of non-Big 4 firms, cannot rely solely on lowering entry barriers or subsidizing smaller firms. Such measures do not affect Big 4 clients and may instead intensify competition within the non-Big 4 segment without increasing the overall market dynamics.
What affects switching costs?
Qiang Guo’s study confirms that switching costs tend to be higher for larger clients due to their complexity. Clients with longer tenure with their current audit firm also typically experience higher switching costs. Firm age may also be associated with higher switching costs. This suggests that learning costs also come into play. Conversely, characteristics of the incumbent audit firm, such as industry specialization or Big 4 status, do not appear to capture switching costs but rather reflect client preferences.
According to Qiang Guo’s research results, companies with well-functioning internal information systems are better positioned to upgrade from a non-Big 4 to a Big 4 audit firm. This is particularly true regarding reporting speed, efficient archiving and possibly previous Big 4 experience, which can help reduce switching costs if the company wants to upgrade its audit firm.
What makes upgrading your auditor expensive?
Upgrading to a Big 4 audit firm can involve significant switching costs because Big 4 firms typically use more sophisticated audit technologies than non-Big 4 firms. As a result, non-Big 4 clients may need to adapt their information systems and processes to ensure compatibility with the new audit firm’s technology and methodology. The findings suggest that switching costs are particularly high when companies upgrade from non-Big 4 to Big 4 audit firms. One possible implication is that greater standardization between audit technologies and corporate ERP systems could help reduce switching costs when companies change auditors.
Trade-offs to be aware of
Qiang Guo’s research provides insight into the trade-offs that often arise when companies consider switching audit firms. This knowledge is relevant both for clients’ choice of audit firm and for the auditors who manage their new client portfolios. For example, Big 4 clients considering switching to non-Big 4 auditors should be aware that although switching costs may be relatively low, the switch may lead to a noticeable loss of matching utility, and switching back later can be costly. Conversely, non-Big 4 clients who are considering switching to Big 4 should be aware that although the switching costs may seem considerable, the potential utility gain can also be substantial.
For audit firms involved in a competitive bidding process, these insights can be helpful for both types of audit firms, says Qiang Guo: Big 4 firms can emphasize that many clients obtain higher matching utility from choosing them and may consider offering discounts to offset switching costs if they sense that the client finds the switching costs very costly.
Non-Big 4 auditors, on the other hand, can emphasize that switching to them does not involve high switching costs and further develop their unique value propositions, as research also suggests that differentiation within the non-Big 4 group is relatively limited.