H&R Block Case Study: Competition, Ethics, and Strategy

Introduction

H&R Block has been a consistent performer since going public, with solid earnings and cash flow. This paper explores H&R Block's performance relative to other, similar industry players, and examines whether the company's leading image in the tax preparation industry will serve it well moving forward — particularly when competing with different kinds of businesses, including the IRS itself.

This paper also analyzes issues that could affect the company in the future, including competition, legal challenges, and future customer demand. Finally, it presents an exposition and analysis of H&R Block's ethical problems related to its tax-return lending division — a major cash flow source, but also a source of significant regulatory and political scrutiny.

Origins and Growth

H&R Block began in the 1940s with a small tax-preparation office on Main Street in Kansas City (H&R Block, 2007). From its inception, the two Bloch brothers did bookkeeping work for small-business clients in the area, as thousands of other such services did at the time. In 1955, a pivotal event changed the company: at a client's suggestion, they placed an advertisement in the Kansas City Star promoting their tax preparation service. The high demand that followed demonstrated there was an untapped business opportunity, and they abandoned all other businesses to focus on tax preparation and consulting.

The U.S. accounting and tax preparation industry now employs approximately 90,000 firms with combined annual revenue of $65 billion (NAMC, 2006). More specifically, the personal tax preparation segment has grown in two ways: through innovation and through organic growth as more American consumers become comfortable with outsourced tax preparation. Tax preparation accounts for roughly one-third — approximately $20 billion — of total industry revenue. The primary drivers of growth in this industry are strong consumer marketing, an increasingly complex IRS tax code, and consumer lending tied to tax refunds.

Overview of the Industry and H&R Block's Role

The industry is dominated by a few major players, of which H&R Block is by far the largest, with $4.021 billion in sales. The tax-preparation segment, however, continues to lose money, with losses increasing from $153.1 million in Q1 2007 to $172.3 million in Q1 2008 — on revenue of less than $70 million. This means the company's core historical business is facing significant competitive challenges as new forms of competition emerge. H&R Block's gross profits of $1.377 billion in the prior year reflect a profitable enterprise with a 25% gross margin and 42.9% operating margin, but continued write-offs in core businesses have led to losses totaling over $500 million across the past five quarters.

The primary competitors are as follows:

Jackson-Hewitt, with revenues of $293 million, is approximately one-fifth the size of H&R Block. Its primary business — tax return preparation and software — provides the bulk of its revenues. In the core tax preparation business specifically, Jackson-Hewitt is roughly twice the size of H&R Block, having prepared 3.65 million tax returns in 2007.

Intuit represents a different kind of competitor. Its approach has centered on tax self-preparation. Its growth in recent years has paralleled H&R Block's, but Intuit's stock has risen 395% since 1995, compared to H&R Block's rise of only 115%. Despite having sales only half those of H&R Block, Intuit's market capitalization is 50% higher, reflecting investor confidence in its cost structure and growth model. Because Intuit is primarily online and software-oriented, its return on assets and equity are both higher than H&R Block's. A key reason is that Intuit's gross profits, at $1.8 billion, exceed H&R Block's.

The IRS is an emerging competitor. Its e-filing initiative, known as Free File, offers free services to individual tax filers online and has captured a meaningful market share. Heavy lobbying by the tax preparation industry caused the IRS to impose income limitations, restricting the free service to individuals with incomes below $50,000 (White, 2006).

Challenges Facing H&R Block and the Industry

Over the past decade, H&R Block's significant growth has been built on the value of information it collects from consumers when preparing their tax returns. The company has monetized this information in several ways:

Refund anticipation loans are directly tied to the tax returns processed by the firm and its franchisees. Because H&R Block knows its customers' tax-refund status intimately, it has been able to build a substantial franchise in this lending area.

Mortgage loans emerged as an outgrowth of the refund lending business, built on the information and relationships H&R Block has developed with its customers over time. This business reached a significant scale, and the company agreed to sell the division to Cerberus Capital — a private equity firm and the recent purchaser of Chrysler — which offered $2 billion. The subsequent meltdown in sub-prime mortgage lending led Cerberus to seek to renegotiate the terms, potentially requiring H&R Block to retain the business within its broader corporate structure.

The greatest competitive threat to H&R Block comes from the Internet. With its network of franchised tax preparation offices, it is difficult for H&R Block to match either the flexibility or the cost structure of online and software competitors. The most significant threats come from Intuit and Microsoft, for several reasons:

Their costs are significantly lower, with gross margin percentages roughly double that of H&R Block in this business. They can replicate the services offered by H&R Block because they have rapid online access to customer financial information, enabling them to offer similar products. Intuit, for example, is expanding its own consumer lending and mortgage businesses and marketing them aggressively. These companies also lack the political and legal history that H&R Block has accumulated in consumer lending, allowing them to avoid some of the regulatory pitfalls H&R Block has encountered — particularly the controversies surrounding high interest rates on tax anticipation loans.

Furthermore, both Microsoft and Intuit are international companies offering tax preparation and consumer financial services globally. Although neither is a significant factor outside the English-speaking world, their low cost structures, minimal barriers to entry in new markets, and ability to operate without an expensive store- and franchise-based infrastructure make expansion considerably easier for these firms.

Conclusion

H&R Block needs to rethink its strategies in order to face increasing competition from multiple directions. Although it has dominated the in-person tax preparation industry, its primary growth has come from ancillary businesses. It must maintain and grow its core tax-preparation operations, since they serve as an important feeder to the rest of its business lines.

H&R Block must also become an active participant in the national debate about consumer financial data and consumer lending. By developing a clear corporate ethics statement and corresponding policies, H&R Block has an opportunity to limit the reputational damage caused by practices perceived as "predatory" by politicians and the popular press.

Finally, H&R Block faces the risk of disruption to its core business by competitors pursuing fundamentally different approaches. As Intuit and others replicate H&R Block's business model at lower cost, the company must develop new revenue streams and delivery mechanisms to remain competitive in the long term.

References

H&R Block. (2007). Our company: A humble history. Retrieved August 30, 2007, from H&R Block: http://www.hrblock.com/company/history/hist.html

Hood, J. (2006, February 26). There's no escaping taxes, but tax scams and outrages are another matter. Consumer Affairs, n.p.

NAMC. (2006). The U.S. accounting and tax preparation industry includes about 90,000 firms with combined annual revenue of $65 billion. Dublin: NAMC.

White, K. (2006, January 23). Online tax preparation may no longer be free. Deseret News, n.p.

Wire, B. (2007, August 30). H&R Block reports fiscal 2008 first quarter results. Retrieved August 30, 2007, from Business Wire: http://home.businesswire.com/portal/site/google/index.jsp?ndmViewId=news_view&newsId=20070830005297&newsLang=en

Note: Based on 2007 revenues; first quarter revenues account for nearly half of overall revenues, at $2.351 billion in the first fiscal quarter ending April 2007 (Wire, 2007).