Professional services firms (e.g., consultants, accounting firms, or advertising agencies) generate and sell business solutions to their customers. In doing so, they can leverage the cumulative experience gained from serving their customer base to either reduce their variable costs or increase the quality of their products/services. In other words, their "production technology" exhibits some form of increasing returns to scale. Growth and globalization, coupled with recent advances in information technology, have led many of these firms to introduce sophisticated knowledge management (KM) systems in order to create sustainable competitive advantage. In this paper, the authors analyze how KM is likely to affect competition among such professional services firms. In particular, they first explore what type (supply-side versus demand-side) of economies of scale are likely to be exploited in KM systems. In the former case, KM's role is to reduce the operating costs of the firm, while in the latter case, its role is to create added value to customers by significantly increasing product quality. Second, the authors analyze the competitive dynamics and market structure that emerge as a result of firms competing with KM systems. The results shed light on the current literature exploring the deployment of KM systems by suggesting that in a competitive setting, when firms' ability to leverage their customer base is high, KM should lead to quality improvement rather than cost reductions. In a dynamic setting, it is also shown that when firms use their KM system to improve product quality, higher ability to leverage the customer base may actually hurt profits and lead to industry shakeout. Beyond normative insights, the results also support a number of recent market trends in management consulting, including the increased emphasis on knowledge-creating activities in modern KM systems, the wave of mergers between consulting firms, and the recent emergence of "retail consulting" services.
