November 16, 2013
Book Review: ‘The Firm’ by Duff McDonald
McKinsey remains the gold standard of consulting. What does it do to earn those hefty fee
Midway through “The Firm,” financial reporter Duff McDonald’s book about McKinsey & Co., the author recounts a hypothetical scenario once described to a new client by one of the consulting firm’s partners: “Let’s say a client asks us what time it is. . . . If you ask Booz Allen, their response will be ‘What time do you want it to be?’ If you ask A.D. Little . . . they will tell you ‘It’s 9:45:20, Greenwich Mean Time.’ But if you ask McKinsey, we will say ‘Why do you want to know? What decisions are you trying to make for which knowing the time would be helpful?’ “
Not a bad characterization of the way McKinsey thinks of itself and its approach to its work. The firm has been compared to the Jesuits and the U.S. Marines for its rigorous mind-set and disciplined work ethic. A ruthless “up or out” policy for new hires ensures that only those who do outstanding work survive; that’s one out of five.
There have been other books about this American icon, but “The Firm” is an up-to-date, full-blown history, told with wit and clarity, about a remarkable enterprise that has had a profound effect on the way businesses operate and has staffed corner offices and boardrooms around the world—but has also made its share of mistakes.
Mr. McDonald (right) nicely decodes the elusive mystique that McKinsey has so marketed over the years—the idea that it sees things in much better focus than its clients. Or, for that matter, its rivals. Some McKinsey partners have long sniffed that The Firm has no competition.
Not quite true. Boston Consulting Group and Bain & Co. have their own impressive accomplishments and distinctive toolboxes. Unlike McKinsey, Bain made inroads by representing only one client in an industry group, staying with that client right through the implementation of its proposals, and by making stock-price appreciation a top priority. Carving out its own niche, BCG focused on selling “products” like the “experience curve,” a way of demonstrating how economies of scale and innovation drive costs down over time. In the 1970s, both firms rattled McKinsey’s cage loudly. “BCG and Bain were the Apple to McKinsey’s Microsoft,” Mr. McDonald notes.
Whatever McKinsey is selling, it has certainly been able to get away with charging a teeth-chattering premium above what others do. In a 1989 competition with Booz Allen for a lucrative deal with a financial-services firm, Booz said it could take up to 4½ months to deliver its analysis, at a cost of about $675,000. McKinsey said it needed up to six months and would require $1.2 million. The low bidder didn’t win.
AT&T paid McKinsey $96 million for five years of hand-holding in the 1990s. Tanzania shelled out so much to McKinsey in the early 1970s to help plan its future that the fees became a line item in the country’s budget. Initially stunned by the proposal, Julius Nyerere, Tanzania’s president, eventually gave in: “If you offer peanuts, you get monkeys,” he said. Never mind that while McKinsey was cashing the checks, tyrant Nyerere was running the country into the ground.
But what exactly does McKinsey do to justify numbers like that? To oversimplify, it sends in a team of supersmart, driven young M.B.A.s to break down the stated problem—say, “we need to increase market share”—into key issues like product quality, sales practice and pricing. Then, after an intensive fact-gathering exercise, the team does its analysis, and constructs a list of actionable options, sometimes relying in part on what the firm has done for other clients with similar needs.
The proposed actions might be just what the client wanted to do to begin with—raise prices or cut costs—but McKinsey’s seal of approval, backed up by a heavily fact-based argument, gives management validation for whatever it wants to do: “de-layer” its management structure, lay off 10% of its workforce, close half its widget plants. To some McKinsey clients, that validation alone—helping to placate board members, shareholders and employees—is worth the hefty fee.
Another key to McKinsey’s success: 85% of the firm’s roughly $7 billion in annual revenues comes from repeat customers, with whom it has what McKinsey calls “transformational relationships.” In the 1990s, American Express had so many McKinsey teams at work over an extended period that the consultants were listed in the Amex phone book. “God, we were sucking off that teat for so long,” one McKinseyite is quoted saying.
Mr. McDonald is generally more critical here than he was in “Last Man Standing,” his 2009 book that came perilously close to bestowing sainthood upon James Dimon—he of J.P. Morgan Chase and a man whose halo and wings had to be recently recalled after that unpleasantness about a $6 billion rounding error in trading losses.
The author walks us through many McKinsey achievements. General Electric, for instance, hired the firm in 1968 to study its strategic planning. The recommendation was to transform the conglomerate’s 360 departments into 50 “strategic business units” and make each of them focus “outwardly” on external market forces rather just fret about the cost of paper clips. There is a strong argument that the reorganization enabled future CEO Jack Welch to accomplish all that he did later. And McKinsey effectively launched the consolidation of the banking industry when it walked Wells Fargo through its acquisition of Crocker bank in 1986.
But Mr. McDonald doesn’t flinch from examining McKinsey’s missteps, including its bad advice to General Motors in the 1980s, when the auto maker was reeling from Japanese competition. Instead of dealing with things that could directly address the threat—increasing productivity, using fewer parts in each car, improving quality—McKinsey focused on structure. It reorganized GM into units by type of vehicle (large, small, trucks) instead of by brand. The result was a lot of people-shuffling. No bump in output, efficiency or profits, just more money down the drain—up to $2 million a month in McKinsey fees.
“The Firm” offers a good dissection of the collapse of McKinsey’s most notorious client, Enron, vaporized by the company’s CEO (and McKinsey alumnus) Jeffrey Skilling, now a guest of the U.S. government. McKinsey emerged largely unscathed from that disaster but took a reputational hit a few years later, in 2010, after one of its directors, Anil Kumar, pleaded guilty to securities fraud in the Raj Rajaratnam insider-trading scandal. Even worse, the firm’s former managing director, the respected Rajat Gupta, was convicted of leaking secrets to Rajaratnam as a Goldman Sachs director.
All that is well known, but readers may not be familiar with a major speed bump from the firm’s early days. In 1935, founder James O. “Mac” McKinsey, an accountant by training, landed Marshall Field & Co. as a client. The retailer was awash in red ink and faced a big loan payment. McKinsey’s solution was for the company to shed a wholesale business and some textile mills, then slash costs.
Marshall Field’s directors liked the plan so much that they persuaded Mac McKinsey to come over and wield the ax himself. What he failed to anticipate was the human cost—to the 1,200 laid-off workers and those remaining who were dismayed to realize that management, as Mark Twain might say, “don’t give a dead rat” about them as people. McKinsey himself received death threats, became depressed and, in a weakened state, succumbed to pneumonia in 1937.
Known thereafter as the “McKinsey Purge,” the bloodbath set the precedent for many more “downsizings” to come. Even now, news that “McKinsey is coming” provokes a flurry of fear and apprehension. And the managers who retain McKinsey know it. Condé Nast hired the firm in 2009 in part to send a message that it was serious about cost cutting.
The man who molded McKinsey into what it resembles today wasn’t Mac McKinsey but Marvin Bower, a lawyer by training who wanted to use the law-firm model to make consulting into a “practice,” not a business like selling used cars. Consultants were to put client interests ahead of the firm’s.
As head of the firm in the 1950s, Bower insisted on recruiting only the top graduates from Harvard Business School and wanted his hires to radiate confidence. No bow ties or argyle socks, please. One hapless young recruit who wore the latter triggered a “proper sock wear” memo to the staff.
Today, although the firm can certainly offer nimble, sector-specific advice to a client needing help on a highly focused project, there is still what Mr. McDonald refers to as the “intellectual masturbation” of the “typical McKinsey schmooze fest.” He quotes a McKinsey alumnus, now the head of a financial-services firm, who fumes when McKinsey partners ask, “How are you feeling about progress?” What he really wants is someone to tell him “how to knock five basis points” off his cost base.
Mr. McDonald raises some concerns about how McKinsey will fare going forward. He wonders whether the firm has become too commercial and strayed too far from Bower’s original value system. And whether it’s now so big that it’s hard to manage and can no longer maintain the quality of its consultants or its work. No longer the friendly local banker that Bower wanted the firm to be regarded as, it is now more like an international banking conglomerate.
Time will tell whether these worries are justified and what impact they may have on the firm’s fate. McKinsey has always engaged in its own navel-gazing. But maybe it should just hire itself full-time to find out what it should do.
—Mr. Pinkerton is a former managing editor of Forbes and a former deputy managing editor of The Wall Street Journal.