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How McKinsey Got Greedy

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How McKinsey Got Greedy

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Dear patient readers, I had gotten most of the way through this post on how McKinsey fell from grace and scheduled it, uncompleted. It auto-launched due to my inattentiveness. But that did impel me to finish it for your delectation. So apologies for the confusion.

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Why has McKinesy, once the ne plus ultra of management consulting, become mired in scandal after scandal? It’s a sign of the times that cracks in McKinsey & Company’s teflon haven’t dented the consulting firm’s allure to clients. A partial list of recent scandals: repaying $74 million in fees on an illegal contract with the South African government to settle criminal charges; identifying key Twitter critics of the Saudi government, leading to their arrest; helping Purdue Pharma combat addiction concerns and focus on high-prescribing doctors so as to boost sales of OxyContin.

McKinsey has also been caught out repeatedly and significantly failing to report conflicts of interest to bankruptcy courts as required, including making recommendations to the court when its own in-house investment arm had a position in some of the securities. McKinsey paid a $15 million settlement to the US Trustee, the largest ever…and chump change to the global firm. And even though McKinsey lost some marquee African clients in the wake of its South Africa criminal charges, McKinsey has sailed on in the face of unflattering in-depth reports at the New York Times and the Financial Times.

Scandals like this aren’t typical of the consulting industry, unlike, say, abuses among big banks, like mortgage securitization frauds and market-rigging. McKinsey’s biggest competitors, Bain and BCG, haven’t had anything dimly resembling McKinsey’s level of well-deserved bad press. And the recent wave of dodgy dealings follows other signs of trouble, such as McKinsey’s deep involvement in Enron, which felled Arthur Andersen yet left McKinsey unscathed, and an insider trading scandal which led to the successful prosecution of the former firm managing director Rajat Gupta as well as a current partner, Anil Kumar.

An article in Current Affairs by an anonymous employee that attempts to explain the firm’s moral decline, McKinsey & Company: Capital’s Willing Executioners, while giving a feel for what it’s like to work for McKinsey now, misses the mark in key respects. The author, who naively thought he was joining the firm to make the world better, seems to feel the need to paint McKinsey, and thus what he was doing, in overly bold colors. He exaggerates McKinsey’s power, particularly historically, which badly skews the entire piece.

The real story is much simpler than the one he tells. McKinsey does not begin to have the clout the author attributes to it. It has done damage, not just as it did sometimes in the past, by doing crappy work and giving clients terrible recommendations, but also by not saying no to clients and studies that were clearly trouble in the making. As one colleague from my era put it: “I remember a time when acquisitions were as verboten as operating in dodgy countries.”

But why did the firm start embracing work it formerly would have turned down? The firm got greedy. And as we’ll explain, the immediate impetus was the rise in financialization that took hold the Reagan era. But it might have happened regardless, just on a slower timetable. As the aforementioned colleague observed, “I see it as simply the consequence of the problem of all organiziatons (including non-proifts such as Mayo). They have to grow or die and eventually they die of growth.”

The Current Affairs piece lacks historical perspective and treats things that are true now as if they were always true. As I’ll discuss in more detail below, McKinsey’s misconduct stems from a combination of factors: prevalent and open corruption in business and politics, which no doubt allowed some partners to rationalize questionable behavior; placing much greater emphasis on revenues and profits starting in the late 1980s, which appears to have intensified after I left; and weak governance, which means these bad tendencies weren’t checked. Remember, McKinsey’s main competitors aren’t all that different, yet they haven’t gotten themselves in anywhere near as much hot water.1

The piece makes too many sweeping statements and has a grandiose view of the firm’s influence. These two bits are all wet and typify how an otherwise insightful piece gets caught up in its own melodrama:

As missionaries for capital, it has helped spread the Good Word far and wide, making the world more productive and efficient as a result.

It has acted as a catalyst and accelerant to every trend in the world economy: firm consolidation, the rise of advertising, runaway executive compensation, globalization, automation, and corporate restructuring and strategy.

The first statement is just unhinged. The writer appears to be confusing McKinsey with Milton Friedman, who was the most effective proselytizer for the internally inconsistent “free markets” ideology. Friedman not only wrote many op-eds, but did mass promotion of his strong-form libertarian ideology, most notably, his best-seller “Free to Choose” and follow-on ten part TV series.

This grandiosity about McKinsey seems to reflect the propensity of the top 10% to hype any activity that could be depicted as an accomplishment, as Thomas Frank described at length in Listen, Liberal. The author has swallowed the Kool-Aid of McKinsey’s sense of self importance. He wrote:

I came into my job as a McKinsey consultant hoping to change the world from the inside, believing that the best way to make progress is through influencing those who control the levers of power.

Having now found out that McKinsey has become too willing to do whatever the client wants in the name of the growth and profit, he is still wedded to the idea that McKinsey is changing the world, just not in a particularly good direction. You can still believe the firm is guilty of serious ethical lapses and has done harm without leaping to a sweeping and inaccurate indictment, that the firm is responsible for every bad trend that ever came out of the business world. That’s simply false because no individual or company has anything approaching that level of sway. And as we’ll discuss later, there are many important business developments that are ethically dodgy or hurt society at large to the benefit of managerial classes, where McKinsey was at best a marginal player.

I’m not defending McKinsey. I left in 1987 due to its deficient governance, with the Current Affairs author confirms in passing but fails to give sufficient weight in his diatribe.

The real issue is that the author appears to have grown up with and never questioned the idea that markets and capitalism are virtuous, or at least not harmful, and had his awakening as to how the world really works at McKinsey. I hate sounding mean-spirited, but it does not take much in the way of powers of observation to see that commerce is often Not Nice, even if you only read orthodox outlets like the Wall Street Journal. Did he miss that, for instance, payday loans are predatory and that some big banks (as in McKinsey client) are in that business? How about mandatory arbitration for just about every consumer contract, like cell phones and credit cards? The arbitration process is stacked against the consumer and the agreements bar consumers from going to court. That prevents class action lawyers from combatting small-dollar, large scale grifting and allows these companies to illegitimately fatten their bottom lines.

In other words, it’s hard to comprehend how when he was dopey enough to think that McKinsey was a “force for good”. No one in my MBA graduating class (1981) would have seen any high prestige, high pay job as having as a significant do gooderism component.

It appears that the prevalence of helicopter parenting and the fixation on making sure children do well means that children of the elite have been intellectually inoculated against the idea that doing well economically, particularly in our era of widespread corruption, is seldom consistent with good conduct. Our Clive wrote a classic essay on how simply having middle class aspirations now typically requires participating in bad behavior:

I’ve spent almost 30 years working in the FIRE (Finance, Insurance, Real Estate) sector, my entire adult life. When I first started, it was viewed as a most suitable career choice for middle class not particularly aspirational sorts who wanted security, respectability and a recognisable position in the community. It was never supposed to be a passport to significant wealth or even much more than very modest wealth. It was certainly never supposed to be anything which oppressed or harmed anyone.

By the early 1990’s the rot, which had started to set in during the mid-1980’s, had begun to accelerate…

Increasingly, if you want to get and hang on to a middle class job, that job will involve dishonesty or exploitation of others in some way…The same disproportionate growth can be seen in financialised healthcare and finacialised education.

Similarly, in my youth, there was enough concern about reputation and bad PR that it was assumed that these employers did harm only at the margin and/or by accident.

We’ll quickly dismiss another wildly overstated claim the author makes, that McKinsey was a missionary for capitalism. McKinsey’s client base, until its recent practice of seeking out government clients, was the C-suite of companies big enough to swallow the firm’s hefty fees. Pray tell how seeking assignments from the Fortune 500 and similar sized private companies could possibly be confused with evangelizing for private enterprise. If you’ve gotten way up on the greasy corporate pole, you can hardly be an apostate.

Even McKinsey’s prolific publishing machine’s most popular offerings, In Search of Excellence, which helped McKinsey pull ahead of Bain, BCG, and Booz Allen in the 1980s, and Valuation: Measuring and Managing the Value of Companies, clearly target businessmen, not the general public.

How McKinsey Changed for the Worse

At danger of oversimplifying, McKinsey, and the modern consulting industry, was built by Marvin Bower, a Harvard Law School and Business School graduate who worked for a few years at Jones Day before James McKinsey recruited him to oversee a newly-acquired New York office. Bower managed to resurrect the New York operation after McKinsey died, and to keep the use of the McKinsey name.

Bower can claim to have professionalized consulting. Before then, business consultants were most often Taylorite time and motion study experts. James McKinsey, an accounting professor who published two seminal texts on business accounting, aspired to give broader business advice but his practice was still based on his accounting expertise.

Bower took his model for a professional firm from law firms. He wanted McKinsey consultants to be seen as senior members of their business community. Like law firms, McKinsey didn’t solicit assignments; even in my day, they responded to inquiries which they got via marketing. A device in the firm’s early days was to host dinners where local notables would mix with McKinsey consultants, with a short presentation on an interesting business issue to help demonstrate the firm’s intellectual sheen. The firm also did pro-bono work for important not-for-profits. McKinsey later published a “McKinsey Quarterly” for clients and prospects and built a substantial publishing operation, with employees helping partners conduct research and edit books, and on occasion ghost writing them.2

Bower also focused on the idea that the consulting advice needed to have an impact on client. Bower would often sell studies by telling clients that if he sent a bill and they though the work wasn’t worth it, they shouldn’t pay anything.

The anonymous writer recounts as an offense that, in 2016, idealistic overwhelmingly Hillary-voting young McKinsey consultants were subject to the indignity of being expected to continue to work for a Federal agency after the “direction of our client…had markedly but predictably shifted” under Trump.

Mind you, that does not mean that McKinsey, despite its carefully cultivated shiny image, hasn’t revealed itself to have lost its moral compass (or more accurately, as we’ll explain, have such weak governance that it can’t supervise and rein in reckless partners) and given some fabulously bad advice.

The real story is simpler than the Current Affairs piece would have you believe: over time, McKinsey got greedy, and it even had a strategic rationalization: needing to respond to the famed “war for talent”.

But to make sense of what happened to McKinsey, you need to go back to its earlier days.

Keeping Up With the Joneses, Um, Wall Street

I joined McKinsey the downwardly-mobile way, by having left Goldman Sachs in 1983. I didn’t take a pay cut but there was clearly more upside to staying on Wall Street.

As the 1980s progressed, investment bank profits soared. McKinsey, which saw itself as an elite recruiter, in a blow to its institutional self-esteem, found it was losing out on campuses.

In the early 1980s, the top consulting firms, McKinsey, Bain, and BCG, offered higher first year compensation to new MBAs than the top investment banks; investment bank remuneration typically pulled ahead after the second year. The consulting firms felt they had as good a success rate with landing top graduates as the most tony Wall Street firms, and they also felt they were looking for a somewhat different type: more cerebral, more interested in influence and stature than maximizing their pay. And at Goldman, partners retained most of their wealth in the firm; the joke was that Goldman partners lived poor and died rich.

But that all changed. Not only was McKinsey having fewer of its MBA offers accepted, with it losing out not to other consulting firms but to finance, but it was also having more and more well-regarded engagement managers poached by a booming Wall Street.3

I had determined I was not going to stay at McKinsey as a result of a seeing a partner on a project in the London office engage in behavior Goldman never would have tolerated. I didn’t want to become a partner in a firm with partners like that. But unlike my departure from Goldman, I wasn’t about to leave just to leave, I wanted to find the right time.

Two years later, I managed a very splashy study, the one ironically when McKinsey recommended that its client Sumitomo Bank invest in Goldman. I was far enough away from the window where I would have been up for consideration for partner that it would be clear I was leaving at a high point and not because I was worried about not making partner. So I marched in the day after my pension vested to announce I was leaving.

Leaving the firm then was one of its biggest perks. McKinsey alumni are its biggest source of new business, so it wanted them to leave happy and gave departing staffers ample time to search. As long as you were at least 50% billed out, the firm was very tolerant of leisurely searches.4

During my exit period, I was put on an odd and revealing assignment.

The election for the managing partner of the firm was coming up in a few months. Three of the top contenders, Carter Bales (a big producer in the New York office, whose clients were mainly media and communications companies, but he had also snagged Merrill Lynch), Fred Gluck (who won the contest; Fred was an electrical engineer whose clients were largely industrial concerns) and Don Waite (then head of the New York office and a member of the banking practice) had apparently decided they needed for the good of the firm to agree on what the firms’ response to the loss of talent to Wall Street should be. Purnendu Chatterjee, a principal who was also leaving the firm (he landed at Soros Fund Management) and I were assigned as their minions.

It was clear the three of them had never been in a room together with no one in charge; there was quite a lot of sparring. It was also clear that they knew shockingly little about Wall Street economics. I decided to write them a paper on the main profit centers of major investment banks.

What came out of this was a decision to modify the selling pitch to new MBAs and to considerably raise the pay level of newly-minted principals, which of course would entail increasing the compensation of all principals.

To do that, McKinsey could either have the tenured partners (the “directors,” who were usually anointed after twelve years to the firm) cut their compensation level, or start charging clients more. They started charing clients more, with no real change in the work product. So McKinsey was explicitly starting to run on brand fumes.

Most observers attribute McKinsey’s mercenary turn to Rajat Gupta, the managing director after Fred Gluck, who served two four year terms. But just as deregulation started under Carter and then became doctrine under Reagan, so to did McKinsey commit itself to paying its top people more without taking any steps to improve what MBAs would call their value proposition. Gupta clearly took the firm much further in this direction, for instance, by increasing leverage across the firm (the ratio of non-partners to partner) and by having the firm engage in selling.

But even so, McKinsey was losing the war on talent. It was hiring from the top 30% of elite MBA programs, as opposed to from the top 10%. It started recruiting non-traditional hires, like scientists, who even though very smart, would still need training to hew to the oxymoron of thinking like an MBA.

Starting in the 1990s, I’d hear a lot of complaints from search firms about McKinsey. It was always the same issues: that the studies were expensive and too often not very good, and that the firm was very pushy. The prototypical scene: McKinsey calls on corporate exec. Partners give pitch about what they think the company needs and how McKinsey can help. Exec says thank you but we think we have that handled. McKinsey tells exec he’s wrong and he really does need McKinsey.

McKinsey’s Poor Governance

This part of the Current Affairs piece is spot on:

The best explanation is structural. McKinsey’s governing model, when compared to other firms of its size and age, is anarchy. The Managing Director (CEO equivalent) has surprisingly little ability to control who the firm serves (said a partner about the Managing Director, “you are definitely not in charge”). McKinsey remains the world’s largest partnership, and partners rule. The general rule of thumb is that if a partner can staff a team, the firm will do the work. If associates don’t want to work with a tobacco company or a defense contractor, they don’t have to. As a result, only a small portion of the consultants need to buy into a client relationship for McKinsey to do work with them. What this means in practice is that the firm doesn’t work with North Korea, but that’s about it.

McKinsey has grown to the point that it is taking on work that prior incarnations of the firm would have turned down due to the political risk involved. To keep lavishing its partners with multimillion dollar annual compensation packages, the firm needs to sustain double digits year over year growth. In a world that’s been thoroughly McKinseyfied, this requires a loosening of standards.

The firm does have a few rules: unlike the Lehman Brothers of the 1980s, different partners don’t compete for the business of the same client. And at least in my day, the person in charge of staffing studies did have a lot of clout and took consultants’ development needs and preferences into consideration when deciding who would work on what.

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1 Bain’s near death experience as a result of the Guiness scandal likely has a lasting effect, but I know virtually nothing about how Bain and BCG manage themselves.

2 I know of one case where a book that was perceived to be in trouble was almost entirely re-written by a colleague who was not given an author credit; there were reports of other books getting substantial help from the editing team.

3 Engagement managers and senior engagement managers (three to six years of tenure at the firm) are the working oars. The window for becoming a “principal,” a non-tenured partner, was five and a half to seven years at the firm.

4 I personally know of one associate, who was asked to leave as opposed to chose to leave, who took eighteen months before the firm cleared its throat and told him to hurry up.

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