The Firm: The Story of McKinsey and Its Secret Influence on American Business

by Duff McDonald

  It seems commonsensical, but McKinsey’s new way of looking at the use of the budgeting process sparked nothing short of a revolution. “No other mechanism of management of similar scope and complexity has ever been introduced so rapidly,” wrote one commentator just ten years later. “It is estimated that 80 percent of budgets installed in industry have been put in since 1922.”21

  Up to that point, budgeting was a one-way exercise: Accountants added up all of a firm’s expenses and then tossed in a sales projection almost as an afterthought. In McKinsey’s view, companies should start by developing their business plan, figure out how to achieve it, and then estimate the costs of doing so. In this new context, budgeting wasn’t just a ledger activity; it could also be used to identify excellence in performance (i.e., those who outperform their budget), to spot weaknesses (those who underperform), and to take corrective action. “[While] there are many who do not yet plan scientifically . . . ,” he wrote, “there are few who will deny the merits of the system.”

  Two subsequent books fleshed out McKinsey’s ideas: 1924’s Managerial Accounting and Business Administration. The former taught students how accounting data could be used to solve business problems. Using the data of traditional recordkeeping, he suggested the possibility for much greater control over a company’s destiny, including the establishment of standard procedures (how things should be done and to whom information should be reported), financial standards (ways to judge operating efficiency), and operating standards (including nonfinancial measures, such as quality). To today’s business student, this kind of comprehensiveness seems obvious. But at the time, the idea of planning, directing, controlling, and improving decision making by means of regular and rigorous reporting of company results was novel. The latter book contained the seeds of McKinsey’s General Survey Outline—a thirty-page system for understanding a company in its entirety, from finances to organization to competitive positioning. It became part of his consultants’ toolkit sometime in the early 1930s.

  It is hard to overestimate the impact of the General Survey Outline (GSO). It served as the foundation of his approach to understanding a company and provided novice consultants with a clear road map to do so themselves. The survey also shaped consultants’ thinking: The emphasis in the GSO was more on why managers did things, as opposed to how they did them. Using the GSO, consultants started every engagement by thinking of the outlook for the industry of their client, the place of the client in the industry, the effectiveness of management, the state of its finances, and favorable or unfavorable factors that might affect the future of the firm. No detail was too small to take note of, whether it was a study of all firm policies—including sales, production, purchasing, financial, and personnel—or an analysis of whether the layout of equipment in a company’s plant provided for the most efficient flow of the production operations. By the time the young consultant had completed the survey for his client, he knew the company and its business cold.

  “You can see McKinsey’s intellectual development,” says John Neukom, who worked at McKinsey from 1934 to the early 1970s and wrote a brief memoir of his time at the firm. “He had lost interest in the details of accounting. By the time I arrived, he had lost interest in the budgetary procedure and was now excited and interested in analyzing companies and seeing how companies worked. He was clearly diagnosing the total problems of the company.”22 In a 1925 speech at a conference for financial executives in New York, McKinsey offered the kind of pointed insight for which he is remembered: “Usually, I find that the executive who says he does not believe in an organization chart does not want to prepare one because he does not wish other people to know that he had not yet thought through his organization properly. For the same reason many men are opposed to budgets. They are unwilling for anyone to see how little they have thought about what they are going to do in future periods.”

  Armed with that insight—and the general philosophy that management can shape a company’s destiny—he decided to set up shop and sell it.

  Bastards Require No Diplomacy

  In the mid-1920s, McKinsey began doing business under the banner of James O. McKinsey and Company, Accountants and Management Engineers, the progenitor of the modern-day McKinsey & Company. Strangely for a company that prides itself on getting the details right, the actual date of its founding is unknown—a firm training manual from 1937 suggests 1924,23 while John Neukom’s memoir says 1925.24 Whichever it was, McKinsey’s timing was excellent. The economy was booming, and the need for consulting services was seemingly endless.

  It is worth noting that the word “consultant” was not in the name of his firm. Rather, the term “management engineers” reflected the prevailing ethos of the time: that science held the answers to most serious questions, and even human commerce could profit from the rigors of this kind of data-driven analysis. McKinsey’s standard working pads have always been crosshatched graph paper, another nod to engineering. The fact that McKinsey himself employed no actual engineers was beside the point.

  Intellectual underpinnings aside, the firm’s real-world roots were in red meat. McKinsey’s first client was Armour & Company, one of the country’s largest meatpackers. The treasurer of Armour had read Budgetary Control and wanted McKinsey to help rethink the meatpacker’s approach to budgeting and planning.

  The first partner McKinsey brought on board was A. Tom Kearney, who had been director of research at Swift & Company, another Chicago meatpacker. Kearney was a warmer, more congenial complement to McKinsey’s formal and pointed demeanor. Another early partner was William Hemphill, the same treasurer of Armour who had hired McKinsey in the first place.

  McKinsey continued to teach at the University of Chicago for a time, but he eventually switched full-time to the firm. One reason he seems to have juggled so many responsibilities is that he didn’t waste time with niceties at the office. In Hal Higdon’s 1970 history of consulting, The Business Healers, one associate recalled him saying: “I have to be diplomatic with our clients. But I don’t have to be diplomatic with you bastards.”25 (Marvin Bower later modeled his own approach to constructive criticism after McKinsey’s tough love approach.)

  McKinsey was blunt, but he was also a quick and agile thinker. He once diagnosed a client’s problems just by looking at the company’s letterhead. A Midwestern maker of air conditioners had stationery that announced “Industrial Air Conditioning Installations—Coast to Coast from Canada to Mexico.” In an era before salespeople traveled by airline, McKinsey observed that travel expenses were probably eating up the majority of the company’s profits and that employees should confine themselves to a radius of five hundred miles around Chicago. He was right.26

  Even the Depression couldn’t stop the growth of the firm. By 1930, McKinsey’s professional staff totaled fifteen. In 1931 he drafted the General Survey Outline, and the next year he opened a New York outpost in the offices of a defunct investment house at 52 Wall Street—six offices with a reception area. The New York–based consultants busied themselves working not only for local industrial companies but also for investment banks like Kuhn, Loeb & Co. In 1934, the Chicago office moved to the forty-first floor of the new Field Building on 135 South LaSalle. By the mid-1930s, McKinsey’s partners were charging $100 a day for their services—a giant figure, though nothing compared with the founder himself, who was billing five times that, the highest rate for a consultant in the country.

  Taking the Pianist Out of the Brothel

  Before James McKinsey could be successful, he had to clean up the reputation of management as a concept. In The Management Myth, philosophy-student-turned-consultant-turned-author Matthew Stewart’s highly critical look at the history of management thinking, the author argued that it was flawed from the get-go. And he pinned original sin on Frederick Winslow Taylor, the father of “scientific management.”

  Taylor’s famous time-and-motion studies used stopwatch analyses of manual labor with the goal of shaving seconds off rote, repeate
d activities, thereby enhancing productivity. There was, Taylor argued, just “one best way” to produce anything, and a manager armed with Taylor’s tools could identify it. In Stewart’s account, Taylor was a pseudoscientific proselytizer who promoted the spurious notion that “laborers are bodies without minds, managers are minds without bodies.”27

  But Taylor’s ideas about improving the efficiency of labor were very popular and influential in his day; in 1911 he published Principles of Scientific Management, an instant hit that was eventually translated into eight languages. In 1914 he attracted 16,000 people to a New York speech on his theories.28 Edwin Gay, who opened the Harvard Business School, was a Taylor disciple. Henry Ford’s line production system was a pure distillation of Taylor’s thinking. Even Lenin and Trotsky embraced him, envisioning Taylorism as the solution to Russia’s problems.29

  As Taylor rocketed to fame, countless firms sprang up to cash in on similar technical-sounding solutions to business problems. Most have vanished, including Harrington Emerson and Bacon & Davis, though some live on more than a century later: The consultancy Arthur D. Little was founded in 1886. ADL’s engineers earned early acclaim for actually making a silk purse from a sow’s ear in 1921 by spinning gelatin from the sow’s ears into artificial silk. Edwin Booz founded his eponymous firm—later Booz Allen Hamilton—in 1914. There was also Charles E. Bedaux, who developed a system called “payment by results” and founded his Bedaux Company in 1919. He was one of the first consultants to expand overseas, planting a flag in Britain, Germany, and France in the 1920s. By 1930 more than a thousand companies were using Bedaux consultants, including Eastman Kodak, DuPont, and General Electric.30

  The fact that just about anyone could call himself a consultant meant that shysters and scam artists abounded, tarnishing the entire field’s reputation. E. N. B. Mitton, a mining engineer who joined the British office of Bedaux in the 1930s, joked at the time that he would rather tell his mother that he was working “as a pianist in the local brothel” than admit that he had joined a consulting firm.31

  From the very beginning, James McKinsey went to great lengths to distinguish his firm from its less savory predecessors—he and his partners had multiple university degrees and strong connections to the establishment. And just as McKinsey flipped accounting on its head, he and his contemporaries likewise turned Taylorism on its head. Instead of focusing on line workers at the bottom of the organizational chart, they zeroed in on the growing white-collar bureaucracy and top managers.32 But Taylor’s pretensions to scientific rigor were very much part of McKinsey’s sales pitch too. By co-opting the rhetoric of engineering, wrote Harvard professor Rakesh Khurana, McKinsey grounded managerial authority in the realm of the “disinterested expert”—instead of just one side in an increasingly violent struggle between capital and labor—and helped provide justification for management’s ultimate dominance in the relationship.33

  As the managerial class grew in size, so too did the demand for consultants. Between 1930 and 1940—while the country was in the grip of the Depression—the number of consulting firms grew from 100 to 400. By 1950 there were more than 1,000 such firms in existence.34 This kind of growth—far in excess of the overall economy—makes sense for an emerging profession. What’s remarkable is that the consulting industry outgrew the economy for pretty much the rest of the twentieth century too.

  Critics of the field have long lamented what they consider the fundamental question at the heart of consulting: whether its contributions to corporate growth and innovation justify its own growing piece of the economic pie. Stewart’s argument is that it doesn’t actually matter whether Taylor and his immediate descendants provided genuine value. Consultants saw demand and sought to satisfy it—what else is there to business?

  “Their specialty, at the end of the day, [was] not the management of business, but the business of management,” wrote Stewart. “[And] as in any business, what separates the winners from the also-rans isn’t independently verifiable expertise; it is the ability to move product.”35 Over the next four decades, no firm moved this product as well as McKinsey & Company.

  The First Ex-Consultant

  Given that the early years of the James O. McKinsey & Company coincided with the Depression, it makes sense that the firm built its original reputation helping clients deal with financial difficulties. A good portion of the work was pure restructuring and help in analyzing possible merger and takeover scenarios in the hope of finding efficiencies of scale or relieving competitive pricing pressure. But the firm’s bread and butter was finding more effective—and profitable—organizational structures, and a lot of the demand for that came from bankers. Because banks were prohibited from selling their own consulting services, they brought in firms like McKinsey to analyze potential deals, like a proposed merger in 1934 of corporate rivals Republic Steel and Corrigan-McKinney.

  The firm did so much work for bankers in the 1930s that the General Survey Outline, James McKinsey’s proprietary model for analyzing companies, was colloquially termed the Bankers’ Survey. But the firm made inroads in other industries too, particularly in steel. Client work took the consultants from coast to coast: John Neukom wrote in his memoir that he spent 179 nights away from home in 1936, covering 31,000 miles, 33 cities, and 112 Pullman sleeper cars.36 McKinsey himself became chairman of the board of the American Management Association that same year.

  James McKinsey’s connections fed the firm’s business. He claimed to have taken “every important banker in Chicago or New York to lunch,” with the result that “nearly every one at one time or another has given me work.”37 But it wasn’t long before the firm found out how to survive without him.

  James McKinsey’s career as a consultant came to an end in 1935, when McKinsey was retained by Marshall Field & Company, the largest department store in the Midwest. The retailer was in critical condition; it had lost $12 million over the previous five years and was faced with an impending $18 million loan repayment. McKinsey attacked the problem with overwhelming force, dispatching a team of 12 consultants to interview 752 retailers in 32 states, as well as paying visits to factories and wholesale outlets.

  McKinsey’s conclusion was that Marshall Field should specialize: unload its wholesale business, sell its 18 textile mills, focus entirely on retail, and cut, cut, cut. The board members of Marshall Field not only loved this idea but also asked McKinsey if he would carry it out. While many consultants would recoil at such a notion, McKinsey was intrigued—and in October 1935, he accepted the post of chairman and chief executive of Marshall Field.

  Over the years, numerous consultants have left the field because they preferred to “do, not tell.” As McKinsey himself found out, it’s harder than it sounds. The cost-cutting measures that McKinsey had recommended were brutal to implement. In what came to be known as McKinsey’s Purge, more than 1,200 employees of Marshall Field were let go,38 and though the moves restored the retailer to solid financial footing—it survived until its acquisition by Macy’s in 2005—management lost the hearts and minds of its employees.

  For several years, the retailer grappled with a disenchanted workforce that had suddenly woken up to the fact that their corporate benefactors didn’t actually care about them beyond their ability to punch a clock. The process revealed a flaw that critics continue to see in a preponderance of consultants: While long on ability to intellectualize their way out of a business situation, they often come up short on the human factor. It’s why words like “restructure,” “downsize,” and “rationalize” have found their way into the modern business lexicon, all elegant euphemisms for laying people off. Management consultants may bring value to a company’s bottom line, or to its executives’ bank accounts, but they are rarely accused of adding value to the life of the rank and file.

  The job took a serious toll on McKinsey himself. Contending with the day-to-day implications of his harsh prescriptions, he became depressed and physically run down. “Never in my whole life before did I
know how much more difficult it is to make business decisions myself than merely advising others what to do,” he famously told a colleague—a stinging indictment of the nascent field he had helped found.39 Not only that, but the effects of the Depression were confounding the problems at Marshall Field. McKinsey soon found himself cutting whole divisions, retiring people early, and firing veteran employees.40 His son Robert later recalled his father receiving between ten and twenty letters threatening his life.41

  A Temporary Alliance

  While off at Marshall Field, James McKinsey did not abandon his own firm. He was far too controlling for that. In the same month he started his career as a retail executive, he orchestrated the merger of McKinsey & Company with Scovell, Wellington & Company, a rival accountancy/consulting outfit founded in 1910. The deal resulted in a company with two arms—the consulting outfit McKinsey, Wellington & Company and the accounting concern Scovell, Wellington & Company. The firms were supposed to work in close concert. At the time, in 1936, McKinsey, Wellington had twenty-two professionals in Chicago, seventeen in New York, and five in Boston.