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

by Duff McDonald

  Likewise, women made slow progress up the ranks, due to both internal and external factors. “I remember working for a prominent CEO at the time,” said current McKinsey director Nancy Killefer. “I was pregnant with my first child, and I had to explain to him that I wasn’t disabled, I was just pregnant.”10 Four years after hiring its first female associate, the firm put a woman in charge of a study for the first time: in 1968 Mary Falvey headed an engagement for the Insurance Company of North America, a predecessor to CIGNA.

  Not long after taking office, Walton told a New York Times reporter questioning the firm’s lack of diversity that he, Walton, was evidence of diversity: a Roman Catholic heading a firm that, to that juncture, had been a Protestant stronghold. The company could even count several Jews among its ranks.

  The Phone Stops Ringing

  McKinsey’s foreign strategy was modeled on its British experience. It seeded the new enterprise with proven American managers and then tried, over time, to develop a consulting staff of local nationality. By 1969, of the seventy-six consultants in London, fifty-six were British. (Thirteen were American, and eight from elsewhere.) The American presence helped establish and maintain the important one-firm ethos, and the gradual shift to local talent ensured that the firm could relate culturally to its clients, while also providing a buffer against any flare-ups of anti-Americanism.

  The problem was that the firm was no longer able to find new clients in huge, critical markets like London. McKinsey was a victim of economic woes but also of its own success: It had successfully reorganized Europe. “Somewhere around 1970, the phone stopped ringing,”11 said London office manager Hugh Parker.

  Christopher McKenna has pointed out that developments in England paralleled those in the United States: Once the decentralization business was done, the firm needed government work to pick up the slack. But that came with major drawbacks. Executives at private companies have occasionally tried to publicly pin their problems on their consultants, but not often, in large part because it might raise the issue of their own competence. Politicians face no such constraints. Savvy cabinet ministers in England love shifting blame to consultants, especially when they have to lay off government workers.

  What’s more, the firm was facing up to the fact that some high-profile clients were less than enamored with the work McKinsey had done for them. The firm had been brought into Volkswagen in Germany in 1968 by CEO Kurt Lotz to help with organization and marketing issues, including helping Lotz devise a successor for the “Bug.” But when Ernst Leiding succeeded Lotz in 1971, he fired McKinsey and disregarded all its work to that point.12 Other German manufacturing firms were also abandoning the M-form structure and reverting to earlier organizational forms because McKinsey’s one-size-fits-all model of decentralization had proven more problematic due to a number of local factors, including the role of the banks in corporate affairs, concentrated shareholders, and the country’s dual system of corporate boards—one of which represented shareholders and the other management.13, 14 The sheen from the 1950s and 1960s had faded. When Parker stepped down as London office manager in 1973, no one wanted the job. Jan van den Berg finally filled the vacant position two years later.

  By 1972 it was clear that Walton had abjectly failed to restart the McKinsey engine: In fiscal 1972, revenues fell for the first time in a decade. Both the volume of work and the profitability of that work were sagging. What’s more, it was getting more difficult to corral the firm’s far-flung consultants and focus them on common goals. Whereas the Bower era had been marked by centralized power, the Walton era was defined by the opposite. Power migrated to new places. In the mid-1960s, the managers of the Amsterdam, Dusseldorf, London, and Paris offices had become known as the “barons”—a powerful group that wielded growing influence, from hiring to staffing to a tendency to vote as a bloc. Walton’s tenure was described as “weak king, strong baron.”15

  Remarkably, though, the firm was still able to summon the strength to turn down work when it was obvious that it couldn’t meet Bower’s mandate of having a true impact on a client. One client in the late 1960s was the Railway Express Agency, a national monopoly set up by the U.S. government in 1917 that functioned much like UPS today, except via rail. One of the REA’s predecessor companies was the railway express division of Wells Fargo. When McKinsey consultants visited some storage facilities in New York City to see what the REA had been paying to store over the decades, they discovered about thirty roll-top desks and a couple of stagecoaches. Rod Carnegie, the director in charge of the engagement, resigned immediately. “I remember what his exact words were,” recalled former consultant Logan Cheek. “He said, ‘I lack faith in the client’s ability to execute.’ ”16 (Carnegie replied that the finding of the relics in the warehouse wasn’t the reason for resigning the engagement, but that it certainly was an indication of management’s likely inability to “respond to the modern world.”)17

  Having Their Lunch Eaten

  If McKinsey was stalling in the early 1970s, Bruce Henderson’s Boston Consulting Group was on a roll. In addition to his four-box matrix, Henderson had recently added a second weapon to his arsenal: the experience curve. Its purpose was to help clients see how costs go down systematically along with experience and market share. For each doubling of experience, the curve suggested, total costs declined by 20 to 30 percent due economies of scale and innovation. This was not rocket science—Henry Ford had long before proven that volume begets cost savings—but a generation of American managers latched on to BCG’s insights for dear life.

  Some clients were surely attracted by the eye candy: the charts, graphs, lists, and matrices. And while the idea of strategizing wasn’t even new—there were talented managers who had been “strategizing” for decades—it turned out that most managers couldn’t name their top customer across business units, couldn’t say how profitable that customer was, and couldn’t identify which division was eating more capital than it was creating. Organization Man had been asleep at the wheel.

  McKinsey had never imagined that its sophisticated clients could be sold “products” such as the growth-share matrix and the experience curve. Under Bower’s lead, the firm had deliberately avoided flavor-of-the-month ideas, thinking that its clientele wanted smart people, not smartly packaged ideas. It was dead wrong about that. Its clients apparently wanted both.

  Black & Decker was a typical BCG client of the time, wrote Walter Kiechel in The Lords of Strategy. By using the tools of the experience curve—both analyzing and predicting costs—the consumer product maker took its circular saw business from 50,000 units to 600,000 units, a result of pushing its retail pricing down from $35.00 or so to $19.95. Although the iconic brand at first had trouble with its distributors when it suggested slashing prices, it quickly won converts when it used the curve to show how rapidly increasing volumes negated any margin loss when a market leader used its power to take market share.18

  The appeal of BCG was in the tangibility of its advice. It was not a process or an intellectual exercise. “While McKinsey was selling its own innate brilliance, BCG was selling products and selling lots of them,”19 said business author Stuart Crainer. Henderson took a direct shot at McKinsey when he told a reporter that “good strategy must be based primarily on logic, not . . . on experience derived from intuition.”20

  McKinsey had been through lean times before. But now the firm had to ask itself: Was this our own fault? The Boston Consulting Group had seen the end of the organizational consulting boom coming and had adjusted accordingly by inventing the business of strategy consulting with its growth-share matrix. McKinsey had nothing to counter with, and by the late 1960s, the firm’s client share of the top fifty industrial companies was declining. In 1969 BCG outrecruited McKinsey at Harvard Business School. “[BCG] hurt us by outrecruiting us, and for a while we weren’t even in the contest,” one insider told BusinessWeek.21

  After the oil crisis, many corporations concluded that long-term planning was me
aningless and that BCG had the antidote—a cold, hard look at the present state of affairs. Pretty much every consulting firm abandoned McKinsey’s expansive approach and followed BCG’s lead. Boston Consulting Group spawned Bain & Company and Braxton Associates, as well as Strategic Planning Associates, Kaiser Associates, and Marakon Associates. Corporate executives had always relied on the experience of the McKinsey crowd. Now they had a second option: the ideas of the BCG retinue. McKinsey had its Quarterly; BCG began sending out Perspectives, a less substantive but more compelling broadside that didn’t feel like homework. BCG and Bain were the Apple to McKinsey’s Microsoft.

  McKinsey even found itself in the wrong town. In the early 1970s, New York City was falling apart and approaching the nadir of its national popularity. Boston, by contrast, was Silicon Valley’s antecedent, a cleaner, safer, and more humane place to start one’s career as a young consultant. Competition for recruiting Harvard’s best and brightest became a multifaceted argument, not the least factor in which was quality of life. New York was fit for the likes of Lew Ranieri, the Salomon Brothers hustler who sold real estate bonds like a used car salesman. If you were refined, Boston was your town.

  Bill Bain bolted BCG in 1973. He made two decisions that distinguished his new consulting firm, Bain & Company, from McKinsey and BCG. First, he would work for only one company in an industry, but only if that company agreed to a long-term relationship. Second, he and his colleagues argued that the quality of its consulting boosted the share price of its clients. While this was a refreshing departure from McKinsey’s long-stated claim that it was impossible to measure the consultants’ impact, it took credit for things over which consultants had no influence. On the other hand, Bain was putting real skin in the game.

  When the firm established Bain Capital in 1984—headed by Mitt Romney—at least a portion of its investment dollars were targeted for investment in clients of Bain & Company. For Bain Capital, share price was a true measure of success, and so the claim that stock appreciation was a good measure of success was arguably as good a yardstick as one might find. Bain & Company was deliberately eschewing the consulting industry’s traditional routine of passing along competitors’ secrets—the economy of knowledge gained by talking to all players—so its consultants were forced to come up with truly company-specific advice and its fortunes could actually rise and fall along with those of its clients.

  The idea of taking similar action was discussed, and then rejected, in the corridors of McKinsey. In the face of real innovation in its competitive set, the firm chose to stick to its knitting. Not for the first time, some critics argued that McKinsey had become what it counseled against—hidebound—and was stuck in what Economist editor Adrian Wooldridge later described as a “complacent torpor.”22 As late as 1976, then-managing director Al McDonald referred to BCG as a “disconcerting strategic actor of no concern.” A charitable explanation is that he was bluffing.

  Still, it was hard to say whether BCG’s emergence marked a genuine revolution in consulting or was merely a triumph of salesmanship. Consultants at Bain & Company referred to “the million-dollar slide”—a single chart or graph that told a company so much about itself that it was worth a million dollars in fees.23 For all the rhetoric about the “strategy revolution,” companies continued to make the same mistakes they’ve always made despite having paid through the nose to chart their bold course into the future. “The most reliable way to make money from strategy,” observed Matthew Stewart, “is to sell it to other people.”24

  He’s right. “Strategy,” as it is sold by consulting firms, is essentially a pipe dream. Why? Because you can sit in a boardroom and plot all you’d like, but once the game has started, it’s pretty much improvisation from that point forth. The best companies stay efficient and effective, and they do well because their people are trained to do their jobs. The hardest thing in any big organization is to keep execution discipline in the forefront. There is a huge usefulness to that kind of consulting—process improvement—versus the elusive promise of big breakthrough thinking. The idea that executives need to be smart and heroic is a new invention. The essence of efficient management is hiring and training unheroic, ordinary people to play by certain rules. You need to take care of that before trying to create leaders or heroes.

  That said, there’s nothing wrong with looking for big insights—strategy with a capital S—that can take you to where the market opportunities will be. But that wasn’t what McKinsey and its peers were selling. Consultants sell an analytical approach to strategy, argued McGill professor Henry Mintzberg, but that’s never going to give you the big insight into what product or service will make you profitable again. No amount of reductive analysis of customer needs, market sizing, or competitive positioning can do that. For that you need to innovate, and there’s something about the whole analytical mind-set that effectively drives the ability to innovate out of the building.

  “McKinsey people are very sharp analysts; there’s no doubt about that,” said Mintzberg. “And that’s what you should look for when you hire them—analytical advice. They may couch it as managerial or strategic advice, but it’s merely analysis. You won’t hear it from them, but strategy is a learning process; you can’t just buy it from someone. Any chief executive who hires a consultant to give them strategy should be fired.”25 And, truth be told, McKinsey had been as guilty of this sleight of hand as anyone—it promised big breakthrough thinking, but what it really delivered was lots of analysis. It made sure its clients didn’t do anything really stupid, but was that really what companies were paying it the big bucks for?

  Over time, McKinsey regained some lost ground. Even if Henderson and his ilk were making inroads with some clients, McKinsey was still the consultant of choice, especially for the largest of firms. In 1968, GE CEO Fred Borch asked McKinsey for help in evaluating his corporation’s strategic planning. GE had deemed BCG’s four-box matrix intriguing but inadequate for the real world. A three-month study produced the GE/McKinsey nine-block matrix. If it seemed a petty response—you have four? we have nine!—it still satisfied the client.26

  GE’s problem was typical of the conglomerates of the era. Up until that time, the assumption had been that all business units were created equal and that all general managers should grow their own businesses. The result, though, was that GE was growing profitlessly. Revenues were up, but profits were flat. The same thing was happening at Westinghouse. The great insight of the strategy practitioners was that not all businesses are created equal, and it is the job of the CEO to divvy up capital according to which ones could put it to best use. This wasn’t a new idea, but it had been lost in the enthusiasm regarding growth and success of the postwar boom.

  Some answers to the complexity served a purpose, but in the end they were like Band-Aids on a broken bone. A lot of CEOs of the era, for example, had gotten to the top by exercising internal control. GE’s Borch, for one, read the profit-and-loss statements of all his departments every year and told them to stop spending on paper clips. Budgeting and control were at least one part of leadership, but such immersion in detail has its obvious limitations. If you’re wearing a green eyeshade, you’re not looking at the battlefield. Suddenly you look up, and—whoops!—Napoleon is coming for you!

  With McKinsey’s help, GE created strategic business units, or SBUs, that were organized not for span of control but for businesses around which a cohesive competitive strategy could be developed. BCG talked about market share and growth rates; McKinsey threw industry attractiveness and competitive strength into the mix. GE needed to shift its focus from internal control to external factors, the consultants argued. While it had sold a lot of televisions, for example, the corporation suddenly had no answer to Sony. The problem was that GE was too inward looking, and it wasn’t thinking about its business units in the right way—outwardly, analyzing all manner of factors beyond just production costs. The sprawling conglomerate—GE had 360 departments before the study—ended with ju
st 50 SBUs. This organizational idea then swept the world, and it helped McKinsey stem the tide of competitors.

  Former McKinsey consultant Mike Allen argued that McKinsey’s work at General Electric laid the groundwork for Jack Welch’s acclaimed career. “Without McKinsey, he would have not had an organization that worked,” said Allen. “He would have had no strategic planning or organizational structure to work with. We helped put him on the map. It was the high point of our interaction with GE, from a creative standpoint.”27

  Though BCG and Bain took a toll, they didn’t deter McKinsey from its global march. In 1971 the firm opened offices in both Tokyo and Sydney. Early clients in Tokyo included Japan Airlines and Sanwa Bank. In 1972 Copenhagen; 1973 Stamford; 1974 Caracas and Dallas; 1975 São Paulo, Munich, and Houston. (Although Caracas was shuttered that same year due to a lack of business.) McKinsey also worked on a few signature engagements, like the one in 1973 in which the firm, while engaged on an electronic coding project for Heinz, did work that led to the creation of the universal product code—or bar code—for food. McKinsey research correctly predicted that the code would revolutionize the grocery business and improve Americans’ quality of life at the same time. That is exactly what they did, making stores vastly more efficient and dramatically reducing checkout times.

  By the mid-1970s, the existential threat posed by the likes of BCG had largely passed. Some of this was McKinsey’s doing, and some of it was because the fad had burned out. Henderson had grown so enamored of his ability to conjure up salable theories that he veered off into folly. In 1976 he wrote an essay titled “The Rules of Three and Four,” in which he claimed that a stable competitive market never has more than three significant competitors, the largest of which has no more than four times the market share of the smallest.28 The rule was merely a hypothesis, he said, and “not subject to rigorous proof.” Henderson was fat and happy from his decade of success, and this was a casual and careless approach to providing insight to clients—to which McKinsey had successfully defined itself in opposition. “In my view, the best thing that ever happened to the Firm was the onset of BCG,” said Fred Gluck, who succeeded Ron Daniel as managing director of McKinsey in 1988. “I think that the Firm’s market success in the 1960s had developed into a sense of smugness and self-satisfaction that was counterproductive.”29