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

by Duff McDonald

  Overall, the numbers were increasingly coming in as they had before the rough transition out of the Marvin Bower era. In 1973 McKinsey had the highest billings of any consultancy. In 1978 it was in fifth place, behind Arthur D. Little, Booz Allen Hamilton, Arthur Andersen, and Cooper’s & Lybrand.8 The firm had never prided itself on being the industry’s largest player—it just felt it was the most important one—but losing ground opened the eyes of partners to the ways in which the firm had become a hostage to its traditions. Whereas McKinsey had always focused on its image and its relationships, BCG, Bain, and other upstarts had shifted the battle to the realm of ideas, where McKinsey had little to offer. “BCG and Bain had convinced the world that they had better ideas than McKinsey,” said academic Matthias Kipping.9 Under Daniel’s leadership, McKinsey created the machinery to produce ideas of its own. By the time he was done, the firm had recaptured the client mindshare that had gotten away from it.

  Superteam

  Under Bower, McKinsey had a small, idiosyncratic leadership structure. He managed the firm with a kitchen cabinet of three or four people at most. Lee Walton expanded that, creating a shareholders committee of some forty-five members. Daniel brought more than a hundred partners into firm management decisions, a power-sharing arrangement that enabled the firm to become a global force. What Daniel proved was that McKinsey could evolve. In the Bower era, the firm rode the wave of growing demand for basic organizational consulting, first in the United States and then in Europe. The next four managing directors had to contend with a stagnation of demand and the internal complications that ensued. To find new opportunities for McKinsey, Daniel shifted the focus of the firm to “knowledge.”

  This is a critical concept, and one that took a while for McKinsey old-timers to absorb and get used to. They were accustomed to working with industrial firms that never needed to explain to their customers what they “knew”—they had a product, and the customer could choose to buy it or not. Some professional services firms—lawyers, for instance—have no need to explain themselves either. People know when they need a lawyer. But consultants have to, in essence, constantly make an argument for their own existence, which by the mid-1970s McKinsey had grown confused about. What exactly was its expertise, and how could it convince the world to keep buying more of this?

  After his election, Daniel made a point of asking the firm’s partners what they thought the firm should be focusing on. Fred Gluck responded with a memo detailing how McKinsey was falling behind, not only in strategy but in operations and organizational consulting too. Sure, BCG had outflanked McKinsey with a couple of savvy charts, but there was an underlying problem more insidious than that: Clients now wanted consultants who knew something, and McKinsey’s database of knowledge was razor thin.

  The partners agreed that the most pressing need was to expand its offering of strategic planning tools. Daniel asked Gluck if he would head up a new strategy practice. Gluck was concerned about being pigeonholed—the generalist ethos still held great sway at the firm—and he offered instead to act as head of a strategic steering committee. As Walter Kiechel pointed out in The Lords of Strategy, this made him, de facto, the head of the firm’s strategy practice, but at McKinsey, where semantic subtlety was an art form, the compromise worked for everyone.10

  Peter Foy, who managed the London office from 1984 to 1991, said that McKinsey’s fortunes changed after a June 1977 meeting of the firm’s strategy experts at the Westchester Country Club. Twenty-three of McKinsey’s top strategy buffs sat around bouncing ideas off each other. And even in a gathering of that much intellect, Tokyo consultant Kenichi Ohmae stood out. At the end of the meeting, Foy offered the group a scorecard: “Lions 10, Christians 5, Ohmae 37.” Years later, he sent Gluck a silver tray with that inscription. Although he was one of the firm’s first champions of a strategy practice, Ohmae became famous for his later repudiation of the idea of formal corporate strategy—arguing a variant of Prussian general Helmuth von Moltke’s dictum that all strategic plans become nullified on first contact with the enemy. By definition, you improvise in battle, and he who improvises best wins.

  The meeting was an early step in the firm’s belated response to the major competitive threat posed by BCG and Bain. Gluck soon put together an immodestly named group, the Superteam: a half-dozen consultants from different offices who were to midwife a strategy practice over the next decade. It was about time: One 1979 survey showed that 45 percent of the Fortune 500 were using some sort of BCG-style matrix analysis in their strategic planning.11

  One thing Gluck didn’t want to do was merely mimic BCG. “People were saying, ‘What we need, Fred, is not a lot of complicated stuff. We need a conceptual supernova, a direct response to BCG’s matrix. And I rejected that notion. That was exactly what we didn’t need. We want to help our clients solve the problems they have, not the problems we know how to solve. We don’t want to be a solution in search of a problem, and that’s what the four-box matrix was. That’s what the experience curve was. Sometimes they worked. And sometimes they didn’t.”12

  Gluck continued: “I said we should forget about trying to do what BCG did. That we should tip our hat to them for what they accomplished, and then get on and do what we do best, which is to understand our clients’ strategic problems and bring our extensive knowledge and experience to solving them.” To that end, Gluck introduced practice bulletins, one-page summaries of what had been learned on a particular engagement or series of engagements with clients, so as to keep all consultants abreast of current work being done by the firm. Gluck intended to build an internal McKinsey knowledge network one piece of paper at a time.

  And McKinsey approached strategy in a far more nuanced way than drawing a couple of graphs on a page. Gluck’s 1978 paper, The Evolution of Strategic Management—the inaugural McKinsey Staff Paper—was something of a battle cry, marking the firm’s intention of taking back lost market share. The paper’s approach to strategy was the furthest thing imaginable from the General Survey Outline. The GSO was based on the premise that by following a checklist, managers could better understand their companies. But it was too inward looking. The strategic revolution was about looking outward, and adding exhaustive competitive analysis to the simple data gathering that was the core of the GSO.

  Gluck’s paper laid out four phases of a company’s evolution in strategic decision making. The first, financial planning, was essentially old-school budgeting. The second, forecast-based planning, considered a far larger number of factors affecting the company. The third, externally oriented planning, called for in-depth analysis of a company’s “business environment, the competitive situation, and competitive strategies.” The fourth phase was full-fledged strategic management.

  In a lengthy and colorful breakdown of the four phases, Walter Kiechel, author of The Lords of Strategy, credited McKinsey with bringing the discussion of strategy back around to organizational structure. The answer to a desire to be strategic, Gluck and his colleagues were arguing, was to organize one’s company around that desire. And nobody understood organization better than McKinsey. By the end of 1979, some 50 percent of the firm’s billings came from fine-grained strategy work, making it a bigger player in the realm than either BCG or Bain. “Bain and BCG turned consulting into a rock star profession,” said former McKinsey partner Clay Deutsch. “But we benefited more than they did. Once we got our act together, we cornered it.”13 Indeed: Whereas in 1980 BCG was over one-third the size of McKinsey, by 1985 it was less than one-fifth.14

  Snowball Makers

  The revolution in how the firm collected and synthesized just what its consultants knew went far beyond its push into strategy. McKinsey also put two overlays on its geographic setup, establishing fifteen functional groups (e.g., corporate leadership, finance, organizational behavior) as well as increasing the number of industry specialties (e.g., banking, insurance, consumer products) from three to eight. The smart consultant maintained a generalist image while cultivating
a niche in one or more functional or industry practices. Gluck oversaw this effort too, a clear indication of his status with Daniel.

  In beseeching his colleagues to develop something more than a generalist expertise, Gluck uttered a line that became enshrined in McKinsey lore. In arguing that the firm needed both “snowball makers” (specialists) and “snowball throwers” (generalist rainmakers), he said, “Every McKinsey consultant needs to be a generalist, but it’s not necessarily a handicap to know what you’re talking about.” He later added, “Would you want your brain surgery done by a general practitioner?”15

  It was under Daniel that the firm first produced its practice-information system (a database of client engagements), its practice-development network (for knowledge gleaned by the firm’s different practice groups), and a knowledge-resource directory (basically, an in-house phone book of experts and document titles). The last of the three—which didn’t become computerized for years—became one of the McKinsey man’s prized possessions, a little red spiral-bound book running to several hundred pages, never to be let out of his grasp.

  What’s more, a real premium began to be placed on being part of this knowledge oeuvre—not just in what McKinsey knew but in who at McKinsey knew these subject areas. An unstated understanding emerged that if you were a logistics expert in, say, the retail sector and you were called by a partner you had never met who mainly did work with pharmaceutical companies, you would nevertheless return the call. That reputation for contributing was your asset in the firm. It was endlessly discussed and recognized, and in the process, such sharing really did enter the firm’s culture. “Other places have extensive systems for knowledge management, but what Daniel and Gluck built was a culture for sharing that was completely in the service of the firm,” said former partner Partha Bose.16 Such a profound shift does raise the question of what constitutes knowledge of an industry or function and whether consultants can actually capture it, but clients were keen to let them try to do so in any event.

  Despite Gluck’s resistance, the firm did produce a direct response to BCG’s matrix—the nine-box McKinsey matrix—but it also set about formulating a series of frameworks through which the consultants could analyze companies in new and important ways. Hours upon hours of data collection and analysis went into each framework, and the degree of intellectual engagement required of a McKinsey associate was substantial. By the end of the 1980s, the firm required that new recruits learn more than a dozen core analytical frameworks, ranging from “the raider’s perspective” to return-on-equity trees, business systems, industry cost curves, value-delivery systems, economic value to the shareholder (or customer), and the strategic game board.

  While the inputs and thought processes differ greatly, most frameworks try to achieve the same goal, which is breaking down one’s business into component parts and thinking about them from a fresh perspective. The business system comes in two flavors, for example—the traditional product-orientated system and the value-delivery system. In the former, consultants break down a client’s business to its basics: create the product (product design, process design), make the product (procurement, manufacturing, and service), and sell the product (research, advertising, promotion, pricing, and sales and distribution. The latter is about the “value” involved—choose the value (understand desires, select the target, define the benefits), provide the value (product process design, procurement, manufacturing, distribution, service, and price), and communicate the value (sales message, advertising, promotion and PR). It all sounds simple—even banal—but every executive can lose sight of such fundamental issues when bogged down in the day-to-day, and McKinsey and others were offering to help them get centered again.

  The frameworks also looked into the future. For its part, the strategic game board offered CEOs a way to think about their companies much as the BCG matrix did—with four types of potential strategic “moves.” Whatever it is you make or sell, McKinsey’s consultants learned to advise their clients, you should continuously be deciding whether to choose to do better and more of the same; re-segment the market to create a niche; create and pursue a unique advantage; or exploit a unique advantage industrywide.

  Such were the more prosaic frameworks. The real ball-busters, though, were heavy on the numbers, from cost of capital to returns on all manner of investments. Just looking at a return-on-capital-employed tree can make the head spin with its accounting jargon overload, from “days sales in inventories and payables” to asset utilization, depreciation, and costs per unit made and sold. This was strategy via microeconomic analysis—getting to the on-the-ground numbers at the heart of the issue—McKinsey’s expertise. Work for Citicorp in 1984, for example—code-named Project Alpha—was aimed at a so-called Activity Value Analysis, a database-heavy analysis of how the bank’s corporate office functioned and where cost savings could be found.

  This increased focus paid off: Whereas banking clients represented just 3 percent of the firm’s revenues in 1975, by 1983 they accounted for 25 to 30 percent in both New York and London. This was not by accident. When brought to bear on a specific subject, the collective McKinsey intellect is powerful. In 1988 two consultants, Jim Rosenthal and Juan Ocampo, wrote Securitization of Credit, a road map that helped Citibank and Chase Manhattan survive the South American debt crisis. The book, the first on a subject that soon washed over the financial world like a tsunami, showed the banks, unable to earn their way out of their bad debt situation, that by securitizing the loans on their books—packaging them up and selling them into the secondary debt markets—they could effectively walk away from the loans, albeit while still taking a hit to their balance sheets.

  The subtext to all the knowledge development was that consultants had to participate in cataloging and disseminating that knowledge into the firm’s burgeoning repositories of such. While Bower had paid lip service to contributions to the firm beyond billings, his consultants still largely ate what they killed. Top compensation went to top billers. But as Daniel began emphasizing knowledge development, the soft side of the compensation discussion became meaningful. With Gluck by his side, Daniel slowly persuaded his colleagues that knowledge development deserved to be a core, ongoing pursuit.

  McKinsey’s efforts in this area would take the firm into uncharted territory: popular culture. The holy grail of the consultant is an idea that attracts clients but is still vague or complex enough that they need your help in carrying it out. This is why consultants are great progenitors of buzzwords, ideas like scientific management or lean production or reengineering. If it’s got its own name, you probably want to hire the expert on it, don’t you? In the 1970s and 1980s, the argument extended all the way to the land of the rising sun. Having lost significant market share in industries from automobiles to consumer electronics, managers gladly paid through the nose for the inside scoop on Japanese management techniques, such as just-in-time production, total quality management, and continuous improvement. It was the existential threat posed by Japan that led to one of the most idiosyncratic achievements in McKinsey’s history: Its consultants produced a book that even Joe Six-Pack wanted to read.

  The Secrets of Excellence

  While Ron Daniel relied on Gluck for strategy, he asked Cleveland-based director Jim Bennett to oversee work on bulking up McKinsey’s knowledge base in organizational effectiveness. Bennett, in turn, recruited an energetic San Francisco associate named Tom Peters to help lay the groundwork on the project, including a survey of all the extant literature as well as a poll of McKinsey clients. Later, Bob Waterman replaced Bennett as head of the effort. At the time, though, this was not a big priority for McKinsey. Expectations for the organizational work were somewhere between low and very low.

  In fact, it transformed McKinsey. But that took years.

  Though his tenure was relatively short and he left under contentious circumstances, Peters is the most famous consultant McKinsey has ever produced. His influence on the firm was enormous and helped raise it
s profile beyond Bower’s wildest dreams. More like Bower’s nightmares, actually. Peters helped rebrand McKinsey as a group of thinkers while at the same time revealing some less-than-great qualities of McKinsey, such as its utter incapacity to deal with a star in its midst.

  Peters, a Cornell graduate who majored in civil engineering, spent four years in the navy, then eventually got his MBA and PhD in organizational behavior from Stanford. After a stint in the Office of Management and Budget, he landed a job in McKinsey’s San Francisco office in 1974. “McKinsey was as cool as it gets at the time,” recalled Peters. “If you didn’t have some grand desire in life, it was the place to be.”17 (That idea—the delaying of one of life’s major choices—still holds true for many McKinsey recruits today.)

  Waterman, a graduate of the Colorado School of Mines with a Stanford MBA, had been at McKinsey since 1963. After focusing on banking and forest products in the San Francisco office, he’d been sent overseas to help open the Osaka office in 1970 and later took over management of the Melbourne office, which he ran for three years. He then did what few have done at McKinsey: He took a sabbatical with his wife and two kids that included some teaching in Switzerland. “When Ron took office, though, he made it quite clear that he wasn’t in love with my leave of absence idea,” said Waterman. “So we came back to San Francisco.”18

  In 1977 Bennett put Peters in charge of the project that aimed to find out what made companies effective beyond the areas of strategy and structure in which McKinsey excelled. Over the course of a few years, Peters and Bennett (and then Waterman) researched the question—Peters hopscotched all over the globe, visiting twelve business schools and a number of companies in both the United States and Europe19—and eventually compiled their findings in a twenty-page folio they called “Excellence.” It was presented to Shell in July 1979, along with talks from Fred Gluck on strategy and Ken Ohmae on “life.”