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

by Duff McDonald

  One of the first successes of the Beijing office was helping four Chinese rice farmers who had decided to get into the bottled-water industry. “They had just bought a bunch of machinery,” Orr said. With McKinsey’s guidance, the outfit eventually became the number-two bottled-water provider in China, worth $200 million. McKinsey also advised two companies—Ping An Insurance and Legend Computers—that went on to become global players.

  McKinsey’s success in China hasn’t been linear. The firm has had to contend with counterfeit operations that offer “McKinsey Reports” for as low as a hundred dollars. And the early years were very lean. Orr recalled at least one stretch in 1997 when one client supported the entire fifty-plus-person Beijing office. Some competitors pulled out of China when the times got tough—Booz-Allen left, only to return a few years later—but McKinsey hung in there, and its perseverance ultimately paid off. Within ten years, McKinsey had three hundred professionals in China. By 2011 it had eight hundred. The firm also built a Consumer Insights Center in China, to monitor the spending patterns of sixty thousand Chinese consumers and inform McKinsey research about the increasingly important economy, and in 2012 opened the McKinsey China Leadership Institute in Beijing.

  A Walk down Wall Street

  Back in the United States, McKinsey continued its intimate dealings with the rapidly growing financial sector. The firm’s influence ran so deep that it could actually make good on its mandate to confront clients with uncomfortable truths. MacLain “Mac” Stewart, a key figure in McKinsey’s financial services practice, had a particular knack for dispensing blunt, unflattering advice to even the most puffed up of Wall Street CEOs. After sitting through a terrible presentation given by Dick Fuld, then beginning his career as CEO of Lehman Brothers, Stewart looked Fuld in the eye and told him that if he wanted to be successful, he’d better hire a speech coach.

  In another instance, Stewart dressed down Citicorp chief Sandy Weill, whose meeting style was to say his piece, and then, while others responded, compulsively watch Citi’s stock price on his Quotron. In a meeting with Stewart, Weill did just this and then briefly left the office. While he was away, Stewart put a book in front of the screen. When Weill returned and noticed the book, he erupted, asking who had had the temerity to do such a thing. “You’re wasting my time,” Stewart told him. “That’s sending the wrong message.” Weill paused, then said, “No one ever told me that before.” The engagement moved forward.

  Former Federal Reserve chairman Paul Volcker once told a pro-McKinsey dinner companion that there are four signs of an impending bank failure: (1) The bank has “rebranded”; (2) it has built a new headquarters; (3) it has acquired a corporate jet; and (4) McKinsey has been in there. That might not be good news for the bank involved, but it was very good news for McKinsey. The firm had become the consultants of last resort.

  McKinsey was pulled in to mediate the battle inside Lazard Frères between chairman Michel David-Weill and deputy chairman Steven Rattner over the question of how the boutique investment bank should govern itself, particularly in divvying power among its three primary offices in New York, London, and Paris. According to journalist William Cohan, in 1998 McKinsey interviewed forty-six of Lazard’s partners and helped establish a power-sharing arrangement in the mergers and acquisitions department.14 The engagement highlighted the respect with which McKinsey was by this point held by its Wall Street clientele—the struggle for control at Lazard was one of the investment world’s most Machiavellian dramas, and the idea that McKinsey could help find a way for two of Wall Street’s largest egos to find peace was a high compliment indeed. With a McKinsey-aided fix, Lazard went on to strengthen its niche as a boutique M&A advisory power.

  There was some criticism of the work at the time, including the suggestion that McKinsey had produced a “camel”—a horse designed by a committee—instead of actually solving Lazard’s power-sharing problems. “[We] ended up with this mishmash of a structure that wasn’t any better than we already had, really,” one Lazard employee told Cohan. Still, the firm helped stop Lazard from splitting at the seams, a real accomplishment for a boutique bank that had been on the verge of doing just that.

  A big part of McKinsey’s influence in the financial sector was due to its alumni network. In 1996 the firm had well-placed alumni in the management suites of SBC Warburg (George Feiger), Lehman Brothers (John Cecil), HSBC Capital (Steven Green), Swiss Re (Lukas Muhlemann), UBS (Peter Wuffli), Morgan Stanley Dean Witter (Phil Purcell), and Goldman Sachs (Larry Linden).15 Hamid Biglari left McKinsey in 2001 to join Citicorp. Jay Mandelbaum, until 2012 one of Jamie Dimon’s closest advisers at JPMorgan Chase, is an alumnus. Not all of them have had successful runs—Purcell’s Morgan Stanley tenure ended in his being deposed in a coup, Muhlemann’s post-McKinsey career was a decidedly mixed bag. But that didn’t stop boards of directors from going back to the McKinsey talent well again and again.

  The firm infiltrated private equity as well. Don Gogel left McKinsey to become CEO of private equity powerhouse Clayton Dubilier. Chuck Ames, also formerly of McKinsey, worked alongside him. Ex-McKinseyite Sir Ronald Cohen was an early player at Apax Partners, one of England’s largest private equity shops.

  One primary reason that McKinsey has made significant inroads into the financial sphere is that finance is all about the numbers; it takes no stretch of the imagination to conclude that financial problems can submit to McKinsey’s style of fact-based analysis. What’s more, both consulting and finance tend to attract similar personalities—think MBA Mitt Romney instead of free-ranging “intellectual” Newt Gingrich—and so the two populations find themselves speaking similar problem-solving languages. And once deregulation had all the CEOs in finance looking to acquire or be acquired, they lined up for McKinsey’s help in understanding the brand-new competitive landscape. Gupta wasn’t part of McKinsey’s New York financial institutions mafia, but he, like his predecessors in the corner office, knew to leave it well enough alone—that extended from Lowell Bryan’s iron grip on the banking practice to Pete Walker’s in the insurance industry.

  McKinsey wasn’t just in finance, though; it was everywhere. By the late 1990s the CEOs of America West Airlines, American Express, Delta, Dun & Bradstreet, IBM, Levi Strauss, Morgan Stanley, Polaroid, and USG were former McKinseyites.16 In 1999 Fortune ran a story titled “CEO Super Bowl.” The story suggested that just as the University of North Carolina “manufactures” basketball stars, and the University of Michigan “cranks out” football stars, so too was there a CEO factory in the country—McKinsey. The network is without a doubt the most powerful the world has ever seen. “You don’t realize it until you’re gone,” IBM chief Lou Gerstner later told another McKinsey partner.

  The Value of Values

  Gupta initially seemed to grasp the importance of the firm’s culture and values. In his first year as boss, he commissioned an internal task force, which aimed to identify what was wrong in the life of the firm’s junior partners and what could change. It had impact. Whereas in previous years, the firm’s profit sharing was split in the directors’ favor—as a group, they received two-thirds of the pool, to principals’ third—the task force convinced the shareholders committee to merely divvy the profits proportionally. Gupta also oversaw EAGLE—Exciting Associates for Greater Long-Term Enrichment—proving that a firm addicted to acronyms will always find newer and sillier ones.

  Another effort, the Firm Strategy Initiative (FSI) in 1997, showed quite clearly just how rigorous McKinsey consultants can be. The goal of FSI, which they called “the mother of all engagements,” was nothing short of a reconsideration of the most basic questions about McKinsey’s raison d’être: To whom should we provide our consulting services? What scope of services should we provide? What kinds of delivery models and fee arrangements should we employ? A management group of more than six hundred members attended two conferences; sixty partners served on the task force; fifty associates and analysts worked on the project; more than a thousand
survey questions were asked; forty “vision” papers were written by partner teams; six progress reports were produced, a total of more than fifteen hundred pages; over a hundred videos were made; more than a hundred and fifty exhibit decks were prepared; and over two hundred speeches were delivered.

  One of the main conclusions of FSI was that McKinsey must restrict client engagements to the very top rungs of management. If they allowed their work to slip down to the middle rungs, the consultants reasoned, the money they’d make would come at the expense of their hard-won reputation for being the confidants of CEOs. This was a demonstrative reinforcement of Boweresque values. The FSI also reiterated McKinsey’s commitment to loose corporate governance, despite the firm’s growing size. This was also true to the firm’s tradition of giving consultants the freedom to exercise their entrepreneurial instincts.

  At the margins, however, change was creeping in. Usually it had to do with money. One result of FSI was the establishment of new “fee mechanisms” to enable the consultants to work with small but fast-growing companies. In lieu of its customarily high rates, the firm started taking equity in clients, something Marvin Bower had considered unwise. But the dot-com boom was in full flower, and McKinsey wanted a piece of the action. FSI also concluded that the consultants should officially enter the M&A advisory business, where they would compete with investment banks.

  Rajat Gupta didn’t change the firm all by himself—he needed his partners’ assent and he had it. Still, under his watch, McKinsey began to chase top billings in a way it never had before. More than half of the partners had told the FSI that about 20 percent of their work wasn’t interesting. And if you’re going to be bored, you might as well be making money. Everyone else was. “His first term was very good,” said an expartner of the firm. “But I think he took counsel of the wrong people. If you couldn’t invoice $1 million from a client by 1997, you were encouraged to drop that client. That was pretty much the minimum.”

  In the 1990s McKinsey’s revenues grew almost four times while the partnership grew by only two and a half. Associate leverage—the measure of associates relative to partners in the firm—grew from two to one to four to one by the end of the decade. McKinsey’s partners were wringing more profits from their hardworking associates than ever. And the associates were feeling the pain. Yves Smith, a former McKinsey consultant and prominent blogger, has suggested that McKinsey’s turnover reached 30 percent annually in the heat of the boom. That was not only disruptive; it threatened to waste the not insubstantial cost of training young recruits. What good is a shared narrative if people don’t stick around to share it?

  McKinsey, which had blocked its ears to the siren song of the go-go years in the 1960s, couldn’t resist getting caught up in the dot-com frenzy. The shift was at least partly a response to increased turnover at the level of principal. With so much money being made so quickly in Silicon Valley and on Wall Street, McKinsey had to not only raise salaries but also shorten the time to partnership. “Some partners wondered whether the firm was abandoning its value, ‘Clients first, firm second, professionals third,’ ” noted a Harvard Business School study. Short answer: It was.

  As for the tradition of working only for the most prestigious companies, well, that too went out the window. In 2003, for example, SHC, Inc., the parent of the dying Spalding sporting goods brand, paid the firm $569,000 for consulting services. A year later it was bankrupt. McKinsey, it seemed, would actually work for anyone with an open checkbook. And it had introduced those new fee mechanisms. In 2001 McKinsey traded its advice for a 12.5 percent stake in a satellite-based advertising company in the convenience-store industry called OnVance. The firm was later sued for $1.6 million by the bankruptcy trustee of a busted OnVance under the logic that McKinsey wasn’t a creditor but an insider. Billing rates came down as well: In 2001 an industry researcher made this claim: “You can hire McKinsey for what it would have cost you to hire A.T. Kearney a year ago.”17

  Despite Marvin Bower’s hope that it wouldn’t happen, the envy of corporate (and Wall Street) cash overtook McKinsey consultants in the thick of the late 1990s dot-com boom, a time during which CEO pay was skyrocketing. The facilitators of CEO-ism—the consultants, lawyers, and bankers—lost their willingness to be paid the way professionals had historically been paid. It’s extremely difficult for doctors to make more than $1 million a year. But by generally targeting only the largest of corporations, consultants have figured out how to secure ever-larger paychecks for themselves. What’s a $10 million fee to a corporation with $2 trillion in assets? At one point Citigroup had eight active teams from McKinsey running around inside its offices.

  If McKinsey’s professional idealism had been attractive to MBAs in previous years, its more aggressive commercial orientation hardly slowed the flow of job applications. “Never underestimate the lemming-express effect that obtains among students at ‘top’ business schools and colleagues,” wrote author Walter Kiechel. “You compete to get into the most prestigious college. Then you compete to get into the top-ranked business school. After you’ve learned and displayed so much independence of mind, what’s left but to compete to be hired by the employer all your peers were clamoring to join?”18

  9. BAD ADVICE

  Rajat Gupta achieved a lot as the eighth managing director of McKinsey. He successfully diversified the firm’s hiring, more than doubling the number of elite schools from which the firm recruited, from seven to twenty, as well as broadening the kind of applicant, including continuing and expanding the push to bring in PhDs as well as MBAs. He helped McKinsey gain a step on most of the corporate world in the outsourcing boom, not only counseling its clients to take advantage of a networked world but doing so itself. The firm’s own number-crunching Knowledge Center in New Delhi brought labor costs down while also serving as a model for outsourcing to its clients.1 Gupta’s protégé Anil Kumar headed the effort.

  And even as the firm had lowered some of its standards in search of growth, it hadn’t taken the final money-hungry leap—selling shares to the public—a decision that positioned it to correct course far more effectively than it might otherwise have done with angry shareholders breathing down its neck. “This is a knowledge-intensive business,” Gupta said in 2005, “not a capital-intensive one.”2

  Still, by late 2002, the firm wasn’t feeling very good about itself. The consultants wondered whether the Gupta-led expansion had cost them too much in terms of culture and values. Enough wondered so in interviews with BusinessWeek writer John Byrne in a wide-ranging 2002 feature on the firm that one of Gupta’s last moves as managing director was to push the firm’s head of marketing and public affairs, Javier Perez, out the door as a result of the picture of poor morale painted by Byrne.

  Ron Daniel had once told a partners conference that he thought the firm could sustain maximum growth of about 10 percent a year while still being able to absorb its people effectively. Gupta threw that out the window and chased an even faster rate of expansion of nearly 20 percent. Many partners, though, pointed out that he did it with their acquiescence. “Rajat made us all rich,” said one.

  That’s fine for those who had made the money but weak gruel for those who had already left but still felt that at least part of their reputation depended on McKinsey’s. “The place evolved from a very elite professional services firm to kind of a large factory that produced consulting projects,” said one senior partner who left during Gupta’s tenure.

  McKinsey is not a command-and-control organization. The managing director does not manage by diktat. He must persuade. That said, he does get to choose committee leaders, office managers, and more. And on the margin, Rajat Gupta chose people who were more economically driven than in years past. That’s how you move a firm like McKinsey. If you are the managing director for nine years, which Gupta was, every single person who is a junior partner got elected on your watch, as well as more than 50 percent of the senior partners. That allows you to change the character of an organiza
tion, and that’s what Rajat Gupta did. And the new character of McKinsey suddenly seemed one that was capable of making a number of seriously questionable decisions—about which clients it got close to and what it advised those clients to do.

  Sleeping in Enron’s Bed

  The most infamous McKinsey client of the Gupta era was Enron, the natural-gas-trading powerhouse that, when it imploded in 2001, destroyed not only itself but also Arthur Andersen, one of the Big Six accounting firms. Miraculously, though McKinsey was earning some $10 million a year in fees from Enron at the peak, it emerged unscathed. The whole ordeal nevertheless revealed quite a bit about the less attractive elements of the consulting business.

  Jeff Skilling, one of the chief Enron villains, was himself a McKinsey alum. He joined the consulting firm in 1979 and quickly earned a reputation for an oversize ego. “Skilling worked for me indirectly for a short period of time,” recalled Tom Peters. “God knows, he was intellectually arrogant in a way that beggars the imagination.”3 If you didn’t believe Peters, you could ask Skilling himself; he once told BusinessWeek that he had “never not been successful at work or business, ever.”

  He was a standout, to be sure. After starting his career in Dallas, he moved to the Houston office six months later, where he was just the third employee. In five years he made principal, and he was elected director five years after that. He’d certainly found his intellectual home. “It was difficult to disagree with Jeff because he would elevate the disagreement to an intellectual disagreement, and it was hard to outsmart him,” a former McKinsey partner said.4