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

by Duff McDonald

  A number of other states, as well as other insurers, also sued Allstate. “[Insurers] are systematically [underpaying] policyholders without adequately examining the validity of each individual claim,” former Texas insurance commissioner Robert Hunter told a U.S. Senate committee in 2007. “If you don’t accept their offer, which is a low ball, you end up in court. And that was the recommendation of McKinsey.”42

  What was McKinsey’s response to the growing roster of disastrous engagements? Flat-out denial of responsibility. “In these turbulent times,” Gupta told BusinessWeek, “with our serving more than half the Fortune 500 companies, there are bound to be some clients that get into trouble.” Once again, McKinsey stuck to its long-held precept that it bore no ultimate responsibility for anything that went on at a client. All that mattered was whether there was any meaningful blowback on McKinsey. And as far as it could tell, there was not. “[McKinsey] is the beneficiary of the fact that it is able to dispose of its mistakes, hide its embarrassments and display a façade that seems almost golden,” said the Sunday Times in 1997.43

  The Kids in the Conference Room

  Rajat Gupta’s McKinsey looked quite different from its starchy past. It recruited the best and brightest from around the world, regardless of gender, race, or nationality—and the machine hummed more efficiently than ever. This was Gupta’s great achievement. He institutionalized the firm’s practices to such an extent that as it grew, both its external reputation and its internal culture gained power, right along with its profits. With the double draw of intellectual cachet and personal riches, it had an inside track on the smartest graduates from all over the world. In 2003 the firm even lured Bill Clinton’s daughter, Chelsea, to its ranks.

  But it also started to attract serious, and often unfavorable, attention. Books like The Witch Doctors (1996), Dangerous Company (1997), and Consulting Demons (2000) all took a very a dim view of the consulting industry and its undisputed leader. Christopher McKenna’s 2006 book, The World’s Newest Profession, while an academic treatise, also focused on whether Bower’s aim of professionalism had been discarded for commercialism during the economic boom at the end of the century. Indeed, as the 1990s drew to a close, critics wondered whether the consulting industry had grown so large and powerful that it was helping itself far more than it was helping its clients, a charge also leveled at the financial industry. Like bankers, consultants no longer looked or acted like the servants of industry. They’d passed through the looking glass and were now calling the shots.

  John Byrne of BusinessWeek took offense at Dangerous Company. He accused authors James O’Shea and Charles Madigan—both award-winning journalists at the Chicago Tribune—of writing “an ill-informed, anti-consultant screed filled with grievances that have been leveled at consultants for decades. The pair decry the industry’s high fees, its recycling of old advice, its willingness to tell clients only what they want to hear, and its penchant for putting raw MBAs into key problem-solving roles. But this is hardly news to anyone who has been either a victim or a beneficiary of a consulting assignment. Meanwhile, they fail to describe how the business really works—and why it has been so successful. . . . So consumed are the authors with a few of consulting’s well-known foibles that they fail to explain why companies willingly pay $50 billion a year to advice-givers.”44

  But Byrne was missing the point. The alarm was sounded not because people had suddenly realized the above. The alarm was being sounded because, by the end of the twentieth century, the explosive growth of consulting (and investment banking, to be fair) meant that an alarming proportion of the graduates of the country’s elite MBA programs were being diverted into places like McKinsey. The question being raised wasn’t whether consulting itself had merit; it was whether the opportunity cost of consulting’s rise was greater than previously understood.

  Americans had also begun asking themselves deeper questions about their particular brand of capitalism than they had in the past. What, in an increasingly services-heavy economy, was American capitalism anyway? What did the country make anymore? Could the world’s most powerful economy really eschew the dirt and grime of the making of things in favor of merely financing and advising others on how to do the same? Enron was the culmination of a capitalism severed from real things. And the collapse of the Houston-based company kicked off a broad ideological argument that continues to this very day: What role should business play in society itself?

  The origins of Wall Street, for example, are good in theory: helping connect holders of money to users of money. But by 2011 the perverted structure of international finance was widely viewed as a drag on the system, not a catalyst. The financial sector took real economies hostage and pushed the entire global economy into chaos. The origins of consulting, by comparison, are also good in theory: helping executives answer tough questions and provoking much-needed change. When the advice givers start to outnumber the advice takers, though, the system tilts in the wrong direction. What the authors of all of the above books were wondering was whether consulting as a whole (and McKinsey, as its standard-bearer) had become more drag than game changer.

  In a memorable 1999 New Yorker story titled “The Kids in the Conference Room,” Nicholas Lemann posed the question of whether, by virtue of McKinsey’s overwhelming recruiting success, the United States had decided, “in effect, to devote its top academic talents to the project of the streamlining of big business.” The question was—and remains—poignant. If there is no longer any disrepute in working in the field of commerce—which McKinsey surely does, even if it proclaims itself a profession—why weren’t more MBA graduates going into business itself as opposed to a support industry such as banking or consulting? Taken to its logical extreme, if everyone becomes a consultant, who will be left to consult?

  Lemann also explored what he ultimately saw as the sham at the heart of the McKinsey method itself. “The McKinsey method isn’t merely about business,” he wrote; “it’s about making the chaos of the world yield itself to the intelligent and disciplined mind. You’ve been trained and selected over and over for all your life, and this is the payoff: at last, you can do something. You have an omni-applicable power to figure out stuff and explain it to people. In truth, it is more a simulacrum of intellectual mastery than intellectual mastery itself, but what’s more important is how it feels. It feels as if you’d been given a key that opens up everything.”45

  In July 2002, the New Yorker ran yet another piece that constituted a further assault on the latest illusions of the cult of the MBA and, by extension, the cult of McKinsey. Penned by cultural commentator Malcolm Gladwell, the story, titled “The Talent Myth,” concluded that the McKinsey echo chamber had fooled itself into buying its own bullshit. “The consultants at McKinsey,” wrote Gladwell, “were preaching at Enron what they believed about themselves.”46

  While he focused on Enron, Gladwell was concerned that the obsession with “talent” had extended well beyond the McKinsey-Enron axis. McKinsey’s 1997 study, “The War for Talent,” had caused a mad rush to add a new (and questionable) dimension to the traditional human resources function: the talent manager. The idea, in its simplest sense: Rapidly promote “talented” employees (whatever that meant), encourage them to think outside the box, and pay them more than they are worth. One Enron employee quoted in McKinsey consultant Richard Foster’s book Creative Destruction made the following absurd remark: “We hire very smart people and we pay them more than they think they are worth.” It was nothing short of theory gone mad in practice. As Gladwell wryly observed in reference to Enron, “It never occurred to them that, if everyone had to think outside the box, maybe it was the box that needed fixing.”47

  “What if smart people are overrated?” asked Gladwell. Alternatively, argued consultant and author Kevin Mellyn in his 2012 book, Broken Markets, an excessive worship of formal credentials (i.e., the MBA) instead of actual ability has surely had the unintended effect of depriving the economy—and, just as surely, M
cKinsey—of true top talent.

  If clients weren’t exactly asking the same questions about McKinsey, a growing legion of journalists was. At first the firm didn’t care; outsiders had questioned its merits since the beginning, yet clients were still banging at the door. But then something happened: Its own people—specifically, its young people, the fuel for its engine—started asking tough questions as well.

  Grading Gupta

  If Gupta found himself distracted by the external public relations fallout from Enron and other botched engagements, he was soon confronted with an equal if not greater internal challenge. McKinsey had stared down many a competitive recruiting threat in its lifetime—from Boston Consulting Group and Bain to Wall Street—but it had never seen anything like the dot-com boom. No one had.

  BCG had once promised greater intellectual satisfaction than working at McKinsey, but the firm had essentially negated that threat in the Gluck era. Wall Street had always promised more money than a life in consulting, but it came with more punishing hours, bigger risk, and (to be truthful) a far greater proportion of bosses with a tendency to be assholes. And if Microsoft was minting millionaires, well, so what? For every Microsoft millionaire there was a broke software entrepreneur who’d been steamrollered by the software giant. Working in Silicon Valley wasn’t exactly riskless, and then there was the whole nerd thing to contend with.

  But then, almost in the blink of an eye, any MBA with a business plan with a .com at the end of it and the chutzpah to sell his idea to an ever more credulous stock market could get rich overnight, with little risk to no risk at all. How could McKinsey compete with that? How could law firms? How could Wall Street? Every single establishment firm in America suddenly had the same problem: Each looked like the past.

  By 2001 Silicon Valley employed 1.35 million people, three times the total twenty-five years earlier.48 The old guard of technology—Microsoft, Intel, and Dell—was being roughly pushed aside by a new generation of Internet-related companies, from network equipment maker Cisco to pure Internet players like eBay and eventual dominant players including Amazon.com and Google. By 2000 about 25 percent of U.S. household wealth was invested in stocks—particularly technology stocks—up from only 10 percent during the 1990s.49

  McKinsey consultants were unable to resist joining the exodus from the seemingly old to the fancy and new. Overall attrition at the firm rose from 16 percent to 22 percent during the bubble. That didn’t present a gigantic challenge, but the firm did take some hard blows: McKinsey lost the heads of both its insurance and its technology practices,50 while one-third of the firm’s San Francisco office left seeking new opportunities in 1999.51 So many people were leaving that the office soon became referred to internally as “the launching pad.” McKinsey veterans joined startups like CarsDirect.com, Cyber Dialogue, and Pet Quarters.

  It wasn’t just dot-com startups that were alluring. A whole new class of consulting firm burst onto the scene, with hipper names—Razorfish, Scient, Viant, and Sapient—and sexier projects. The work they were doing seemed far more crucial than redrawing organizational charts. They were helping companies use the Internet to transform everything about the way they did business—from sourcing to distribution to how they treated and served their customers.

  The loss of this consultant or that one was no mortal blow. What seemed to have the potential to be so? The change in the way McKinsey operated in response to the challenges. The firm that emerged from the dot-com frenzy was very different from the firm that had entered it: Led by Rajat Gupta, the consultants systematically gave up whatever was left of Bower’s hallowed principles.

  The first operational change: Historically, McKinsey had refused equity stakes in lieu of cash payment for its services. Taking equity, Bower had argued, would sow the seeds of conflict, leading to the possibility that the consultants might offer advice that would produce short-term equity gains at the expense of long-term client success. Under Gupta, that policy was jettisoned. As of 2002 the firm had taken equity stakes in more than 150 companies over the previous three years, including dubious enterprises such as Applied Digital Solutions, which advertised itself as a developer of “life-enhancing personal safeguard technologies.”52 McKinsey pointed out that equity participation accounted for just 2 percent of revenues, compared with 40 percent or more at other consultancies. Still, with 2001 billings of $3.4 billion, that was $70 million worth of equity, not a small number.

  The second: Gupta also sanctioned the linking of pay to client performance. Bower and his contemporaries had been adamant that McKinsey’s advice was what it was: advice. It was up to the client to carry it out. As with equity stakes, Bower saw contingency fees as a path to conflicted advice, because they would take consultants’ eyes off delivering the best possible result in favor of delivering that which might produce the most attractive payoff. When the firm advised Spain’s Telefónica on the spinoff of an Internet subsidiary, it earned a $6.8 million bonus.53 That was all well and good, but the move also opened up the notion that McKinsey could be judged on the success of its clients, something Bower had long preached against.

  The third: While the firm would never admit as much, under Gupta, McKinsey began working for just about anyone with a fat bank account and a checkbook. From the days of James O. McKinsey, the whole idea had been that McKinsey could secure its place at the top of the consulting pyramid by working only for companies at the top of the corporate pyramid. That policy went out the window when the likes of Pets.com and eB2B commerce—firms well below McKinsey’s long-held standard of quality—came calling. The firm had a thousand e-commerce assignments at the height of the madness.

  The fourth: The firm’s cherished culture of dissent was smothered under an “everything is good” attitude engendered by the sheer amounts of money being made. In that environment, suppression of independent thought or behavior occasionally reached levels of absurdity. At a full partners conference in 1994, urged on by a few senior directors including Gupta and Henzler, all the assembled partners stood up, held hands, and swayed to the saccharine lyrics of “We Are The World.” Many of those present were aghast, but they felt powerless to resist. Gupta’s style (as well as that of a large number of his closest associates) was “You’re either with me or against me,” and the old value of fierce internal debates and arguments gave way to acquiescence followed by grumbling over drinks in private. The culture of open debate and the free flow of ideas—where only the content mattered and not the person expressing it—was replaced by a culture of “bag carriers” (a notable McKinsey insult) who did as they were told.

  The fifth: Compensation of senior directors went so high that the historic tradition of voluntary retirement began to be ignored. Second homes and country club memberships gave way to ranch ownerships and art collections. Houses were renovated to Architectural Digest standards. Directors would invite young recruits carrying massive college debts to their homes for dinner with the unsaid proposition: “Someday you could live like this.” To add insult to injury: The same directors would walk past the young recruit the next day in the corridor of the New York office with no sign of recognizing them.

  As a private partnership, McKinsey doesn’t divulge its finances, but estimates of Gupta’s take as managing partner run to more than $5 million annually. At this point, the ratio of the most senior compensation to that of the juniors now approached forty to one. After becoming managing director, Gupta moved with his family into an $8 million mansion a stone’s throw from Long Island Sound in Westport, Connecticut, that was once owned by the J.C. Penney clan. Gupta’s winter getaway is a sprawling $4 million oceanfront house on Palm Island, a private resort on Florida’s gulf coast. One estimate in 2012 pegged his wealth at $130 million.

  • • •

  In April 2001 the dot-com bubble burst. McKinsey’s revenue bubble soon did the same: For the first time in recent memory, the firm’s top line declined, from $3.4 billion in 2001 to $3.0 billion in 2002, a 12 percent drop. It took
only three years to climb back to the 2001 levels—the firm claimed $3.8 billion in 2005 revenues—but at the time the decline caused great consternation at the firm. The New York Times even headlined an article in 2002, “Hurt by Slump, a Consulting Giant Looks Inward.”

  What was it looking at? First and foremost, the merits of Rajat Gupta’s tenure. It had taken Gupta an unusual three ballots to get elected to his third term in 2000, and even though he had guided the firm to an unprecedented level of prosperity, he had also overseen skyrocketing growth that left it exposed when the downturn came.

  In June 2001 Gupta asked all 891 partners of the firm to contribute to McKinsey’s capital base. Some senior partners gave as much as $200,000. Partner compensation also fell by one-third. In this instance, McKinsey wasn’t paying partners anymore; they were paying McKinsey.

  McKinsey’s balance sheet problems weren’t entirely surprising. Because consulting firms pay out all their profits at the end of each year, they are usually funded for about the next three months and nothing more. Their lines of credit smooth out blips in business, but there’s a balancing act to be done, even if McKinsey claims it doesn’t focus on the bottom line. “Remarkably, these places are only ninety days away from going out of business,” said financial services consultant Chuck Neul.54

  Gupta turned the firm’s focus even more toward client development and even farther from knowledge building. “The pendulum does swing a little bit,” Gupta told BusinessWeek in 2002. “I’d say that client development in the last year or two is more in the forefront, simply because that is the biggest need right now.”55 And, as Walter Kiechel pointed out in The Lords of Strategy, “When business falls off, partner interest in breaking new intellectual ground largely evaporates; the rallying cry becomes client development, maintaining current relationships, and hunting for fresh ones.”