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

by Duff McDonald

  Interestingly, the McKinsey Global Institute was doing substantial research of its own on developments in the global financial markets during the boom years, and it had reached conclusions that stood in opposition to the strategies of the firm’s largest financial clients. “Like the rest of the world, we failed to have a full grasp of what was happening in the lead-up to the financial crisis,” said Diana Farrell, “but we were beginning to sound a drumbeat about the degree of leverage in the economy.”35 MGI created a unique global database and captured a concept called “financial deepening,” which indicated that it wasn’t enough to look at individual institutions; a true understanding could come only from a systemwide analysis. MGI noted that financial assets were equal to global GDP in 1980, rose to two times in 1990, and rose to three times in 2000. “We were probing and understood this was important and worth ringing the bell on,” explained Farrell. “But we did not fully understand that it was unsustainable.”

  What was acceptable to McKinsey—and its competitors serving many of the same financial institutions at the time—was that the profits of the financial services sector were skyrocketing, from 15 percent of U.S. corporate profits in 1980 to 41 percent in 2007. And so what its consultants told their clients was not necessarily the same thing Farrell suggested had been concluded at MGI. According to the New York Times, in 2007, in an engagement meant to evaluate the risks in General Electric’s finance unit, McKinsey told its client that money from countries with trade surpluses—such as China and Middle Eastern oil producers—would provide a buffer for the increased lending and leverage for the foreseeable future.36 That advice could not have been more wrong.

  Perhaps in karmic reward for its contribution to the bubble, McKinsey lost money on its own investments in the aftermath. The value of McKinsey’s Supplemental Retirement Plan declined by 21 percent in 2008, shedding $780 million out of a total of $3.8 billion at the start of the year. When it came to investments, the firm’s bust-era results could be as spotty as some of its advice. What’s more, McKinsey could be as gullible as any other investor: The firm lost $193.5 million in the Petters Group Ponzi scheme. On the other hand, McKinsey did manage to benefit from investment banks’ and hedge funds’ rigging of the CDO game, as it had investments in the Magnetar hedge funds, creators of the now-infamous “Magnetar trade.”

  Swiss bank UBS hired McKinsey to help it decide whether or not to enter the leveraged buyout market for midsize companies in 2002. But McKinsey and UBS’s own board dithered over the notion until 2006, when the best idea was to exit middle-market LBOs. “I looked at one of my colleagues and asked him, ‘How do we stop this?’ ” related a former executive of UBS. “He told me that it would take me three years to do so. People thought UBS was risk-averse at the time. I’d say they were decision-averse. They couldn’t pull the trigger without letting McKinsey study something for a year or more.

  “What drove me crazy was that McKinsey knew how screwed up UBS was,” continued the executive. “They knew it. But when I asked them why they didn’t tell the CEO in Zurich or the board of directors, I already knew the answer: telling them would put McKinsey’s job in jeopardy. And that would cut off the $8 million to $10 million they made from us on that single project.” The complaint leads to an important question, which is whether or not Wall Street firms have any business hiring six-month consultants to tell them how to set strategy. If you’re making cars or selling soup, you may have a longer lead time; but trading securities is not conducive to six-month analysis. This is arguably the reason Goldman Sachs has for so long set itself apart from the competition. The company has people who make decisions. They make calls that would have taken UBS two years to consider.

  Since pretty much every bank of importance had hired McKinsey, you had fifty companies in the mid-1990s focused on the same thing—global strategy—at the exact same time.37 The same was true ten years later, raising an interesting issue of systemic risk. While the firm’s fingerprints were once again nowhere to be found in the detritus of the real estate collapse, its consultants had been advisers to many of the companies that both inflated the bubble and collapsed as a result of it. Whatever the specific advice to specific clients, McKinsey had once again failed to give them the best advice of all, which was to go in the direction of less, not more. That makes the value of the advice it did give incidental at best, and destructive at worst.

  What was McKinsey’s response to the crisis? In October 2008 it opened a Center for Managing Uncertainty, headed by Lowell Bryan. This was the same Lowell Bryan who had developed a formidable U.S. banking practice by recommending the same thing to one U.S. bank after another. There was a joke in the New York banking practice: “We will do branch bank network rationalization and keep doing it in bank after bank until the banks have cut too far and the pendulum swings the other way, at which point we will then do a bank branch network expansion study and look for ways for organic expansion, acquisitions, and so on, until the pendulum swings again. Rinse. Repeat.” Repeat studies of the same kind are the consulting world’s cash cows. You don’t need to create selling documents or work documents. Just fill in the frameworks with the client’s data and do the same thing you’ve done before, thereby reaping the benefits of the simplest of equations: Low Cost = High Margins.

  In 2009 the consultants began urging governments to tackle “whole-government transformation”38 to deal with the credit crunch, with the consultants as trail guides on that journey. Oliver Jenkyn, who headed McKinsey’s retail banking practice during the moment of the industry’s worst excesses—in both mortgage and credit card lending—was hired by Visa in August 2009 as its head of strategy and corporate development. Failure to advise properly once again proved no impediment to further engagement.

  In 2009 Edward Liddy, CEO of flailing insurance giant AIG, hired McKinsey to help sort out its multibillion-dollar mess—perhaps because of the goodwill the firm earned while working for him at Allstate. AIG referred to the engagement as Project Destiny. But the consultants failed to gain their usual purchase on the company, a remarkable failure considering the utter crisis that AIG was experiencing at the time. “AIG had workout specialist AlixPartners and McKinsey,” recalled a consultant who also spent time at the insurer. “The Alix guy kept telling management that McKinsey was working in a theoretical vacuum. Alix was the M*A*S*H hospital, McKinsey was the brain surgeon who had no business being in a M*A*S*H hospital.” That made McKinsey expendable when AIG’s situation became increasingly acute: Liddy’s successor, Robert Benmosche, promptly canned the consultants upon taking over as CEO in mid-2009.

  Victims of Their Own Success

  Remarkably, McKinsey didn’t see much of a falloff in its business as a result of the global economic downturn. Revenues, which had flat-lined in 2003 at $3 billion, kept growing right on through the financial crisis, hitting $6 billion in 2008. By that point the firm had eighty-two offices around the world and more than fifteen thousand employees.

  In 2007, at the firm’s partners conference in Singapore, Davis and Michelle Jarrard presented the findings from an internal study of just how the firm had gotten sideswiped by the dot-com bubble. The dot-com boom and bust, which had affected just 5 percent or so of the world economy, hit McKinsey hard. Given the resultant financial squall in Silicon Valley, New York, London, and Scandinavia—McKinsey strongholds—that wasn’t so much of a surprise. But the financial crisis, which hit some 60 percent of the world economy, barely left a scratch. That was due at least in part to Davis and Jarrard focusing the firm on internal controls as well as traditional client development.

  McKinsey found itself facing new questions, though. And one, in particular, began showing up in a number of different guises. Was the firm now so successful—and so big—that it was running the risk of becoming what it had long warned clients against becoming themselves: a hidebound bureaucratic organization that had lost the spark of its youth?

  In 2007 Google knocked McKinsey out of the number one spot
on the Universum MBA student ranking of preferable employers, a spot the consulting firm had held for the previous twelve years. This was certainly due in part to Google’s astounding success, but McKinsey had outlasted any number of pretenders to its throne over the previous decade.

  In 2009 Fortune named McKinsey the fourth-best company in the United States for producing leaders, after IBM, Procter & Gamble, and General Mills. This was no small honor, but also a comedown from the era when McKinsey was viewed as the preeminent creator of leaders the world over. That same year, Google retained the top spot over McKinsey in the Universum survey, a position it maintained through 2012. Adding insult to injury, the annual Glassdoor list of best places to work in 2012—a ranking created entirely from employee reviews—had Bain & Company (number one) placing ahead of McKinsey (number two) for the fourth year in a row. Google is one thing, but such success by a direct competitor is another. According to the website Poets & Quants, in 2011 McKinsey was still the single largest recruiter of MBAs from top schools.39 Whether quality has kept up with quantity is an open question.

  By 2009 McKinsey was attracting a very different crowd, according to some. “It felt deadening,” said one person who worked in a support role for the firm. “Of course, it might not have felt that way to all those MBAs, engrossed in their charts and their teams. They were people who went to good schools but who weren’t very intellectual. They were very successful grinds.

  “I think the fundamental problem at McKinsey is that they have no real product,” she continued. “What do you do when there’s nothing there? You commoditize things that other people consider part of life, like personality and intelligence. You turn them into ‘units.’ They objectify basic human ideas and force them into ‘workflows’ and ‘dichotomies’ and ‘frameworks.’ These are not intellectuals. They are institutional people. They are people who spent a lot of time in the library memorizing things. They may talk of their new ‘framework,’ but it’s not like it’s an electric car or something.”

  The firm tried to continue what was an increasingly transparent illusion of exclusivity. The annual corporate charity run sponsored by JPMorgan Chase requires a company logo on participants’ T-shirts. In 2009 there was substantial (and preposterous) internal debate about whether or not McKinsey should decline because of the requirement.

  More important, McKinsey was now large enough that the possibility of questionable behavior—by both current employees and alumni—began rising coincidentally. In 2007 Chinese police detained twenty-two people in a bribery investigation related to equipment orders that had made its way into McKinsey’s own procurement division. Upon investigation, it turned out that two McKinsey employees had taken $250,000 in bribes from four equipment suppliers.40 And in 2008 Deustche Post CEO and McKinsey alumnus Klaus Zumwinkel resigned in disgrace after getting caught evading some $1.5 million in taxes and appearing on television in handcuffs.

  McKinsey has a long tradition of feigned ignorance of its own financials in favor of obsessing about client needs. Do good work, the saying went, and the numbers would always come through at the end of the year. But that kind of informality doesn’t really work anymore when you’re so big that any line item on your income statement runs in the hundreds of millions or more. In 2008, despite outwardly robust results, McKinsey rolled a third of its partners’ bonuses over to 2009.41 The firm proceeded to slash some $440 million out of support services, including marketing, “reputation,” risk, and IT support.

  Ian Davis had done what he was elected to do, which was to steady McKinsey & Company after the turbulent Gupta years and impose some stringent internal controls. He not only did that; he oversaw continued robust growth. On July 1, 2009, the relatively low-key Dominic Barton, a Canadian who had spent much of his McKinsey career in Asia, succeeded him. Barton was the coauthor of a book titled Dangerous Markets: Managing in Financial Crises. It was an apt title for the era. But Barton soon found himself managing over another kind of crisis entirely.

  11. BREAKING THE COMPACT

  The Mild-Mannered Canadian

  In 2009, Dominic Barton was elected just the eleventh managing director of McKinsey—following in the footsteps of James O. McKinsey, Crockett, Bower, Clee, Walton, McDonald, Daniel, Gluck, Gupta, and Davis. And he is surely the most understated in the firm’s history. Despite his enormous influence in global affairs, he still carries around a bit of the small-town boy from Sardis, a farming community outside Vancouver, British Columbia. Press him, and he will even evince a certain amount of surprise at his being elected at all.

  But he would be the only one to do so. Because once more, McKinsey seemed to have found the managing director fit for the times. On the surface, Barton represents a continuation of the more restrained leadership of Ian Davis. He had been mentored by Davis, after all. And this was clearly what the rank and file was looking for: In one industry survey, he was one of only six CEOs of the top fifty companies to receive a 100 percent approval rating from his employees.1 But he is more than that. If Al McDonald was a dose of tough medicine in the 1970s, Fred Gluck a signal of the importance of expertise in the 1980s, and Rajat Gupta a celebration of global growth in the 1990s, the selection of Dominic Barton showed that, like the rest of the world, McKinsey was turning its attention to the Far East, as a source not just of both clients and consultants, but of ideas about business itself. McKinsey was taking the long view again.

  Our Man in Shanghai

  Barton joined McKinsey in 1986, as part of what was still a relatively rare breed at the time—the new hire without an MBA. Not that he was too far outside the norm—the graduate of the University of British Columbia went on to win a Rhodes scholarship and obtain an MPhil in economics from Oxford. And he had what McKinsey values almost as much as academic degrees and good comportment: a restless curiosity as well as genuine and fruitful interactions with his colleagues. Two years before his election, Barton was the director cited by the most consultants as a mentor. Senior partner Larry Kanarek noticed it at the time but says he didn’t realize he was looking at the 2009 election results twenty-four months in advance.

  In a stark departure from past managing directorships, Barton gave a wide-ranging interview to Canada’s Globe and Mail newspaper just two weeks after taking office. This was the new McKinsey, one that once again proactively maintained strong relationships with journalists, after several years of a much more defensive posture. In the interview, Barton told the reporter of being born and spending his early childhood in Uganda, where his parents—an Anglican missionary and a nurse—were scolded by an army officer for letting their son sneak aboard a Land Rover without permission. That officer: Idi Amin, the future tyrant.2

  While the family did return to Canada—Barton spent the first eleven years of his McKinsey career in the Toronto office—the Ugandan experience had given him wanderlust, and Barton jumped at the chance to move first to Sydney, Australia, and then Seoul, South Korea, when the firm was having trouble finding partners to staff that office. Almost as soon as he arrived, the Asian financial crisis hit, dealing a severe blow to the Korean banking system. For Barton, though, the crisis was a bit of a godsend: With thirty-four of the country’s banks insolvent, his first big project was to help Korea restructure its entire banking system. “The public sector work was exciting,” he recalled. “And then when the entire region was on the move, it was totally enthralling.”3 Barton later ran the firm’s Asian operations out of its Shanghai office before moving to London upon his election as managing director. (Like all McKinsey partners, he’s done quite well financially and keeps homes in Shanghai, London, and Singapore, as well as a summer cottage in Canada’s exclusive Muskoka region.)

  Barton is the polar opposite of Rajat Gupta in terms of academic output. He has written more than eighty articles on Asia alone, and two years after his election he wrote a prescription for the mess that had been made of Western economies, “Capitalism for the Long-Term,” published—where else?—in the Harvard Business R
eview. He is so academically inclined, in fact, that in his early years with the firm, the Toronto office partners informed him that while wearing tweed jackets with elbow patches might play well in the ivory tower, it was a no-no at the firm.

  The paper was a clarion call for business leaders to take control of their own destiny by reforming “the system” before governments exerted control. It was also a reaffirmation of one of McKinsey’s basic tenets: that business should be a force for good, and that it was incumbent on executives to fix the failures of “governance, decision-making, and leadership.” In it, Barton espoused a move from what he called “quarterly capitalism” to “long-term capitalism.”

  “In my view, the most striking difference between East and West is the time frame leaders consider when making major decisions,” he wrote, drawing on the twelve-plus years he’d spent in Asia. “In my discussions with the South Korean president Lee Myung-bak shortly after his election in 2008, he asked us to help come up with a 60-year view of his country’s future . . . [whereas] in the U.S. and Europe, nearsightedness is the norm.”4

  Barton cited McKinsey research that has found that 70 to 90 percent of a company’s market value is related to cash flows expected three or more years into the future. “If the vast majority of most firms’ value depends on results more than three years from now, but management is preoccupied with what’s reportable three months from now, then capitalism has a problem,” he wrote. He even dared touch the third rail of the corporate governance debate, excessive CEO pay, and suggested a number of changes to current approaches, including the idea of evaluating executives over rolling three- or five-year time frames.