The Firm: The Story of McKinsey and Its Secret Influence on American Business (12 page)

The firm has protected its status as the best by intensive training and review at every level. As early as 1952, the firm had designed a 1,000-point scale for partnership share allocations that included firm development (150 points), leadership (200), recruiting (50), personnel development (100), client introductions (200), tenure (50), prestige clients (125), and building firm reputation (125). There’s something a little ridiculous about such a detailed scale, but it demonstrates a belief in the power of the firm’s own internal processes.

Training went even further than that. In the 1960s, McKinsey reportedly spent nearly $400,000 a year in psychological evaluations of its employees,
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something it continued to do sporadically into the 1990s. Most important, in 1956 the firm abandoned the partnership structure and incorporated. The notion had been considered and rejected in 1949 and again in 1951 by Bower and Crockett out of concern for possible changes in the firm’s character: The more they moved away from pure partnership, they worried, the more removed partners might feel from the institution. They were ultimately persuaded that the advantages outweighed the risks, and when they finally pulled the trigger, it allowed them to offer tax-sheltered profit sharing for employees, more cost-effective ways of handling retirement and death claims, and more tax-efficient accumulation of capital for growth. (Under U.S. partnership law, partners are taxed on their share of earnings, regardless of whether or not those earnings are distributed that year, making reinvestment an after-tax—and thus more expensive—proposition. Incorporation eliminated that issue.)

There were certainly profits to be shared. Marvin Bower drove a Cadillac and lived comfortably in a series of ever-larger houses in the affluent New York suburb of Bronxville. And along with the rest of the industry, McKinsey embraced the notion of staffing leverage as much as any other. In 1960, 176 nonconsulting staff members supported the 165 consultants at McKinsey. In other words, the 42 partners had 300 other people working for them, a “leverage ratio” of seven to one.
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Most consultants can bill a maximum of 2,000 hours per year. Utilization between 80 and 100 percent is considered achievable.
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The challenge of this “pyramid” form is stretching top talent across many projects at once, while fresh-faced Harvard graduates carry on the legwork. Partners then take home the lion’s share of the money earned through the work of junior consultants—a departure from earlier, experience-based consulting firms that had no such junior talent to exploit. Still, if they held on to income, they were nevertheless sacrificing ownership, and this is no small testament to Marvin Bower’s persuasive powers.

Or to his obsessiveness. While Bower always maintained that the first obligation of the consultant is to be financially independent—otherwise you are unable to act in a professional manner—he nevertheless kept his eye on every penny.

Even as he was getting quite old—his wife, Helen, died in 1985, but he lived another eighteen years, to the age of ninety-nine—Bower still stuck around the firm, reminding people of all the little things that made McKinsey great. One former employee recalled traveling to Dusseldorf shortly after starting his job in the early 1980s and receiving a message that Marvin Bower had called. He promptly called Bower back.

“Where are you?” asked Bower.

“In Dusseldorf, sir,” replied the employee.

“Why are you calling me from Dusseldorf?” Bower barked.

“I’m returning your call, sir.”

“Well, you’re going to have to learn to be more responsible with the firm’s money,” Bower said. “My call wasn’t important and could have waited until you’d returned to New York.”

“Yes, sir,” said the employee. “But I didn’t know whether the matter was urgent or not.”

“An unnecessary call is just wasting money,” said Bower, ignoring the logic of the response. “I just wanted to set a time to get together and introduce ourselves. Good-bye.”

The great open secret of the McKinsey business model is that a large part of its success has come by reselling the insights of others. The primary product McKinsey sold, for several decades, was a customized version of the decentralized, multidivisional organizational structure pioneered by the likes of DuPont. Clients know this. In fact, they often engage consulting firms for the very purpose of finding out what the competition is up to. As Christopher McKenna has stated so plainly: “Consultants will carry information in and information out. The client has to decide which of those flows is worth more.”

So it is ironic that the most significant competitive challenge McKinsey has ever faced was a rival firm selling managerial intelligence that came from the very same wellspring, DuPont. In 1963 Bruce Henderson, a veteran of Arthur D. Little, founded the Boston Consulting Group. With a radically simple four-square matrix, he inaugurated the era of “strategy consulting” and sent a shot across McKinsey’s bow that sent the firm reeling for several years.

There was nothing new about “strategizing.” Companies had been doing it for several decades. What distinguished the approach of managers
at DuPont was that they had stopped letting
every
group manager shoot for the moon with aggressive sales projections and instead adjusted their product portfolio—and the capital allocated to each product—on the basis of more realistic and analytically sound projections. This was James McKinsey’s theory in practice: Managers had to prove that they could grow their division through sound budgeting and forecasting. If they couldn’t, they were out of luck. “Around 1965 or so, [strategy] burst onto the scene as the essential discipline of management,” wrote Matthew Stewart. “It became—and has remained—the defining task of CEOs, the copestone course in business education, and the product supplied by the world’s most expensive consultants.”
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Henderson’s insight was to package product portfolio management in an easy-to-consume form. His now legendary “growth-share matrix” suggested that executives look at their products as one of four types: a cash cow (to be milked), a rising star that needed that same cash to grow, a dog that needed to be put down, and a question mark that needed further study. By reducing a complicated corporation to a simple, one-page chart, Henderson had out-McKinseyed McKinsey. Major decisions could be made with clarity and confidence. This division is a rising star? Then throw more money at it! This one is a dog? Put the thing out of its misery! And this one’s a cash cow? Let’s crank prices up and milk the thing for all it’s worth before its time has passed!

Strategy was the answer to the end of the decentralization era. Most large companies had already reorganized. What top management needed now was justification for their own nonoperational jobs. Companies might actually make or do something real at the end of the day, but the self-reinforcing management/consulting relationship lived in its own parallel universe.

This new focus on strategy unleashed a torrent of concepts, and reinvigorated the business-school curriculum. Whether it was Total
Quality Management or Management by Objectives, a cycle of management ideas had begun. Peter Drucker, who once claimed to have “invented” management, was its first truly famous purveyor. His 1946 book on General Motors,
Concept of the Corporation
, put him on the map as a management theorist, and a half century of demand for his teaching and consulting services followed. Others came after, most famously Harvard’s Michael Porter, but most of the new theories—including Porter’s famous Five Forces—were new recipes from the age-old ingredients: product, customer, supplier, and competitor. And they all had the very same goal: how one could contemplate one’s competitive position in a brand-new light.

There’s no shame in recycling, as long as you finesse it properly. McKinsey earned great acclaim in the 1990s for arguing that companies in the United States were engaged in a war for talent. No matter that the Carnegie Corporation in 1956 had decreed the existence of the Great Talent Hunt. If three decades have passed, any management idea is fair game for reconstitution, which is just what Henderson did with insights DuPont had figured out in the 1930s. McKinsey didn’t know it yet—and disdainfully dismissed Henderson’s firm for nearly a decade after its founding—but the ground was moving beneath its feet.

By the end of the 1960s, McKinsey was working for so many companies that clients started to worry about conflicts of interest. Some refused to keep hiring its consultants if they worked with direct competitors. What was the professional response? Bain & Company, another new consultancy founded in 1973, took the view that it was proper to serve just a single major client in any industry. McKinsey
came to the opposite conclusion: that to truly understand an industry, the firm needed to work for any and all comers.

This issue had come up a few times over the years. In 1960 the CEO of Texaco—then McKinsey’s largest client—had demanded that the firm drop Socony Mobil, Union Oil, and Sun Oil. The consultants balked, and Texaco backed down.
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The petroleum company had enjoyed such success in cost cutting with the help of McKinsey that, when faced with the repercussions of its demands, it relented. Therein is one of the closely guarded secrets of McKinsey: As much as it might tout its expertise in top-level strategic thinking, it is often most valuable to its gigantic corporate clients in finding new ways to slash costs. There may be no better army of cost cutters on the planet.

In the late 1960s, McKinsey faced a similar showdown with Citicorp, which did not want to share a consulting firm with its archrival Chase Manhattan. This time things didn’t go quite so smoothly. “We were very well on the road to building Citicorp into quite an attractive long-term client when, lo and behold, we received an inquiry from David Rockefeller, who was then the chairman and CEO of Chase,” recalled Jon Katzenbach. “We decided that we should be able to serve both banks because we have a policy of serving competitors. In fact this single event is one of the most interesting tests of that policy. The firm decided to go ahead and serve Chase. [Citicorp CEO Walter] Wriston made good his threat. We were fifteen years without ever doing a piece of work over there.”
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That setback aside, McKinsey’s work with Citicorp is a showcase of its ability to reach into all aspects of its clients’ businesses. First, McKinsey helped organize the bank around discrete markets—retail, wholesale, and private—rather than functions: lending, deposits, and processing. Then it was on to strategy, planning in particular for the coming wave of deregulation that allowed the New York–based company
to grow into a financial services conglomerate. Such contemplation entailed endless possibilities and therefore endless work.

A February 1965 story in
Fortune
by Walter Guzzardi Jr.—“Consultants: The Men Who Came to Dinner”—outlined a development that had actually begun in the 1950s. The title was a riff on the hit 1939 play
The Man Who Came to Dinner
, about an acerbic houseguest who breaks his hip and is put up in order to convalesce but who presumably never leaves. In like manner, once they get their hooks into a client, McKinsey consultants never let go. “The best of the management consultants scorn[s] the hard sell as unnecessary and ineffective,” wrote Guzzardi. “He scoffs at the standard soft sell as unimaginative and unworthy. True to the traditions of his craft, the big-time management consultant has invented something new: the self-perpetuating sell.”
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Citibank and Mobil were two of the firm’s first megaclients—the latter in particular provided a river of consulting assignments from the 1950s through the 1970s—but many more followed. A late 1960s boom in mergers and acquisitions had developed into a full-grown mania by decade’s end. Whereas in 1965 there were 2,000 such transactions in the United States, in 1969 there were more than 6,000. (That number dropped to 2,861 in 1974, in line with a collapsing economy, but for the time being the M&A market was on fire.)
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Chief executives buying businesses that they had no business buying were suddenly in great need of outside help—thus, there was even more demand for consulting. The pell-mell buying and selling of companies for diversification purposes among American conglomerates soon spawned its own evil offspring—Wall Street’s business of buying and selling businesses themselves.

There were missteps. The firm lost Philip Morris as a client for a time after McKinsey consulted with New York City about a tax on
cigarettes based on their tar and nicotine levels. The McKinsey motto, “The client before anything” can clearly run into complications when two clients are seeking precisely opposite outcomes. But that was a rare instance. McKinsey has almost invariably won in stare-downs with clients who insist on exclusivity, something that McKinsey has steadfastly refused to offer.

And why not? Because for an extended moment, it surely seemed as if the sky was the limit, that double-digit annual growth could continue unabated. Consulting—and McKinsey in particular—was now a part of the American establishment. In 1965
BusinessWeek
pointed out that there was one consultant for every hundred “managers” in the country. (By 1995 it was one for every thirteen.)
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“To hear some consultants tell of it,”
Fortune
magazine added, “their appearance on the scene ranks with the Second Coming.”
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McKinsey had become a luxury brand, and luxury brands do not apologize or explain. Considered in that light, the firm’s high fees were justified for their own sake. Said a colonel in the U.S. Air Force, a McKinsey client at the time: “Consultants lend a lot more credibility to what you’re doing. A fellow who works for us at a billing rate that amounts to $166,000 a year is making ten times my salary. This lends him a certain amount of stature. You can use a consultant as a communications aid.”
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In other words, when you hire McKinsey, your employees should know that you’re not kidding around anymore. Still, it’s a costly communications aid: McKinsey charged clients three times what it paid its consultants, to cover salary, overhead, and profit. In that light, there’s another way to look at it: Hiring McKinsey was a sign of affluence.