The Firm: The Story of McKinsey and Its Secret Influence on American Business (14 page)

McKinsey suffered a financial squeeze in its 1971 fiscal year, as flattening client demand and the expense of opening new offices drained the firm’s cash accounts. The experience revealed the extent to which McKinsey had not prepared for tough times—it had no rigorous cost controls. It also led the firm to resolve that it would borrow only to fund operations. Capital expenditures would have to be self-funded.

The 1970s were not merely an inflection point for the American economy; they were also an inflection point for the American self-image. Company Man finally looked in the mirror and saw what others had long seen: Conformity had its costs, and the flush postwar years had left him fat and lazy. The era of managerialism was coming to a close, to be replaced by a more aggressive, less genteel era of so-called shareholder capitalism. Along with it came an emphasis on leaner companies—and thus less demand for McKinsey’s bread-and-butter
business, organizational consulting. In 1969 the United States was home to forty of the world’s top fifty industrial firms. By 1974 that number had dwindled to less than thirty. Management was indicted—justifiably so—for its failure to prepare for such seismic shifts in the global economy. The auto industry was hit hardest. In 1950 85 percent of
all
cars worldwide were made in the United States. By 1980 Japan had overtaken the United States as the world’s largest producer of cars.
⁶
America was in the throes of its own corporate Pearl Harbor.

Billings disappeared virtually overnight, and McKinsey found itself dealing with its own executive bloat. “Almost overnight, McKinsey’s enormous reservoir of internal self-confidence and even self-satisfaction began to turn into self-doubt and self-criticism,” explained a Harvard Business School case study.
⁷
A 1971 Commission on Firm Aims and Goals concluded that McKinsey had chased growth at the expense of quality.

“We realized that we didn’t have nearly as strong a partner group as we should have, that we had elected a lot of partners who should not be partners, that the [firm] was capable of doing bad work, and that we weren’t necessarily on a winning streak forever,” future managing director Ron Daniel said later. “It was an era of coming to terms with the fact that the giddy growth of the 1960s was over for us.”
⁸
As for Bower, semi-retirement didn’t bring contentment. The firm’s troubles were his troubles, and the years 1967 to 1972 have been called his “dark years,” as the institution he had so painstakingly built struggled for balance.

Lee Walton, a five-foot-seven Texan partial to gold steer cuff links,
⁹
had joined the firm in 1955 after stints in the Air Force and oil industry.
He had worked in the Chicago office, in Venezuela on the Shell project, then in London, Amsterdam, and Chicago again. While he’d been a favorite of Bower, particularly due to his contributions to European expansion, he was no Bower acolyte as managing director. In fact, he pointedly chose not to consult the older man on major decisions, a move he later conceded might have rubbed Bower the wrong way. He even made a ruling or two contrary to Bower’s cherished “professionalisms,” such as when he decided to let Bower’s contemporary John Neukom serve on a few corporate boards while still working at McKinsey. To Bower, such arrangements presented glaring conflicts of interest.

Walton was the first of the second generation of McKinsey leaders. Only forty-two when he was elected, he took the brunt of the frustration that the firm’s older partners surely felt at turning over their creation to a band of ungrateful youngsters. Worse yet, his era as managing director—from 1968 through 1973—was a painful time for the firm, as was that of his successor, Al McDonald. The nine-year period following Bower’s stepping down in 1967 through the election of Ron Daniel in 1976 is quite clearly one the firm would like to forget. McKinsey had to contend with not only lackluster growth, but also the appearance of savvy new competitors.

Walton opened his tenure as head of the firm in a way that has since become tradition. He formed a number of new committees, like the Management Group Administration Committee, to evaluate candidates for advancement to director, as well as compensation for both principals and directors; and the Principal Candidate Evaluation Committee. These were, in effect, his cabinet.

He also devised new ways for the firm to study itself, putting together the Commission on Firm Aims and Goals. (McKinsey’s navel-gazing knows no bounds). A year later, the commission reported that the targeted growth of the firm’s professional staff should be 7 to 8
percent annually, and that its associate-to-partner ratio should be no more than 5 or 6 by 1975. These were reasonable targets, and ones the firm unremittingly stuck to for two decades.

Like the law firms it emulated from the start, McKinsey was fundamentally conservative. But its model of white Protestant males in dark suits counseling other white Protestant males in dark suits was out of sync with the times. The firm responded belatedly to the civil rights movement, not hiring its first black consultants—Bob Holland and Jim Lowry—until 1968. Holland became the firm’s first black principal in 1974, before leaving to become CEO of Ben & Jerry’s in 1981. At the end of the 1990s the firm had just five black principals, and it didn’t name a black director until 2005.

Likewise, women made slow progress up the ranks, due to both internal and external factors. “I remember working for a prominent CEO at the time,” said current McKinsey director Nancy Killefer. “I was pregnant with my first child, and I had to explain to him that I wasn’t disabled, I was just pregnant.”
¹⁰
Four years after hiring its first female associate, the firm put a woman in charge of a study for the first time: in 1968 Mary Falvey headed an engagement for the Insurance Company of North America, a predecessor to CIGNA.

Not long after taking office, Walton told a
New York Times
reporter questioning the firm’s lack of diversity that he, Walton, was evidence of diversity: a Roman Catholic heading a firm that, to that juncture, had been a Protestant stronghold. The company could even count several Jews among its ranks.

McKinsey’s foreign strategy was modeled on its British experience. It seeded the new enterprise with proven American managers and then
tried, over time, to develop a consulting staff of local nationality. By 1969, of the seventy-six consultants in London, fifty-six were British. (Thirteen were American, and eight from elsewhere.) The American presence helped establish and maintain the important one-firm ethos, and the gradual shift to local talent ensured that the firm could relate culturally to its clients, while also providing a buffer against any flare-ups of anti-Americanism.

The problem was that the firm was no longer able to find new clients in huge, critical markets like London. McKinsey was a victim of economic woes but also of its own success: It had successfully reorganized Europe. “Somewhere around 1970, the phone stopped ringing,”
¹¹
said London office manager Hugh Parker.

Christopher McKenna has pointed out that developments in England paralleled those in the United States: Once the decentralization business was done, the firm needed government work to pick up the slack. But that came with major drawbacks. Executives at private companies have occasionally tried to publicly pin their problems on their consultants, but not often, in large part because it might raise the issue of their own competence. Politicians face no such constraints. Savvy cabinet ministers in England love shifting blame to consultants, especially when they have to lay off government workers.

What’s more, the firm was facing up to the fact that some high-profile clients were less than enamored with the work McKinsey had done for them. The firm had been brought into Volkswagen in Germany in 1968 by CEO Kurt Lotz to help with organization and marketing issues, including helping Lotz devise a successor for the “Bug.” But when Ernst Leiding succeeded Lotz in 1971, he fired McKinsey and disregarded all its work to that point.
¹²
Other German manufacturing firms were also abandoning the M-form structure and reverting to earlier organizational forms because McKinsey’s one-size-fits-all model of decentralization had proven more problematic due to a
number of local factors, including the role of the banks in corporate affairs, concentrated shareholders, and the country’s dual system of corporate boards—one of which represented shareholders and the other management.
^13
,
14
The sheen from the 1950s and 1960s had faded. When Parker stepped down as London office manager in 1973,
no one
wanted the job. Jan van den Berg finally filled the vacant position two years later.

By 1972 it was clear that Walton had abjectly failed to restart the McKinsey engine: In fiscal 1972, revenues fell for the first time in a decade. Both the volume of work and the profitability of that work were sagging. What’s more, it was getting more difficult to corral the firm’s far-flung consultants and focus them on common goals. Whereas the Bower era had been marked by centralized power, the Walton era was defined by the opposite. Power migrated to new places. In the mid-1960s, the managers of the Amsterdam, Dusseldorf, London, and Paris offices had become known as the “barons”—a powerful group that wielded growing influence, from hiring to staffing to a tendency to vote as a bloc. Walton’s tenure was described as “weak king, strong baron.”
¹⁵

Remarkably, though, the firm was still able to summon the strength to turn down work when it was obvious that it couldn’t meet Bower’s mandate of having a true impact on a client. One client in the late 1960s was the Railway Express Agency, a national monopoly set up by the U.S. government in 1917 that functioned much like UPS today, except via rail. One of the REA’s predecessor companies was the railway express division of Wells Fargo. When McKinsey consultants visited some storage facilities in New York City to see what the REA had been paying to store over the decades, they discovered about thirty roll-top desks and a couple of stagecoaches. Rod Carnegie, the director in charge of the engagement, resigned immediately. “I remember what his exact words were,” recalled former consultant Logan Cheek. “He said, ‘I lack faith in the client’s ability to execute.’ ”
¹⁶
(Carnegie replied
that the finding of the relics in the warehouse wasn’t
the
reason for resigning the engagement, but that it certainly was an indication of management’s likely inability to “respond to the modern world.”)
¹⁷

If McKinsey was stalling in the early 1970s, Bruce Henderson’s Boston Consulting Group was on a roll. In addition to his four-box matrix, Henderson had recently added a second weapon to his arsenal: the experience curve. Its purpose was to help clients see how costs go down systematically along with experience and market share. For each doubling of experience, the curve suggested, total costs declined by 20 to 30 percent due economies of scale and innovation. This was not rocket science—Henry Ford had long before proven that volume begets cost savings—but a generation of American managers latched on to BCG’s insights for dear life.

Some clients were surely attracted by the eye candy: the charts, graphs, lists, and matrices. And while the idea of strategizing wasn’t even new—there were talented managers who had been “strategizing” for decades—it turned out that most managers couldn’t name their top customer across business units, couldn’t say how profitable that customer was, and couldn’t identify which division was eating more capital than it was creating. Organization Man had been asleep at the wheel.

McKinsey had never imagined that its sophisticated clients could be sold “products” such as the growth-share matrix and the experience curve. Under Bower’s lead, the firm had deliberately avoided flavor-of-the-month ideas, thinking that its clientele wanted smart people, not smartly packaged ideas. It was dead wrong about that. Its clients apparently wanted both.

Black & Decker was a typical BCG client of the time, wrote Walter Kiechel in
The Lords of Strategy
. By using the tools of the experience curve—both analyzing and predicting costs—the consumer product maker took its circular saw business from 50,000 units to 600,000 units, a result of pushing its retail pricing down from $35.00 or so to $19.95. Although the iconic brand at first had trouble with its distributors when it suggested slashing prices, it quickly won converts when it used the curve to show how rapidly increasing volumes negated any margin loss when a market leader used its power to take market share.
¹⁸

The appeal of BCG was in the tangibility of its advice. It was not a process or an intellectual exercise. “While McKinsey was selling its own innate brilliance, BCG was selling products and selling lots of them,”
¹⁹
said business author Stuart Crainer. Henderson took a direct shot at McKinsey when he told a reporter that “good strategy must be based primarily on logic, not . . . on experience derived from intuition.”
²⁰

McKinsey had been through lean times before. But now the firm had to ask itself: Was this our own fault? The Boston Consulting Group had seen the end of the organizational consulting boom coming and had adjusted accordingly by inventing the business of strategy consulting with its growth-share matrix. McKinsey had nothing to counter with, and by the late 1960s, the firm’s client share of the top fifty industrial companies was declining. In 1969 BCG outrecruited McKinsey at Harvard Business School. “[BCG] hurt us by outrecruiting us, and for a while we weren’t even in the contest,” one insider told
BusinessWeek
.
²¹

After the oil crisis, many corporations concluded that long-term planning was meaningless and that BCG had the antidote—a cold, hard look at the present state of affairs. Pretty much every consulting firm abandoned McKinsey’s expansive approach and followed BCG’s lead. Boston Consulting Group spawned Bain & Company and Braxton Associates, as well as Strategic Planning Associates, Kaiser Associates,
and Marakon Associates. Corporate executives had always relied on the experience of the McKinsey crowd. Now they had a second option: the ideas of the BCG retinue. McKinsey had its
Quarterly
; BCG began sending out
Perspectives
, a less substantive but more compelling broadside that didn’t feel like homework. BCG and Bain were the Apple to McKinsey’s Microsoft.