The Firm: The Story of McKinsey and Its Secret Influence on American Business (35 page)

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.”

McKinsey also suddenly found itself overstaffed: MBA acceptance rates had been steadily dropping due to competing opportunities, but in 2000 the trend reversed itself. McKinsey had made 3,100 offers that year, expecting 2,000 acceptances. More than 2,700 people accepted. As dot-com ventures suddenly appeared risky again, the firm found itself in the middle of a flight to quality by MBAs now looking for stability again. Attrition at the same time plummeted to a mere 5 percent. As these factors were combined with falling demand, the result was that McKinsey was carrying too many employees—the firm calculated at one point that it was overstaffed to the tune of about two thousand consultants—and consultant utilization fell to its lowest level in thirty-two years: just 52 percent, versus some 64 percent a few years earlier.
⁵⁶
In other words, half of the consultants were getting paid to do nothing.

“We honored every offer and didn’t push people out,” Gupta told
BusinessWeek
. “And we had no professional layoffs other than our traditional up-or-out stuff.” That just wasn’t true: In 2001, 9 percent of associates and analysts were “counseled out” of the firm, versus just 3 percent in 2000.
⁵⁷
McKinsey shrunk considerably over the next few years, with the number of consultants falling from 7,631 in 2001 to 5,638 in 2004. The firm’s North American staff declined by 40 percent, while Europe and Asia each fell 15 percent.

The experience revealed the downside of McKinsey’s cherished ethos of hiring good people and just letting them do their thing. When you employ ten thousand people around the world, and you let local offices take care of their own hiring without any centralized oversight—or, equally important, without centralized financial planning—the entire institution can be put at real economic risk by a sudden external change. And that’s what happened. The firm got ahead of itself, grew too quickly, and chased some clients it shouldn’t have. At one point, associates were leaving with just a week’s notice in
the middle of studies. Partners were furious with them for not honoring their professional obligations. And then, when the downturn came, associates were angry about getting neither bonuses nor the kind of exposure to CEOs that McKinsey promises. If the contract between associates and partners wasn’t broken, it was at least cracked.

Still, for all the consternation over the Gupta era at McKinsey, the downturn proved just a blip in the top line. Even before Gupta turned over the reins to Ian Davis, the business had turned a corner and begun to accelerate. From a trough of $3 billion in 2002 billings, the consultants
doubled
revenues, to $6 billion by 2008. Even in the immediate wake of Enron, clients were still lining up for advice. The British Ministry of Defense hired McKinsey in May 2002 to help streamline “performance” of its $6 billion Defense Logistics Organization.
⁵⁸

Marvin Bower died on January 22, 2003, at the age of ninety-nine and a half. “I told him he’d lived to his hundredth year, and that it was time to let go,” said his son Dick.
⁵⁹
Bower had outlived by four years his second wife, Clothilde de Veze Stewart, whom he’d married three years after his first wife, Helen, had passed away.

Rajat Gupta delivered the last of five eulogies in the Reformed Church of Bronxville, New York. “[Marvin had] a vision of a profession that did not exist,” he said. “[He] sensed the opportunity in our profession, defined our aspirations, formulated our values and led our firm. . . . In many ways, certainly in spirit and soul, Marvin continued to lead it after he retired, and he leads it still.”

While obviously heartfelt, the words were laced with irony—because the McKinsey of 2003 was no longer Marvin Bower’s McKinsey.
It was Rajat Gupta’s. “Bower gave the firm its principles,” said one McKinsey veteran. “Ron Daniel gave it class. Fred Gluck gave it intellectualism. And Rajat? Don’t ask me, because I haven’t a clue, except maybe Kremlinesque politics.”

Bower had turned consulting from a business into a profession, and McKinsey into its standard-bearer. His final reward? He got to see Rajat Gupta and Gupta’s cohort turn it back into a business. The institution survived, but the cherished values fell by the wayside. Rajat Gupta’s McKinsey was a business—not a profession—and that’s all there was to it. It was, of course, a remarkably successful business, and the charitable view of Gupta’s tenure can hardly ignore the firm’s continued growth and deepening influence across the globe, as well as the exponential change in the partnership’s wealth.

Of course, half a decade later—when he’d already quietly left through the side door—Rajat Gupta did more damage to McKinsey than he’d ever done sitting in the corner office. In 2012 he was convicted of insider trading—at least some of which activity had taken place while he still had an office at McKinsey.

In the 2000 election for managing partner of McKinsey, Rajat Gupta put back a surge—from Ian Davis, then head of the London office; and Michael Patsolos-Fox, who was head of New York—in order to win his third and final term. An affable, polite Brit who had been at McKinsey since 1979, Davis had stood—unequivocally—for a return to Boweresque values and a pullback from the more commercial tilt of the past decade. But Gupta won the challenge. It was 2000, after all, and the full report on the dot-com mirage had not yet been filed.

Three years later, with Gupta unable to run for a fourth term, Davis and Patsolos-Fox faced off again. On Friday, February 27, 2003, the
Economist
ran a story on the coming election that Sunday. “Do not be fooled by the polite, low-key tone,” the magazine wrote. “Next week’s announcement will mark a critical moment in the [firm’s] history.”

The magazine wrote that Davis “wears his ambition lightly but is deeply committed to the firm’s traditional values, in particular the need to invest in long-term relationships with clients and to nurture the associates who represent the firm’s future.”
¹
This was a gift-wrapped
endorsement that had obviously been helped along by loose lips within the firm. The magazine didn’t criticize Patsolos-Fox; it merely positioned him as more of a continuation of the Gupta era. At a time when the firm’s 280 senior partners no longer knew each and every one of their colleagues, the article surely helped tilt the election in Davis’s favor.

Patsolos-Fox didn’t come out too badly: Davis made him head of the firm’s American practice as a consolation. Likewise, when Don Waite lost out to Gupta, he’d been made the firm’s chief financial officer. The majority of people who lose in McKinsey elections
don’t
leave the firm in a fit of pique. “Where would they go, anyway?” asked a former partner. “If you’ve been at McKinsey for twenty-five years, you’re making $3 million to $5 million a year. There are not a lot of places you are going to go to, unless someone is going to make you CEO of a major company.”