McKinsey – the Insider Company (Part 1)
Their business is based upon trust. They penetrate the innermost parts of a client's firm. They are analysts, concept designers, psychotherapists and sparring partners – all-in-one. It is hard to believe they would gamble their most valuable asset – trust – yet that actually happened. And it happened to the number one in the sector – McKinsey & Company Inc.
In October 2012, a US federal court in New York found McKinsey's long-standing boss guilty of selling confidential information to a hedge fund manager. Rajat Gupta was jailed for two years and fined $5 million. The world's top consultant, with private wealth estimated at $100 million, was downed by his own greed and arrogance. He abused the trust placed in him and handed confidential information to a criminal financial manipulator for a big bundle of dollars.
This startling misdemeanor could, perhaps, be excused as an isolated incident – if Rajat Gupta was the only swindler and cheat, if his burning ambition and lust for power was unusual. Unfortunately it was not unusual, it was typical of McKinsey(1).
The persona is impressive
Rajat Gupta, the son of a Montessori school teacher, graduated from Harvard Business School in 1973 and then worked at McKinsey, 'the Firm', for 34 years. In 1994, Gupta(2) became the first non-US citizen to be elected Managing Director of McKinsey. He was voted 'Mr. McKinsey' for three consecutive terms (1994-2003) – the maximum allowed by company rules. Gupta remained Senior Director with Special Responsibilities until 2007. Gupta's re-elections were facilitated by his inter-cultural background and elegant manners, but a decisive criterion was his promise to act as servant of the Partners. At first Gupta kept that promise: during his time as boss Partner salaries tripled. Gupta himself accrued great wealth and property including three prestigious residences and a ranch.
The business is mysterious
McKinsey (founded 1926) is the biggest, most famous, most international, and supposedly the most discrete consultancy of all. With around 17,000 staff (9,000 Consultants, 1,000 Partners and 400 Directors) and annual revenues of $6 billion in 53 countries, McKinsey is the size of a major conglomerate. Two-thirds of the largest US corporations (and most German DAX companies) are McKinsey clients. Under Gupta's leadership, it grew rapidly and soon became truly global(3). Between 1994 and 2000, the number of Consultants and Partners rose by 250 percent and the number of local offices rose from 58 in 24 countries to 81 in 44 countries. This accelerated growth would not have been possible without first changing the firm's philosophy and diluting its quality standards(4). These had been defined and upheld by long-time boss and father-figure Marvin Bower (born 1933, died 1995) who was Managing Director from 1950-1967(5). Bower's parting words upon leaving McKinsey are memorable, "My departing wishes are, ... secondly, that our Directors and Partners speak out loud if they have the slightest doubt that we are doing something which contradicts our ever-lasting values of professionalism or ignores and degrades these values; and thirdly, that you stand up to be counted if these principles which constitute our philosophy are no longer being obeyed."
That appeal was soon forgotten. Subsequently, the high standards expected of applicants were lowered, contracts and customers were bought (special discounts on fees), equity in start-up firms acquired (equity instead of fees), clients paid for McKinsey reports to be published (the Excellent Companies report 1980 was co-financed by Siemens), and it set up its own business accelerators(6). Gradually more and more cases of business failures and insolvencies also came to light. One tactic in this aggressive drive for growth was to get close to political parties, and to interact professionally and socially in Washington. McKinsey played a prominent role in the election campaign teams of Bush and Obama. In short, conflicts of interest were no longer taboo, they were accepted. All that mattered now was fees and margins(7).
The circumstances are strange
It was almost by coincidence that the Galleon-Gupta Connection was exposed. The U.S. Securities and Exchange Commission (SEC), which enforces federal securities laws, was investigating reports of stock market manipulation by hedge funds. Forensic analyses by the FBI – extensive mobile phone monitoring and analyses of trading – confirmed the initial suspicions of a comprehensive insider trading network. The Galleon case, named after the accused hedge fund, soon became the biggest insider scandal in the U.S.A. for 30 years. Gupta was investigated for passing on confidential information. In September 2008, immediately after attending a Goldman Sachs board meeting, Gupta had informed his cronies of a deal with Warren Buffet. And this at Goldman Sachs which, more than any other bank, prides itself, just like McKinsey, on being discrete and highly professional. To top it all, this took place at the height of the global financial crisis(8). Upon appointing Gupta to its board, Goldman Sachs had promised that, "Our shareholders will be fortunate to have his strategic and operational expertise and judgment." What his appointment actually did was to cost Goldman Sachs a lot of money, because the bank's executives had previously committed the bank to paying the legal fees of board members. Consequently, the bank was accountable for the advance fee of over $30 million for Gupta's defense. Over-confident to the last, Gupta said that if found guilty of insider dealing, he would gladly repay Goldman Sachs these legal costs. The accused, now being presented as a philanthropist and humanitarian, was supported by prominent and powerful friends: Bill Gates, whose trust Gupta worked for, Kofi Annan, former U.N. President whom Gupta personally advised, and hundreds of Friends of Rajat Gupta for Fair Play and Justice who attested his human qualities(9). A prominent defense lawyer, Gary Naftali, grandly declared, "He has always acted with honesty and integrity". Gupta was still found guilty, but his two-year sentence was a mild one(10).
The behavior is symptomatic
While Gupta was still Senior Director at McKinsey, he had invested personally in equity stock – a violation of McKinsey's company rules. Later attempts to become a Partner at the largest private equity player KKR (Kohlberg, Kravis, Roberts) came to nothing. Finally, he joined up with his friend and the owner of Galleon hedge fund Raj Rajaratnam(11).
People who knew Gupta concurred that his declared aim was to join the Billionaires' Circle: mainly owners or partners in private equity firms and hedge funds in New York. He wanted to join the 'big-time movers and shakers' and pocket $100 million (within 5 to 10 years) with ease. Bala Balachandran, a business professor who had known Gupta for 30 years, is said to have warned him, "... if you are in a herd of pigs, you will also smell." Whether this referred to McKinsey or Goldman Sachs is not known. Devoured by greed, Gupta ignored Balachandran's advice. If it was only fame he desired, he already had enough: he held numerous chairs or board memberships at universities (Yale, Chicago, Wharton and Harvard), at trusts (above all Bill & Melinda Gates), at health organizations (above all The Global Fund to Fight AIDS, Tuberculosis and Malaria) and was Chairman of the International Chamber of Commerce(12).
Gupta – not an isolated incident
At the same time as Gupta, his minion Anil Kumar also pleaded guilty to passing on confidential information about clients. Kumar, as Senior Director, was a big number at McKinsey: he was joint founder of the Silicon Valley office, Account Manager for AMD, eBay, Business Objects, Cisco, Samsung and other high-tech firms. In one instance, secret strategy papers of two fierce rivals, AMD and Intel, were given to the other. Kumar, disliked for his arrogance, said he had repented and therefore wanted to act as witness for the prosecution. Kumar, whose annual income was nearly $10 million, admitted misappropriating $500,000 that belonged to Raj Rajaratnam (billionaire founder of the Galleon Group) and therefore felt obliged to do him a favor in return, or so he said. A third McKinsey Partner and Director (top executive level), David Placek, the Head of Semiconductor Practice, also joined their Insider Circle (or was about to join it). His sudden death left many questions unanswered.
Is it wrong to call this "systematic parasitism"? After all, McKinsey's foundation of trust was nothing but PR-speak. Any self-respecting executive manager who is considering some consulting therapy should ask themselves: was Gupta really an isolated incident or a symptom of a system?
Parasitic value extraction
A managing director of Goldman Sachs once called McKinsey, "the psychiatrist-in-chief for corporate America". If that is true, then Gupta was the chief psychiatrist who wanted more, and thought he knew how to get it. As the gold mine of prospective clients (industrial conglomerates and banks) became exhausted(13), McKinsey aggressively attacked the government sector: education authorities and state-owned financial institutes were targeted. Then another new sector emerged in the 1990s: private equity firms. Next came the hedge funds sector and these were swiftly identified as potential wealthy clients who were big movers, familiar with huge fees, but publicity shy. Major private trusts were also welcome clients because McKinsey believed its own brand of professionalism was uniquely suited to serve the aims of private trusts. But the list is not complete: churches were also targeted, as evidenced by the activities of Fred Gluck, a former McKinsey boss, who is joint founder of the National Leadership Roundtable on Church Management.
McKinsey's business model is continually expanding. The company has comprehensive sector knowledge and insights on the inner workings of most big corporations. The use of tried-and-tested Best Practice Groups ensures client care and an uninterrupted exchange of know-how about different sectors, technologies, processes, methods and tools which has been gradually intensified and internationalized. Knowledge is an asset that must be kept in continuous circulation so that it can be fully exploited to benefit McKinsey. Over time it becomes increasingly easier to acquire new clients thanks to this huge pool of in-house knowledge. It can be used to demonstrate to potential clients what advantages an admired or hated competitor has, and how McKinsey can help develop an urgent counter-strategy, which is shown to be essential. Thus the consulting firm became an information broker, working on its own account while offering total discretion and strictly separate (firewall) client teams(14).This story is still successfully sold to eager new clients. Observers may well ask how managers are so easily talked into buying a product which consists of two seemingly incompatible parts: openly accessible business school theory and exclusive professional knowledge.
The burning ambition and 'smartness' of McKinsey's Partners drives them to want ever more money and influence: Who else can I outsmart? The 'Firm' is number one in the consulting sector, but there are other businesses where 'partners' can still earn a lot more: the top private equity and hedge fund companies. However, only one firm has more overall influence than McKinsey and that is Goldman Sachs. That fact tempted McKinsey to venture beyond consulting and attempt to broker big deals, to 'befriend' CEOs and to prompt them to 'think big'(15). You can earn a lot more money on business deals than on business consulting. This is why 'Mackies' continued to abandon ship for the extra money on offer elsewhere(16). This was especially true during the age of internet hype, when many McKinsey offices in California, and in Germany, quickly emptied. Then venture capital became the place to be, closed followed by private equity, and then money transactions. Many McKinsey 'alumni' were soon to be found in this sector. Next in line were hedge funds(17) and that is where Gupta came to grief. These are all constellations of (money) value extraction in its highest form.
Despite declarations to the contrary, those who join McKinsey as business consultants do have a common characteristic: greed and arrogance.
McKinsey and Enron – a close relationship
Americans talk about evil companies when lying and cheating occur, when responsible officers submit to greed and a lust for power. Nowadays this is common, although never openly admitted. A good (or rather bad) example of this is Enron: an energy business that mutated into a derivates trader, and was one of the most highly capitalized corporation in the world.
So who actually planned Enron's transformation and who continuously and closely accompanied it during this transformation? No prizes for guessing the correct answer. In the media McKinsey was referred to as "The firm that built Enron". In fact, McKinsey considered Enron to be the real-world prototype of a business which was asset light (minimum capital assets and minimum value added). Loose-tight leadership (in fact, a contradictory concept of entrepreneurial freedom and strict supervision, but it sounds good), off-balance-sheet vehicles (to shrink the balance sheet, hide risks, and personally enrich Enron top management), and a mark-to-market valuation method(18). Overall it was said to be, "... the model of a new way to do business". A core element introduced to benefit Enron management was the 'individualistic performance culture' favored and advocated by McKinsey. They opened the door wide open for egomaniacs and self-promoters to claim successes of subordinates for themselves and to blame others for any failures. The McKinsey Quarterly even declared the following: "New breed of tightly focused and vertically specialized Petropreneurs; ... built a reputation as one of the world's most innovative companies by attacking and atomizing traditional industry structures."
At many business schools, first and foremost Harvard, Enron had an excellent reputation as the innovator of business models. Coincidentally, in the years prior to its bankruptcy, Enron was world leader in hiring MBAs. Enron also became known as the MBA Company consulted by McKinsey. Three McKinsey Account Managers were assigned to Enron including Richard N. Foster who even attended Enron board meetings. Enron's future President and COO, Jeffrey K. Skilling (one those McKinsey Account Managers) was hired by CEO Kenneth Lay to head one of the fastest growing Enron divisions. Skilling was one of the youngest ever McKinsey Partners and an exemplary alumnus. His character is summed up by his own words upon being admitted to Harvard Business School: "I am fucking smart". Skilling's career came to a halt when he was accused of 35 serious offences: perjury, insider trading, and other white-collar crimes. Skilling was sentenced to 24 years in prison. Just like Gupta, Skilling denied all the accusations. The appeal proceedings and defense costs amounted to over $70 million, at time of writing.
Unlike auditing firm Arthur Andersen LL, then one of the big four accounting partnerships, McKinsey somehow emerged unscathed from the Enron disaster, despite its long-time close engagement with Enron, which was a huge surprise for many observers(20). Arthur Andersen, on the other hand, was found guilty of shredding documents and then crashed into insolvency.
While a whole book could be written about the fraud, deceit and unbridled egoism of Enron managers, the full extent of McKinsey's insider role will never be revealed.
We are special: painfully expensive and smarter than you
Advice from McKinsey is not cheap. A McKinsey consultant costs on average $3,000 per day. A Senior Consultant can cost three-times that(21). Smaller consulting projects can cost around $200,000 per month. Major projects such as reorganizing the procurement function of a global corporation can cost well over $10 million(22). The McKinsey business is profitable especially for Partners and Directors: Partners earn over $1 million annually and Directors pocket a multiple of that. This is due to the McKinsey fee system, which functions like a system-sales scheme. High-rankers are rewarded disproportionately and the gap to the bottom level is often over 200 percent, whereby variable components play a key role (23). Those on the bottom rung are well paid compared to others elsewhere in the same age group who are equally educated and motivated. However the average annual starting salary of €80,000(including all elements of pay) is not actually excessive given the working hours and time commitment expected. Another incentive for status-conscious beginners is not just money but the dress code, accommodation and travel arrangements on offer: it's just like being a 'junior' CEO. According to former McKinsey workers, what really clinches it is the prospect of a first-rate job subsequently and permanent membership in an exclusive club.
McKinsey gives a high priority to customer loyalty: also aptly called customer capture. This is facilitated by tactics such as unsolicited offers of McKinsey studies, continual references to the 'strategic moves' of competitors (or competitor countries/ economic regions) and the newest 'discoveries' from science and technology, as well as gossip on colleagues and competitors. The dramatization of threats and the dissemination of uncertainty and sketching of problems, which are called 'challenges', is a common McKinsey tactic; another is claiming that the expertise of the client and his/her management and staff is inferior and out-of-date.
The most important business acquisition strategy of McKinsey is to build a network of contacts within client organizations. This can mean placing McKinsey 'alumni' in corporate units which have 'consulting' roles: in-house departments like Corporate Development, Mergers & Acquisitions, Controlling and Consulting. This gains McKinsey early warning of any upcoming consulting work and builds entry barriers against competitors. Inserting a McKinsey Key Account Manager(24) in a client's corporate management is an excellent result. This was achieved at Siemens. An even better result was scored at Deutsche Post, under CEO Zumwinkel (ex-McKinsey), with three former McKinsey consultants appointed to the Executive Board. This clever tactic, strangely ignored by business media, can also be described as embracing, befriending, encircling or stalking.
Another tried and tested McKinsey tactic is to address topics: in other words to adopt, package and sell new social trends(25). A current example is diversity, which all major companies feel obliged to consider – at least in their PR. To launch this campaign, McKinsey published a global study of 180 corporations, which came to the conclusion that diverse companies (using McKinsey's own definition of diverse) demonstrate a performance capability two-thirds higher. Armed with these self-made facts, a cross-party alliance of interests is set up in each country: for example, the ministry for families, major business companies (with close McKinsey connections), and other interested organizations join a project association. The next stage is the roll-out: the selling of consulting 'solutions' to business corporations, government institutions and agencies(26) who wish to appear progressive and generous. Then, with everyone 'embracing' and 'owning' this social good, and in alliance with prominent stakeholders, the corporate engineering can begin (27).
The McKinsey solutions toolbox includes well-know formulas: for rail companies (Railtrak Group plc) cut infrastructure spending; for automobile and household insurance firms be tough on claimants ( "from good hand to boxing gloves")(28); for public schools cut 'high cost' teacher pay and privatize under-performing schools (i.e. the lower 25 percent). In situations where businesses miss claimed or actual developments, massive 'catch-up programs' are recommended, as they were during the dot-com boom. Later banks were advised to enter the investment banking sector, and then to develop and offer structured products. Such advice was willingly followed by German banks, and later resulted in massive write-offs.
These projects gradually took on ever bigger dimensions: examples are transformation programs under the 'world class' label for whole operating divisions or diversification programs for entire corporations(29). Mega-projects include facilitating the consolidation of whole sectors of the economy, preferably the infrastructure, such as post and telecommunications. A favorite tactic emerged: whereas the scope of projects was previously rather narrow, they usually also included follow-on projects: over the past 20 years, these follow-on projects are incorporated from the start, and therefore the scope of projects is now much larger.
The outcome is managerism
A lot has been said about firms who hire consultants like McKinsey to do their management work for them. To find out why, just compare serial-clients and non-clients. A business with weak corporate supervision, is a public corporation, is headed by an MBA or executive management made up largely of MBAs, with externally hired managers (careerists) at the top, is likely to become a McKinsey serial-client. It is run by managers who play safe and take no risks, who reinforce the gap to subordinates, and keep them at a distance, and make sure that any incompetence is well hidden (close control of PR by top executives helps). Alibis are also essential ("McKinsey recommended it!"): something that plays into the hands of external consultants. And no other business consultancy is as keenly aware of this as McKinsey.
These behavioral characteristics show how businesses controlled by managerists are easy prey to management consultants, whereas businesses controlled by owner-entrepreneurs or manager-entrepreneurs, typical for the German mittelstand (SMEs), where operational control is still in the hands of people who are able and willing to be both responsible and accountable, are usually more consulting resistant. Surely the time has come for business schools (who teach 'management science') to rigorously compare business performance pre- and post-McKinsey and also to seriously question the current state of corporate supervision.
Managerism is a form of behavior that can be directly traced to the triad of CEOs/board members, equity fund managers and management consultants. Commercial behavior recommended by McKinsey is an inappropriate form of Anglo-Saxon business methods: it prioritizes short-term thinking, promotes managerism as well as selfish and narcissist managers and weakens solidarity in organizations. McKinsey spreads managerism to public corporations and government agencies, and thereby infects the economy and civil society as a whole.
Part 1 analyzes the impact of McKinsey and similar firms, mainly in the U.S.A.
Part 2 will consider their role and influence on business and politics in Germany.
The purpose of this Thinkpiece is to open the McKinsey veil of secrecy and declare a rightful civil interest in knowing what effect this powerful consulting business is having not just on businesses but also on the economy and society as a whole. It challenges the media to ensure greater transparency.
(1) This case was presented by the US media, almost without exception, as the failing of an individual. The German media devoted one of two transcripted press agency reports to this 'story'. McKinsey kept its head down the whole time. Its most important clients were pacified at confidential meetings.
(2) Gupta means war lord. The Guptas were a dynasty (line of rulers) in India.
(3) See Walter Kiechel III, former Editorial Director of Harvard Business Publishing and Managing Editor of Fortune, author of The Lords of Strategy: The Secret Intellectual History of the New Corporate World (2010), Harvard Business Press. This is a book that elaborates the history and hyperbole of strategy consulting.
(4) Core Principles (1937): "A McKinsey consultant is supposed to put the interests of his client ahead of increasing The Firm's revenues; he should keep his mouth shut about his client's affairs; he should tell the truth and not be afraid to challenge a client's opinion; and he should only agree to perform work that he feels is both necessary and something McKinsey can do well".
(5) Marvin Bower (1903-2003) studied law (Harvard Law School and Harvard Business School) and specialized in the professional standards of reputable legal practices. He was known as the "Father of Modern Management Consulting". Robert H. Waterman, a Senior Partner, famous for his best-selling book In Search of Excellence, was opposed to the new 'drive for growth' strategy: he subsequently left the company.
(6) The business incubators planned worldwide should help McKinsey to broker not only Startup Consulting Services but also Recruiting, Legal, Financial, Marketing and PR and – the decisive factor – earn a lot from these accelerated IPOs.
(7) The similarities to Goldman Sachs are clear: in particular the transition from a Partner Investment Bank to a public finance corporation with a strongly expanding trading business including own-account business.
(8) A similar case of insider dealing took place at Procter & Gamble.
(9) Including alumni of the Indian School of Business in Hyderabad. At an inauguration ceremony, Gupta propagated selflessness: "Try to make other people successful."
(10) Compared to the eleven years of Rajaratnam
(11) Gupta attempted to win hedge funds as clients for McKinsey.
(12) See http://managerismus.com/en/kommentare/aktuell/28-kommentare/aktuell/96-ikone-der-korrektheit-und-professionalitaet-tief-gefallen-ex-chef-gupta-und-weitere-mckinsey-leute-angeklagt
(13) The claim that strategy consultants contributed to the deindustrialization of the USA is justified: Thinkpiece No. 8
(14) This has similarities with certain investment banks who claim to completely separate Analysis and Trading. They deny that any conflict of interest exists.
(15) An example of this in Germany was Jürgen Schrempp, who was advised by both McKinsey and Goldman Sachs. The former McKinsey Partner Alexander Dibelius was appointed a Partner at Goldman Sachs as a result of the Chrysler deal and is still the most active and best-connected dealer in the German-speaking area.
(16) Insiders refer to this as "pigging out."
(17) In recent years, twenty five of the highest-earning hedge fund managers pocketed more than the CEOs of the 500 largest US corporations combined. Whereas Rockefeller and Carnegie from the real economy were once the richest US citizens, more recently people from the financial economy who are 'good at figures' lead the rankings.
(18) E.ON decided against an equity holding because a PWC audit assessed these "off-balance vehicles" as secretive and critical. Using the "mark-to-market" method the assumed future profit on an order is booked at the current value (instead of booking only the accrued costs).
(19) Before its collapse, Enron even ventured into the "chip trade" (trading in cyclical D-RAM semiconductors).
(20) Some believe that McKinsey's role was overshadowed by Andersen's catastrophe.
(21) Compare this to the often criticized daily rate for a scarce construction expert for airports (hired by Berlin's mayor for the new Berlin airport) who invoiced two thousand euros per day plus expenses.
(22) For data protection reasons, the names of individual orders are withheld.
(23) This coincides with disproportionate pay for top managers. McKinsey has yet to criticize excessive executive pay, probably because high-earners at McKinsey earn the same as CEOs.
(24) A classic case was the unexpected hiring of Edward Krubasik by Siemens under the auspices of Hermann Franz (Chairman of the Supervisory Board) and Herbert Henzler the McKinsey Europe boss and former Account Manager for Siemens.
(25) The metathemes include vocational training and education, energy, climate change and the euro.
(26) Following this pattern, Business Plan competitions were imported from the USA, then sold twice to the Bavarian government, then featuring as sponsor, attempting to place ex-McKinsey people in the organization, and then claiming corresponding seats on the advisory board.
(27) McKinsey increasingly adopts social and politico-economic topics: from early education for children to programs for saving the euro and Greece.
(28) Examples are the insurance companies State Farm and Allstate Insurance.
(29) This includes projects such as Daimler, Siemens and UBS.