Mass Layoffs? Overpaid CEOs? Blame McKinsey!

Inside McKinsey & Co., the management consulting firm everybody loves to hate.

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In his new book, The Firm, veteran journalist Duff McDonald offers a rare glimpse inside McKinsey & Co., one of the world’s largest management consulting firms and almost certainly the most influential. Indeed, for a business with so many failures in its wake, McKinsey continues to hold an esteemed position in corporate “C Suites” throughout the world. In an interview, McDonald to explains this and other curiosities about the 87-year-old firm. (Note: McKinsey has consulted for Time Inc. in the past.)

Why does McKinsey matter?

McKinsey has been a behind-the-scenes influencer to the country’s largest companies, to the government and to the non-profit sector for the better part of a century. And the extent of their influence is almost incalculable. And what do they sell? Advice. The nature of that advice changes from company to company and according to circumstance, and it means that their “product” is always in flux—in effect, they sell what their clients are buying.

Some would say we can blame the failings of American capitalism on McKinsey and firms like it?

I wouldn’t go that far, but their influence has certainly had both positive and negative effects. What’s more interesting to me is the fact that they help clients with their most pressing problems makes them a wonderful prism through which to look at the broader history of American business. McKinsey was a major player in the efficiency boom of the 1920s, the postwar gigantism of the 1940s, the rationalization of government and rise of marketing in the 1950s, the age of corporate influence in the 1960s, the restructuring of America in the 1970s, the massive growth in information technology in the 1980s,  globalization in the 1990s and the boom-bust-and-cleanup of the 2000s and beyond. If you understand the story of McKinsey, you understand the story of American business itself.

As a leading outsider expert, I’m guessing you’re asked to weigh in on whether McKinsey is a force for good or evil. So which is it?

In short, it’s both. Criticisms of McKinsey are not hard to come by, starting with the fact that the firm dares to suggest that young MBAs with no actual business experience are in a position to tell seasoned executives how to better run their businesses. Or that given the power of the brand itself, executives also find it hard to resist hiring McKinsey to merely rubber-stamp a decision they’ve already made. Third, there’s the issue that because they rarely get involved in actually implementing any course of action that might come out of their advice, they have a blind spot regarding things like the human implications of important corporate decisions.

Such as?

I make the point in the book that McKinsey might be the single greatest legitimizer of mass layoffs in history—although that would be pretty much impossible to measure. Companies do need to lay off workers in tough times, that’s a simple fact. But the whole idea of corporate powerhouses laying off thousands of people during good times simply to juice profits—and, naturally, executive compensation—is something that McKinsey has definitely had a hand in as well.

That sounds like a vote for evil, to me.

Except that Western capitalism is a merciless thing, and there’s no way that McKinsey would still be around after nearly a century without providing something that some of the country’s smartest people consider to be of great value. They have been extremely helpful in spreading new ideas in management thinking, from organizational structure to capital allocation, IT strategy, globalization and more. They bring fresh outside perspective, which is never a bad thing, and an understanding of what others have done in similar situations. It’s expensive to hire smart young people, too, and the rationale for hiring McKinsey to help you solve a problem can be as simple as the fact that it’s cheaper than actually hiring new employees to do the same work. Those who would dismiss them for the timeworn reasons that people criticize consultants miss the point that if there were no value to what they did they’d have disappeared long ago.

So is there a classic, undisputed example of McKinsey advice that was an unqualified success?

You’re getting at a really interesting issue regarding McKinsey and its interaction with clients. And it’s this: McKinsey actually sells the credit for its good ideas along with the ideas themselves. In other words, they never try to take credit for an idea that a client uses to its advantage. What CEO wants to tell the world that the smart strategy he or she gave the green light to wasn’t actually theirs? So even their most satisfied clients don’t talk about their satisfaction all that often. But consider this: more than 85 percent of the firm’s business comes from repeat customers. You can hardly get a better endorsement than that.

But here’s one anyway: In 1981, Hugh McColl, who was head of then-tiny North Carolina National Bank, asked McKinsey to help him design an organizational structure that wouldn’t require changing until he’d turned NCNB into the biggest bank in the country. At the time, it had only $6 billion in assets, nothing compared to financial giants like Citicorp or Chase Manhattan. And they helped him do so. Seventeen years later, when what was then called NationsBank acquired Bank of America, McColl had himself the biggest bank in the country. You can be sure he wasn’t asking McKinsey for a refund.

So let’s flip it. Is there an example on the other side? That is, strategy from McKinsey that was undisputedly theirs and undisputedly a failure?

I think that would be Enron. That company’s CEO, Jeff Skilling, who’s now serving time in prison, was ex-McKinsey, and so much about how Enron fell apart was due to ideas that Skilling brought over from McKinsey and that McKinsey celebrated at Enron—emphasizing vision over execution, a ruthless human resources policy that resulted in excessive employee churn, as well as more prosaic issues like off-balance-sheet financing and securitization. They’re certainly not immune to buying their own B.S.

You mentioned executive compensation earlier. One of the more interesting nuggets in a book filled with them is the suggestion that McKinsey might be responsible for the CEO-to-worker pay gap. Can you elaborate?

It’s a company’s board of directors that sets any particular CEO’s pay, so they’re ultimately responsible for compensation at the end of the day, but I found in my research that the origins of the pay gap—which now sits at an absurd 354-to-1 ratio—can arguably be traced to one McKinsey consultant and work that he did for clients as far back as the 1950s. Call it the original sin of executive compensation. In 1951, General Motors hired McKinsey consultant Arch Patton to conduct a study of executive compensation. The results appeared in Harvard Business Review, with the particular finding that from 1939 to 1950, the pay of hourly workers had more than doubled, while that of top management had risen only 35%.

That must have made Mr. Patton very popular in the C Suites.

Absolutely. McKinsey’s clients glommed on to his research immediately. After reading about it, Juan Trippe, who was then CEO of Pan American World Airways, asked Patton to work on a study of stock options for his management team. Before long, managers everywhere had taken note of the news that they were underpaid, and demand for Patton’s imprimatur on increased pay packages went through the roof. For several years, Patton accounted for almost 10% of McKinsey’s billings. Once started, the demand to increase and justify executive compensation became a perpetual motion machine that’s still chugging along in 2013.

Two McKinsey people got caught up in the insider trading scandal that centered on Raj Rajaratnam and his Galleon hedge fund. But you suggest that their involvement did no damage to McKinsey. How is that possible?

On the surface, it is kind of surprising, especially considering two things. The first: Anil Kumar, the McKinsey consultant who pled guilty to selling client information to Rajaratnam, was violating the fundamental promise of consulting itself—you tell us your secrets, and we won’t tell them to anybody else. The second: Rajat Gupta, who was found guilty of insider trading for alerting Rajaratnam to non-public information he learned from his board seat at Goldman Sachs, was McKinsey’s managing director for nine years. On closer examination, though, it’s easy to understand how neither man’s actions really hurt McKinsey itself. For starters, neither was a case of the institution acting badly—these were two individuals making individual choices. In Gupta’s case, he’d left McKinsey several years previously, so it was actually the case of a former employee breaking the law, not a current one.

What’s most amazing, though, is that even those particular clients whose secrets Kumar was selling remain clients of McKinsey. And why is that? Because the firm brings so much to its clients that they were seemingly able to set aside the betrayal of confidence on the assumption that it was one bad apple who’d wronged them. The most interesting thing, I would say, is that the whole scandal did more to hurt McKinsey’s self-image than it did their billings. They just might be the most self-satisfied group of people on the planet, and the idea that they’d had criminals in their midst is mortifying to them. But not, apparently, to their clients.