11 Notes on McKinsey

European Straits #172

Hi, it’s Nicolas from The Family. Today, I’m pursuing my “11 Notes” series focusing on interesting companies in the Entrepreneurial Age, and here’s McKinsey & Company.

I’m back to my “11 Notes” series dedicated to interesting businesses in the current paradigm shift, following installments on Amazon, Berkshire Hathaway (with my cofounder Oussama Ammar), Goldman Sachs, Lego, and Y Combinator. A new episode on McKinsey & Company was suggested to me on Twitter and since I find this firm interesting and revealing, I decided to make them next up.

Note that I’ll follow up with an in-depth focus on the consulting industry in this week’s Friday Reads, which will be sent to paying subscribers only. If you want to receive it on Friday, now is the time to subscribe!

1/ I’ve never had a high opinion of consulting in general. The first time I saw actual consultants was at a job fair while in engineering school (Telecom Bretagne) back in 1998 or ’99. They were with Andersen Consulting, which later became Accenture. (McKinsey didn’t even bother showing up for a job fair at my tier-2 school.) There was something weird about those Andersen Consulting guys: they all wore literally the same suit, same shirt, and same tie—like they were members of a sect. Needless to say they didn’t make the best impression on a campus full of Linux nerds!

At the time, I hardly knew McKinsey at all—both because I was in another world, and their brand wasn’t that strong in France anyway (for reasons I’ll explain below). Later I discovered the company from a client’s perspective during my work with France’s Inspection générale des finances. Nicolas Sarkozy’s cabinet had mandated that the government should rely more on outside expertise, and I was chief of staff of a task force working with McKinsey consultants who were supposedly helping us reform the French research and higher education system.

I was impressed by some things, and was much less so by others. McKinsey’s contribution, from my perspective, was in project management. Meetings started on time, the agenda was clear, everybody had their say, and the McKinsey guy in charge would always sum everything up rather well, with clear directions as to what everyone had to do. What was much less impressive, however, was the substance. The juniors spent hours asking for my views and then transcribed them word-for-word on slides—which was useless because I was the one making the final cut, and I didn’t really need the notetaking. Anyway...

Another thing was quite revealing. The senior partners had wisdom, insights, and the tact needed to address touchy senior civil servants like us. But those partners were rarely available. As time went by, they pretty much disappeared from the weekly meetings, evidently called away by other, more lucrative clients, and we ended up stuck with the juniors who didn’t contribute much except for making meetings run on time. I came out of the whole experience sympathetic but underwhelmed.

2/ Later I learned more about McKinsey from a big-picture perspective. I discovered that outside France it was considered the best firm to join if you were an ambitious young person interested in business. Then, having entered the tech world, I learned about Rocket Internet’s clever practice of hiring McKinsey alumni, thus outsourcing the hiring process to one of the most demanding employers on Earth.

More recently, searching through my Evernote (which contains almost 35,000 articles at this point), I noticed just how negative the press about McKinsey has been over the recent years. They’ve been accused of selling bad advice to governments and international organizations; of tying their alumni up in strict non-disclosure agreements, preventing even presidential candidate Pete Buttigieg from ever mentioning his years with McKinsey on the campaign trail; of being too complacent when it comes to working with non-democratic governments around the world; even of destroying the middle class 😱 There was also a trial involving a ‘secret’ investment fund managed by McKinsey that contributed to creating conflicts of interests when advising certain clients. Have a look at Institutional Investor here.

I would say that a large portion of that bad press is the reward for McKinsey’s past successes. And today they still have a powerful brand and attract some of the best and the brightest. So let’s dig a bit deeper 👇

3/ McKinsey is a byproduct of the shift to the 20th-century age of the automobile and mass production. I usually explain to audiences that the history of capitalism is that of businesses scaling up, from railroads to steel mills to car assembly lines to tech platforms. Yet as I wrote in a past issue, prior to publishing my book Hedge,

Most people assume that a corporation’s edge is derived from simply being bigger, as the bigger the size, the more value it can create and capture. But we tend to overlook the fact that scaling up demands difficult trade-offs. In practice, a corporation can grow in size only if it offloads some weight by outsourcing certain assets, functions, and risks to other businesses. This is what corporate strategy is all about: helping corporations expand their reach and scale up without becoming overweight.

Indeed, there are two levers you can pull to make giant firms move:

  • One is operational effectiveness. As I wrote in 2016 in In Search of Scalability, “The “experience curve” was the concept designed by the Boston Consulting Group’s Bruce Henderson to account for the capacity of larger firms to achieve superior operational effectiveness. The larger those firms grew, the more they could lower their unit cost of production.”

  • The other is strategic positioning. Continuing from the same 2016 article about scaling up businesses, “operational effectiveness led most players (who invariably imitated one another, in no small part thanks to consultants) to cut down the prices, leading to wars of attrition; but competitive advantages enabled some among them to escape those dreaded wars that systematically resulted from a competition solely based on price. Scale proved the key both to lower unit production costs and to sustained long-term profitability.”

Firms such as McKinsey contributed to the prosperity of the business world on both fronts. As described by Christopher McKenna, because firms were prevented from talking to each other by antitrust authorities, they had to rely on consultants as a third party who could pass information related to operational effectiveness. And because they actually had to compete on things such as price and quality, it was critical that they bring in outside expertise to help them find the best strategic positioning—another area where consultants can make a big difference.

4/ We all know the McKinsey brand, but we don’t know where it came from. In 1922, James McKinsey, then a young professor of accounting at the University of Chicago, wrote his fifth book, Budgetary Control, which made a big impact by introducing the following ideas:

Budgetary control involves the following: 1. The statement of the plans of all the departments of the business for a certain period of time in the form of estimates. 2. The coordination of these estimates into a well-balanced program for the business as a whole. 3. The preparation of reports showing a comparison between the actual and the estimated performance, and the revision of the original plans when these reports show that such a revision is necessary.

As pointed out by Duff McDonald here, this sounds like common sense. What we all tend to overlook, forward-looking as we are, is that it was only made possible by swift progress in information systems. Here’s what I wrote in 2016:

[For a long time], available information systems were not very effective in tracking what happened in a company’s operations and finances. Retail businesses had to wait for the cash register (invented in 1879 in Dayton, Ohio) to entrust their employees with the company’s day-to-day money. So we can imagine what it meant for shareholders to trust an entire company with the much higher sums they were willing to invest. How could they make sure the money was put to work in the company and not embezzled by the CEO or their employees? Without a proper information system it was difficult to determine how much profit a company made, let alone if it made a profit at all.

In 1926, McKinsey the man went on to found McKinsey the firm, trying to put his ideas into practice. He didn’t really see his creation thrive, as he died ten years later at the relatively young age of 48. But his name endures to this day as the most valuable brand in consulting.

5/ Now here’s an important question: What makes McKinsey different from (and better than) its most direct competitors? Well, the truth is that at first sight it doesn’t really stand out. Distinctive features have usually been introduced by competitors, only then emulated by the mighty McKinsey. Here are two examples:

  • The Boston Consulting Group. From Walter Kiechel’s masterful The Lords of Strategy, I retain that the BCG’s Bruce Henderson was a pioneer in publishing content (in this case, the BCG Perspectives) so as to promote his business. In the process he consolidated the idea that intellectual substance is critical if you want to succeed in the consulting business. But then McKinsey caught up, and now they’re on par when it comes to generating interesting content, especially with McKinsey Quarterly and the McKinsey Global Institute.

  • Bain & Company. Back in the 1970s (also told by Walter Kiechel), Bill Bain abruptly left the BCG, where he was poised to succeed Henderson as chief executive, and launched his own firm with a different, bolder ambition: longer-term assignments and a relentless focus on measurable value creation. In this respect, the rise of Bain & Company announced the shift of corporate executives’ focus from improving operations to maximizing shareholder value—and here, again, McKinsey played catch up, being lifted up by everyone in the shift to the age of financialization.

And so how has “McKinsey” become synonymous with consulting? Maybe it’s simply the name—a name which, just like “McDonald’s”, “sounds like America”, as pointed out in the movie The Founder 🍔

6/ In truth, however, the best explanation I have found as to what’s really at the heart of McKinsey is in this interview with renowned economist W. Brian Arthur, himself a McKinsey alumnus:

To McKinsey’s credit, it didn’t go in there and just reorganize on day one. They went into large companies like Deutsche Bank, or BASF, and they just sat and sat.

They didn’t do anything. They just sat and observed and interviewed and observed and thought and went back and observed. It cost plenty to do this, but they were quite patient. This would go on for months until they had what I would now call a complex picture of what was going on. The opposite of that would be to come in with some cognitive picture saying, “You need to be reorganized this or that way.”

They actually let a picture emerge, and this wasn’t lost on me. I would now call this an inductive rationality rather than deductive rationality. Rather than laying a framework on top, they simply let the framework emerge. [Emphasis mine.]

It takes guts to refuse to sell a pre-existing framework (like BCG’s Henderson was fond of, he who invented The Experience Curve, the Growth/Share Matrix, and the Rule of Three and Four), to instead embrace Arthur’s “inductive rationality”. I think the reason it’s been so successful, despite the obvious difficulty in selling it, is that it’s very much in line with what the business world is all about.

At The Family, we see entrepreneurs interested in recipes all the time (and many writers, myself included, occasionally fall victim to that fascination with ready-to-use frameworks). But we know how it ends: if what you’re selling is a documented framework, everyone will see themselves in it and people will end up resorting to tricks to fit in rather than actually building a great company.

It’s the same when it comes to the work of consulting firms such as McKinsey: what makes strategy so difficult to explain as a discipline is that there’s absolutely no recipe. The only approach that works is assessing the particular situation of a given client and helping them find the right strategic positioning by applying “inductive rationality” to the various components of a good strategy (see here for details).

7/ Clearly another of McKinsey’s assets is human resources, which in turn compounds in the brand. I’m sure it’s obvious for most of you, but let’s go through the reasoning again:

  • Consulting is a labor-intensive business; thus on paper, it’s not scalable. The more clients you serve, the more consultants you need to hire. And so how can you possibly play the game of capitalism—which is all about increasing returns to scale? Well, you hire mostly juniors, make them work very hard in exchange for a relatively small amount of money, and you allocate the rest to paying the senior partners and generating that additional surplus.

  • But then how do you motivate those young people to work hard without earning nearly as much as the senior partners? You make them play a very competitive game, the Partnership Track. Of course you need to let go of many people along the way, but you make it bearable by cultivating good relationships with those anyway. After all, the chances are high that they could become clients in the future. This is one of the many positive feedback loops that benefit McKinsey.

That system doesn’t work everywhere. A key part of the equation is that you actually attract the best and the brightest, and so you need to beat the competition on the labor market. Yet clearly over the past 20 years financial services, then tech, became strong contenders for potential recruits. And in specific countries such as France, well, here’s the thing: until very recently, if you wanted the best career, you didn’t join McKinsey; instead, you went to study at the École nationale d’administration, got to top of your class, joined the highest spheres of government, and then switched to the private sector (yes, I did all these things). And I’m sure there are many other exceptions depending on various local cultures and institutions.

8/ It’s difficult to assess how McKinsey is doing in our transitioning economy. However, I’ve reflected a bit based on the information I have, and here’s my assessment.

On the bright side, it’s clear that incumbents need more consultants than ever. The shift to the Entrepreneurial Age forces every legacy organization to take a hard look at its strategic positioning and reflect on making it evolve. Then once the new direction is settled, there are so many operational challenges at every level of the organization that the helping hand of consultants can be most welcomed. Whether it’s a public corporation or a company recently acquired by a buyout firm, there’s an urgent need to reposition and transform, and consulting firms can potentially help—as I’ll explain in greater detail in Friday’s industry focus on consulting.

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As such, why would you work with McKinsey rather than with any other firm, given our current context? Let’s start with the pros:

  • I’ve been reading a lot of McKinsey stuff over the past decade, and there’s the occasional exceptional piece that makes me think they’re really in this game. Have a look at Creating value in the age of distributed capitalism (by Shoshana Zuboff 10 years ago, before she turned to denouncing surveillance capitalism!), Grow fast or die slow (pointed out to me in 2014 by my friend financier Grégory Edberg), and more recently the excellent The social contract in the 21st century (which resonates a lot with my own work in Hedge).

  • Another thing that should work in McKinsey’s favor is their propensity to just sit down and observe, without being encumbered by preconceived notions about how business should be done. If that’s still the way they approach their work (and that’s a BIG if!), then it makes them the best consultants to help clients navigate the current paradigm shift and reposition themselves for the Entrepreneurial Age. Do they still work like in W. Brian Arthur’s description?

9/ But there are also cons—things that suggest that McKinsey is not doing terribly well in the current shift. Here are some examples:

  • I hear they’re expensive, and the current period is definitely not one in which clients are willing to throw a lot of money at consulting gigs—and especially not at a firm where all the press lately seems to be negative (although I’m sure they’re managing that risk).

  • I mentioned the interesting publications, but there are still way too many buzzwords out there (“Big Data”, “Artificial Intelligence”—you know the drill). Also, I would never trust a consulting firm that still deems “Technology, Media & Telecommunications”, or “TMT”, to be a separate, homogeneous category.

  • Do they still attract the best and the brightest? I doubt it. The startup world is where bright, ambitious people want to work these days. And having made that detour through consulting might become a bad signal in the entrepreneurial future (it can mean indecisive/superficial/impractical).

The latter (not attracting the best) is probably the biggest threat to McKinsey’s flywheel. How can you justify the high price tag if you don’t hire the best and brightest anymore? And how can you attract the best and brightest if your operating margin is going down because clients don’t want to pay as much?

10/ More generally, it’s likely that McKinsey, like every large incumbent with a high-fixed cost structure, could fall victim to the innovator’s dilemma. They have to pay those bonuses to all those senior partners, which is why they’ve been veering so far away from strategy consulting and are now, either directly or by way of acquisitions, doing basically everything: strategy consulting, management consulting, assisting with mergers and acquisitions, conducting due diligence on behalf of investment firms, helping their clients implement a strategy by getting their hands dirty, working for governments because it brings prestige (and is also countercyclical), designing technological products...

The reasons McKinsey is doing all this seem to fit what the late Clayton Christensen points out as strategic threats to any successful incumbent:

  • They’re focusing on the highest-margin segments on the market. That’s not strategy (which requires only a handful of very well-paid senior partners) but more management and implementation (which makes it possible to hire many juniors, whom you don’t pay much while still putting a high price tag on the service because it seems so labor-intensive).

  • They work for clients, not customers, which makes it difficult to explore new directions. Those long-standing clients require not redefining the categories because it would be too confusing for them (hence, the dreaded “TMT”). Plus, once a client has a strategy, the only business left to do if you want to keep working with them is switch to management and implementation.

I don’t think McKinsey will disappear anytime soon. As I’ve laid out in my 11 Notes on Goldman Sachs, you can achieve many shifts and make the most of many challenges in business services, provided you have a good brand, you attract the right talent, and you put the right people in charge. However, I’m convinced they still have to navigate the radical reinvention that the consulting industry is about to go through—a topic into which I’ll dig much deeper in Friday’s paid edition 👇 

11/  The 11th note is always a reading list, and that one is part of the Friday Reads paid edition. You should definitely subscribe to receive that comprehensive list of articles documenting McKinsey’s history, business, and likely future 🤗

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Nicolas