Scaling McKinsey: Inventing Management Consulting - Commoncog Case Library

[cedric]

James McKinsey’s untimely death in 1937, at the age of 48, left his consultancy firm in peril. 

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This is a companion discussion topic for the original entry at https://commoncog.com/c/cases/scaling-mckinsey/

[TylerD]

Similar to luxury in that a market was created by exploiting psychological forces – in this case, not only the psychology of customers but management too. That was combined with good timing on a couple constructive tailwinds (shift in retail shopping preferences + WWII) to get consulting off the ground.

The magnitude of fees persists because I think it’s an easy argument for management and boards to make – with a multi-billion dollar company, paying a consultant $20m for an engagement could drive hundreds of millions of value.

Not surprising that general ‘management consulting’ is basically an oligopoly today (McKinsey, Bain, BCG). The lifeblood is prestige.

I won’t get into my personal views of management consulting!

[cedric]

Having recently skimmed The Luxury Strategy, I found myself wondering how much of it applies to McKinsey. After all, people tend to speak about McKinsey in superlative terms — they don’t really compare it to other consulting firms. But I’m not very familiar with how management consulting firms are actually bought, and, like you, I don’t have a great impression of management consulting engagements or big firm management consultants generally. I suppose I still don’t fully understand why or how McKinsey has a moat! Maybe it’s just brand?

[TylerD]

I think it’s brand, yes, because when management says, “We’re engaging McKinsey/Bain/BCG for X project” it hits a bit differently than even Kearney or the Big 4 accounting firms with consulting arms. There’s nuance that statement ignores, but generally, this I think is the case. Same thing for investment banks – Goldman Sachs, JPMorgan, Morgan Stanley, Bank of America – those banks do the biggest IPOs and tend to own a lot of M&A share for mega deals (again, there’s nuance, but generally true). It’s along the lines of “the biggest and best” work with these companies. Mostly brand. Brand gets them the biggest fees in the market.

Then I think there’s scale plus client relationships/body of relevant work plus specific-persons expertise that all reinforce each other. If you’re McKinsey and you’re trying to pitch Liquid Death on an engagement, you can say you’ve worked with Coke, Pepsi and 10 other CPG names everyone on the management team and board of Liquid Death has heard of and are relevant. And while showing you a 100 page deck with all sorts of fancy results and data, they’ll say the senior team who worked on the Coke engagement are the senior people who will work on yours (so long as no current conflicts of interest).

[Brian_Knoles]

@TylerD

If you’re McKinsey and you’re trying to pitch Liquid Death on an engagement, you can say you’ve worked with Coke, Pepsi and 10 other CPG names everyone on the management team and board of Liquid Death has heard of and are relevant

This sounds like network effects! I believe Roger Martin is sharply critical of expecting your competitors’ strategists to magically find you an advantage they didn’t provide to their past clients, but buyers value the accumulated experience enough to pay more. Every high profile engagement grows the perceived value of the next engagement. And this pairs with the uncertainty reduction (or more cynically, the CYA potential) of their brand power.

To whatever extent McKinsey actually delivers “better” results than other consultancies, there must be some kind of process power? Their combination of hiring/onboarding/management systems cannot be replicated by other firms even if they wanted to?

[cedric]

So something interesting: the major source for the two McKinsey cases was Duff McDonald’s The Firm. One major thread that McDonald pulls on throughout the book is the idea that management consulting firms win work from companies in an industry segment because every other competitor in that same segment had hired the same consulting firm.

He then asserts — and this isn’t his theory alone, but one held by many observers in the space over the decades — that this is a form of acceptable corporate espionage, where best practices spread across an entire industry through the vector of management consulting firms. In a way, if you don’t hire a management consultant who has worked with your competitors, you’re at a disadvantage.

McDonald also presents this as a positive thing. There is some economics research suggesting that management is a technology, and that having management ideas spread throughout an industry is a form of competitive advantage for the nation in which that spread occurs. Whether or not this is actually true, I don’t really know (it’s not germane to my outcomes, at the level that I work at), but it’s certainly a narrative that McDonald himself believes in.

@TylerD

I think it’s brand, yes, because when management says, “We’re engaging McKinsey/Bain/BCG for X project” it hits a bit differently than even Kearney or the Big 4 accounting firms with consulting arms.

This certainly gives credence to what @ellen said in the Luxury Strategy thread, about marketing in the coaching context!

[Brian_Knoles]

@cedric

that this is a form of acceptable corporate espionage, where best practices spread across an entire industry through the vector of management consulting firms.

Funny when you compare this to McKinsey’s founding principles:

3. Never reveal a client’s private or proprietary information

There’s a way to practice both (best practices aren’t necessarily private/proprietary), but they sure are in tension.

They still have “preserve client confidences” listed in their values. In fairness, “practice the acceptable level of corporate espionage” is not on that page.

[cedric]

Oh! I should add that these two cases are best understood through the lens explained here:

All Professional Service Firms Have The Same Mission - The Consulting Business...

And more broadly explicated in David Maister’s Managing the Professional Services Firm. McKinsey proves to be an excellent case study — this case on scaling in particular. But I’ll probably have to commission other cases on the other firms for this to be maximally useful.

[cedric]

Another reference, probably just as useful to make sense of this case:

@cedric

81 years after Brown created the DuPont equation, David Maister took that same equation and modified it for services (read: consulting) businesses. Maister argued that the equivalent for ROE for a consulting firm was ‘Profit per Partner’, and wrote that — like pre-control DuPont — most services firms were measuring subpar metrics, which in turn meant they had subpar control systems.

                      Profit     Fees       Staff
Profit per Partner = ———————— x ——————— x —————————
                       Fees      Staff     Partner

Or, put simply, profit per partner = margins x productivity x leverage. Notice that this is a very special kind of leverage — the ratio of staff to partners. I’ve written about this in The Consulting Business Model.

Maister observed that most firms tracked either fee levels, margins, or ‘staff realisation’ reports (meaning the number of hours charged, or, in other words: ‘# of billable hours successfully realised’). He then pointed out that such reports incentivised partner behaviour that was contrary to the firm’s interests. For example:

• Tracking margins incentivises partners to pick work that is high fee in nature.
• Tracking realisation has an upper limit and as such should be seen as a ‘hygiene’ factor not a ‘health factor’ (you can’t get staff to work 996, so above a certain realisation level, you will have hit a ceiling).
• Tracking fee levels rewards partners with high fees. But Maister observed that it was often the case that partners charging lower fees, but keeping a larger group of junior associates busy with a larger volume of work would throw off higher profits to the partnership compared to the single partner who charged high fees at a high realisation rate.

No, all of these were dumb controls, Maister concluded. Profit per partner should be the logical measurement. Maister then went further: he argued that (like the DuPont equation), the firm should track the PPP of each partner as a control mechanism, and leave it to each individual partner how they might want to achieve a high number. This almost inevitably results in some combination of higher margin or higher leverage. And, if the partner is underperforming, it is trivial for the firm to break down their PPP number to diagnose how he or she should fix it.

The equation then automatically suggests a list of activities to increase PPP, from most impactful to least:

1. Increase fee levels — i.e. raise prices (health)
   1. Earn higher fees through specialisation, innovation, adding more value
   2. Use marketing to get ‘better’ work
   3. Speed up staff skill-building — so you can put them to work on higher value projects
   4. Invest in developing new (higher-value) services
2. Decrease variable costs — lower delivery costs per engagement (health)
   1. Improve engagement management performance
   2. Increase leverage in delivery of services
   3. Increase use of paraprofessionals
   4. Develop methodologies to decrease duplication of effort
3. Fix underperformers (health/hygiene)
   1. Deal with underperformers
   2. Drop unprofitable services
   3. Drop unprofitable clients
4. Increase volume (hygiene)
   1. Increase utilisation (billable hours per person)
5. Lower overhead costs (hygiene)
   1. Improve billing speed
   2. Improve collection speed
   3. Reduce space and equipment costs
   4. Reduce support staff costs

[Jami]

@cedric

One major thread that McDonald pulls on throughout the book is the idea that management consulting firms win work from companies in an industry segment because every other competitor in that same segment had hired the same consulting firm.

Another interesting consulting case study could be Independent Project Analysis (IPA), a consulting firm that advises billion-dollar megaprojects, such as wind farms, oil pipelines, and mining rigs.

Companies risk billions of dollars in overrun costs if they misestimate a megaproject’s budget and schedule. To avoid this, they rely on IPA’s proprietary database of past megaprojects to benchmark their plans against their industry peers. In this process, IPA is allowed to further grow their treasure trove of data.

Seems like this megaproject database would be an incredible flywheel of a moat: the bigger your database is, the more likely a client is willing to provide their data to you in exchange for your insights.

I couldn’t find much on the origin story of IPA, but there was this interesting Goodreads review by a megaprojects PM for a book by Edward Merrow, IPA’s founder and CEO:

Enter Edward Merrow and the consulting firm he founded in 1987. I imagine he started by collecting megaproject data when he was still a research analyst at the RAND corporation […] With his initial data trove he found he could open more doors and get more information on the spectacular budget and schedule blowups of the day.

Fast forward 30 years, and Ed runs the world’s best stocked data warehouse of capital project information and not only has he been able to draw many statistically relevant conclusions on how not to do megaprojects, he is also been able to become a partner of choice to provide value assurance reviews for the capital projects of most major companies all over the world. For example, the majority of oil majors allow his company to pick their project data apart for benchmarking and make their project teams go through Ed’s pacesetter reviews. And I am sure the same holds for many other industries. Quite a gig - and a wonderful consulting success story.

But none of that would have happened if Ed’s data was not so darn hard to get, or if the lessons he draws from them were not so valuable to the managers of megaprojects. Regretfully, most of the value of this treasure trove of project information is carefully hidden behind thick paywalls, which only companies with billion dollar project budgets may penetrate.

[cedric]

Man that’s such a great example. This would be a cornered resource Power, I think.

I’ve long puzzled over competitive advantage in the context of services businesses. I know a fair number of services entrepreneurs, and there are some running fairly impressive consulting businesses here in this community, but I don’t understand how the business can become easier over time. (Which is my operator-measure for whether you’re building Power or not: the business should feel more ‘fun’ to run the more Power you build.) Maybe there is Power, but the delta is small, because it grows slowly?

I’m willing to bet that Ed Merrow had a business that was more ‘fun’ to run than most consulting companies.

[eric]

I think the competitive advantage that builds over time in a service business is referrals. When you are starting a business, you have to find and sell every new client. Once you are established, then your clients refer others to you, which takes care of lead generation and makes closing sales much easier because you have trusted people vouching for you.

You also can develop proprietary approaches to helping your target clients that means you can help them more quickly and easily than starting from a blank sheet with each new client.

I still don’t have a feel for the 7 Powers so not sure what that maps to, but those two trends are what have made my life easier as a service provider over time.

[Brian_Knoles]

@cedric

I’ve long puzzled over competitive advantage in the context of services businesses

Same. I’ve worked for several, cofounded one, and my father retired as an executive of a ~500 person civil engineering firm. I think you can spot all of the 7 powers in different contexts, but my theory is that service business markets tend to be competitive indefinitely. My dad’s company grew a lot over the course of his career. They built brand power via a stellar reputation, and institutional expertise that might be network economies. They counter positioned into different niches like environmental site work. My dad created and implemented a quality program in the 90s that you might consider process power. But I don’t think it ever got easier to run that company. Bids were competitive. Staff worked long hours.

Not sure if this means “small, fragile, or fleeting moats are still moats”, or something more like “the theory that competition drives profit to zero is oversimplified”.