The Firm: The Story of McKinsey and Its Secret Influence on American Business (31 page)

In the 1990s McKinsey’s revenues grew almost four times while the partnership grew by only two and a half. Associate leverage—the measure of associates relative to partners in the firm—grew from two to one to four to one by the end of the decade. McKinsey’s partners were wringing more profits from their hardworking associates than ever. And the associates were feeling the pain. Yves Smith, a former McKinsey consultant and prominent blogger, has suggested that McKinsey’s turnover reached 30 percent annually in the heat of the boom. That was not only disruptive; it threatened to waste the not insubstantial cost of training young recruits. What good is a shared narrative if people don’t stick around to share it?

McKinsey, which had blocked its ears to the siren song of the go-go years in the 1960s, couldn’t resist getting caught up in the dot-com frenzy. The shift was at least partly a response to increased turnover at the level of principal. With so much money being made so quickly in Silicon Valley and on Wall Street, McKinsey had to not only raise salaries but also shorten the time to partnership. “Some partners wondered whether the firm was abandoning its value, ‘Clients first, firm second, professionals third,’ ” noted a Harvard Business School study. Short answer: It was.

As for the tradition of working only for the most prestigious companies, well, that too went out the window. In 2003, for example, SHC, Inc., the parent of the dying Spalding sporting goods brand, paid the firm $569,000 for consulting services. A year later it was bankrupt. McKinsey, it seemed, would actually work for anyone with an open checkbook. And it had introduced those new fee mechanisms. In 2001 McKinsey traded its advice for a 12.5 percent stake in a satellite-based
advertising company in the convenience-store industry called OnVance. The firm was later sued for $1.6 million by the bankruptcy trustee of a busted OnVance under the logic that McKinsey wasn’t a creditor but an insider. Billing rates came down as well: In 2001 an industry researcher made this claim: “You can hire McKinsey for what it would have cost you to hire A.T. Kearney a year ago.”
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Despite Marvin Bower’s hope that it wouldn’t happen, the envy of corporate (and Wall Street) cash overtook McKinsey consultants in the thick of the late 1990s dot-com boom, a time during which CEO pay was skyrocketing. The facilitators of CEO-ism—the consultants, lawyers, and bankers—lost their willingness to be paid the way professionals had historically been paid. It’s extremely difficult for doctors to make more than $1 million a year. But by generally targeting only the largest of corporations, consultants have figured out how to secure ever-larger paychecks for themselves. What’s a $10 million fee to a corporation with $2 trillion in assets? At one point Citigroup had eight active teams from McKinsey running around inside its offices.

If McKinsey’s professional idealism had been attractive to MBAs in previous years, its more aggressive commercial orientation hardly slowed the flow of job applications. “Never underestimate the lemming-express effect that obtains among students at ‘top’ business schools and colleagues,” wrote author Walter Kiechel. “You compete to get into the most prestigious college. Then you compete to get into the top-ranked business school. After you’ve learned and displayed so much independence of mind, what’s left but to compete to be hired by the employer all your peers were clamoring to join?”
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R
ajat Gupta achieved a lot as the eighth managing director of McKinsey. He successfully diversified the firm’s hiring, more than doubling the number of elite schools from which the firm recruited, from seven to twenty, as well as broadening the kind of applicant, including continuing and expanding the push to bring in PhDs as well as MBAs. He helped McKinsey gain a step on most of the corporate world in the outsourcing boom, not only counseling its clients to take advantage of a networked world but doing so itself. The firm’s own number-crunching Knowledge Center in New Delhi brought labor costs down while also serving as a model for outsourcing to its clients.
¹
Gupta’s protégé Anil Kumar headed the effort.

And even as the firm had lowered some of its standards in search of growth, it hadn’t taken the final money-hungry leap—selling shares to the public—a decision that positioned it to correct course far more effectively than it might otherwise have done with angry shareholders breathing down its neck. “This is a knowledge-intensive business,” Gupta said in 2005, “not a capital-intensive one.”
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Still, by late 2002, the firm wasn’t feeling very good about itself. The consultants wondered whether the Gupta-led expansion had cost them too much in terms of culture and values. Enough wondered so
in interviews with
BusinessWeek
writer John Byrne in a wide-ranging 2002 feature on the firm that one of Gupta’s last moves as managing director was to push the firm’s head of marketing and public affairs, Javier Perez, out the door as a result of the picture of poor morale painted by Byrne.

Ron Daniel had once told a partners conference that he thought the firm could sustain maximum growth of about 10 percent a year while still being able to absorb its people effectively. Gupta threw that out the window and chased an even faster rate of expansion of nearly 20 percent. Many partners, though, pointed out that he did it with their acquiescence. “Rajat made us all rich,” said one.

That’s fine for those who had made the money but weak gruel for those who had already left but still felt that at least part of their reputation depended on McKinsey’s. “The place evolved from a very elite professional services firm to kind of a large factory that produced consulting projects,” said one senior partner who left during Gupta’s tenure.

McKinsey is not a command-and-control organization. The managing director does not manage by diktat. He must persuade. That said, he does get to choose committee leaders, office managers, and more. And on the margin, Rajat Gupta chose people who were more economically driven than in years past. That’s how you move a firm like McKinsey. If you are the managing director for nine years, which Gupta was, every single person who is a junior partner got elected on your watch, as well as more than 50 percent of the senior partners. That allows you to change the character of an organization, and that’s what Rajat Gupta did. And the new character of McKinsey suddenly seemed one that was capable of making a number of seriously questionable decisions—about which clients it got close to and what it advised those clients to do.

The most infamous McKinsey client of the Gupta era was Enron, the natural-gas-trading powerhouse that, when it imploded in 2001, destroyed not only itself but also Arthur Andersen, one of the Big Six accounting firms. Miraculously, though McKinsey was earning some $10 million a year in fees from Enron at the peak, it emerged unscathed. The whole ordeal nevertheless revealed quite a bit about the less attractive elements of the consulting business.

Jeff Skilling, one of the chief Enron villains, was himself a McKinsey alum. He joined the consulting firm in 1979 and quickly earned a reputation for an oversize ego. “Skilling worked for me indirectly for a short period of time,” recalled Tom Peters. “God knows, he was intellectually arrogant in a way that beggars the imagination.”
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If you didn’t believe Peters, you could ask Skilling himself; he once told
BusinessWeek
that he had “never not been successful at work or business, ever.”

He was a standout, to be sure. After starting his career in Dallas, he moved to the Houston office six months later, where he was just the third employee. In five years he made principal, and he was elected director five years after that. He’d certainly found his intellectual home. “It was difficult to disagree with Jeff because he would elevate the disagreement to an intellectual disagreement, and it was hard to outsmart him,” a former McKinsey partner said.
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John Sawhill, who was head of the firm’s energy practice at the time, asked Skilling to help McKinsey client Enron, the product of a merger between Houston Natural Gas and Omaha-based InterNorth, decide whether it ought to move its headquarters from Omaha to Houston. Skilling refused to work on the project, knowing that whatever he recommended would make him an enemy of one faction
within the company. “How do you win this one, John? How do you decide this? I want nothing to do with it,” he said.
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A typical young McKinseyite would never be able to get away with turning down an assignment. But Skilling was anything but typical. He was already a star at the firm, and Sawhill didn’t make an issue of it, instead pushing the firm’s Washington office to help Enron make the call. (Houston was the final answer.) And Skilling, who eventually took Sawhill’s place as head of the firm’s worldwide energy practice, continued to advise Enron; his work included an assignment in the late 1980s on how to use derivative contracts to “smooth” the energy company’s earnings.
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The singular insight of Skilling’s McKinsey career was the one that launched Enron into the stratosphere. As the natural gas industry grappled with deregulation and its attendant uncertainty, the largest players moved from predominantly long-term contracts to using the so-called spot market for 75 percent of gas trading. The change left both buyers and sellers vulnerable to rapid swings in the price of gas. Skilling suggested Enron step into the breach, creating a “gas bank” to buy gas from producers and sell it to customers, capturing the spread between the two. Before Skilling’s revelation, Enron had been a humdrum operator of gas pipelines. With the gas bank, he had helped turn it into a financial wheeler-dealer.
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“The concept was pure intellectually,” Skilling later said, sounding
very
McKinsey-like. When he presented the idea to Enron’s top twenty-five executives in 1987, he used just a single slide—also
very
McKinsey-like.
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In large part due to his success with Enron, Skilling was elected a director at McKinsey in the summer of 1989. That December, Enron president Rich Kinder asked him to join Enron. At first he demurred, but he later reconsidered. This was his chance to go big, to show he could
do
, and not just
tell
. He jumped ship and had soon replaced Kinder as president of Enron.

Enron chief financial officer Andy Fastow was flabbergasted at the move. “You walked away from McKinsey?” he asked Skilling. “I did,” the latter replied. “Why?” “Hey,” Skilling replied. “How often do you get a chance to change the world?”
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Skilling turned Enron into a new economy darling that darted from market to market with blazing speed. It became the most celebrated company in the country, with revenues topping $60 billion in 2000. As Bethany McLean and Peter Elkind pointed out in
The Smartest Guys in the Room
, Enron was beloved by all: “
Fortune
magazine named it ‘America’s most innovative company’ six years running. Washington luminaries like Henry Kissinger and James Baker were on its lobbying payroll. Nobel Laureate Nelson Mandela came to Houston to receive the Enron Prize. The president of the United States called Enron chairman Kenneth Lay ‘Kenny Boy.’ ”
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Skilling took the McKinsey ethos with him to Enron. A description of him by McLean and Elkind reads like that of a typical McKinseyite: “He could process information and conceptualize new ideas with blazing speed. He could instantly simplify highly complex issues into a sparkling, compelling image. And he presented his ideas with a certainty that bordered on arrogance and brooked no dissent. He used his brainpower not just to persuade, but to intimidate. . . . But he also had qualities that were disastrous for someone running a big company. For all his brilliance, Skilling had dangerous blind spots. His management skills were appalling, in large part because he didn’t really understand people. He expected people to behave according to the imperatives of pure intellectual logic, but of course nobody does that. . . . He was often too slow—even unwilling—to recognize when the reality didn’t match the theory. Over time his arrogance hardened, and he became so sure that he was the smartest guy in the room that anyone who disagreed with him was summarily dismissed as just not bright enough to ‘get it.’ ”
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Skilling paid homage to his former employer on countless occasions, including one time when he decried Wall Street’s value system to
BusinessWeek
. “Given the financial churning many investment banks do, I’m not sure I’d feel real good about it when I went home at night,” he said. “[McKinsey] has its values in the right place. You feel like you’re doing God’s work when you’re there.”
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He spoke of Enron in similarly reverential terms. “If you walk the halls here, people have a mission,” he said. “The mission is we’re on the side of angels. We’re taking on the entrenched monopolies. In every business we’ve been in, we’re the good guys.”
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He also took time out of an extremely busy schedule to have more than twenty meetings with McKinsey partners Ron Hulme and Suzanne Nimocks between May 2000 and December 2001—this while also sitting for nearly twenty photo shoots for publications as varied as
Industry Standard
and
Architectural Digest
.
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Skilling had spent twenty-one years at McKinsey. Like many who’d left before him, he kept the connection strong. He tried unsuccessfully to lure McKinsey consultant Ron Hulme to come join him as Enron’s chief financial officer, though that hardly damaged his relationship with his old firm. Enron remained the Houston office’s most important—and lucrative—client. Hulme, who took over Skilling’s role heading the consulting firm’s energy practice, became a star in his own right. “Despite his young age, [Hulme] had a tremendously high standing and power that derived from the Enron relationship,” a former McKinseyite told
BusinessWeek
in 2002.
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At one point, his name was bandied about as a potential successor to Gupta.