The Firm: The Story of McKinsey and Its Secret Influence on American Business (34 page)

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When you’re in the business of predicting the future, it’s not a crime to be wrong. McKinsey may have steered Swissair right into a storm, but such advice isn’t shameful, it’s merely bad advice. On the other hand, the work McKinsey did for the insurance giant Allstate in the mid-1990s stands among the most questionable it has ever done for a client.

Allstate management initially brought in McKinsey to help improve
“efficiency,” which basically meant reducing the amount it paid out in claims. The insurer, known by its slogan “You’re in Good Hands with Allstate,” began ratcheting down payments to policyholders in 1996. The results were dramatic: In 1987 the insurer had paid 71 percent of its premium income to claimants. In 2006 that proportion was just 48 percent. Operating income rose thirtyfold as a result, the stock more than quadrupled, and company executives paid themselves extravagantly. Edward Liddy, who was chief operating officer of Allstate and then later CEO, made a fortune as a result of Allstate’s skyrocketing stock price, pulling down $54 million in compensation between 2001 and 2005 alone. (It’s no wonder that when he was brought in as CEO of AIG in 2008, one of the first things he did was hire McKinsey. His successor, Robert Benmosche, showed the consultants the door.)

New Mexico attorney David Berardinelli sued Allstate on behalf of one of its policyholders and subsequently became embroiled in a multiyear lawsuit that forced Allstate to release what became known as “the McKinsey documents.” One McKinsey slide advising Allstate to take a more combative stance with claimants had the title “From Good Hands to Boxing Gloves,” a phrase Berardinelli later used as the title of a book. An industry that once prided itself on helping people in need had become just another executive money grab, aided and abetted by its fancy consultants.

Another slide produced in court proceedings against Allstate was called “Alligator One” and had the caption “Sit and Wait,” which suggested that payments to claimants be stalled for as long as possible so that they might accept a lowball settlement. Another, titled “McKinsey Perspective on Claims,” suggested that “the potential for economic improvement is substantial, typically 5 to 15 percent reduction in severities and 10 to 20 percent reduction in expenses.” The basic idea: to pretty much
stop
paying Allstate’s policyholders at all.

“What if you discovered a secret set of construction plans for the Mother’s Peas factory, proving that the company designed the machines to under-fill every can of peas by 30 percent?” asked Berardinelli. “What if you also had proof that the Mother’s Peas Company did this to generate windfall profits for their shareholders and huge bonuses for their executives? Then you’d probably think you were the victim of a fraud.”
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A number of other states, as well as other insurers, also sued Allstate. “[Insurers] are systematically [underpaying] policyholders without adequately examining the validity of each individual claim,” former Texas insurance commissioner Robert Hunter told a U.S. Senate committee in 2007. “If you don’t accept their offer, which is a low ball, you end up in court. And that was the recommendation of McKinsey.”
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What was McKinsey’s response to the growing roster of disastrous engagements? Flat-out denial of responsibility. “In these turbulent times,” Gupta told
BusinessWeek
, “with our serving more than half the
Fortune
500 companies, there are bound to be some clients that get into trouble.” Once again, McKinsey stuck to its long-held precept that it bore no ultimate responsibility for
anything
that went on at a client. All that mattered was whether there was any meaningful blowback on McKinsey. And as far as it could tell, there was not. “[McKinsey] is the beneficiary of the fact that it is able to dispose of its mistakes, hide its embarrassments and display a façade that seems almost golden,” said the
Sunday Times
in 1997.
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Rajat Gupta’s McKinsey looked quite different from its starchy past. It recruited the best and brightest from around the world, regardless of gender, race, or nationality—and the machine hummed more efficiently
than ever. This was Gupta’s great achievement. He institutionalized the firm’s practices to such an extent that as it grew, both its external reputation and its internal culture gained power, right along with its profits. With the double draw of intellectual cachet and personal riches, it had an inside track on the smartest graduates from all over the world. In 2003 the firm even lured Bill Clinton’s daughter, Chelsea, to its ranks.

But it also started to attract serious, and often unfavorable, attention. Books like
The Witch Doctors
(1996),
Dangerous Company
(1997), and
Consulting Demons
(2000) all took a very a dim view of the consulting industry and its undisputed leader. Christopher McKenna’s 2006 book,
The World’s Newest Profession
, while an academic treatise, also focused on whether Bower’s aim of professionalism had been discarded for commercialism during the economic boom at the end of the century. Indeed, as the 1990s drew to a close, critics wondered whether the consulting industry had grown so large and powerful that it was helping itself far more than it was helping its clients, a charge also leveled at the financial industry. Like bankers, consultants no longer looked or acted like the servants of industry. They’d passed through the looking glass and were now calling the shots.

John Byrne of
BusinessWeek
took offense at
Dangerous Company
. He accused authors James O’Shea and Charles Madigan—both award-winning journalists at the
Chicago Tribune
—of writing “an ill-informed, anti-consultant screed filled with grievances that have been leveled at consultants for decades. The pair decry the industry’s high fees, its recycling of old advice, its willingness to tell clients only what they want to hear, and its penchant for putting raw MBAs into key problem-solving roles. But this is hardly news to anyone who has been either a victim or a beneficiary of a consulting assignment. Meanwhile, they fail to describe how the business really works—and why it has been so successful. . . . So consumed are the authors with a few of consulting’s
well-known foibles that they fail to explain why companies willingly pay $50 billion a year to advice-givers.”
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But Byrne was missing the point. The alarm was sounded not because people had suddenly realized the above. The alarm was being sounded because, by the end of the twentieth century, the explosive growth of consulting (and investment banking, to be fair) meant that
an alarming proportion
of the graduates of the country’s elite MBA programs were being diverted into places like McKinsey. The question being raised wasn’t whether consulting itself had merit; it was whether the opportunity cost of consulting’s rise was greater than previously understood.

Americans had also begun asking themselves deeper questions about their particular brand of capitalism than they had in the past. What, in an increasingly services-heavy economy, was American capitalism anyway? What did the country make anymore? Could the world’s most powerful economy really eschew the dirt and grime of the making of things in favor of merely financing and advising others on how to do the same? Enron was the culmination of a capitalism severed from real things. And the collapse of the Houston-based company kicked off a broad ideological argument that continues to this very day: What role should business play in society itself?

The origins of Wall Street, for example, are good in theory: helping connect holders of money to users of money. But by 2011 the perverted structure of international finance was widely viewed as a drag on the system, not a catalyst. The financial sector took real economies hostage and pushed the entire global economy into chaos. The origins of consulting, by comparison, are also good in theory: helping executives answer tough questions and provoking much-needed change. When the advice givers start to outnumber the advice takers, though, the system tilts in the wrong direction. What the authors of all of the above books were wondering was whether consulting as a whole (and
McKinsey, as its standard-bearer) had become more drag than game changer.

In a memorable 1999
New Yorker
story titled “The Kids in the Conference Room,” Nicholas Lemann posed the question of whether, by virtue of McKinsey’s overwhelming recruiting success, the United States had decided, “in effect, to devote its top academic talents to the project of the streamlining of big business.” The question was—and remains—poignant. If there is no longer any disrepute in working in the field of commerce—which McKinsey surely does, even if it proclaims itself a profession—why weren’t more MBA graduates going into business
itself
as opposed to a support industry such as banking or consulting? Taken to its logical extreme, if everyone becomes a consultant, who will be left to consult?

Lemann also explored what he ultimately saw as the sham at the heart of the McKinsey method itself. “The McKinsey method isn’t merely about business,” he wrote; “it’s about making the chaos of the world yield itself to the intelligent and disciplined mind. You’ve been trained and selected over and over for all your life, and this is the payoff: at last, you can do something. You have an omni-applicable power to figure out stuff and explain it to people. In truth, it is more a simulacrum of intellectual mastery than intellectual mastery itself, but what’s more important is how it feels. It feels as if you’d been given a key that opens up everything.”
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In July 2002, the
New Yorker
ran yet another piece that constituted a further assault on the latest illusions of the cult of the MBA and, by extension, the cult of McKinsey. Penned by cultural commentator Malcolm Gladwell, the story, titled “The Talent Myth,” concluded that the McKinsey echo chamber had fooled itself into buying its own bullshit. “The consultants at McKinsey,” wrote Gladwell, “were preaching at Enron what they believed about themselves.”
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While he focused on Enron, Gladwell was concerned that the obsession
with “talent” had extended well beyond the McKinsey-Enron axis. McKinsey’s 1997 study, “The War for Talent,” had caused a mad rush to add a new (and questionable) dimension to the traditional human resources function: the talent manager. The idea, in its simplest sense: Rapidly promote “talented” employees (whatever that meant), encourage them to think outside the box, and pay them more than they are worth. One Enron employee quoted in McKinsey consultant Richard Foster’s book
Creative Destruction
made the following absurd remark: “We hire very smart people and we pay them more than they think they are worth.” It was nothing short of theory gone mad in practice. As Gladwell wryly observed in reference to Enron, “It never occurred to them that, if everyone had to think outside the box, maybe it was the box that needed fixing.”
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“What if smart people are overrated?” asked Gladwell. Alternatively, argued consultant and author Kevin Mellyn in his 2012 book,
Broken Markets
, an excessive worship of formal credentials (i.e., the MBA) instead of actual ability has surely had the unintended effect of depriving the economy—and, just as surely, McKinsey—of true top talent.

If clients weren’t exactly asking the same questions about McKinsey, a growing legion of journalists was. At first the firm didn’t care; outsiders had questioned its merits since the beginning, yet clients were still banging at the door. But then something happened: Its own people—specifically, its young people, the fuel for its engine—started asking tough questions as well.

If Gupta found himself distracted by the external public relations fallout from Enron and other botched engagements, he was soon confronted with an equal if not greater internal challenge. McKinsey had
stared down many a competitive recruiting threat in its lifetime—from Boston Consulting Group and Bain to Wall Street—but it had never seen anything like the dot-com boom. No one had.

BCG had once promised greater intellectual satisfaction than working at McKinsey, but the firm had essentially negated that threat in the Gluck era. Wall Street had
always
promised more money than a life in consulting, but it came with more punishing hours, bigger risk, and (to be truthful) a far greater proportion of bosses with a tendency to be assholes. And if Microsoft was minting millionaires, well, so what? For every Microsoft millionaire there was a broke software entrepreneur who’d been steamrollered by the software giant. Working in Silicon Valley wasn’t exactly riskless, and then there was the whole nerd thing to contend with.

But then, almost in the blink of an eye, any MBA with a business plan with a
.com
at the end of it and the chutzpah to sell his idea to an ever more credulous stock market could get rich
overnight
, with little risk to no risk at all. How could McKinsey compete with
that
? How could law firms? How could Wall Street? Every single establishment firm in America suddenly had the same problem: Each looked like the past.

By 2001 Silicon Valley employed 1.35 million people, three times the total twenty-five years earlier.
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The old guard of technology—Microsoft, Intel, and Dell—was being roughly pushed aside by a new generation of Internet-related companies, from network equipment maker Cisco to pure Internet players like eBay and eventual dominant players including Amazon.com and Google. By 2000 about 25 percent of U.S. household wealth was invested in stocks—particularly technology stocks—up from only 10 percent during the 1990s.
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McKinsey consultants were unable to resist joining the exodus from the seemingly old to the fancy and new. Overall attrition at the firm rose from 16 percent to 22 percent during the bubble. That didn’t
present a gigantic challenge, but the firm did take some hard blows: McKinsey lost the heads of both its insurance and its technology practices,
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while one-third of the firm’s San Francisco office left seeking new opportunities in 1999.
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So many people were leaving that the office soon became referred to internally as “the launching pad.” McKinsey veterans joined startups like CarsDirect.com, Cyber Dialogue, and Pet Quarters.