Why We Are So Cash Conscious
Unfortunately, money’s much more than a tool for survival.Why We Are So Cash Conscious
Any discussion about the costs and benefits of capitalism is incomplete without a conversation about the costs and benefits of consulting, especially global consulting behemoth McKinsey & Company. Do consultants make the world a better place, or is their advice solely geared towards making their clients (and themselves) money in the short term, without regard to any potential societal damages?
On this episode of the Capitalisn’t podcast, hosts Bethany McLean and Luigi Zingales speak with Pulitzer Prize-winning investigative journalist Walt Bogdanich about his book When McKinsey Comes to Town: The Untold Story of McKinsey & Co., the World’s Most Controversial Management Consulting Firm. Bethany and Luigi then discuss the ethical implications of the consulting industry and the questions raised about the accountability of powerful societal institutions, including the role of business education.
Walt Bogdanich: If I’m a consultant, am I going to come up with a plan that’s going to say, “Look, the workers need to be taken care of better. I think you’re making too much money”? If the CEO doesn’t like it, they’re not going to get hired again.
Bethany: I’m Bethany McLean.
Phil Donahue: Did you ever have a moment of doubt about capitalism and whether greed’s a good idea?
Luigi: And I’m Luigi Zingales.
Bernie Sanders: We have socialism for the very rich, rugged individualism for the poor.
Bethany: And this is Capitalisn’t, a podcast about what is working in capitalism.
Milton Friedman: First of all, tell me, is there some society you know that doesn’t run on greed?
Luigi: And most importantly, what isn’t.
Warren Buffett: We ought to do better by the people that get left behind. I don’t think we should kill the capitalist system in the process.
Bethany: As frequent listeners know, here on Capitalisn’t, we discuss what’s working and not working in capitalism. If we’re discussing the costs and benefits of capitalism, we can’t avoid discussing the benefits and costs of consulting in general, and McKinsey, in particular. In a scathing piece in Current Affairs, a former McKinsey employee wrote this: “McKinsey is capitalism distilled.”
I’ve always wondered this about consulting firms: do they make the world a better place? Is their advice geared toward helping clients and themselves make money in the short term without regard to any damage they might be doing? When they find themselves in the middle of a scandal, is it simply due to incompetence?
In recent years, the New York Times, among others, has published a series of stories about scandals in which McKinsey has played a starring role, but yet somehow managed to sidestep any controversy. According to that Current Affairs piece, over its 90-year history, McKinsey has been a whisperer to presidents and CEOs. McKinsey serves more than 2,000 institutions, including 90 of the top 100 corporations worldwide. It has acted as a catalyst and accelerant to every trend in the world economy: firm consolidation, the rise of advertising, runaway executive compensation, globalization, automation, and corporate restructuring and strategy.
OK, then. Luigi, what do you think of McKinsey?
Luigi: I think what I think of consulting in general, because McKinsey is just the front end of an entire industry of consulting. I think there is no doubt they’ve been very successful. In my view, there is no doubt that they add value to clients. The question that we should address is whether they add value to humanity or society, in general, or not.
Bethany: I’m not sure it’s so clear that they always add value to clients. That was my reference to incompetence above because McKinsey has been at the center of a few things that haven’t worked out so well. Most notably Enron, where McKinsey consultants ran around that company for years and ran around the globe preaching to their clients how they could make themselves more like Enron executives. I’ve always thought that speaks to the ubiquity of McKinsey but also perhaps adds a question mark about whether they really do add value.
Luigi: I think that you’re definitely right that they might add value for the person hiring them, which is the CEO, not necessarily for the shareholders that pay for them.
Bethany: Yes, I think that’s a great point. The old saying is, and I’m sure you’ve heard it before, is that you’ll never be fired for having hired McKinsey. You do that and everything they tell you to do is blessed because they’re McKinsey. It becomes a circular argument, in a way. Certainly, if you’re a CEO, then that’s what you’re going to choose to do, because it’s the safe bet, even if their advice turns out to be wrong.
We wanted to delve into all of these questions further. As this episode’s guest, we have Walt Bogdanich. He’s worked as an investigative reporter at the New York Times for some 20 years, where he’s won three Pulitzer Prizes. His very critical work on McKinsey in the Times really shifted the conversation about the firm. Last fall, he and his Times colleague, Michael Forsythe, published a book called When McKinsey Comes to Town: The Hidden Influence of the World’s Most Powerful Consulting Firm.
Luigi: I think that they have a lot of examples of not just bad behavior but pretty evil behavior. The story about the way opioids were pushed, I think, is egregious.
Speaker 8: According to reporting in the New York Times, company documents show a proposed plan to offer rebates to distributors for every Oxycontin overdose attributed to pills they sold.
Luigi: But they have a lot of other, maybe less-dramatic stories, but pretty bad ones—
Speaker 9: Until recently, the tobacco industry still marketed its products with the help of the consulting firm McKinsey.
Luigi: —to the way they cut maintenance costs with, at least allegedly, a lot of damages, to the way they consult with corrupt governments like the South African one.
Speaker 10: Its guidance to adversarial governments in Saudi Arabia and Ukraine and to state-owned firms in Russia and China . . .
Luigi: There are a lot of examples of bad behavior that are pretty thought-provoking.
Why don’t we start by asking a few questions to Walt, and then we’re going to come back and discuss this.
Bethany: Let’s get started with the most basic question of all. What made you start looking into McKinsey?
Walt Bogdanich: Good question. I knew some people who went to work for them, and they wouldn’t discuss what they did. It was easy to find out that it was a powerful organization. It was big, it was secretive, and that’s catnip for investigative reporters.
It was a bit of a challenge at the New York Times for a couple of reasons, not the least of which, they were advising the New York Times, as they were advising the Washington Post, telling each how to beat the other, which I found an interesting business model, which, of course, I learned a lot more about later on.
Bethany: Of all the stories you told and all the examples that you came across in your reporting for the paper, what stood out to you as the most extreme example of McKinsey’s venality, for lack of a better word?
Walt Bogdanich: Well, I think there’s probably two areas. One area involved just turning the selling of addictive products into a profit center. They hire the smartest people; they talk about that all the time. They’re very proud of that. They recruit heavily at the best schools.
So, it made no sense to me that these smart people would continue to advise, say, the tobacco industry, the cigarette companies, long after it was proven that they were lying to the public and that their product was the most lethal consumer product in history. That’s one area.
The second area is the conflict of interest in government, which is appalling, in my view. I know reporters aren’t supposed to have opinions, but I can’t avoid that one. They say there isn’t a conflict of interest when you’re advising Purdue Pharma, while you’re advising the opioid makers, while you’re advising the government that regulates and the FDA. McKinsey thinks that’s fine. I think most reasonable people looking at that, particularly given the result and all the thousands of people that died, would think that that’s not a good idea. A sensible person would say: “You don’t do that. You have competing agendas.”
Luigi: What I’m surprised about is that you don’t mention at all the conflicts of interest that are potentially there with the McKinsey Investment Office. We know that McKinsey is running, basically, a $30 billion hedge fund, and McKinsey directly or indirectly invests in firms it advises. McKinsey, if I’m not mistaken, settled a case with the SEC. Of course, they did not admit any wrongdoing, but they paid a substantial amount of money, because they were advising and investing at the same time in bankrupt firms.
Again, you are the journalist, but my understanding is that it was reprimanded by a judge for not disclosing the fact that when it bid for the job of advising the Puerto Rico government, it was investing in Puerto Rican bonds through the hedge fund. So, this seems like pretty juicy material. Why don’t you cover it in the book?
Walt Bogdanich: Well, because we covered it in the newspaper. We didn’t want to turn this into a story where we’re regurgitating what we already wrote, and we had other things that were more overtly alarming and concerning to us, and we thought readers, that we decided to focus on that instead.
Luigi: The story is very compelling, but at the end, I’m a little bit puzzled about what your implications are. Is it that consultants are bad people? Is it that they have bad incentives? Does McKinsey have a bad firm culture? Or—this is particularly concerning for me—are they taught the wrong lessons by business professors like me?
Walt Bogdanich: I just think it’s the age-old story of being blinded by desire for more and more and more money. Now, I know a lot of McKinsey consultants, and they’re good people, and many of them have become my friends. So, they are not necessarily an evil culture.
Bethany: I always thought that it was much easier to be able to say, “I did what was allowed,” than to have to say, “I chose to do this.”
But a slightly different spin on Luigi’s question: Martin Bauer, the McKinsey partner way back when, used to make a big deal about integrity. He’d say that nothing was worth sacrificing your integrity for, because that was all you had to sell.
Did you view that always as a cover story, or did you think the pressures that grew along the way as income inequality widened, as McKinsey got bigger and bigger, as there were more and more mouths to feed, more and more money to be made in a world that was increasingly awash in money, that these issues plaguing McKinsey also got bigger and bigger?
Walt Bogdanich: Oh, I think I agree with your conclusion there. I think Marvin Bauer was an honorable man, and he viewed the word commercialism as an obscene statement. He crafted a whole new language around what they did. He patterned it after a law firm, a partnership, which planted the seeds of the problems that develop later, because authority was so diffused. It was spread out around the world. Particular offices had a great deal of autonomy to make decisions and work for certain clients, and it got out of hand.
I think over time, the Marvin Bauer outlook, probably his principles, got lost. One of the former McKinsey consultants who we quote in the book said, “It’s the banality of evil, MBA edition.” It’s a pretty great quote. It’s a strong quote, but he worked there, and he knew the lay of the land, and that’s why he said it, I guess.
Bethany: One of the things I’ve found revelatory about your reporting: I always knew that McKinsey played a large role in shaping what the private sector did, but I don’t think I’d ever realized that they played such a large role in shaping what the government did, and that McKinsey is one of the most successful government contractors.
How do you think about the influence of those two roles? You talked earlier about the conflict of interest between the two, but how do you think about that overall, the nexus of how, in that case, what a huge role McKinsey plays in shaping our overall world?
Walt Bogdanich: Well, it plays a huge role, obviously, and I can understand, to a large degree, why they don’t discuss or disclose their activities dealing in the private world. But when it comes to government, you have an obligation to account for how you spend the taxpayer’s money and what you’re doing.
For a long time, they didn’t want to do government work, because they didn’t believe they could accomplish what they wanted to accomplish. But then they saw their competitors doing it, and they realized that there was a revenue stream to be taken in, and they went after it in a big way and got into trouble. The first time they really got into big trouble was in South Africa, and they’re, of course, under criminal investigation now for their conduct over there, the fact they got entangled in a government scandal that led to the president losing his job.
Luigi: Now, I recently learned an interesting factoid. If you are, for example, a firm in a crisis, and you hire one of those crisis-management people, if you hire them through a lawyer, the lawyer has a duty to the corporation, not to who is hiring them.
Imagine that you are the CEO, and you ask me, as a consultant, what to do. If I realize that the best thing for the corporation is to get rid of you, I can go to the chairman of the board and say, “I have a duty to disclose this to the chairman of the board. That’s the right thing to do.”
Do you think that a norm like this for business consultants is needed? Because at the end of the day, one of the things I got from your book is that they act too much, basically, as the hired guns of the CEOs, because the CEO has the power of the purse, and they are very interested in that purse, and so they do whatever it takes to ingratiate themselves to the purse. They’re basically hired guns for CEOs, not even for the corporations.
Walt Bogdanich: Well said. I agree that that’s one of the problems. If I’m a consultant, am I going to come up with a plan that’s going to say, “Look, the workers need to be taken care of better. I think you’re making too much money”? If the CEO doesn’t like it, they’re not going to get hired again. McKinsey’s business model is, once you get in, you don’t leave. Somebody said, you spread like an amoeba; you wedge yourself in and spread like an amoeba and start finding all these other problems that either exist, or exist only in McKinsey’s mind, and that they tell the CEO need fixing. But I agree. There isn’t this sort of independence that would really help matters.
Luigi: You write quite compelling stories about undermaintenanced organizations like US Steel or Walt Disney after some serious cost-cutting done by McKinsey. We all know the fact that a couple of people die after vaccination doesn’t mean that the vaccine kills you, because people might die regardless of the vaccine. I think to prove the costs or the benefits of vaccine, we need some more systematic analysis. Ideally, this analysis is done with a controlled experiment, but if this is not possible, then at least you do some statistical analysis.
You do have the list of firms that are treated by McKinsey. At least, you say in the book that you have the list. So, why don’t you do a statistical analysis of the effect on work safety of this cure and not just rely on two anecdotes?
Walt Bogdanich: Well, that’s a good question. You go with what you have. I worked there, I saw the unsafe conditions, I knew what McKinsey was telling US Steel in terms of, we’ve got to cut maintenance. You’d have to really be an idiot not to realize that cutting maintenance in a dangerous occupation like that could be very, very dangerous.
Luigi: But, sorry, you do have the list. My understanding—and tell me if I’m mistaken—from the book, you say that you have the list of all the engagements of McKinsey, so could you do a systematic analysis?
Walt Bogdanich: Well, their list is so diverse. I don’t know exactly what I would be analyzing. Yes, I do have the list, but they were governments, they were the Saudis, the Russians. There’s a limit to what I could do with that.
Look, in the best of all possible worlds, I would be able to do some systematic analysis, but I’m just a reporter. I’m not an economist like you. So, I’m trying my best.
Bethany: As a question from another reporter, is the issue also partly that the list gives you the client names, but it doesn’t necessarily tell you what the engagements were for those clients, and that McKinsey’s work is so sprawling and so multifaceted that arriving at any sort of systematic representation of what they did is very fraught?
Walt Bogdanich: Exactly, exactly. True. We did have sources tell us, on occasion. We had a sense, in a small number of cases, exactly what they were doing. In other cases, with the government, we filed record requests, and we were able to do some kind of analysis of what they were doing and how much they were getting paid. So, yes, that’s accurate, Bethany, that is some of the good explanation of the limitations.
Luigi: Why don’t you publish your list of engagements that you obtained so that researchers like me can study some of these irregularities?
Walt Bogdanich: Well, then you won’t buy the book. I want you to read the book and try to figure it out. Now, look, that’s a good question. We just decided that this was something we didn’t want to do, in part because . . . The possibility that it could lead to the person who gave it to us is one of the explanations. Maybe it doesn’t satisfy you in that regard, as a researcher who wants to study it, but also because it only captures a certain time frame, and it seemed incomplete.
Luigi: I told a colleague that I was reading your book and I was liking your book, and this colleague said, “Oh, it is full of cherry-picking and finding the worst outcomes. Out of 30,000 employees, you can always find a bad apple, blah, blah, blah, blah, blah, blah.” I can see why you can make that accusation.
However, I think this is where the secrecy is important. Because they don’t disclose, it’s very hard for outsiders to get a proper sort of view. Certainly, if I look at the worst reporting of the New York Times, I find a lot of problems, and we can discuss that on a different day. But the good thing about the New York Times is that anybody can look at the record. If I cherry-pick and I describe the New York Times cherry-picking, somebody else can correct me. In the case of McKinsey, they cannot.
I developed with another company—it actually was Uber—this idea that I called the Sherlock Holmes principle. I don’t remember which story it was of Sherlock Holmes, but there is a question: why did the dog not bark? It is because there was no dog.
What I want to say is that whenever a company keeps the data secret, if I can make an allegation based on some facts that the company can refute with some data analysis and they don’t, by assumption, my allegation is correct.
McKinsey could tomorrow refute your statement that their cost-cutting is increasing work-related accidents. They can, because they have the data, and after all, they are a data-oriented company, and they should be able to show with the data that you have done cherry-picking. If I were you, I would challenge them to actually prove you wrong.
Walt Bogdanich: Yeah. But they won’t answer my questions. They’re not going to do that. That’s the problem. I have put tough questions to them, and they haven’t answered them all. They answer what they want to answer.
The idea that someone would somehow find fault with what we reported by calling it cherry-picking, and I understand where they’re coming from, that I think would be insulting to the families who lost loved ones from the opioids that they were helping to push and turbocharge sales in the middle of an opioid epidemic. When the government had started to crack down on it, they decided, “Well, we’re going to figure out a way around those efforts and establish our own sort of independent supply chain.” You can say that’s cherry-picking. I say, that’s a damn important fact to report and something they should be held accountable for.
Our book has many examples. We have quite a number of chapters that I think make our point that change needs to come to McKinsey.
Let me add this one point; I haven’t yet. McKinsey did institute some reform after our stories in the New York Times. They said they changed how they vet clients and they’re going to be rejecting more of them. So, we’re going to make changes because we think we need to make changes. I think that’s a good thing.
What I don’t think is a good thing is that the managing partner who pushed for that was voted out of office by the partners after one term. That doesn’t speak well. It doesn’t speak well to the fact that McKinsey, according to people we’ve talked to, has asked employees not to buy our book. What are they afraid of? Look, I’d be happy to refute the cherry-picking thing if they were to open up their books to us, and we could look more carefully at what they’ve done. I suspect there’ll be a lot more cherries to be picked.
Luigi: As you know, consulting was born in the 1920s, when antitrust started to make it difficult for industry associations to share information. George Stigler, who is the namesake of the center that sponsors this podcast, showed a long time ago that information asymmetry, particularly about costs of production, makes it difficult for firms to collude. The flip side of this result is that information sharing makes it easier to collude. One of the things that I find quite shocking is that McKinsey consults for many, many firms in the same industry. For example, they consult for State Farm, and they consult for Allstate. I don’t know whether they consult for Progressive Insurance as well.
Walt Bogdanich: Well, yeah, they consult for everybody they can find in the same space. Anticipating your question here, they say they’re not going to share information with the Washington Post while they’re working with the Times and vice versa. But if you start advising everyone in the same area, you bring a certain general knowledge to the table. It’s that kind of general knowledge that, while you’re not going to maybe give chapter and verse on what you’re telling company A, there are general conclusions that you can share with company B. This ended up being a way for businesses to know where to set prices and how to sell their products in a way that sort of defeated the whole concept of competitiveness.
Luigi: In the literature in economics, there is this concept of common ownership, that if firms are owned by the same mutual funds, they may end up colluding. I think here we have a case of common consultancy, that by having a common consultant, maybe inadvertently, but they end up knowing the same stuff and that facilitates tacit collusion.
In your view, after this investigation by your paper, in your book, are you suggesting that the DOJ should open a case on McKinsey or consultants in general?
Walt Bogdanich: Well, I’m not an editorial writer, but I will tell you this, you shouldn’t be able to pull in tens of millions of dollars without having competitive bidding. McKinsey is so well connected; it’s burrowed so deeply into these government agencies. They’re able to accomplish this and to do things that other companies, their competitors, can’t do.
I lay out some examples of that in the various state governments, where I looked at how they were getting these contracts to deal with Obamacare and expansion of Medicaid. I’ll give you one example. In the poor state of Arkansas, they were able to get more than a hundred million dollars in contracts without competitive bidding. That’s a lot of money in a very, very poor state or in South Africa, a country with some of the worst income inequality in the world, where they were coming in and extracting tens of millions of dollars.
Bethany: It strikes me that a big part of the problem is lack of transparency. I find it a really interesting issue in our modern world when so much is built upon this notion of transparency. Yet we have very different and really incoherent rules around where transparency is required and when it’s not required. McKinsey strikes me in some ways as the ultimate embodiment of what happens when there is a total lack of transparency. Does that sound fair to you?
Walt Bogdanich: Oh, it absolutely sounds fair. McKinsey just does not believe that their business is anyone else’s business. That’s where I think the government could get involved, Congress or whatever organization, and demand answers and not let them get away with trying to avoid explaining what they do or how they spent the money. Because I know when I file records requests for their contracts with government, oftentimes they come back with huge redactions, to the point where they won’t even name the McKinsey consultants, individuals who worked on this public contract. “Public contract” is the key word here. They have an attitude that, like I said, it’s none of your business.
Bethany: That’s a great line, that their business is not anybody else’s business.
Luigi: But everybody else’s business is their business.
Bethany: Perfect, Luigi.
One of the other things I don’t think I had realized was the role McKinsey played not only in consulting today, but in having sort of set the tone for a lot of the trends that exist in American business today, from exploding executive compensation to layoffs. Was that a surprise to you, too? How do you think about this broader influence McKinsey has had in shaping corporate culture, or even more than corporate culture, shaping the world we live in?
Walt Bogdanich: Well, I think that’s one of the reasons that people are buying the book and why it’s resonating with so many. We go back to 1950, a critical time in American history, where this wonderful contract was arrived at between General Motors and the UAW, the workers, and it basically gave them a passport to the middle class. This was a big deal at that time.
At some point there, shortly after, General Motors started worrying that maybe the workers were catching up to what the executives were making, and other corporations were thinking that. So, General Motors hired McKinsey to study this and survey all these other big corporations and come to a conclusion. And the conclusion was that workers were catching up. What do you do about that? Well, you find a way to have the executives make more money, and you come up with all these various schemes for them to get it, so that it isn’t necessarily reflected that, well, I was paid X amount of dollars, but you get your money through various different revenue streams and financial machinations.
Yeah. So, it started this sort of arms race to the top. In 1950, the average executive made 20 times what a production worker made, and now the numbers we see are somewhere around 350 times. I don’t need to tell you or anyone else that inequality is tearing apart this country and turning people into crazy people who are angry at everything and don’t believe anything. That’s bad for democracy. I think McKinsey contributed to that to some degree.
Plus, they always latch onto the fashion of the moment. For a while, it was that the stability of a corporation is really good. You can count on the workers not to strike. Long-term employment was what was sought after. That’s what I thought. If I’m running a company, I want an employee who’s been there for a long time. He knows the way things work.
Well, that changed, and all of a sudden it was like, “We don’t want long term.” The word they love to use is “disruption.” Everything is disrupting this, and that’s really a good thing. You don’t want a company to stay the same. You want it changing all the time. So, you want to outsource, you want globalization. Then, when globalization started to get criticized, they said, “Well, yeah, OK, globalization; however, it may not be the best, total solution that we’ve made it seem.” On any given day, you kind of don’t know what they’re going to dial up in terms of their beliefs.
Luigi: But of course, they are in favor of disruption, because more disruption requires more consulting services.
Walt Bogdanich: Perfect.
Luigi: Yeah. The question I have is to what extent this agenda has percolated in academia. One of the things that I notice is that this study done in the ’50s for General Motors was published in Harvard Business Review, which is unusual because generally, McKinsey does not publish the results of its analysis. But in this case, they made an exception, and they published regularly for many, many years, starting kind of a cottage industry of researchers studying executive compensation and maybe saying that executives were paid too little and so on and so forth. To what extent are they the link between the interests of the captains of industry and what is studied in business schools?
Walt Bogdanich: Business schools, I don’t think you’ll be surprised to hear me say, have been a huge disappointment to me in terms of not only what they do and what they teach, but in their unwillingness to even discuss McKinsey and what its role is. I have tried to get business schools. I’ve taught at Columbia for 14 years. I cannot convince them to get me to give a lecture to . . . Look, throw your questions at me. I don’t care. Those are the people we should be speaking to. But no business school has invited us to discuss the book, which I think speaks volumes.
When I went to Harvard, I heard that there was a course that one of the professors was offering about, we’re going to study the mistakes that McKinsey made in South Africa so that we could learn from it. I went over there, and I wanted to try to get the syllabus and find out what they were reading and just to interview the professor. You’d think I was a thief who was found stealing something. I was blocked at the door. No, you can’t speak to that person. I knew that would happen because I know the close relationship that Harvard Business School has with McKinsey. But I was disappointed because this was a professor who was trying to actually look at the shortcomings of this company and declined to even meet with me.
Luigi: I think you went to the wrong business schools. You have an open invitation at Chicago, and this podcast is sponsored by a business school.
Walt Bogdanich: I know. I know.
Luigi: Any discussion is open here.
Walt Bogdanich: I stand corrected. Yes, I overstated, which is a mistake journalists shouldn’t make. I apologize.
Bethany: Luigi, what did you think was the most interesting thing from the interview?
Luigi: The most interesting view is what kind of goal Walt had because I didn’t get a clear sense of why he picked and chose certain episodes and not others. He completely dismissed all the cases of potential conflicts of interest. He said, “Oh, because we have written this somewhere else,” but all the other episodes were somewhat written somewhere else.
I think that even if he’s trying to say that he’s only providing facts, I think he had an agenda basically trying to prove that McKinsey contributed to an increase in inequality. He chose the episodes that were feeding that agenda and did not touch the other ones.
But honestly, as an economist, I am—and maybe I’m wrong, and Bethany, feel free to say that I’m wrong—more concerned about conflicts of interest and potential for collusion rather than simply some cases where they might have overly cut costs.
I don’t doubt that they exist and the question is, on average, do they do that or not? This is the part when I was a little bit disappointed. When I challenged him and said, “Why did you pick those cases?” he said, “Oh, those cases are interesting per se.” He had a very journalistic answer, if you want, which is fine.
I would have answered in a much more aggressive way. I would say, “Look, I’m happy to analyze all the cases if you give me the data.” McKinsey is a data-oriented firm that does not prove with data that they add value. This is where I think that the burden of proof is on them.
Bethany: That’s actually a really interesting argument that the best way for McKinsey to push back against this growing negative press would be for it itself to offer transparency and to say, “OK, across the board, here are all the things we’ve done in the last 10 years, and here are the ones in which you say, and maybe we say, too, that we’ve screwed up, and here are all the ways in which we’ve made the world a better place.” Then you’re right, McKinsey itself is the only one who can answer that huge question, which, to me, was the most disappointing thing about Walt and Michael’s book.
It is absolutely not their fault, but you do want some sense of whether these episodes that they’re writing about are the anecdotes that show the truth of the whole firm or whether they’re the exceptions on the margin to McKinsey’s otherwise ethical behavior. There’s no way from what they tell you in the book for you to be able to answer that question. I think the point you just made is really, really right, which is McKinsey itself is the only one that could answer that question.
Luigi: Let me tell you that I heard a story about another consulting firm that really scared me a lot. The story goes as follows: this consulting firm was hired to help local banks increase their profitability. They came in and they realized that there are a lot of small businesses that were kind of captives of this bank. They increased processing fees by 300 percent or 400 percent. The profitability of the bank went up a lot, and this firm even got a cut of the profits because part of their compensation was contingent on success. But then, at the end of the engagement, they said, can you please refer us to other banks? So, bank A will call bank B and say, “We hired such and such. They were very useful in increasing our profits.”
Bank B will hire the same consulting firm. They will come in with the same recipe. That is a way to favor tacit collusion. If we all use the same algorithm, we quickly all converge to the same outcome. If you see from the analysis, for example, McKinsey consulted with most firms in the insurance business. They consulted with State Farm, consulted with Allstate, and as a result, they might have, number one, determined the practices in business but also reduced the competition. Because if everybody chooses the same rule, what choice do I have?
Bethany: I think the theme you’re pulling out of that, which is collusion, is a really, really, really interesting one. But it’s also, in a way, how a practice that is not great in and of itself can become a race to the bottom among all the firms in that industry. If one is raising fees and that’s the way to become more profitable, then they all start raising fees. Then what started as a single case study becomes, suddenly, industrywide practice. It has the effect, too, of taking isolated bad behavior and making it uniform bad behavior.
Luigi: Yeah. But it becomes uniform because there is no competition. If I take advantage of my customers by increasing the fees by 300 percent or 400 percent, there is a strong incentive for everybody else to undercut me. But if they receive the same advice, they are slowly nudged into a tacit collusion equilibrium. I’m not a lawyer, so I don’t know whether this is technically illegal, but certainly from an economic point of view, it is a disaster.
Bethany: That actually is really interesting. The legal question . . . I wonder if an aggressive prosecutor could make a case that you can have . . . it’s not quite third-party collusion . . . diffuse collusion. In other words, can you have collusion that is not done between two firms, but is done between two firms with the benefit of a third party, with a third party as the facilitator, right? We’ll have to get a lawyer to help us answer that question.
Luigi: But there is a new branch of literature now that looks at what the effects are of firms having the same institutional investors owning the stock. It’s called common ownership. I think that more problematic than common ownership is common consulting. The difference is that we can observe common ownership. But, to my point before, we cannot observe common consulting. We don’t know if all the firms in the same industry consult with the same consultant.
Bethany: It is interesting, as I think about that, is there another institution other than consulting firms that has so much power in American business and is so not transparent? Maybe you could just have a disclosure rule where, if you hire a consultant, you have to say in your public filings how much you paid that consultant and what they did for you and what the outcome of the analysis was. Then there would be a way for the outside world to track all of this.
Maybe we should go to the SEC and get them to change the disclosure rules around consulting—which actually leads to an interesting question, which is why they’re exempt from that kind of disclosure anyway, given that most firms would argue that they hire a firm like McKinsey in order to have a material impact on their financial statements. If the consulting firm is having a material impact on their financial statement, shouldn’t it be disclosed?
Luigi: That’s an excellent point. We should talk to the SEC about that.
I wanted to go back to where we started because you quoted that McKinsey is capitalism distilled. I disagree with the statement that McKinsey is capitalism distilled because, number one, consultants don’t really risk anything except maybe their consulting fee. They’re not really taking risk in a way that the typical capitalist does.
Quoting famous economic professor Alan Meltzer, “Capitalism without bankruptcy is like religion without sin. It doesn’t work.” The other thing is that I do believe, and I know that not everybody is on my same page, but I do believe that capitalism needs transparency, and capitalism without transparency is like power without accountability. It doesn’t work, either. I think that the element of secrecy that is around McKinsey is something that naturally worries me because we don’t know what happens in the shade of secrecy.
Bethany: I agree with both your points because McKinsey makes money, whether or not the advice it leaves clients with is good or bad, and whether its clients survive or fail, McKinsey still gets its fees. That’s not capitalism. That’s the opposite of capitalism.
On the other hand, I think what the author was getting at is that McKinsey is arm’s-length capitalism distilled. McKinsey’s advice is capitalism distilled because it’s all about how to be more efficient, how to make more money, how to squeeze more out of something.
Then I think, on a deeper level, McKinsey is capitalism distilled in the sense that if you believe in Walt and Michael’s argument, and the arguments others have made, that it is McKinsey’s intellectual heft behind a lot of the things that have become defining features of American capitalism, whether it’s the growing pay gap between workers and CEOs, whether it’s globalization, whether it’s offshoring, that all of these things have McKinsey at their root. Now, that might be an overstatement, too. It would actually be really interesting to investigate each one of these ideas and see if it would have propagated and taken the place in the American business world that it has if McKinsey never existed. But if you take those two things as a given, then I do understand the point that McKinsey is capitalism distilled.
Luigi: I think that McKinsey is Soviet socialism with incentives. In the Soviet economy, you had some very talented people at the top trying to structure the entire Soviet economy out of first principles. They were selected from the best universities in Moscow, and they were sent to control the economy. And the level of centralization that we have in McKinsey . . . McKinsey is running the world, a bit like the Politburo. The Soviet Politburo was running the Soviet Union, and the only difference is they take more payment in kind rather than taking payment in power. They take both, but more in money than in power. But it is not that different.
To me, the genius of capitalism is the alternatives. It is the fact that, sometimes—and I say this against my interests—but sometimes the best ideas don’t come from the top graduates of the Ivy Leagues. You want experimentation, you want difference. That is what capitalism is about. That’s the opposite of what McKinsey is. It’s like a meritocracy on steroids.
Bethany: I obviously agree with you. I think maybe the right word then for McKinsey is hypocrisy because they have promulgated so many of the ideas. If you take Walt and Michael’s book at face value, they have promulgated so many of the ideas that have come to define American capitalism, and yet they themselves are not capitalistic at all. So, maybe the right word is hypocrisy.
Luigi: It’s important to remember that McKinsey is not a corporation. It is a partnership where partners, in principle, do have a lot of power to change things. But the only one who tried to change things lasted only a year. After the Purdue pharmaceutical scandal, there was an attempt to change the culture inside a bit, and the managing partner who was the leader in this change was not renewed as a managing partner after one or two years, which is really remarkable because generally the managing partners stay for a long time.
Bethany: That’s really interesting. It makes me think of a different reason that it’s so difficult to change the culture, which is that you have a group of people at the top of McKinsey, McKinsey partners, who consider themselves the smartest people in the world and the best-educated people in the world, and therefore they should be making the most money in the world, and yet they’re not.
I suspect that part of what goes wrong there inside the firm is a constant keeping-up-with-the-Joneses feeling because these are people who think they should be competing at the billionaires’ level, and yet they’re not. Once upon a time, maybe 20 years ago, they were as wealthy as the CEOs they were coaching or as wealthy as the hedge-fund managers they might see around them, but they no longer are. I think that would probably create a lot of difficulty inside McKinsey. I think it would be a very difficult place to manage for that reason. That was at the heart of the insider-trading scandal, the former McKinsey partner, whose name I’m blanking on. Oh, my goodness.
Luigi: Rajat Gupta.
Bethany: Yeah, who went to jail because he wanted to make more money than he was making as the managing partner of McKinsey. I think that that’s another force within the firm . . . Whether or not it is a force for good or evil, I think that force cannot be a healthy one.
Luigi: But there is one aspect that at least I should own, not you, but I should own, is that many McKinsey or, in general, consulting employees are trained in business schools. So, to what extent is this a problem of their education versus simply a problem of their firms? I think that there is an issue of us emphasizing quantitative and very short-term results and not thinking more about the bigger picture. We don’t do a good job in conveying that information, and we become more, if you want, cynical and allow people to become even more cynical than we are.
I think that we need to change our education, but not by having ethics classes because the ethics classes are the typical thing that you wash your mouth out after you sin. I think that in the teaching of economics, we should emphasize what are the externalities we produce and what are the costs we impose on others and how bad that is and what responsibilities you have to take. Hopefully, the future generation will be better as a result.
Bethany: Yeah, I would almost suggest a slightly different class, which would be, why does business matter? Why do we do what we do? Why do we need businesses to thrive? What role does it play? Maybe this is completely narcissistic in the sense that it’s some of the questions we’re trying to answer on this podcast, but I do find that they go to the core of things, and they make you think differently, which is that business isn’t just about the narrow goal of making money, or even if it is, where does it fit inside society, and how does it play a role in keeping democracy healthy, and how does it play a role in making democracy unhealthy?
If you’re going to be in business, which side of the argument do you want to be on? Do you want to be part of a force for good, making democracy healthy, or do you want to be part of a force for evil? Maybe if you made people . . . because these are smart kids who go to business school, and if there were some way to make them think more broadly, that might fix a lot of the issues.
Luigi: Yeah. I think that one of the aspects that emerged from the book by Walt is that there is this tension in McKinsey because the younger associates and partners do have a more, if you want, social perspective, and they are confronted with a narrower perspective, where you don’t internalize this aspect. That’s a tension. At the moment, McKinsey has more talk the talk rather than walk the talk. I think that we should all be more honest and walk the talk.
Bethany: Yeah, well, that’s a good thing to aspire to in life overall.
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