The Firm: The Story of McKinsey and Its Secret Influence on American Business

by Duff McDonald

  For better or for worse, McKinsey just might be the most influential collection of talent in the world. How the firm managed to gain and hold on to that influence without most of us noticing is only one part of its story. What it has done with that influence since its founding in the 1920s is what this book is about.

  1. THE OZARK FARM BOY

  From Gamma to Lake Shore Drive

  The history of American business is the story of men who came along with a healthy dose of self-confidence. Henry Ford knew he had found a way to mass-produce cars. Steve Jobs knew there was huge opportunity in taking the computer out of the office and into the home. Jeff Bezos of Amazon.com saw the promise of the Internet early, and he took retailing into the ether.

  James O. McKinsey’s confidence wasn’t about something so tangible. Did you have a problem in your business? Let him have a look at it, and he was confident he could help you figure out what to do about it. Not only that, he promised to tell the rich and powerful what they were doing wrong. It was on these two convictions that he founded the company that eventually became the most powerful consulting firm in the world. It was nervy, and it was new, and in that way it was a distinctly American business that helped shape the history of business itself.

  “I have spent a considerable amount of my time during the last fifteen years in saying and doing things which should have been said and done by others, but which they hesitated to say and do,” McKinsey wrote in a 1936 letter. “I assume this is due to the fact that because of my philosophical inclinations I have developed some tendency to think in a logical manner and when this thinking indicates a conclusion I think it difficult to resist the temptation of stating it. Furthermore, when such a conclusion indicates definitely the need for action I feel I am rendering a service by trying to secure such action. I suppose I am doomed, therefore, to go through life doing things which make people think I am aggressive and hardboiled.”1

  Yes, people thought both those things. But they also thought he was the man to call when the problem seemed insoluble, the one who could set a wayward billion-dollar operation back on the right track. Even though McKinsey’s death at a relatively young age deprived him of the chance to properly reflect on his own career, he had already made it a long way from his days as a barefoot farm boy in the Ozarks,2 and he died as one of the most respected businessmen and innovators of his era. He didn’t just understand the needs of the giant corporations that were reshaping American society in their own image—he anticipated those needs and helped companies solve problems they didn’t even know they had.

  It all started with accounting, which McKinsey rescued from the dismal routines of bookkeeping and reimagined as a tool of strategic management. He was a straight talker whose air of assurance inspired others to follow his lead. He defined corporate management away from managing the routines of a bureaucracy and toward imagining the future and preparing a workforce for it. He was an early advocate of downsizing and other means of cost cutting as a way to save struggling firms. And he used all these ideas, and many more, to build what in time became the most powerful consulting firm, and one of the strongest business franchises, on the planet.

  McKinsey was born in 1889 to James Madison and Mary Elizabeth McKinsey in Gamma, Missouri, and was raised in a three-room farmhouse. At a young age, he distinguished himself as a wizard with numbers. One early biographer claimed that McKinsey’s high school principal hired him to teach algebra to his own teachers,3 though another said that he merely taught other students, not teachers.4 Whatever the version of the story, teaching was clearly his early passion, and it looked as if it would become his lifelong profession. He graduated from the state teachers college in Warrensburg, Missouri, in 1912 with a bachelor’s degree in pedagogy. He saw himself first—and above all—as a man who had lessons to give.

  Those who met him remarked on his “presence”—he was tall, at six feet four—and forthright mien. He was also quite stubborn: Despite suffering temporary blindness while in college, he later ignored his doctor’s advice to quit smoking cigars or risk another loss of eyesight.5 Whether or not the doctor knew what he was talking about is beside the point; McKinsey refused to change his behavior.

  Teachers college was just the start of an education odyssey that included a bachelor of law degree from the University of Arkansas at Fayetteville, a stint studying and teaching bookkeeping in St. Louis, and a bachelor of philosophy degree from the University of Chicago. As it did for most of the young men of his era, World War I took him on a detour. In 1917 he was drafted into the army; starting as a private, he was promoted to lieutenant in the Ordnance Department the next year and traveled across the United States, working with suppliers of war matériel.6 He was shocked by what he found: The inefficient and disorganized supply system offended his orderly accountant’s inclinations. Here was a problem that cried out for expert management, but where could it be found?

  Following his discharge at the age of twenty-nine, McKinsey continued to add to his list of credentials. In the span of a single decade, he managed to obtain a master’s in accounting from the University of Chicago, was appointed an assistant professor of accounting at the university, and joined fellow professor George Frazer’s accountancy firm of Frazer and Torbet. But that was not all. In 1923 he was named vice president of the American Association of University Instructors in Accounting, and in 1926 he became a professor of business policy at the University of Chicago.

  This last appointment was the first hint that the man knew accounting could be more than mere bookkeeping—that numbers could reveal not just profit and loss, assets and liabilities, but the whole story of a business and what it could accomplish. To that point, accounting had been viewed as a record of the past. McKinsey spun it around and aimed it at the future, turning it into a tool of effective management.

  Mac met Alice “Polly” Louise Anderson of Sioux City, Iowa, when she took an accounting class taught by McKinsey at the University of Chicago. In just the second session she told him that she was dropping the class, as she had decided there was nothing more she could learn from him.7 With her boldness, she won his heart, and the two were married in 1920. In 1921 she gave birth to twin sons, Robert and Richard.

  But McKinsey’s life was defined by ambition more than by family. His son Robert remembers him as an absentee father who bore the scars of his threadbare upbringing. Although he became very rich by his late thirties—he once rented a summer farm that had its own polo fields and eventually moved to one of Chicago’s elite addresses on the 1500 block of Lake Shore Drive—he refused his children toys because he considered them “inessential” purchases.8

  He was a workaholic who was rarely at home. He once claimed that he ate all his lunches, half of his breakfasts, and a third of his dinners with prospective clients.9 When he was around, his children were not allowed to bother him while he was “working.” While he had the ability to be warm and affable, he deployed those qualities only for work. He had no interest in literature or culture. While he joined many local clubs, he did it for professional contacts, not for the social or extracurricular pleasures of the clubs themselves.

  That’s pretty much all that is known about Mac McKinsey’s personal life. But a few points are worth reinforcing. First, McKinsey saw that a company’s secrets could be found in its accounting. He proudly wrote books about the minutiae of budgeting and forecasting, because he believed it was only through rigorous adherence to such “fact-based” analysis that a company could truly reach its potential. His protégé Marvin Bower, however, later distanced McKinsey & Company from this image of accounting, so much so that it came to define itself in opposition to the field. In Bower’s mind, accountants were drones bound by rules while consultants were free thinkers whose vision and creativity extended far beyond balance sheets. Bower’s McKinsey started with the numbers and then added perspective.

  Second: With his own experience as proof of concept, McKinsey attracted a cohort that wanted to achieve in life
the same things he did—rising above an often humble upbringing to become rich and important men. McKinsey pursued success by combining an ability to focus relentlessly with a knack for breaking rules. And he decided early on that he would gain power by speaking truth to it. “He was quite poised,” wrote William Newman, who worked with McKinsey in the 1930s. “No trace of Ozark poor farm boy, not the least. He’d had poverty in his childhood and I think that left its mark. He wanted to succeed, but he also wanted to have money, the satisfaction that he did have money and that he was free to spend it.”

  The American Century

  In 1941 Time Inc. publisher Henry Luce coined the term “American Century” in a Life magazine editorial. He was describing the country’s global economic and political dominance leading up to World War II. But Luce was also correct in the literal sense: The American Century had actually started several decades before.

  The building of the railroads and coincident spread of the telegraph in the United States in the middle and second half of the nineteenth century helped create the world’s first truly “mass” markets. If an executive had ambition, his company didn’t have to serve just local customers. It could serve an entire continent and beyond, if it had the wherewithal to get the organization and logistics right.

  The economic historian Alfred Chandler documented the momentous changes in what came to be known as the Second Industrial Revolution in his seminal book Scale and Scope—the title of which referred to the simultaneous revolutions in both scale (in manufacture) and scope (in distribution) in American enterprise. Those twin revolutions transformed the United States from an agrarian society to an industrial powerhouse in the span of a single generation. In 1870 the nation accounted for 23 percent of the world’s industrial production. By 1913 that proportion had jumped to 36 percent, exceeding that of Great Britain.10

  By 1920, when only a third of homes in the country had electricity and only one in five had a flush toilet,11 the country’s business establishment was embarking on a course of radical, unprecedented expansion. This brought with it a dilemma that has preoccupied business leaders ever since: how to grow big while maintaining control over the enterprise. Moving from a single-product, owner-run enterprise into a complex and large-scale national one is a difficult task. First, you have to build production facilities massive enough to achieve the desired economies of scale. Second, you have to invest in a national marketing and distribution effort to ensure that sales have a chance of matching that scaled-up production. And third, you have to hire, train, and trust people to administer your business. Those people are called managers, and in the first half of the American Century, they were in very short supply.

  The benefits to successful first-movers were gigantic. In industries where only one or two companies took the plunge early, they dominated their field for a very long time to come; this group includes well-known names like Heinz, Campbell Soup, and Westinghouse.12 A ten-year merger mania, from 1895 through 1904, also brought the creation of a number of corporate entities the likes of which the world had never seen—1,800 companies were crunched into 157 megacorporations,13 including stalwarts like U.S. Steel, American Cotton, National Biscuit, American Tobacco, General Electric, and AT&T.14

  The key business problem identified during this transition—and one that underwrote McKinsey’s success for several decades—was that a single, central office could no longer adequately administer such far-flung empires. Power had to be ceded to the extremities. The question was how. It was a quandary that beguiled some of the great thinkers of the time, including political scientist Max Weber, who argued that a systematic approach to marshaling resources through bureaucracy was a necessary and profound improvement over pure charismatic leadership.

  In his book American Business, 1920–2000: How It Worked, Harvard professor Thomas McCraw pinpointed the issue: “In the running of a company of whatever size, the hardest thing to manage is usually this: the delicate balance between the necessity for centralized control and the equally strong need for employees to have enough autonomy to make maximum contributions to the company and derive satisfaction from their work. To put it another way, the problem is exactly where within the company to lodge the power to make different kinds of decisions.”15

  Companies such as DuPont, General Motors, and Sears Roebuck were the first to address this problem systematically. According to Chandler, DuPont sent an emissary to four other companies experiencing similar issues—the meatpackers Armour and Wilson and Company, International Harvester, and Westinghouse Electric—to ask what they were doing.16 And the answers were remarkably similar: The innovators moved from the centralized system to a multidivisional structure with product and geographic breakdowns. The concept left operating division chiefs with total control over everything except funding resources. Top managers took a more universal view of the business, monitoring the divisions and allocating capital accordingly.

  The most successful companies of the era, such as General Electric, Standard Oil, and U.S. Steel, all employed some variant of this model. But by and large, they had developed these ideas on their own, a process of trial and error that was costly and time consuming. They would have much preferred hiring outside experts to help them with it, if only such experts existed. This was a huge commercial opportunity that called for an entirely new kind of service.

  Stepping into the Breach

  Unwittingly, the federal government did its part to create the modern consulting business. Starting in the last part of the nineteenth century, Washington made periodic regulatory efforts to curb the power of big business, including the 1890 Sherman Antitrust Act, the Federal Trade Commission Act and Clayton Act of 1914, and the Glass-Steagall Act of 1933. The intended effect of these measures was to prevent corporations from colluding with one another to fix prices and otherwise manipulate the markets. The unintended effect, according to historian Christopher McKenna, was to accelerate the creation of an informal—but legal—way of sharing information among oligopolists. Who could do that? Consultants.17

  Regulatory efforts paid another rich benefit to the likes of McKinsey: Restricted from cutting backroom deals with each other, firms were thus obliged to actually compete, which meant they needed to make their operations more efficient. Here again, consultants were the answer.

  But perhaps the circumstance that most aided the creation of the consulting industry was the entry of a new, key player into business itself. Empire builders with names like Carnegie, Duke, Ford, and Rockefeller had built huge, vertically integrated companies, but they had neither the time, the talent, nor the inclination to create and carry out management systems for those entities. These were the conquerors of capitalism, not its administrators. And yet, as Chandler pointed out, “their strategies of expansion, consolidation, and integration demanded structural changes and innovations at all levels of administration.”18

  Into the breach stepped a new economic actor who was neither capital nor labor: the professional manager. Gradually, he replaced the robber baron as the steward of American business. Alfred P. Sloan, the legendary president of General Motors, was the first nonowner to become truly famous for his managing skills. His decentralized, multidivisional management structure gave GM the agility to outmaneuver the more plodding Ford Motor Company and snatch the industry lead. Ford may have revolutionized manufacturing, but Sloan realized that the car-buying market had become big enough to be segmented into people who bought Buicks, Cadillacs, Chevrolets, Oldsmobiles, and Pontiacs. By the late 1920s, the car market was maturing, and people wanted choice. Sloan also gave them the ability to buy a car on credit—a groundbreaking idea at the time. Before the decade was over, GM had surpassed Ford as the market share leader, a position it didn’t relinquish until the 1980s.

  Sloan and his ilk were perfect customers for McKinsey: Lacking the legitimization of actual ownership, professional managers felt great pressure to show they were using cutting-edge practices. And who better to bring those practices to the
ir attention than consultants who were talking to everyone else? This was the beginning of a decades-long separation of ownership from control in corporate America, and the consultant was an able ally to the professional manager in this tug-of-war—an ally who wasn’t gunning for the manager’s job. Thus began the era of managerial capitalism.

  For more than two centuries, economists had argued that companies operated in some sense at the mercy of Adam Smith’s “invisible hand” of the market. But the revolution in management thinking in the United States offered up an alternative idea: the “visible hand” of management, which made things happen, as opposed to merely responding to external market forces.

  The academy helped move this ideology along. Before 1900, there was only one undergraduate business school in the country, the University of Pennsylvania’s Wharton School of Finance and Economy, founded in 1881 with a $100,000 donation from financier Joseph Wharton. The Tuck School of Business at Dartmouth followed in 1900. Over the next decade, pretty much every major institution started explicitly preparing its students for careers in management.

  Although the rise of today’s industrial-farm-style MBA programs is really a postwar phenomenon, Harvard founded its Graduate School of Business Administration in 1908, with a second-year business policy course designed to give the student an integrative approach to addressing business problems, including accounting, operations, and finance.19 The purpose of the course, according to the school, was to give the student an ability to see those problems from the top management point of view. Much of James McKinsey’s academic writing centered on this very issue and later informed the practice of his firm.

  McKinsey’s Oeuvre

  As a young academic, McKinsey was a prolific writer, if not an especially engaging one. His first four books were dry tomes on the nitty-gritty of accounting and taxes: Federal Incomes and Excess Profits Tax Laws (1918), Principles of Accounting (cowritten with A. C. Hodges, 1920), Bookkeeping and Accounting (1921), and Financial Management (1922). But with his fifth effort, he broadened his horizons significantly. Budgetary Control (1922)—the first definitive work on budgeting—turned accounting on its head, promoting it as an essential tool of managerial decision making. “Budgetary control involves the following,” McKinsey wrote. “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.”20