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Inside a McKinsey Electricity Strategy Engagement

Stories which delve behind the scenes of consulting engagements are very rare. Today’s lengthy post is just such an article. It is an in-depth analysis of a major McKinsey assignment in a developing economy, South Africa.

Background

There are many ways in which we collect this type of information. We obviously have an extensive and active network in management consulting who feed us information and serve as corroborating sources. Sometimes we get lucky and are fortunate in that a user sends us lots of material about a critical project. We treat this information from the latter source carefully. Usually we do not do much with it. We try to honor privacy codes and where we share information; we present such a sanitized view that it is difficult to decide the overall impact of the study. Early this year we received over 45 documents by email from an employee of a South African state-owned-enterprise called Eskom (Pty) Ltd. We did not know much about the company and simply ‘filed’ this as an interesting set of documents worth looking at later. Then the FIFA 2010 World Cup came along and shined a spotlight on South Africa and we learnt a few interesting things about the country. Three things changed our mind about the value of the documents.

For one, Eskom is not a little company. It is the world’s 5th largest integrated (generation-transmission-distribution) utility. It is in the league of EDF, RWE and South California Edison Power. It is big. The company is running the world’s largest, yes that’s right – largest, construction program to build a fleet of new coal, gas, hydroelectric and nuclear power stations. Clearly what happens to this company is important.

Second, we found it surprisingly easy to speak to Eskom employees off the record. Although no one wanted to be mentioned by name, not only could we confirm lots of detail, but were also able to extract lots of information to support our review of the project. Several employees actually emailed us corroborating documents. The level of access stretched all the way from managers at power plants to executives at the head office. Many employees seemed to have a story to tell and were willing to share the information. At no point did we mislead employees. We were forthcoming with our intent to publish the information. Consultants at McKinsey’s rivals in South Africa; Accenture, Monitor, Burlington and Bain (London Office) were also willing to talk to us off the record.

The story was definitely big; A major company facing severe problems building power stations to support the national and regional economy. Africa’s first World Cup was bearing down and there was the prospect of no power. There was very little cash as shown by the Finance Minister’s plea for a $3.5B World Bank loan.

Third, about 5 months before we wrote this article, the newly-appointed South African Minister of Finance, Pravin Gordhan, wrote an interesting, if not slightly desperate, opinion-piece in the Washington Post explaining why the World Bank should approve Eskom’s request to build the world’s largest and highly polluting coal fired power plant. His argument was that South Africa needed electricity and was running out of it. If South Africa’s economy struggled due to power shortages, it would pull its neighbors down into economic malaise. In fact, South Africa did have rolling-blackouts repeatedly over the last 3 years. If the Minister Finance was getting involved, how could this not be important?

The story was definitely big; A major company facing severe problems building power stations to support the national and regional economy. Africa’s first World Cup was bearing down and there was the prospect of no power. There was very little cash as shown by the Finance Minister’s plea for a $3.5B World Bank loan. The story essential writes itself.

McKinsey refused to comment on this story. Phone calls and emails to Adam Fine (Partner) and Norbert Dorr (Managing Partner in Sub-Saharan Africa) went unreturned. Therefore this is just one side of the story. The lesson here is in understanding how McKinsey projects are developed and the challenges of dealing with clients under extreme pressure.

Finally, we have decided not to publish the Eskom documents. It was not necessary for our story. Eskom indicated they are confidential documents and were released without the company’s permission. We could have presented the slides, but that seemed inappropriate especially since Eskom was so polite in making their request. So we will outline the story based on information we have received in our investigations.

The Client

Eskom’s Megawatt Park head office is a massive complex in the leafy and upper-class suburb of Sunninghill, Sandton. You are likely to see more German luxury sedans here than any Tony suburb in the US or London. Business men and women dressed in designer gear pack the many outdoor eating spots around the office. As you drive over a hill via the closest thoroughfare, the huge and sprawling head office complex looks very much like a massive university. Posted on the entrance are large signs advertising Eskom’s award as global power utility of the year. The head office has been renovated and substantially upgraded over the last 5 years.

Hearing the current Eskom employees describe EE brings back feint recollections of Fortune Magazine articles about Enron’s free-wheeling culture in the International Business under Rebecca Mark – the Enron business responsible for building power stations.

Arriving in the main foyer is an experience. This could be any building in a modern western economy. The foyer leads into a cavernous building with a huge open space in the middle and offices around the space. A football field could easily fit into this space. Offices extend all the way to the 5 floor. The buzzing sound of bees gives the first clue that close to 10,000 people work here. At elevators nearest to the entrance is a modern looking Koi pond with some very large, expensive and overly excited Koi. If you walk past them, they follow you in the hopes of snaring some food. Eskom’s refurbishment of its head office was not merely decorative. It coincided with a huge change in the company’s strategy and direction. Between 2003 and 2005 Eskom embarked on a new business strategy. To understand the size of the change, it’s worth understanding how they operated in the 5 years earlier.

Eskom had a massive wholly-owned subsidiary called Eskom Enterprises (EE) with about 20,000 employees. EE was a rather enterprising place to be. It attracted the cowboys and renegades of the business. Hearing the current Eskom employees describe EE brings back feint recollections of Fortune Magazine articles about Enron’s free-wheeling culture in the International Business under Rebecca Mark – the Enron business responsible for building power stations. Chasing a steep profit target, the EE executives jetted around the world to secure contracts to build power stations, refurbish plants and basically hook into anything which would generate a profit.

Deals counted more than execution and this culture of deals-first is easy to understand when you look at EE’s executive suite. EE was led by a flamboyant and debonair CEO, Dr Enos Banda. Always dressed in bespoke suits and Hermes ties, the law doctorate recipient from George Washington University and an ex-CSFB executive built an all-star Ivy League executive team. The head of EE Strategy was Tebogo Skwambane, a Harvard-MBA with all of three years experience at Bain & Company. This team embarked on a shot-gun like approach to building profits. EE was involved in a huge mix of businesses which had no obvious synergy. From printing companies in Africa to fish farms in South Africa, EE chased any profit.

Of course, such an implicit guarantee is only of value in countries with a poorer credit rating than South Africa, which ultimately explains the mix of client countries EE stacked up.

These were however all side-shows to the lucrative job of building power stations around the world. A direct outcome of this build-anywhere strategy was that it sucked engineering talent out of South Africa and transplanted these specialists into unforgiving locations like Bosnia, Vietnam, Russia, the Congo and other strange places. In a country with a disastrous brain-drain, this did not help. Yet, this did not hurt the Eskom at all. A loss to South Africa was a gain to Eskom in the form of lucrative construction and turn-key fees ultimately backed by the balance sheet of the South African treasury. Since Eskom was a state-owned-enterprise, there was an implicit belief in the market that Eskom was backed by the full power of the South African government. Therefore when EE won engineering and construction contracts abroad, a key reason for the award was the belief the South African government would never allow Eskom, and EE to fail. Of course, such an implicit guarantee is only of value in countries with a poorer credit rating than South Africa, which ultimately explains the mix of client countries EE stacked up.

As EE was replicating Mark’s mistakes, the South African government led by former President Thabo Mbeki desperately wanted to make South Africa competitive and open up the economy. The energy sector seemed ripe for change. The federal government was insistent that all new power projects would be undertaken by consortia of private companies. Eskom was specifically forbidden from getting involved in new power projects. While this debate was raging in the press, South Africa’s reserve margin started falling dangerously low. The reserve margin is the excess electricity output versus greatest expected demand. All countries have a reserve margin to handle unexpected spikes in demand, problems with the infrastructure assets which may result in generation capacity going offline or just poor forecasting.

Since the last major power station construction boom in the 1980’s South Africa’s industrial base had slowly caught up and started to eat into the reserve margin. Here’s the scary part independently corroborated by two senior general managers at Eskom and the Department of Minerals and Energy in South Africa. Between 2000 and 2003, at no time did Eskom’s internal forecasts show that the country was running dangerously low on its reserve margin. Eskom and South Africa was blind-sided.

The crisis was created from three sides:

• Eskom did not see the problem of a declining reserve margin.

• All the talented engineers who could build the stations were committed to projects in other parts of the world. Bringing them back or ending the early projects would incur significant break-up fees.

• The federal government was insisting that Eskom should not build power stations.

As all these problems came to a head, the Eskom board realized that:

• A power crisis was coming.

• It needed to build the power stations, despite federal government objections.

• EE would need to end its profit focus, lose its international mandate and focus on building power stations in South Africa.

This massive strategy change resulted in Eskom painfully and expensively withdrawing from its international commitments. Eskom Enterprises was brought back into Eskom and made into a division of Eskom. Employees were pulled in from all over the company and country to reposition Enterprises Division. It was and remains a monumental effort as the company strains to meet its build targets.

Strategy Firms

A single coal-fired power station can cost anywhere from $2B to $5B to build. Coal stations are a difficult undertaking. Like a hydroelectric station, a coal station needs to be close to its source of fuel. Therefore coal, stations need to be built next to or on top of a coal field. Therefore when you build and manage a coal-fired station, you are sometimes effectively building and managing a power station and a mining operation. Sometimes Eskom buys the coal from BHP Billiton or Xstrata. In other cases, it manages the mines itself. The planning and permitting can be a nightmare unless they are managed well. However, back in 2005, these issues were still far into the future for Eskom. Eskom was focused on building power stations.

Eskom’s decision to build its own stations meant that it would need to manage the massive procurement programs that would go hand in hand with this process. Typically large constructions projects are handed to EPCM companies like Bechtel or Flour Daniels. Eskom decided to build its own stations. Billions and billions of dollars of steel, turbines, generators, transformers and more would need to be bought. The procurement process would need to be managed and done at a time when China was locking up equipment at a staggering rate. To compound matters, Eskom had no viable procurement capacity or capability to manage the process on this scale. They last built a power station in 1981.

Enter McKinsey. Brian Dames, the current CEO of Eskom and then head of Enterprises Division mandated the appointment of “strategic consultants” to help Eskom understand the scale of the challenge it was facing and how it should respond. As a state-owned-enterprise, Eskom must go through a very transparent and cumbersome procurement processes. An open tender was made and the following firms responded:

• McKinsey

• Accenture

• Monitor Company

• Burlington

• Cap Gemini

• Deloitte Consulting

“McKinsey knew the problem very well. They were able to outline things even we did not realize.”

A shortlist consisting of McKinsey, Accenture and Deloitte Consulting were invited to present. Two Eskom managers who attended the presentations provided the following reasons for McKinsey’s success in securing the work:

• “Very polished presentation and people. Lots of international experience and they had done similar work around the world.”

• “They were willing to think through our problems and provide some meat in the presentation. Many of the other companies provided generic cases and information.”

• “McKinsey knew the problem very well. They were able to outline things even we did not realize.”

• “McKinsey seemed to be presenting a very global view with best-practices drawn from around the world. The other firms seemed to be presenting their local expertise with the international ideas sort of added in as an after-thought.”

• “In some ways McKinsey did not just win because they were so much better. They won, despite their very high fees, because everyone was so much worse.”

• “Deloitte brought in a huge consortium of specialists. They seemed far too technical and local in their viewpoint. The team also had some ex-Eskom employees and we felt this would lead to a recycling of old ideas.”

McKinsey

The McKinsey engagement team of 8 was staffed out of the McKinsey Johannesburg and Dusseldorf offices. At the Eskom head office, the engagement team apparently commandeered the allocated office space assigned to an engineering unit. We mentioned earlier the head-office was undergoing renovations so space was in extremely short supply. This did not go down well with the engineers who created quite a bit of noise about it. To make matters worse, the McKinsey team created a shingle with their engagement name (“Sisonke”) and hung it in their working space. This did not seem to help matters. The team did not get off to the best start possible.

To make matters worse, the McKinsey team created a shingle with their engagement name (“Sisonke”) and hung it in their working space. This did not seem to help matters.

The entire engagement lasted 5 months and in that time the team structured their work into the following components:

• Two teams with each focusing on IT Spend and Transformer spend over the first 6 weeks.

• Followed by the organizational design over the next 6 weeks.

• Concurrent with the organizational design, the diagnostics of capital procurement was done.

• Finally the clean sheet capital redesign was done over 8 weeks.

• Throughout the project, a change management initiative was conducted.

Eskom employees felt that the McKinsey team seemed to be consistently focused on the following points:

• What is the size of the opportunity and budget commitments over the next 3 years?

• What is the process to set targets and drive them down to the level of individuals?

• What are the organizational design principles and major process changes required to create a sustainable world-class supply chain management capability?

• What is the interim structure needed to achieve these results in the short-term?

• What are the specific actions required to enable the success and rapid bottom-line impact of wave-1 money teams?

• What organizational mindset and behavior barriers exist and how can the ExCo (executive committee of Eskom) help overcome them?

Depending on whom we spoke to, we received very different views on McKinsey’s style and conduct throughout the engagement. We also had to be careful of too heavily counting the viewpoint of employees who had been marginalized by the consultants and were seeking to dismiss them. Sifting through all the comments and reading the reports, we think the following 10 observations probably best describe McKinsey’s behavior:

• McKinsey initially alienated several of the mid-level employees by their decision to take over a previously allocated space. Their decision to advertise their presence was seen as “corny” and an effort to entrench their position at the client. Many employees also did not like the fact that the engagement office was locked and not freely available without the engagement manager’s permission. That said, most people we spoke to felt that within a week or two, the demands of the project and McKinsey’s efforts quickly shifted the attention to what was important. The engagement.

• The engagement team seemed to be operating from a well-defined play book. “They were in control at all times and it seemed like they were well ahead of the client in foreseeing obstacles and data challenges.” This brought lots of comfort to the engagement team allocated from the client side.

• There was uniform agreement that McKinsey underestimated the challenges of collecting data and the quality of the data. People we spoke to mentioned that McKinsey was totally blind-sided by Eskom’s poor data on the “mid-life” crisis facing their power plants. The mid-life crisis is a term used to describe the major refurbishments most plants undergo after about 12-15 years of operation. Eskom’s plants built in mid-1980 had been through their first refurbishment in the mid 1990’s but Eskom wanted to extend their operations and refurbish them again. Refurbishments cost billions of dollars. This data did not exist and had a material impact on the procurement spend, and therefore the final business case.

• McKinsey had detailed access to benchmarks and data from utilities around the world. “There was no spending category which could not be benchmarked.” This was another consistent point. Many employees working with the McKinsey team felt that the consultants were very good at showing opportunities and then showing Eskom’s position relative to its peers. “This competitive view did not exist within Eskom who felt they did not need to be benchmarked.”

• Mckinsey consultants were “razor sharp” but did not always understand the nuances of the situation. Many of the consultant’s ideas and concepts seemed to be centered on free market principles. Unfortunately Eskom does not operate in this way. Eskom follows a federal mandate to procure a minimum percentage from previously marginalized citizens. This does not give them a whole lot of space to chase the best deal. Although it was easy to fix, some of the foreign consultants initially chased ideas, and wasted time, which discounted this constraint.

Apparently Mckinsey was different. It managed to get many of the senior executives to support the idea, change their budgets and behavior, and implement the findings.

• The McKinsey reports and slides were very easy to read and understand. Many of the people we spoke to indicated that previous consultants produced work that was far too complicated. The McKinsey analyses were simple, clear and direct.

• McKinsey had access and clout. Eskom has an internal consulting team with the responsibility to check the work of external consultants. They tend to focus more on the financial side of projects but in many ways they are a type on internal checking system for management consultants. A member of this team pointed out that many consultants have been at Eskom, the company is rumored to spend over $100M on consulting fees, but lack the access and ability to convince Eskom management to make any changes. “We have so many consulting documents sitting in our cupboards collecting dust. These consultants always have good ideas but sometimes nothing happens once they leave.” Apparently Mckinsey was different. It managed to get many of the senior executives to support the idea, change their budgets and behavior, and implement the findings.

• This came from several employees; the McKinsey consultants were friendly and made time to explain things to them. In so many forums we read comments that McKinsey consultants are arrogant, dismissive and lack emotional intelligence. At no time did we pick up any comments like this. If anything, Eskom seems to have enjoyed working with the McKinsey consultants.

• Eskom is not a private company. It is owned by the federal government. Employees felt the project helped open Eskom’s eyes into how to operate more like a private enterprise. Although this was not an objective of the engagement and is difficult to measure, the McKinsey team provided numerous examples of how French, German and Canadian utilities remained largely state-owned but operated like private enterprises. “This was very well received by the Eskom executives.”

• Finally, the comments were evenly split on the ability of the consultants to effect change. Some felt the change management effort was an analysis of opinion and views while others felt the change management effort actually altered the companies thinking. It’s hard to say which is true. Despite this, most employees felt that the McKinsey recommendations led to substantial savings for Eskom.

Lessons

As mentioned earlier, these are largely opinions, albeit informed opinions, of employees involved in the engagement.

There is a more tangible way to measure success. Despite this project, McKinsey had never really made much headway into Eskom in their sweet-spot, corporate strategy. Rather surprisingly, that work went to other firms. This procurement project gave McKinsey a good beach-head to build itself at the client. From this project it was appointed to undertake a technology feasibility study, fuel supply study, organizational design, risk management study and finally in July 2010 it was awarded a study to undertake a corporate strategy engagement for Eskom. That is an ongoing assignment as we write this post. On the basis of this procurement engagement, McKinsey seems to have steadily built a commanding executive mindshare at Eskom.

South Africa had a law stating that companies must try to employ citizens who had been previously marginalized. Stiff penalties appear to be in place for failing to meet this requirement. McKinsey seems to have met this requirement by NOT lowering its criteria.

Several things helped propel McKinsey to an entrenched position within this very large and lucrative client:

• McKinsey never discounted its fees to get the work. It won the procurement work while submitting a fee approximately double the second highest bid. Selling in low simply discounts the value of its image, lowers it margins and ultimately impacts its ability to hire talented and expensive graduates.

• To access Eskom executives, McKinsey partners initially joined several business forums and shared their opinions and views on how to build high-performing companies. They did not offer free work.

• South Africa had a law stating that companies must try to employ citizens who had been previously marginalized. Stiff penalties appear to be in place for failing to meet this requirement. McKinsey seems to have met this requirement by NOT lowering its criteria. It has maintained its very high standards. It has partnered with carefully vetted companies if it did not have the necessary employees.

As the Bain partner in London mentioned, “How can we compete with the McKinsey brand when the pound/dollar exchange rate means we are about parity?”

• McKinsey continues to refuse to build its presence via cheap marketing. The firm does not take part in any surveys, paid publishing or advertisements. This has worked well in emerging markets where executives are still very willing to pay a premium for access to international best practice.

• McKinsey was never hesitant in its push into South Africa. It joined in 1994 and stayed through all the turmoil. It took a long-term view of the market and was willing to invest for the future. It has now produced its first home-grown full partner, Adam Fine and has started exporting ideas from this office. This kind of consistency is recognized by the small business community in South Africa. This in stark contrast to firms like Bain & Company who invest based on profits. Bain has thrice entered the market and thrice left. They are now entering again, with a local partner but having the bulk of their staff seconded from the London office. How the economics will work with pound-based expatriate salaries versus the low-priced South African Rand projects is not clear. They seem to be staffing for a project and will likely shut-down the office again when work slows down. McKinsey appears to understand commitment.

• McKinsey strikes some fear and hopelessness in even its most capable rivals. As the Bain partner in London mentioned, “How can we compete with the McKinsey brand when the pound/dollar exchange rate means we are about parity?” It’s one thing to pretend to be the best firm, it’s quite another when your rivals are vigorously nodding in agreement.

 

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