Emerging markets and micro-finance are hot topics at the moment. Whether it is micro-finance in Mexico, Brazil, India, Pakistan or Indonesia, the sector is definitely growing. All the major consulting firms from McKinsey, the Boston Consulting Group to Bain have tried to break into this sector. As expected, McKinsey has been heavily involved in micro-finance work and has undertaken some of the work significant and landmark projects. This posting is based on a series of discussions we have had with several McKinsey consultants working on a micro-finance project in Latin America. We follow them through a real engagement and see how they tackled the study. The McKinsey consultants interviewed spoke off the record and where not authorized to speak about the engagement.

Background

The country setting for this engagement is a power house among emerging economies. It is usually mentioned in the same breath as Brazil, India, China, Russia, Turkey and Indonesia. A vibrant commercial sector has seen many consultants and consulting firms enter the market. A new president and more open trade policies saw a steep increase in the per capita GDP of the country. It was becoming awash with wealth and this excess liquidity was causing an equally steep rise in the domestic inflation rate. However, this did not bother the élite of the country.
Specifically, why doesn’t the federal government offer similar loans but at more favorable rates?
It did bother the rest of the population who toiled below the poverty line. Like its peer emerging markets, Brazil, Russia, China, India, Philippines, Indonesia and Turkey, this country was saddled with a massive population which does not take part in the formal economy. This large group of the population, comprising tens of millions of people, are usually descendants of the indigenous Indian population, are poorly educated and work in a shadow economy. Life is tough for them. To ease their burden, the government has created many agencies whose sole purpose is to use federal deposits to improve their access to home loans, micro-loans for businesses, emergency loans and other financial facilities. The market is so big that private players have created highly profitable and highly automated processes to offer micro-loans at steep interest rates and incredibly high profit. Mainly due to their success, private players have come in for their fair share of criticism. The federal government has also come under enormous pressure to do more. Specifically, why doesn’t the federal government offer similar loans but at more favorable rates?

That’s where McKinsey comes in. The federal agency responsible for providing micro-loans to entrepreneurs and small businesses wanted to ramp up its efforts. It wanted to offer more loans to customers and at better rates. Of the funding available to the agency, about 80% was not distributed. There were two schools of thought to explain this.

• One was that the absorptive capacity of the market was just not large enough.

• The other was that with the correct distribution channels more loans could be provided.

The Governor General of the agency was enamored with the idea of setting up agency-owned-and-managed offices in the rural areas to improve loan distribution. The middlemen, independent financial providers (IFP’s), who now distributed these loan’s where up in arms. This would create direct competition and eat into their business. It was also a key issue since owning IFP’s were highly lucrative and some of the country’s most influential and wealthy families both directly and indirectly controlled IFP licenses. McKinsey’s mandate was to:

• Determine the financial health of the federal agency.

• Determine the best way to increase the disbursement of funds.

The McKinsey engagement team consisted of 5 members and were a mix of consultants from the USA and Latin American offices. A micro-loan specialist from one of the Asian offices was also assigned to the team. The study was carried out over a 9 week period.

Setting up the McKinsey Financial Engagement

Everyone we interviewed agreed this was a very challenging engagement. In many ways, the most challenging engagements they had ever been on. These were the reasons cited:

• The scope of work was significant. The team needed to spend much time determining the boundaries of the project and understanding how to structure the problem statement.

• Data collection was difficult. Government agencies in emerging markets are not particularly good at collecting and checking data. This was no exception.

• The team was required to do some fairly complex data analyses and modelling. For one, they needed to project growth in different sectors of the economy, estimate the number of small and medium sized business and estimate the number of entrepreneurs who need funding.

• They needed to determine the economics of the channels to distribute funding and estimate the impact on the agency’s overall finances.

• Finally, they needed to model in the different products available to entrepreneurs: equity offerings, loans, credit grants.

• The sector was steeped in conventional wisdom generated from NGO’s and other western funded studies. They would need to use these as guides, but expect extensive criticism when their recommendations were presented.

The McKinsey team made the following decisions in structuring the study:

• The engagement team would focus the majority of their effort on assessing the channels, and particularly the Governor Generals wish to open up agency-owned-and-managed offices. This would be compared against the option of finding other ways to work with the IFP’s, or serve the clients directly with a new retail network of branches.

• The economics of the channels would need to be determined. This would be one focus on the engagement.

• The size, evolution and nature of the micro, medium and small entrepreneurial market would need to be determined. This was the target market and would need to be estimated.

• Finally, the team would need to assemble a set of benchmarks and best-practices from around the world.

Field Visit

The team decided early on to conduct a field visit to understand the nature of the market, meet the recipients of the funding and view the challenges faced on a daily basis. The microfinance market is different in every country and it was important to understand the local issues before the analyses was framed.
The field agents would not change their schedule but would go through a typical day.
The field visits would take place over two days and in two separate cities. They would spend the day with field agents from four different IFP’s. One day would be spent in the sprawling capital city to understand the challenges of serving an urban market and the second day would be in the outskirts of the second largest city. Here they would focus on rural and peri-urban customers. The field agents would not change their schedule but would go through a typical day.

Day 1 started at 7am when the team set out for their first field visit. The capital city is a sprawling urban mess noted for the smog, heat and ridiculous backlogs. The team had several goals in mind when they planned the field visits:

• Assess the challenges with managing a field office and the challenges faced by field officers in collecting outstanding loans.

• Conduct a day-in-the-life study of the field officers and the managers in the field offices.

• Estimate the potential gaps and bottlenecks in the process.

• Map the key processes in the field and in the office to replicate the operations in the financial model.

The team spent the morning visiting three borrowers who had not made their monthly repayments. The field agents normally travelled on scooters while the consultants followed them in the smallest car they could rent. The field agents carried mobile debit and credit card machines to process transactions. All transactions were electronically recorded and processed in real-time. The first client was not home. The field agent mentioned that the client typically tried to hide when she knew a field agent was visiting. They had phoned a day before to book the meeting. This was not the first time she had missed a meeting.
When the client declined to present these, the field agents threatened her with having her interest rates hiked, the funds taken straight out of her bank account, her property seized or a combination of all three.
By quizzing her neighbors, the field agent determined she was in a pool hall a few blocks down the road. The field agents went to the pool hall and questioned the client about her missed payments. They offered to process the transaction right there using either her debit or credit card. When the client declined to present these, the field agents threatened her with having her interest rates hiked, the funds taken straight out of her bank account, her property seized or a combination of all three.

All of this trouble for a $250 dollar loan, with an interest rate of 86%, to open a home-based clothing design studio.

This pattern continued throughout the rest of the day. Clients avoided the field agents when they did not have their monthly payments and the field agents threatened or harassed them.
All of this trouble for a $250 dollar loan, with an interest rate of 86%, to open a home-based clothing design studio.
At the field office itself, things did not run as smoothly. All processes to collect and process payments were automated. Processes to verify claims, payments and record agreements where less than perfect. The office had no documentation to collect complaints. Borrowers had to send their complaint along with their contact information via a drop box at the office. If the information needed to process the complaint was missing, and borrowers were largely illiterate and not aware of what this information could be, the complaint form was discarded.

Notices and guidelines outlining consumer’s financial and legal rights were not to be found anywhere. The law states they should be prominently displayed. Very little advice and counselling were provided to new clients as they signed up. It was also worrying to note that the interest rate charged was never explicitly mentioned to the client unless they asked for the information.

Day two was more of the same but with a twist. The IFP serving the rural areas did invest as much money in automating its processes. The field agents visited fewer clients in the day and seemed less worried about collections and more worried about the borrowers businesses. They were forceful in getting to clients but did not demand payment or threaten any clients. They did not have automated credit and debit card machines. In one case, they offered to take a client to an automated-banking-machine to transfer an outstanding payment. They had to drive very long distances to reach customers and then drive around a little more to find them.

Offices were not automated and poorly sign-posted. No consumer or credit information was provided. Some information was printed in English although every single person in the town spoke Spanish. Records were poorly kept and often lost. There was no central archiving and each field office was responsible for its own document storage.

Financial Study Structure

The team worked very long hours on this engagement; they typically got in between 7:30am and 8am and left the office around 10pm. Initial hypotheses focused the team on understanding the case for the federal agency setting up its own offices in the field. This was loosely termed a “retail structure”. The team structured this part of the analyses around the following questions:

• Why should a retail structure be developed?

• Did a retail structure help the agency’s financial performance?

• Did it enable the agency’s government mandate?

• Was it possible for the agency to develop a retail structure?

• If it was not possible, what was the agency’s are other options?

• If it was possible, how should it be done?

To answer these questions, they needed to understand the following:

• What were the federal government’s mandated expectations of the agency?

• Was it explicitly social, explicitly financial or a hybrid?

• Was the federal government willing to accept the outcome of successfully pursuing the mandate?

• Should the agency target viable parts of the market or leave that to the private sector.

• Which segment and sectors of the market should the agency target?

• Is the micro-loan market more within the agency’s mandate than the small-loan market?

• Is the food and restaurant sector more within the agency’s mandate than the fishing sector?

• Is the north of the country more within the agency’s mandate than the south of the country?

• Should the agency aim to work across the value chain or in segments of the value chain?

• What was the agency’s past performance, successes and challenges and what ability and capacity did this imply?

• What was the performance of the product portfolio?

• What was the return on equity?

• What was the size of the bad debt book? Was this a trend?

• What claim rate was needed to break-even? Could this be achieved?

• How were the IFP’s performing?

• Are they financially viable?

• Do they create jobs in the long-term?

• Could the agency do a better job if it replaced the IFPs?

• Is there any international precedent?

• How does the organization and governance structure match the intent of the business?

• How do other agencies balance between wealth creation and poverty alleviation?

• What is the best way to lend as much as possible, as cost effectively, and as quickly as possible?

• What is the best way reach the most right target audience through the most effective channels?

• What are the required technical and credit skills?

• What is the lending methodology appropriate for risk profiling the target market?

• How should the interest rate be set and used? (Focus on the latter)

Lesson’s Learned by the McKinsey Team

The McKinsey team members outlined the following challenges and lessons learned on the engagement:

• Given the size of the engagement and huge amounts of data, it was easy to get lost in significant and useless analyses. They overcame this challenge by scheduling disciplined sessions to structure the hypotheses and develop an analyses framework. Only when this was done, did they move on to the analyses.
When dealing with federal governments or any mandated federal agency, it is critical to go back to the original legislation governing the agency. You would be surprised how many people have never read the legislation and many misinterpret the agencies mandate.
• This was a fast-moving engagement with many moving parts. On a typical day new data or insights were developed which could change the direction of the engagement. The team held morning meetings every single day to share ideas. Without them, the team would have struggled to work effectively and it would have required substantial rework.

• When dealing with federal governments or any mandated federal agency, it is critical to go back to the original legislation governing the agency. You would be surprised how many people have never read the legislation and many misinterpret the agencies mandate.

• Federal governments are buffeted and pushed by many different priorities. It is difficult to know how their priorities will change over time. Therefore, never ever present the perfect solution by itself. There is no perfect solution. There is only a solution which works under certain conditions and to deliver certain outcomes. Always present a range of options and clearly explain the pros and cons of pursuing each option.

• Maintaining team morale is important on long and arduous engagements. This can easily be done through the type of engagement manager assigned to an engagement and how he manages the engagement. A manager genuinely interested in your development and well-being will make a world of difference.

• Do things correctly the first time. On tough engagements, there is no extra time. You can save yourself much stress by completing something correctly the first time around. There is just no time to do it again.

• Collecting information from the front line (field officers, clients and field office workers) presents a totally new layer to the story developed from top-down analyses. It is difficult to conduct any analyses and develop any meaningful recommendations without speaking to the frontline employees.

New ideas developed about micro-finance

The engagement team developed some new insights and idea about micro-finance. We list a few of them here:

• Agencies providing relatively low dollar value funding to entrepreneurs need to decide if they want to follow the “poverty alleviation” or “wealth creation” strategy. Both cannot be pursued at the same time given the agency’s mandate.

• Agencies which have not adhered to their mandate have consistently failed in the market.

• It’s possible in international markets with high population densities to reach the bulk of the target market in a timely and cost-effective way. Countries with low population densities or no major urban areas cannot reach the bulk of the population and need to segment the country by regions.

• Relatively fewer channels can be used to reach the entire target segment.

• It is essential that all credit provision is supported by training and technical support for the recipients.

• The interest rate offered always exceeds the prevailing market interest rates. This cannot be avoided. Too low-interest rates lead to “moral hazard”.

Key Findings for the Client

• The agency should not directly build, own and control the retail market.

• IFP’s providing loans below a certain size will never be viable.

• Unfortunately, these are the loan sizes the market can absorb and they are not viable. Other products will need to cross-subsidize them.

• Jobs are created only be spending significant amounts of capital and producing very low returns.

• Most products offered destroy value.

• The cost of serving micro-loans is too high and makes them uneconomical.

• The market does not have sufficient absorptive capacity given the current cost of providing the loans.

• To improve job creation, the number of sectors and regions served should be reduced.

• The IFP’s need to be restructured to target viable regions, products, loan sizes, sectors and products. They cannot chase the entire market.

• The legislation government the agency forces it to take actions which will make it unviable.

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.

 

I have spent a long time examining my own career path from associate to principal. Mainly because there was always a fair degree of luck involved. It is not as if I was a break-out superstar and knew I would become a partner. I was good, but there were other better associates who did not become partners.

So, I must have done a few things differently to compensate for this perceived disadvantage I possessed.

I eventually realized that I succeeded not only because I was analytical, could communicate well, develop great storyboards, was great at math etc. Let’s not be mistaken, I needed those skills. Yet, they were not enough if you did not know how to use them. Everyone had those skills when they entered BCG, McKinsey et al and these were not enough to distinguish oneself.

Even today, many outstanding candidates are managed out every month and most are surprised when it happens since almost all have the skills listed above, and in great abundance. I know because we receive several emails a week from distressed management consultants seeking guidance.

I succeeded because a partner took me under his wing and personally mentored me when I was just an associate. In other words, this partner guided my analytical development by showing me how to deploy those critical reasoning skills.

That single act made the greatest difference to my career.

You may think the mentoring did not matter at the time since I was already working as a management consultant. Yet it did. Without the mentoring, I would probably have stayed 1 or 2 years, quite possibly have been promoted but most likely never have made partner. But, I wanted to be a partner, and that was a completely different objective from simply getting an offer or getting promoted to manager.

In other words, you can prepare to just get an offer or you can prepare to rise to partnership level.

I recall two events demonstrating the importance of such mentoring.

Event One

As a young associate leading the business case analyses for a transfer pricing study, I was completely struggling to sketch out the boundaries of my analyses, understand the company’s business model and convert this to an excel model to estimate the impact of the various options we were recommending to the client.

At the time, I did not have any business training and struggled to understand many of the concepts I now take for granted. The client’s business was difficult to understand and transfer pricing is actually very difficult for anyone to understand, irrespective of their background.

I had to determine the prices one division, the releasing division, should charge the next division, the receiving division of the same company, which takes over the semi-finished product as it wove its way through the company towards completion.

Should a division generate a profit? Should a division charge at cost-price? Should a division link their prices to efficiency gains?

It was even harder to do since there was no competition in the market, whose numbers we would typically use to benchmark comparable processes and products.

I received a telephone call from the strategy partner leading the engagement at 8pm on Friday, the first week of the study, asking for feedback on the engagement. It was not going well and I stated as much.

I believe in telling the truth no matter how much pain it would cause.

After realizing I would be in the office the next day, a Saturday, he offered to come in to provide some guidance. I fully expected a 30 minute chat followed by a depressing summer day working by myself and eating vending machine tender.

He came in at 9am EST, brought breakfast consisting of coffee with chocolate croissants, and simply cranked up his laptop and started building the skeleton of the model as if he did this every day. More than that, he took over a whiteboard and taught me how to build the links between different modules of an excel model, using A4 sheets of paper, to depict each module like an income statement, and whiteboard marker to draw connections to depict the relationship between each module – a technique I still use today to teach young consultants.

It was interesting how the learning process became so enjoyable watching a senior partner explain finance, and throw in interesting anecdotes and ideas to explain complex concepts in ridiculously simple ways. Brealey & Myers may know finance, but teaching it is quite different.

Much to my surprise, he stayed through lunch, during which he insisted we order pizza from a hole-in-the-wall which made thin-crust gourmet pizza with only fresh toppings. I was told that the owner, a real Italian mama, will not serve you if she does not like you. Over lunch we talked about how he had learned the technique to visually depict excel models on a white board. He told me the story of a London-based partner who taught him that technique when he was an associate – about 20 years ago.

Since I knew he had dinner plans, I fully expected him to stay until 6pm. Yet, just before the skeleton for the balance sheet module was to be constructed, he calmly whipped out his phone and cancelled his dinner. It seemed like the most natural thing to him.

He did not even make me feel guilty about it. His commitment was unusual and not every consulting partner would do this. In fact, most would not. But he did. And that is what counts. I learned the correct values of helping younger consultants and the importance of critical reasoning. The latter must be important if a partner is spending his Saturday teaching me how to analyze a company’s issues and determine if an analysis was needed. I mirrored this behavior when I was elected a firm principal.

Event Two

In a role-reversal, and a few eventful years later, I was now the principal leading a team through a challenging engagement to redesign the operating model for a client. We were trying to determine how a US$10B emerging markets company should change its operating model as its growth rates dramatically slowed down. Many parts of the business set up to enable that growth, such as a large M&A team and forays into non-core activities, were now redundant.

About 5 weeks into the study, an engagement manager on the team came up to me on a Tuesday morning, I remember this clearly, even the clothing he wore when he entered the room, and explained that the labor cost numbers had been incorrectly calculated and the documents sent to the EVP Operations, for board circulation, were flawed.

Since the labor costs were incorrect, the fixed and a large part of the variable costs had been underestimated and both the cash flow and return-on-invested-capital projections were far too rosy. In other words, the proposed initiatives did not meet the hurdle-rate for the client.

You can only imagine the embarrassment and, possibly, anger if the board of directors debate a major investment over a long-weekend only to be told the numbers were flawed, their recommendations were no longer valid and they would need to meet again to discuss the same issue.

It was a striking mistake for a very important client on a critical engagement. Several senior partners were displeased with the mistake and the impact this would have with a client who was already slightly skeptical about the value we could bring – the client openly questioned our domain knowledge. I particularly recall my mentor, a senior partner, was probably for the first time upset with me that I would let this happen on a study.

The first thing I did was to inform the senior partner leading the study and literally race across the city to inform the client in person. I have learned it is important to pay clients due respect at all times, especially when a mistake is made.

I then hunkered down with the team for the next 2 days to double-check all the numbers and update the board pack. Never once did I fault the team or create an atmosphere of gloom, although there would be a time and place to do a review, it was not now, and there is never a time and place to hinder morale while you need to meet a deadline.

When the senior partner and client separately asked me who was responsible, all I said was I am accountable so it was my fault. My team never forgot that. I did have a long discussion with the manager about fixing the problem, but I was clear that it was mainly my fault for not allocating sufficient time to check the results.

The team’s loyalty to me increased after the incident and word quickly spread around the office, creating even more loyalty. I took all the blame because it was my fault for not checking the numbers carefully, even when I could have easily shifted it to the manager.

Make no mistake, we had several sessions thereafter to discuss the analyses gaps and mistakes. As younger consultants, the team needed to demonstrate proficiency in this area. That said, that is not the main lesson from this story.

I learned to take responsibility for my actions because many years earlier a partner did the same thing when I made a mistake on the revenue analyses I was leading, which the partner forgot to check.

Values are passed from partner to potential partner. Those who live those values become partners. Don’t get me wrong. You need to be very good at generating insights from data. That, however, will only weed you out from the rest. To propel yourself to the next level, and ultimately partnership, you need to layer on much more skills.

We want to expose our clients to those analytical and values based teaching-moments.

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Using the hypothetical decline of McKinsey as an example, this article reveals several crucial career lessons on how to combine frugality, or efficient living, with ethics to significantly improve your career options and career flexibility.

***

Firmsconsulting is built on a strong foundation of ethics. Many clients struggle to understand how that leads to business success. They assume it is an intangible benefit. It is not. There is a clear, measurable and direct link.

This piece explains how such a model can be used to create significant upside in your career.

Career flexibility is a pre-condition for career success. However, you cannot have career flexibility unless you live well within your means. And if you live outside your means you will be forced into poor ethical choices, which further reduce your career flexibility.

How does that work in practical terms?

Ethics, Frugality & Career Flexibility

Most people who breach their values do not get up one morning and decide that today is the day they will cross the Rubicon. It happens much more subtly and usually with a forced drift into such a situation.

Good people routinely do not do good things.

There were times when I have done things I have regretted. It was usually forced. And my regret is not so much that I stepped outside my moral comfort zone. Rather, I regret placing myself in the situation where I was forced to do something unethical.

That is because unless I change the environment, I could likely be forced into the same situation again.

So if the environment matters, how do you change the environment?

When you step outside your ethical boundaries, it is usually because you need to do so or you want to do so. This is a crucial distinction of the two types of ethical lapses.

In the first type, maybe you tried to sell a client a hip replacement they do not need since you are paid a commission and you really need the money to make your monthly rent. If you do not make your rent, your kids and wife will be on the street or you will have to move in with your in-laws.

In this example, you need to breach your ethical boundaries since you really have no choice. You need to do so.

In this type of ethical breach of “need”, living a simpler life could have created a financial buffer or savings, in simple English, which could have allowed you to avoid this situation. In other words, you could have had a choice. If you had a savings cushion, you could realistically have done something you felt was more acceptable.

In most cases, ethical breaches occur because people do not have the financial cushion to create an alternative option. In other words, you have no choices and cannot walk away from this.

You also open yourself to neglect and abuse. If someone knows you really need something, they hold all the leverage.

In the second type, wanting to step outside ethical boundaries, you may not need a Porsche Panamera but you really want it because your friend drives one, and you are willing to do whatever it takes to obtain the cash to fund such a lifestyle. This is the flip side of “need” and it is equally dangerous.

If you automatically throttle your lifestyle back to what you can afford, you will never be in a position to want more. This is not to say you should not be successful or wealthy. It just means that wealth itself should not be the objective, but rather wealth should be the outcome of being successful at what you do.

Ethical breaches of “want” are the ones you read about in the newspaper all the time. They are flashy and get attention. Ethical breaches of “need” are not deemed worthy by the press, but they are more likely to occur to you, especially in the early stages of your career.

Think about any major financial fraud in the recent press. The CEO gets all the vile attention but many junior employees also willingly aided and abetted the act. You could argue one was a breach of “want” and the other a breach of “need”. I can assure you the feeling of guilt is the same for both parties.

Moreover, ethical lapses of “need” can be seductively warped into a heart-jerking story of compassion. Aiding the CEO perpetrate fraud because you needed the job to pay for your child’s medication is one such example. It is clearly wrong to do so but you can see how easily it can be justified. You are doing it for your kids. What could be wrong with that?

Unfortunately it is a moral trap.

The secret to staying within ethical guidelines is to always be in a situation where you have options in life. You must have the ability to walk away from a deal, opportunity, job or promotion if the need arises. Options cost money. Creating alternate paths which may never be taken costs time and money.

It means you have to work harder to save more, improve your skills and network more.

If you think this is not true, remember that Merton, Scholes and Black won the Nobel Prize in Economics for figuring out the equation to price just that optionality. Granted, they did it for financial instruments, but the equation can easily be adapted.

The bottom line is there is value in this optionality.

The insight is that living frugally creates the ability to build that financial cushion to create options in life should you not be pleased with the evolution of your career path. If you have options, you can walk away and avoid ethical lapses.

How this lack of optionality plays for a professional partnership is interesting.

At Firmsconsulting we have a rule: never bet the firm. “What” we do is far less important than “why” we have this rule.

We never undertake any investment or initiative that could expose the firm to catastrophic financial consequences. The crucial point is how we define catastrophic. It is not defined as something that will cause the firm to shut down, need to close off units or even release people.

No, our definition is much more nuanced. Catastrophic is defined as any action, which forces us to accept capital or accept capital on terms which contradict our values.

This distinction is vital to understand. We are not referring to the cost of capital. If we received the cheapest possible capital, and a lot of it, but the investor or loan bank wanted us to focus on profits, it would contradict our values.

Therefore, a catastrophe is an action, which results in limiting our independence to serve our clients interests.

When we make an investment we ask ourselves a simple question: if this failed and was completely written-off, could we survive without altering our values? If the answer is no, we will not do it. It is not even open for debate. This may appear to be a small point, but it is not.

Below, I am going to present a hypothetical situation of how any business could lose its values with the wrong kind of investments, aka living outside its means.

Career Lessons from McKinsey’s Hypothetical Death

Let’s think for a second what could happen if a firm like McKinsey or Booz invested in a major initiative which went south – a bet the firm made which just had to work or they could collapse.

Although, this situation is not so far fetched since AD Little went through this, as did Bain in 1990, there were rumors Booz was in this state before the PWC takeover and there are rumors that Roland Berger may be in this state right now.

Immediately, the firm would lose their independence. Business people think of independence as the legal holding structure. Professionals think of independence as the ability to ignore outside influence. They are distinctly different and the latter usually corrodes before the former.

In this hypothetical example, the loss may be so large that they may need to go to their banker and ask for capital to keep the business afloat. McKinsey’s legal holding structure may not change in this scenario, but they are clearly not independent. If they did things to support their values and the banker felt this was wasting money, the bank would not release the money.

Since McKinsey therefore cannot ignore this outside influence, it means they are no longer independent.

Moreover, the banker is going to ask for a plan to build revenue as fast as possible. Banks are not interested in a client’s long-term viability. They are interested in getting their capital back at the highest return and with the lowest risk. That means McKinsey would likely need to do things in the short-term which will increase revenue but hurt the values they took years to create.

Yet, if they ignored revenue and stuck to they values, they would not get the much-needed capital infusion.

The trouble does not stop there.

This infusion of capital and the related repayment plan creates an operational downward spiral, which changes the structure and philosophy of the organization.

Clients will quickly notice the difference in the way McKinsey operates and the clients McKinsey wants will leave while the clients who are more transaction oriented will join them, since by the mere action of pursuing revenue, they have become a transaction oriented business willing to sell anything to anyone at any time and for any price.

As McKinsey becomes a transaction-oriented business to pay back the loan, they will slowly change. In fact, they have no choice but to change to be a successful transaction business, which is what they would need to be to pay back the loan. That is the irony of the situation, to go back to their original values McKinsey needs to move further away from those values as quickly as possible.

McKinsey’s systems, processes, culture, language, remunerations structures all change to meet the bankers mandate of faster revenue and as much of it as possible. You may think that they can pay off the loan as quickly as possible and go back to business as normal; yet, they are now a new company and likely cannot remember the old model.

During months when McKinsey needs to replay that loan, a typical management meeting will invariably revolve around profits, retained earnings and interest coverage. This conversation is anathema to a professional partnership. McKinsey should never make decisions for the sake of profit.

As these discussions continue, employees will see the change and think profit is the most important measure. That becomes very difficult to change later.

Beyond the culture, do you really think there are many professionals in the world who would want to go back to a smaller McKinsey with higher margins and values, after having feasted at the trough of uninhibited growth?

So, even if McKinsey had the gumption to push for a tighter partnership after repaying the loan, they would need to fire people, lower partnership payouts and deliberately shrink the firm.

Imagine explaining that logic to a business reporter who typically uses growth and share price as proxies for success. Yet, that is exactly what a firm of professionals must do if it is to survive.

Not handled well, that kind of turmoil tears apart a firm, or leads to an ousting of the managing partner and the creation of just another transaction-oriented business, which preaches values but chases the almighty dollar.

Therefore, do not even go down this path of betting the firm. All roads lead to ruin.

Independence must be sacrosanct: personal or professional.

It must not even be a point for discussion.

Living your values

Finally, there is a practical matter about the ability to be independent and live by your values: it must not be an idle threat. It cannot be a fancy set of words which are placed on a website/blog or things you tell your co-workers. It needs to be constantly practiced so that everyone with whom you engage knows it is real.

Unless you are disengaging from people who do not subscribe to your value system, you have no value system.

Eventually through routinely pulling the trigger on value breaches, you will only attract people, friends and employers with those very same values and this has a cascading effect as they draw more like-minded people into your orbit.

However, act and act aggressively on value breaches. In fact, overreact. It is the one time when you cannot be blamed for overreacting. I cannot stress this enough.

The thing is that values/culture change so fast, that unless you stamp out lapses then and there you might as well have poured fuel on the fire.

I recall speaking to the worldwide marketing partner of one of the world’s largest consulting firms last year. We regularly speak since he wants an outsider’s perspective on the firm. In our last conversation he was using terms like “taking market-share in region x” and their plans for doing so.

Midway through that, I very politely stopped him and said he should not be discussing market share at all. If he speaks like this, his junior partners will adopt the language, as will their managers, their associates and finally the business analysts. It is the wrong language and demeaning to clients. No client wants to be taken! They need to be earned.

The only thing his firm should be discussing is how to improve their ability to serve clients’ needs. If they did that right, everything else would follow.

Although, that was a good conversation, he has never called me back since then. We clearly disagreed on how clients should be treated. That is a clear example of living our values. We politely indicated that clients deserve to be treated better.

It should be obvious this independence has a cost: add up all the people with whom you declined to work, and they could well be the majority. This is the cost of having values and it must be embraced.

Michael Boricki is a partner and director, based in Firmsconsulting’s Toronto office.

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After major scandals driven by ex-McKinsey employees like Jeff Skilling (Enron debacle), Rajat Gupta (former 3x McKinsey managing director) and Anil Kumar, McKinsey is on their toes trying to prevent another disgrace. The ethical standards of prospective candidates and employees has never been under a more searing spotlight.

Other top consulting firms have a similar mindset, as their success depends on an unimpeachable reputation for integrity. Will you measure up?

I recently put out a note about a trend around the world where candidates record their telephone-based case interviews with McKinsey, BCG and Bain. They doing it knowing full well it is wrong to do so. Moreover, they are sharing it with us and their network, and asking for comments.

We believe that you should not do this, since it is illegal to record someone without his or her permission. A few people wrote back to me and said they did not know it was illegal or it is not illegal in their country, that’s why they did it.

This highlighted a great misunderstanding some candidates have about what is ethics, how to approach ethical decisions and how to determine if you measure up to be considered a person with high ethical standards, the kind of person McKinsey and other leading consulting firms seek.

My concern is, as it stands now, some of you will not measure up unless you spend sufficient time understanding what is ethics, how to think about ethics, how to make ethical decisions and what changes you need to make to build an unquestioned reputation for high ethical standards.

However, I believe ethics can be taught and mistakes can be fixed with the appropriate guidance.

First, it is important to understand that ethics usually applies to three types of actions. Actions not covered by law, actions for which the law is not enforced or actions for which the law is clearly wrong.

Therefore, when someone tells me, “Michael, I made this recording because it is legal in my country”, what I hear is that the individual is very unethical. This is because even though the person would not like to be recorded without permission and knows it is wrong, they have gone ahead and done it.

Ethics generally covers actions which are not covered by law. For this act where the law does exist, but is not appropriate and we rely on our ethical judgment, the person has demonstrated poor ethical judgement.

This does not make the person evil or bad. Wonderful people sometimes do unethical things.

Many people believe that ethics is an absolute concept, that you know what is ethical with absolute certainty, you know what is not ethical with the same certainty, it is clear as night and day.

In the West we have a tendency to think with absolute certainty that our beliefs are ethical and correct. However, the best way to think about ethics is that it is evolving, what is ethical is often a hypothesis and sometimes there is no right answer.

Judging people for ethical breaches

When judging people for ethical breaches, we have to understand the context. Depending on the person you are analyzing you have to apply more severe or less severe definition of ethics. Imagine someone who grew up in a challenging part of central Africa, surrounded by warlords. The social construct they are part of is obviously not as ethical as that of someone who grew up in Vancouver, the home of Greenpeace. For someone growing up in the strife-torn context in central Africa, we would expect him or her to not be as ethically conscious as someone who was raised in Vancouver.

If both people breach the same ethical value, we should look at the situation and ask, what were their unique circumstances, what was normal for them and did they do what was abnormal for them. That is why our legal system allows judges to apply discretion when casting judgement. It recognizes the importance of context.

A lot of times when we judge people for ethical breaches, we put them on the same level. We think that a person who was raised by a loving family in the United States and went to a great school should have the same punishment as someone who was an orphan in a rural northern China and hardly had exposure to anything good his entire life.

You cannot measure people this way because their actions are shaped by their social network and their environment. We must compensate for this context.

Ethical dilemmas & trade-offs

I will now give you some examples of different ways to think about ethics.

Let’s assume you are walking down a street and you see a burning building. You see a baby in that building and you want to save that baby. The only way to save that baby is to jump on the car parked on the street and put some kind of garbage can on a car to reach the window where baby is, but to do this you will need to damage the car. Would you damage the car to save the baby? Most people would.

Would it change your mind if I told you that the car belonged to someone who needed a very important treatment for a life threatening illness and they needed the car because they were going to sell the car next morning to pay for the treatment?

Clearly, that is a tough decision to make. Do you save the baby now knowing full well that you could kill this person because they won’t get the money for treatment? A lot of people will choose to save the baby. Not because they know with any certainty that they can find an alternative means to pay for the treatment without the car, they may not even be committed to look for one, but because if they don’t save the baby they appear to be evil or unethical in the present moment.

A lot of times when people do things that are ethical, they are not doing it because it is ethical, they are doing it because they are trying to avoid being labeled as being evil or unethical. The flip-side of this is that a lot of actions that we see as being unethical, we see without context.

Just because something looks unethical does not mean it is. You can only make that judgement call when you know the trade-off.

We need to think about trade-offs. There is always a trade-off. A lot of discussions about ethics do not consider trade-offs. That is the problem with an absolute view of ethics.

This is typically a western view. We assume we know with absolute certainty what is right and wrong. We like lecturing other nations. We assume that if we decided that x was the “right thing” to do in 2014, then every other nation who does not come to that same conclusion at the same time as us is wrong. To lecture others is to assume your rate of development in testing and accepting ethical concepts is the norm. Other nations may take longer to get there but who is to say the speed of arrival is the main issue. Is it not the quality of the implementation when it does arrive that matters?

Knowledge of the trade-off will help you make better decisions. A lot of times we hide the trade-off so that when we are judged for the action publicly, saving the baby for example, we end up looking better. No one knows about the guy who was trying to sell his car to get treatment, so we end up not looking bad.

If they knew, they may end up judging us less positively. A lot of times we make ethical decisions because there is an incentive attached to it. This is one example of a way to rethink ethics.

Let’s look at another example. Let’s assume that you run a company and you have a supplier who lost all other clients and is now totally dependent on you. You want to lower your purchasing price from the supplier. You are buying chairs for $200 and you want to lower the price to $150. The supplier proved to you that if he lowers the price to $150 he goes out of business, but on the other hand if he does not lower the price you need to lay off employees to pay for the chairs.

What would you do in this situation? Would you say, “I will do the right thing and lay off people. I will not put someone out of business”? What if you knew that the reason this supplier will go out of business if prices go to $150 is because he hires mostly family members and he overpays them. What would you do knowing this new information?

There is no right answer. But there is a rule. Do things ethically provided it does not put you in a situation where you will cause harm to yourself or anyone else. When I say harm, I mean what the average person will consider being sufficiently harmful to justify sacrificing your values, such as putting yourself or your family in physical danger.

Now let’s look at example of an extreme situation of being too ethical, whereby being too ethical can be damaging to you and others. Let’s look at the massive, and justifiable, debate taking place in the United States about raising minimum wage. Let’s further assume we wanted to do the ethical thing – generously raise the minimum wage.

Economics will dictate that is wrong for a couple of reasons, including the following:

• First, by increasing money supply inflation will spike. The price of goods will eventually go up because there is more money in the system. Even though people are getting paid more, things will end up costing them more to buy, therefore, cancelling the impact of the salary increase. Therefore, in the medium term, the salary increase will not really matter. The system will adjust itself.
• Second, what does it do to the system on which capitalism is built? You should reward people not only for how hard they work but for skills they bring to the job.

If you raised the minimum wage across the United States, you will undertake what is called populist economic measure. You will do something to make people happy because the social construct to which you belong dictates that it is an ethical thing to do. Yet, you are going to cause extreme damage to the system, because you just giving away money without any return. Therefore, you can take extreme ethical stances that actually cause more harm than good.

Personally, I would like to see the minimum wage raised. However, I know this would not solve the problem since the minimum wage is driven by many factors which need to be fixed.

Lastly, here is an example of an ethical decision where there is no right answer.

Let’s assume you are a mother of two sons. Let’s further assume you are from the middle of India. There are a lot of kids in your community and your family is very poor. You’ve got one child who is incredibly promising academically. He is truly brilliant. He aces all the exams. He will probably end up at McKinsey and then as a CEO of some Fortune 500 company. You are almost certain he is going to change the world and take family out of poverty. You have another child who is probably not going to end up at any college anywhere in the world.

Both need a kidney, but only one can get it. Which one will you give it to, assuming you are the only available donor?

This is an extreme ethical situation whereby you know on the one hand the child who is probably not going to go to some good university is not going to have financial resources in the future to take care of himself so you should probably give the kidney to him. The one who is going to make it in the world probably will have financial resources but it is likely he will not make it unless he gets a kidney from you.

If you give the academically weaker child a kidney, the rest of the family will most likely suffer. If you give academically stronger child a kidney, the entire family will most likely be better off, but the academically weaker child will suffer.

There is no right answer. You have to determine what is acceptable.

Addressing 3 myths about ethics

Let us conclude our discussion with addressing 3 myths about ethics.

Myth #1: It is ethical as long as it is legal. These are different concepts. When someone says I did not know it is unethical since it is legal in my country, it is clear they misunderstand ethics. Ethical decisions are required when the legal system fails or there are no laws covering action in question, or related laws are wrong. When legal system is not there, not enforced or wrong you should be guided by your ethical standards.

You can be grossly unethical while obeying the law. You can be extremely ethical while disobeying the law.

Myth #2: If you are ethical, you are by default a nice person and usually a pushover. Being ethical does not mean you are a pushover. People can be tough and demanding, and yet still be values driven in every possible way. Being ethical does not mean you have to be nice to people. Personality and your value system are completely different concepts.

Myth #3: Following the rule the softest pillow is a clear conscience is a sure path to ensure high ethical standards. It only matters if you have a clear conscience if your conscience is attuned to what is actually right. If it is calibrated to things that are incredibly cruel, you will have fundamental problems making judgement calls.

The social construct you belong to determines what you consider to be a clear conscious. You are your friends. When you are deciding whether you are ethical, or not, look no further than at your friends and all those dumb things they do that you find acceptable. By condoning their behavior you are desensitizing yourself to those elements you know to be wrong. You should think twice about whether those are things you should be a part of.

The social network you choose to belong to shapes your values, or lack thereof. When clients ask me if they are ethical I usually tell them I cannot answer this with any certainty. I say this if I do not know their significant others well enough. Your significant other is the most influential member of your social network. At the end of the day, when it really comes down to it, your decisions will be heavily driven by what your significant other considers right. Never ever forget that.

I say this because 95% of people who breach ethical values almost always cite personal circumstances. Here are few examples:

• “I would not normally do this but my husband and I discussed this and…”
• “My partner recently lost his job and we decided…”
• “I would normally never do this, but due to personal reasons…”

You can fill in the rest. The last one is very telling. Somehow, many assume that a personal reason is a license to be unethical. It never was and never will be. Let’s hope you chose your significant other well.

QUESTION(S) OF THE DAY: What is your advice to readers who realize that their social network negatively impacts how ethical they choose to be or even could be? Please let us know in the comments.

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In light of major scandals driven by ex-McKinsey employees (e.g. Jeff Skilling, Rajat Gupta and Anil Kumar) and consequent sharper focus on ethics by top consulting firms, lets continue our discussion about ethics and delve deeper into how to think about ethics, and what shapes ethics.

Ethics is required when the law is not written, not enforced or wrong

To think about ethics, let’s picture a bar chart running vertically. The entire bar represents all the actions you could undertake in your country. It is obviously a hypothetical bar since we could not list every action we could take. Yet, we know we can do countless things.

The bar chart goes from one all the way to the one billion things you could do. The bar is split into two parts. Twenty percent of the bar is dark blue and eighty percent of the bar is white.

Everything that is dark blue depicts every action you can undertake in your country that is covered by the legal system. Therefore, for the dark blue part there is a law that determines if what you are doing is legal or illegal.

Everything in the white section depicts actions not covered by laws in your country.

When we talk about ethics we are most of the time talking about the actions within the white space, where the laws have not been written to cover your actions. If there was a law telling you how to behave in a situation, would it be an ethical debate given the law instructed you what to do? In most cases it will not be.

However, the world is not perfect.

There are times when the law is wrong. For example, when black people were not allowed to attend universities in South Africa or parts of United States. There are laws like that, unjust laws, right now in parts of the world. Therefore, in situations where the law is wrong, ethics should dictate your actions.

That is one example where ethics does not just apply to the white space but also applies to the blue space.

There are other situations where ethics applies to the blue space as well.

Think of countries that have exceptional constitutions. Their constitutions are so amazing that other legal systems around the world quote from these country’s constitutions and higher court opinions. For example, South Africa’s constitutional court rulings are highly referenced internationally.

However, there are parts of that country that are lawless. Clearly the law is not enough if there is no enforcement. If there is no enforcement people will misbehave unless they are ethically bound to behave themselves. Therefore, there are two situations where we need to apply ethics to actions governed by law, when the laws are wrong and when the laws are not enforced.

To summarize, ethics is required when the law is not written, not enforced or wrong.

The application of ethical principles is inversely proportional to the correctness of the law, the reach of the law and the enforcement of the law. If there are no laws, or the law is weak, or the law is wrong, or the law cannot be enforced, you are reliant on your personal judgment to make decisions.

The question is, how good is your judgment.

If ethics is about judgment, what drives our judgement?

We established that ethics is about judgment. Now I will give you 4 situations and I will show you what drives our judgment.

Imagine it is 1940 and you are a brilliant engineering student in Germany – blue eyes, blond hair, handsome but a bit naive. All you know is what is told to you, and you just happened to be a member of the armed forces. You are sitting at a hip Berlin bar. You are in a situation where everyone thinks it is just fine to persecute the Jewish and Slavic nations. Not only is this the kind of group you belong to, it is also aligned with the law in your country.

Let’s take another situation. Let’s assume it is 1910 in Canada. You are going out with your buddies, upstanding gentlemen who don’t agree that women should have the right to vote. That is all you see in the press. That is what people talk about. That is accepted.

How do you break away from that, when it is the only thing you know to be right?

Some of you will say, “Well, we actually know that’s wrong”. However, the reality is, to a large degree, we are defined by our circumstances. It is easy to apply a higher ethical standard in hindsight. We can prove this.

In the first two examples I have presented scenarios that today, in hindsight, we know to be wrong. In the next two examples I will give you things that we don’t necessarily know to be wrong today.

Think about eating animals. Human beings consume millions of tons, may be tens of millions of tons, of animal carcasses every year. It is completely acceptable to do this. It is acceptable to make jokes about it. In a hundred years people may look back at us and think we were animals for doing this.

We think it is acceptable because the network we belong to thinks it is acceptable. If you belonged to a social network whereby your friends thought it was horrible and distasteful to eat animals, you would probably not do it.

If your reaction to this was, it is not so bad so I am going to do it, then remember this is how unethical behavior becomes acceptable. We justify it based on what we see as being commonplace.

Let’s look at another example. Something that I notice every single time I am in a group of people – sexist comments. It is remarkable how much we tolerate sexist comments on television and in social settings. In fact social settings reinforce this behavior. Comments like “you are acting like a girl”, “you throw like a girl” or “only girls do that” are basically accepted discriminatory banter.

Just about every major comedy show in the United States has made some off-hand sexist comments. Some thrive on it and their ratings are directly proportional to this behavior.

One of the most popular shows in United States, “How I Met Your Mother”, actually has a scene whereby the main antagonist, Barney Stinson, talks about how he may have sold a woman into slavery. That show went on to have one of the highest ratings in prime time television for United States. It was a joke, obviously, but the fact is we find those things funny.

This happens right now. We think it is acceptable to belittle half of the human race. So why do we do that?

We do it because everyone else is doing it.

The social group you belong to shapes your ethics

In conclusion, the social group you belong to (your friends, the people from whom you seek acceptance, the people you spend time trying to impress, the people with whom you socialize, engage with, build relationships with etc.) shapes your values, or lack thereof.

The social network you choose to belong to will determine how ethical or unethical you choose to be, want to be or even could be.

So ask yourself: “How do the groups I choose to belong to shape my career and my life?”. If you are not happy with an answer to this question, make the necessary changes.

QUESTION(S) OF THE DAY: Which behaviours or beliefs currently acceptable in Western culture will, in your opinion, not be socially acceptable 100 years from now? Please let us know in the comments.

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Storyboard matters in consulting studies because useful insights mean very little unless they can be woven into a compelling story. Critical insights which are not presented as a story, generally fail to get any traction at a client. In fact, that is one reason strategy studies collect dust on a client’s desk: they did not present a clear message.

When one of FIRMSconsulting partners, Michael, was a corporate strategy partner, he pretty much drove teams a little crazy to constantly refine the story. He still does that. If you are following the US Retail Banking Study (one of step by step consulting studies we released to help train our clients) you would have seen us push for a crisp and compelling story. We do the same on the current power sector study (another step by step consulting study we released for our clients to help them develop strategy, problem solving, leadership, and communication skills). We just push and push for the best story out of the data. A great storyboard will get the client to act.

That’s exactly why you should be looking into a consulting storyboard – to create a compelling story that will convey the key message to your client. Whether you have your team do an analysis and create storyboard ideas based on that, or you have a completely different strategy, your client will see a well-defined path to success. 

And that is what you want at the end of the day.

Where a storyboard fits in a consulting strategy study

Boiled down to the basics, the business consulting strategy engagement structure can be explained as follows. First the key question the team needs to answer in the engagement is determined. The key question has to be split into smaller questions in a logical format. This allows the team to develop a decision tree.

The decision tree has to meet two criteria. It has to be mutually exclusive and collectively exhaustive (MECE). There are two other criteria to be met and that is taught in our programs on strategytraining.com, though if you stick to the MECE rule that will be fine. Based on the decision tree, the hypotheses are developed.

The consulting storyboard is the message engagement team delivers to the client, using the decision tree and hypotheses that have been developed, and it is based on the anticipated results of the consulting project.

Next the team develops analyses to test each hypothesis. Based on the results of the analyses the hypotheses are proved or disproved and the consulting storyboard is refined.

The diagram below shows a structure of a strategy study and a point at which the rough consulting storyboard is developed. Although this diagram helps to understand how strategy engagements are conducted from the structural perspective, keep in mind that a strategy engagement is an iterative process and can be messy. In fact, it is usually messy.

Finally, the idea of using an objective function works in almost all types of strategy and operations engagements, but does not work in corporate strategy. In corporate strategy a very different approach is used because those engagements are different. That will be covered in a different article since corporate strategy studies are so rare. And it is also covered in our advanced strategy training programs, including Corporate Strategy and Transformation Study.

 

What is a storyboard?

To explain the management consulting storyboard concept, let’s use an example from the animation industry. Before producing detailed animations and more, the animation team must first agree on the story.

The animation team gathers together in a room and takes blank pieces of A4 paper, they write out a short 10-word description of a scene on the top of the page and produce a rough 15-second pencil sketch to outline the animation which could go into this part of the movie.

In all, they can produce about 30 to 120 such A4 pages, stick them on a wall in sequence and everyone will be able to follow the story. This allows the animation team to debate the story and messaging without expensive animation work which would definitely change as the story changes.

To extend this analogy to a management consulting storyboard, the team needs to prepare a story of their message so that everyone in the team can understand their thinking and provide feedback. The management consulting storyboard is basically the headlines of the presentation which summarize the anticipated results from the work stream or from the entire strategy study.

In the management consulting industry, these kinds of storyboarding presentations can prove useful to everyone, from seasoned veterans to aspiring consultants trying to improve a crucial set of skills for their consulting career. It helps visualize the key takeaways and create a presentation for the client to see where they are and where they’re going. 

Question from a reader about developing a consulting storyboard

To dig deeper into the concept of developing a storyboard, we will answer a question we received from a reader, let’s call him Henry.

Henry was avidly following the life blog on a study we did in the United States, where we were helping one of the largest Latin American banks to put together a strategy to enter the profitable, large and rapidly growing US financial services market. The study was focused around providing financing to low income entrepreneurs, either immigrants or US citizens.

We had been live blogging the study so everything we did you could follow in real time and we spent a lot of time discussing what we were putting together. Fascinating work. It is definitely a new way to teach strategy consulting and tends to be very popular.

Henry wrote:

“Michael, what you are doing is very interesting but one thing I don’t understand is how is it that you are able to come up with a storyboard for the client only in the beginning of your 3rd week of a 8 to 10 week strategy study?

This kind of seems to me as if you are giving a client a solution that you already have versus relying on the analysis to tell you what the answer will be. And isn’t that the criticism that consultants get that they don’t really develop new ideas for clients but put out what they already know? It does not make any sense to me so I am not sure how it can be right. “

I can understand the reader’s confusion but he is wrong and I want to explain why he is wrong.

Piece of advice on how to communicate

First it is important to point out one thing about this guy’s communication style. And, to be fair, many people have this style of communicating so it is worthwhile to address it here.

Henry is basically saying, “I don’t understand something. And because I don’t understand it, it must be wrong“. This is a really bad way to communicate.

It is extremely naïve or egotistical, or arrogant, you pick, to assume that if there is something you don’t understand then it must be wrong. For all you know, it may make perfect sense but you don’t have the necessary mindset or the necessary prerequisite knowledge to understand it.

If you don’t understand, it is better to say, “Look, I am sure it makes sense. I don’t actually get it so I will let you try it out and maybe I will get it later.” But don’t make it sound that if you don’t understand it then there is something wrong with the actual work.

It is just not appropriate. It sounds really bad to clients, superiors and colleagues when you do it. You sound like a 5 year old child.

How we could come up with a storyboard in such a short time

Besides that piece of advice on how to communicate, let’s get into how we were able to write a storyboard in such a short time.

Note that anything that we will be able to teach you here will be at a high level. You can learn these concepts in depth as you go through our strategy training. How to develop a storyboard and other strategy capabilities is also taught in our book “Succeeding as a Management Consultant“.

Now let’s address how we were able to come up with the storyboard so early.

Think about the logic here. We are not doing analysis just because we have to do it. We are doing analysis because we are trying to answer some questions.

If you are just doing the analysis because this is the analysis you always do in a strategy study (e.g. market segmentation, cost effectiveness and revenue analysis), then yes, you have to wait for the analysis to be done to see what the analysis will tell you.

But this is not the way we do things. We do the analysis for a reason and that is the fundamental mind shift you have to make.

We start off with the objective function. What is the problem we are trying to solve for the client? We then break that objective function into the direct drivers of the problem. We then continue breaking down those drivers until we get what looks like a Christmas tree, that is actually a decision tree.

The objective function is the apex of the tree and the tree breaks out. We then prioritize the branches that are most important in the decision tree to help us figure out where to spend most of our time (refer to the exhibit below for an example).

For each of those prioritized branches we then say, “Ok, what is the hypothesis to explain why this is the issue impacting the objective function?”.

Once we have the hypotheses, we can then say, “Hey, if these are the hypotheses, what tests do we need to do to prove or disprove the hypotheses?”.

Those tests then become the analyses.

We do the analyses which directly help us answer the hypotheses, which directly helps us determine if each of the prioritized branches should in fact be prioritized and, therefore, what drives the objective function.

So even before we finish the analysis, because we know why we are doing the analysis, we can say, “Ok, if the analysis turns out to be this, what is the message we will give to the client?”.

For each analysis you probably will have one or two, at most 3, possible outcomes. Rather than writing a storyboard for each outcome, we write a storyboard for what we think is the most likely outcome. And then, if the analyses turn out to be a little bit different than we expected, obviously the storyboard will be revised.

But more or less we don’t turn out to be wrong. We turn out to be right most of the time because of the logic we apply and because we are attacking the problem from so many angles that this allows us to cross reference and cross check things.

And that is the crucial point here. We don’t just do analysis for the sake of doing it. And, therefore, we don’t have to wait to see what the analysis is telling us. The analysis is being done to check certain hypotheses that we developed at the start of the consulting study. And the hypotheses are not random. They are built off the decision tree, which is also not random because the decision tree is actually brainstorming the issues which are driving the objective function.

And this is the important difference in which elite firms do analysis. We don’t just decide, “Ok, this is the checklist of analysis we need to do, let’s do it”.

We say, “Hey, hold on a second, why are we doing the analysis? What purpose does it serve?”. In our mind we are developing the storyboard which states if these are the issues and this is the way the issues turn out in the analysis, then this is the recommendation we give to the client.

We can write that consulting storyboard in the first, second or third week. And once we complete the analysis, we can go back and check if the storyboard we wrote out, based on what we thought the analysis will turn out to be, makes sense.

And if it does not, we will revise the storyboard. But I can tell you right now, 80-90% of the storyboard usually turns out to be correct. The more and more you think about it, even 95% of it could turn out to be correct.

By the 3rd week of the study, the storyboard is more or less there. Yes, few things will change. The data will definitely change. For example, we may know that a certain segment of the market is unprofitable, but likely will not know why it is unprofitable or by how much it is unprofitable. But we more or less will be able to figure out it is unprofitable.

So that explains how we are able to come up with the consulting storyboard so early. Because we are not doing analysis for the sake of doing it but because we have a reason for doing it, and the reason allows us to structure the storyboard.

What is next?

If you need an example of developing a consulting storyboard, presenting a storyboard and using a storyboard to structure analysis you may find this article helpful.

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