The New York Times published a major story yesterday on how the consulting powerhouse McKinsey got itself eyeball-deep in a corruption scandal in South Africa that has become the focus of a major government investigation. It has led major multinationals operating in South Africa like Coca Cola to cease doing business with McKinsey there.
Among other things, as the Times explains, the firm got about $100 million in performance payments for performance that may not have even occurred from a state-controlled energy company Eksom. It got the assignment in connection with a local partner that was controlled by an Indian family, the Guptas. The Guptas in turn used their connections with then South African president Jacob Zuma to loot various state-owned entities. Oh, and on top of everything else, McKinsey’s contract was illegal.
McKinsey no doubt hoped the scandal would not get that much play outside Africa, despite its size and the fact that there is no way McKinsey can pretend to distance itself from what happened. The Financial Times has run some good pieces on the scandal as it unfolded, and if my recollection is correct, at least one was a lead story, but this is apparently the first account that covers the full terrain of the scandal and focuses hard on what decisions and actions various members of the firm took.
At the end of this post, we’ve reproduced the text of an e-mail McKinsey sent to former partners right before the story went live. You can see how defensive and aggrieved it is. It insinuates that the famously business-friendly Times has an anti-globalist, anti-commerce agenda.
It is also notable what this e-mail does not do: it does not discuss any reforms that McKinsey has put in place to prevent this sort of misconduct from happening again. It instead fixates on the progress the firm has made in “restoring our reputation.” The former partner harrumphed about the tone-deafness of the close, which was hand-wringing that the Times had the bad taste to release their expose “we approach Values Day in many parts of the world.” As he put it, “If you have values one day of the year, you don’t have values.”
McKinsey heretofore has managed to avoid being tainted by scandal even when it had its fingerprints all over the crime scene. McKinsey was the moving force being what may still stand as the biggest value-destroying acquisition of all time, Time Warner’s purchase of AOL. The board turned down McKinsey’s “dare to be great” speech in favor of the deal four times. Unfortunately, it relented on McKinsey’s fifth go. McKinsey was also deeply involved in Enron, to the degree that it was touting Enron as a model. Many alumni have remarked to me that they don’t understand how McKinsey escaped being dragged into investigations. More recently, McKinsey has tried to shrug off important stories by Pulitzer Prize winner Gretchen Morgenson, now at the Wall Street Journal, and Tom Corrigan, on how McKinsey has become heavily involved in advising parties to major corporate bankruptcies, yet has routinely flouted legal requirements to disclose conflicts of interest, including investments by its in-house retirement funds.
Despite doing an impressive job of pulling together the threads of the sordid affair and identifying the responsibility of specific partners in McKinsey for key decisions and actions, the reporters too often give McKinsey the benefit of the doubt based on its successful history of secretiveness and image management. One jaw-dropping example:
Certainly, consulting firms other than McKinsey keep client lists confidential and work for authoritarian governments. And McKinsey has undeniably been a force for good, through its pro bono work and by helping many organizations become more efficient engines of economic growth.
“Force for the good”?
I worked only briefly for McKinsey, in the mid-1980s, and left on good terms (doubling my pay in the process). That was before the firm became mercenary during the tenure of Rajat Gupta as managing partner. Unlike quite a few people early in their career at McKinsey, I worked almost entirely for decent managers and partners. Even then, I can’t imagine anyone calling the firm a “force for the good” with a straight face.
You could say the firm did useful and even important work easily through the 1960s and 1970s. Duff McDonald’s history of McKinsey described how it would effectively take what we would now call best business practices and propagate them across Corporate America. That became less tenable as a core approach as more companies hired MBAs and more consulting firms started to compete with McKinesy.
And even during the brief period I was there, it was not hard to find counterexamples to the pretense of virtue. One report (as in not a client study but a document the firm presented as a major think piece) had clearly fabricated data (as in there was no way it could have been compiled). The partner responsible was not sanctioned. The firm pushed bank deregulation hard, pushing its clients to embrace securitization, and in the late 1980s and early 1990s, taking credit for playing a critical role in getting financial regulators to accept that banks needed to be turned loose so they could make more money (see Lowell Bryan’s Bankrupt as an example).
The Times’ undue deference to McKinsey meant it missed or skipped over key issues.
Failure to make the mine-field of performance-based pay central to the piece. Marvin Bower, the true architect of McKinsey, would be spinning in his grave to learn that McKinsey was entering into performance-based pay deals Bower recognize the paramount importance of being able to give untainted advice and of being able to say things that clients didn’t necessarily want to hear (something the firm does much less than it pretend to, but Bower was a strong advocate of straight talk).1
But a host of small boutiques with ex-McKinsey people started doing cost cutting and taking a percentage of the savings. McKinsey partners apparently couldn’t stand to see what they were leaving on the table and so this sort of arrangement came to be seen as legitimate, to the degree that the firm was able to rationalize not just bad ethical choices, but even an obviously bad commercial risk because the payoff potential was so high. From the Times:
In late 2015, over objections from at least three influential McKinsey partners, the firm decided the risk was worth taking and signed on to what would become its biggest contract ever in Africa, with a potential value of $700 million…
It did not take a Harvard Business School graduate to explain why South Africans might get angry seeing a wealthy American firm cart away so much public money in a country with the worst income inequality in the world and a youth unemployment rate over 50 percent.
And a bitter irony: While McKinsey’s pay was supposed to be based entirely on its results, it is far from clear that the flailing power company is much better off than it was before….
Since the Eskom disclosures, much of McKinsey’s business in South Africa has evaporated…
Indeed, the harm to the McKinsey brand is more profound than the fallout from the epochal Galleon hedge fund case almost a decade ago, in which McKinsey’s former managing director and a senior partner were convicted on charges related to insider trading. Neither man acted on behalf of McKinsey.
Halfway through the story, the article does point out how dangerous performance-based arrangements are, but in a story this long, it winds up getting short shrift by being buried in the middle:
In the late 1980s, an up-and-coming partner in McKinsey’s energy practice, Jeffrey K. Skilling, had been part of a committee considering whether payment should be based on delivered results, such as reduced costs.
As Mr. Skilling told the journalist Anita Raghavan, the panel concluded it would not work, because getting paid based on impact, for example, could give McKinsey an incentive to tell clients to reduce costs even if it was not in their interest. Doing that, Mr. Skilling said, “could destroy” the firm.
Mr. Skilling — who would become Enron’s chief executive and end up in federal prison after its vast accounting fraud was revealed — saw the ethical trap.
Failure to depict this scandal as evidence of poor governance. Again, even as a young person at McKinsey many years ago when the firm was much smaller, the firm was clearly lax about risk, and that was due to its management structure. I had come from Goldman, which was a partnership, and the result was that the partners were very stringent about who they made a partner, since anyone could conceivably bankrupt all, and they had many formal and informal checks, including partners having very narrow spans of control and being expected to be very hands on in the business they operated. By contrast, McKinsey was modeled on a law firm. Once you reached the tenured class, there were no mechanism for partners to ride herd on what other partners were doing.
See how the Times fell for McKinsey’s spin that the South Africa fiasco was the result of lapses, not woefully deficient controls:
But an investigation by The New York Times, including interviews with 16 current and former partners, found that the roots of the problem go deeper — to a changing corporate culture that opened the way for an aggressive push into more government consulting, as well as new methods of compensation. While the changes helped McKinsey nearly double in size over the last decade, they introduced more reputational risk.
The firm also missed warning signs about the possible involvement of the Guptas, and only belatedly realized the insufficiency of its risk management for state-owned companies. Supervisors who might have vetoed or modified the contract were not South African and lacked the local knowledge to sense trouble ahead. And having poorly vetted its subcontractor, McKinsey was less than forthcoming when asked to explain its role in the emerging scandal.
The Times clearly backs McKinsey’s rationalization, that this episode was somehow out of character: “That is why McKinsey’s behavior in South Africa is so startling.”
It does not consider that the South Africa as opposed to a sign that the firm had managed to maintain its brand image while evolving into something significantly different. For instance, the firm has become crass in how it pitches business. I’ve been hearing complaints for over a decade that McKinsey staffer will meet a client or a prospect, and tell them why it would benefit them to have McKinsey do a particular project for them. When the client says, “No, we don’t think we need that and here’s why,” or “Yes, we’ve thought about that, and we only think one part is relevant and we’ve already started on that,” the McKinsey representatives would argue with them, effectively telling them they were wrong and they really needed to hire McKinsey.
The Times account has the smoking gun, which the authors instead twist into a defense of sorts:
Concerns notwithstanding, the prospect of a big payday made the contract popular not only in Johannesburg but throughout McKinsey’s global empire…
In situations like these, risk managers are supposed to serve as corporate lifeguards, ready to whistle back dealmakers if they expose the company to unnecessary legal and reputational peril. Yet the Eskom contract was approved with less scrutiny than regular public contracts. That was because state-owned enterprises were treated as private corporations, where reviews focused on commercial viability, not political risk.
Had McKinsey vetted the Eskom contract properly, it might have spared itself some of the grief to come. The contract, it turned out, was illegal: The power company had failed to get a government waiver from the standard fee-for-service payment, despite assuring McKinsey that it had done so.
“For the scale of the fee, they were prepared to throw caution to the wind, and maybe because they thought they couldn’t be touched,” said David Lewis, executive director of Corruption Watch, a local advocacy group.
Now why does this, “Oh, this was a government contract, and so a different sort of contract than we normally enter into, so our risk controls weren’t fit for purpose” a load of steaming bull?
The very same story had this section earlier:
By the early 2000s, McKinsey re-entered the public sphere in a major way — and now government contracts and work with state-owned companies make up 16 percent of the firm’s revenues.
McKinsey damned well knew, or ought to have known, how to handle the Esksom project. It has a decade and a half of experience and a significant proportion of total firm revenues from this type of client. Either the processes were never any good, which is a major problem in and of itself, or partners in the Jo’burg office lied or hid information from the mother ship. Neither possiblity reflects well on McKinsey.
Failure to recognize how money-driven McKinsey is. Consider this bit:
One very public flap emerged in the summer of 1970, when The Times (also a McKinsey client over many decades) published front-page articles detailing an explosion in consulting fees paid out by New York City. At the center of the controversy was a young McKinsey partner, acting as an unpaid official in the city’s budget bureau even as the city was spending taxpayer dollars on contracts with the firm.
It looked bad. And while McKinsey was cleared of wrongdoing, the experience helped steer the company away from government work, avoiding the publicity, the ethical quandaries and the generally lower fees that came with public contracts.
I was at the firm in its New York office in the mid-1980s and the partner who was at the center of that scandal didn’t appear to have taken a hit for it. And the party line internally wasn’t that government work was too ethically problematic, or that it could lead to bad press.
It was that it was too hard to get paid.
Failure to question lame excuses. Admittedly, the Times is hampered by journalistic conventions, but some of the things the McKinsey folks claim does not stand up to scrutiny. To get the Eskom assignment, they needed to have a local black-owned firm as partner. McKinsey swears up and down they had no idea who they’d teamed up with, much the less that the entity was connected with the Guptas.
We are supposed to believe this:
McKinsey knew little about Trillian — a new company, with no track record, that had broken off from McKinsey’s previous minority partner, Regiments, after a business dispute. What’s more, Trillian had refused McKinsey’s requests to divulge its ownership.
When we are told this staring in the next paragraph:
What McKinsey did not yet know was that Eskom’s chief executive, Mr. Molefe, had placed dozens of phone calls to one of the Gupta brothers during and after contract negotiations.
An influential senior partner in Johannesburg, David Fine, had grown increasingly uneasy about Trillian, according to his testimony to Parliament. One source of concern: Over the objections of two senior partners, McKinsey’s team leader, Mr. [Viksa] Sagar, had been meeting with Eskom and Trillian without any other McKinsey officials present.
So Sagar, a McKinsey partner, who appears to have had more that a bit of a clue about this supposedly mysterious project partner, is not “McKinsey” for the purpose of this story? The Times won’t hold McKinsey accountable for the knowledge of one of the two lead partners on the Eksom assignment?
And the Times curiously fails to comment on this part, say by getting a third party quote:
That conclusion was based in part on a letter obtained by a widely respected human-rights advocate, Geoff Budlender, who had been asked to investigate Trillian…
Mr. Budlender asked to interview McKinsey but was told to put his questions in writing…In response to one question, McKinsey denied working “on any projects” with Trillian, as either a subcontractor or a black-empowerment partner.
With his trap laid, Mr. Budlender pounced. He attached a Feb. 9, 2016, letter from the McKinsey team leader, Mr. Sagar, to Eskom. “As you know,” Mr. Sagar had written, “McKinsey has subcontracted a portion of the services to be performed” to Trillian. The letter went further and authorized Eskom to pay Trillian directly, rather than through McKinsey, as was customary for a subcontractor.
Asked to explain the conflicting answers, a McKinsey lawyer, Benedict Phiri, took weeks to respond, saying he needed to speak with his colleagues. Finally, he wrote that, given ongoing legal disputes, it was “inappropriate” to comment.
Mr. Budlender concluded that McKinsey’s denial was false….
In the interview with The Times, the McKinsey managing partner, Mr. Barton, said the office leadership in Johannesburg had been unaware of Mr. Sagar’s letter….
McKinsey’s lawyers said that the letter should never have been sent.
So get what happened. Sagar and perhaps others knew McKinsey was going to satisfy its black empowerment obligations by getting a contractor involved who had ties to the Guptas, meaning to the then prime minister. Oh, and I forgot to mention that this contract was awarded on a no-competition basis, which also should have set of alarms at head office. Sagar found a way to get Trillian paid and keeping McKinsey looking clean by not having McKinsey in the money flows to Trilian.
And what is McKinsey’s comment when this is exposed? Not that this was wrong, not that they never knew (they could have easily thrown Sagar under the bus; the fact that they didn’t suggests he could show the firm knew plenty well much if not all of what was going on) but that the letter should never have been sent. In other words, Sager hadn’t committed a perfect-enough crime.
Mark Ames’ take on the story: “Looks to me like standard colonialist propaganda. I had no idea McKinsey was so virtuous until now. Am I missing something?”
Or if you want to be more charitable: it’s a shame the Times did such a good job of fact gathering and lost its nerve on reaching conclusions. Thee Grey Lady was apparently unwilling to get into what would have been a milder version of staring down legal threats that the Wall Street Journal did with Theranos. That sort of journalistic courage is almost a relic.
From: Dominic Barton and Kevin Sneader
Subject: New York Times story on South Africa
Date: June 26, 2018 at 2:37:04 PM EDT
As a former Partner of the Firm, we wanted to let you know that we expect The New York Times to publish a lengthy story on McKinsey later today, focused primarily on the challenges we have faced in connection with Eskom, the state-owned power utility in South Africa and a client of McKinsey since 2005.
We tried to cooperate in every way with the journalists working on the article over the last several months, and provided multiple in-depth briefings with senior colleagues (including an on-the-record interview with Dom), alumni, and outside advisors on how we work, our policies for managing risk, and the results of our investigation—and we have been open with them about the lessons we have learned coming out of the issues in South Africa.
That said, throughout the reporting process the journalists demonstrated a somewhat cynical view of the role played by ‘global business’ and our Firm. This was clear from their lines of questioning—for example, challenging whether it was appropriate for us to operate in many parts of the world, including China, the Middle East, and Africa; whether we should serve the public sector at all when we also serve private sector institutions doing business with governments; and whether we should work for any defence clients or any oil and gas clients.
Despite the article’s likely point of view and portrayal of unacceptable individual behavior that falls well short of our values, the reality is we are continuing to make progress in restoring our reputation and standing in South Africa—though we know it will be a long road ahead. We have built relationships with the new government and are engaging in discussions with clients on the results of our investigation (which is now complete and which found no evidence of corruption or bribery)—and are working to finalize the repayment of our fee to Eskom.
None of us likes it when the Firm gets this sort of media attention. There are clearly things we need to learn from the mistakes we made, and we have. We remain focused on what really matters: delivering great impact for our clients and developing and inspiring our people.
Given we have not seen the article, we may well be in touch with further thoughts after publication. Please take this as a sign of our commitment to you as alumni to engage you in events affecting our Firm, and know that – as we approach Values Day in many parts of the world – our commitment to those values remains as strong as ever.
Dominic and Kevin
1 This talk was not all bluster. I got McKinsey fired from a project for telling the client something that contradicted his pet preferences. The partner on the study thought it was hysterical. He had agreed to do what amounted to a mini-study as a favor to this guy, who was a mid-level manager at Citi, and he thought the client getting stroopy with me confirmed that he was a time waster.