Freakonomics Radio - 102. I Consult, Therefore I Am

Episode Date: November 21, 2012

There are enough management consultants these days to form a small nation. But what do they actually do? And does it work?

So, Levitt, between college and graduate school, you worked as a consultant. Can you tell us a little bit about that? I did. I worked for a little company called Corporate Decisions, Inc. That sounds so made up. Corporate Decisions, Inc. CDI, and it was a Bain spinoff, which was later acquired by Mercer, and it had four partners, and maybe there were 70 or 80 of us young people. Was it a job that you were excited to get, or was it kind of a fallback?

No, it was a great job. See, I had trouble getting jobs because I'd never really worked. And the fact that I had spent my summer before my senior year of college, when most students were doing internships, I had decided the right thing to do was to go start a little horse racing gambling hedge fund and to lose all the money of my investors in the previous summer. Didn't really speak to many of the employers. And so it turned out it was harder to get a job than I thought. But the thing is, the CDI, they actually took that as a positive that I had had the initiative and the chutzpah to go out and lose

a bunch of money at the racetrack. Okay. So you got a job at Corporate Decisions, Inc. And what kind of consulting were you doing? What kind of firms were you going into? Strategy consulting. So I worked mostly on pharmaceuticals while I was there. And how much did you know about pharmaceuticals generally before you got there? I knew that you could buy aspirin at the grocery store. From WNYC and APM American Public Media, this is Freakonomics Radio, the podcast that explores the hidden side of everything. Here's your host, Stephen Dubner. Raise your hand if you know somebody who works as a consultant. Yeah, I thought so. Pretty much everybody.

There are more than 500,000 management consultants in the U.S., more than 700,000 if you count the self-employed. And there are even more on the way. The Bureau of Labor Statistics estimates that the consulting field will grow another 22% over the next decade, which means there will be more new jobs for consultants than there will be for computer programmers or lawyers. Now, how does consulting pay? Quite well, thank you. A median salary of about $78,000. That's more than architects, post-secondary teachers, and a lot of scientists and engineers. So if you're Steve Levitt, that's my Freakonomics friend and co-author who was telling us earlier about his first job at Corporate Decisions. Or more precisely, if you're like Steve Levitt was 20 years ago, a bright new college graduate, not quite sure of the next step, then consulting looks pretty good.

In fact, at his alma mater, a certain school up in Boston, 11 percent of the 2012 graduating seniors become consultants, with another 11 percent going into finance. The only more popular destination at 17% is graduate and professional school. I did not go to a top school and did not get snapped up by one of the top firms to be paid obscene amounts of money to say relatively straightforward things. Oops. That's Robin Hanson, an economist at George Mason University. He's a little bit skeptical about the value of consulting. Okay, so it makes perfect sense that sometimes companies will want to get outside advice about stuff, how to do things, how to change things. And, of course, those companies have to hire somebody.

So it makes sense that the people who do that should be knowledgeable, somewhat intelligent and experienced. But what we see in the world, I think, is companies willing to pay a lot for management consulting advice if it comes from a few really top firms that everybody knows the name of. When Hanson talks about the really top firms, that means the big three in the consulting world, McKinsey, Bain, and BCG, or Boston Consulting Group. They tend to get a lot of the glamour jobs, offering strategic advice to the biggest and most important companies in the world, and they charge accordingly. And then you've got industry workhorses like Accenture and Deloitte, which are a little bit more likely to give operational advice, how to restructure a division or make a factory as efficient as

possible. There are thousands of consulting firms out there, very big and very small. But according to industry experts, the top 25 handle the bulk of the work, which generates hundreds of billions of dollars a year in global revenues. But to Robin Hansen, at least, the numbers don't quite add up. Two puzzles stand out. One is that people who are closely involved tend to say that the advice you get isn't spectacularly insightful. It's often puzzling why companies pay often millions of dollars for sort of generic, straightforward advice.

If you had asked around in your company, you would have gotten some similar advice. And then it's also puzzling the companies that give this advice. What they tend to do is hire people out of the very top schools, immediate graduates, and then a large fraction of their workforce are these immediate graduates of top schools. And you've got to wonder, well, I'm sure they're sharp, but doesn't it help to have some experience? In today's episode, we'll try to answer some of Robin Hanson's questions, like, are consultants worth the money? But let's start with the basics. Like, what does a consultant actually do?

I had conversations with sort of fellow consultants and associates, and their advice was that 50% of the job is nodding your head at whatever's being said. 30% of it is just sort of looking good. And the other 20% is raising an objection, but then if you meet resistance, then dropping it. And that was sort of the breakdown of my role as a consultant. That's Keith Yost. Back in 2009, he went to work for BCG. He was 23 at the time, just out of MIT, with a double bachelor's in economics and nuclear engineering and a master's in nuclear engineering. That master's degree made him especially valuable.

He was sent to Dubai. And the starting salary was about $130,000, signing bonus of $20,000, a housing allowance, which was roughly another $20,000, performance bonuses, which varied between 0% and 25% of your base salary. And then there was profit sharing. So on top of your base salary. And then there was profit sharing. So on top of your base salary and whatever performance bonus you got, you got an automatic extra 15% at the end of the year. We should say here that Keith Yost didn't actually earn all that money because he was fired after about five months,

which, frankly, is why he's here today telling his story. If he were still a consultant in good standing with BCG, he wouldn't be. In any case, when Yost started out, he was nervous. This was his first real job. He was sent to work at a startup, an industrial firm that had hired BCG for a special project. And they basically handed us a big tub full of consulting reports they'd commissioned. Looking at the reports, Yost could tell that the company didn't quite know where it was headed. Almost to the level where they couldn't tell whether or not they wanted to make hamburgers or automobiles. And they had four years of consulting reports, by my estimate,

probably $20 million worth of consulting that they had done. So his job was to help sift through the old consulting reports and recommend the best of the old recommendations. We basically had this process where we went through all the consulting reports. And anytime two independent reports said the same thing, we'd put it in our report and make a slide. And it seemed difficult to justify charging that much money. I don't know. It's rough for me to assess the good or bad that we did in that case. Clients should not hire management consulting companies just because they don't know what to do.

That's Tracy Entell. Chief Human Capital Officer and partner at Booze & Company. Booze & Company is one of the biggest and oldest consulting firms in the United States. In the 1950s, it helped MGM cut filmmaking costs. In the 60s, Booz worked with Lockheed Martin to build a better nuclear sub. More recently, Booz helped General Motors try to spiff itself up during the government bailout. I think that companies hire us when they have a really hard problem to solve. And they're looking for a team of people who will connect with them, who will understand them and who they have confidence in, in terms

of helping them craft a problem. And Tracy, let me just ask you, tell me what you find to be the most common negative stereotypes of management consulting and then dispel them for me. I think the most common myth about management consultants is that all we do is cost cut. So the up in the air movie, which I quite enjoyed, but didn't seem like the profession I was in. And I would say that cost cutting is certainly part of management consulting. But at Booz and Company, we think about cost cutting as a step in order to grow stronger and gain or regain competitive advantage in your industry. So I just want to help listeners understand the specific functions that management consultants serve. If you would just play along with me a little bit in some parallel thoughts. So for

instance, if you could compare consulting to a few other professions, tell me in what ways is a consultant like, let's say, a doctor? A consultant is like a doctor in that they need to be able to connect with the person that they're talking to and try to understand perhaps the underlying need versus the presenting need, similar to the way a patient might come into a doctor and talk about presenting injury, but it might be something quite different that is the underlying reason. And that is a very common occurrence in consulting, where the consultants need to really understand what the question beneath the question or the problem beneath the problem.

What's the symptom and what's the cause, in other words, yeah? That's right. How is a consultant like a therapist? A consultant is like a therapist in that they often are asking a client a set of questions that help them achieve a self-discovery around the answer to that question in a way that enables them to own the answer and drive the change from within their company. Okay. And one more. How is a management consultant like, let's say, a golden retriever, man's best friend? A management consultant is like a golden retriever or what I would say a boxer, given that boxers are my favorite.

Okay. In that they need to form lasting trust-based relationships with their clients. You are good, Tracy. I see why they sent you. All right. So we're starting to get a feel for what management consultants do. Next, we look into the harder question. Does it actually work? The answer we found quite simply is yes, massively.

That's coming up on Freakonomics Radio. From WNYC and APM American Public Media, this is Freakonomics Radio. Here's your host, Stephen Dubner. We are talking today about management consulting. It is a massive industry and massively misunderstood. We're asking some basic questions. Who are these consultants? What do they actually do? And most

important, does management consulting work? But before we plow forward, let's take a giant step backwards. Let's find out how consulting was born. Americans were always worried about the power of bankers and about the power of monopoly and what those kind of experts might do for competition. That is Christopher McKenna. He is a business historian at Oxford University. And particularly after the great crash of 1929 in the Depression, they grew particularly worried about the power of banking. And so they famously passed a series of laws in the 1930s, Glass-Steagall being the most important of them, which separated investment and commercial banking, but other related banking acts. And all of those laws, we know, led to a series of professions, in effect, because as commercial bankers and investment bankers broke apart, investment banking grew rapidly.

Once you were required to have quarterly and annual financial reports, auditors also grew rapidly. Once you were required to have quarterly and annual financial reports, auditors also grew rapidly. But what's less understood is that management consultants also emerged from this. And they came out of a mix of actually accountants and bankers, because they would have worked for bankers, they would have been inside the banks, but all of a sudden they were prohibited from being inside either the commercial or the investment banks. And so a mix of people who were cost accountants who worked for bankers emerged. And the firms that you now know, particularly McKinsey & Company, James McKinsey was a cost accountant who was also trained as a lawyer who largely worked for bankers out of Chicago. And that was the early origin of the firms.

So as Chris McKenna sees it, government regulation written to prevent conflict of interest among financial firms gave rise to this new profession, management consulting. Although, as we'll learn in a little bit, it's not exactly a profession. But let's get back to McKenna talking about how consulting works today. The easiest way to think about this is really that they divide the roles into two parts. And the first part is the one that we tend to understand the best and the one that we tend to think of in the most positive terms. And that is that they bring advice to a firm that doesn't otherwise have it. So far, so good. Okay.

That sounds legitimate and helpful and probably very valuable, right? Terrific. Right. Okay. So, the second thing that they provide is legitimacy. And that's the one that seems a little bit strange. So, you've made a decision or you think you might know what you'd like to do about entering those markets or making a new product. And instead of just going ahead and doing it, you hire the consultants to confirm what you already thought. And those consultants come in and they say, yes, you're right. Or even imagine you're having a political fight within the firm and both sides hire consultants. And in fact, they both produce reports and somebody wins that fight with the help of that extra amount of knowledge from outside. Now, Chris, you've written a book that is called The World's Newest Profession, Management Consulting in the 20th Century, from which we would infer, one would infer, that management consulting is indeed a profession. Is that a fact? Is management

consulting in fact a profession? So, there's a double entendre in the world's newest profession, right? Because your first thought should also be the world's oldest profession, which is prostitution, which I think we can all agree is not actually a profession. And if you think about it, partly it's because anybody can call themselves a consultant. There's no actual requirement that you take a state-certified test. There isn't actually a requirement that you take a particular educational regime to get there. There isn't necessarily a centralized body of knowledge. It's not clear that there are particular journals that you have to read. In fact, one of the best ways to decide whether a profession is really a profession is whether it can be accused of malpractice. And there, it's very difficult to

say that consultants are actually a profession because they claim not to really be able to be judged on the basis of malpractice. Okay, Chris, so what we really want to know here is what kind of value, if any, management consulting adds to a firm. So can you help us at all answer that question? I wish I could. So the interesting problem here is that one way to do this is to go back and look, and I have looked consecutively at what people say after the fact. Okay, so after the fact, people will often evaluate the consultants and say, was this worthwhile that we hired these people or should we not have? And on balance, they generally seem to say that it was a good decision. But wait a minute, wait a minute. My suspicion hackles immediately rise because the people who are being asked to answer the survey question are most like the people who were involved to some degree in the hiring of said company in the first place,

right? Sure. So there's an automatic bias inherent. The only thing I can fall back on is to sort of say they keep hiring these people over and over again, right? So there's some value they bring, but I see your problem. So how can you tell whether management consulting is effective, if it works, if it's worth the money? That's hard, in part because most big companies do use consultants. And what you'd really want to do is take maybe 100 of those firms and tell a randomly selected half of them to keep using consultants and the other half to stop and then measure what happens. That's not very likely, right? But it would be a good way to find out if consulting is really effective, to run a real randomized experiment. The experiment took place out in India, in Bombay, the commercial capital, in large textile firms.

That's Nick Bloom. I'm a professor of economics at Stanford University, and I do a lot of research on how to make firms more productive. Before he was a professor, Bloom had a different job. He was, yes, a management consultant. Yes, I previously worked for a year and a half in, or just under a year and a half in McKinsey in London. So it made sense that Nick Bloom, along with some colleagues, were the first people to run what Bloom believes is the first ever

randomized trial of management consulting. Basically, we took a bunch of 28 plants and we randomized over who got intensive five months of consulting versus a control group that got one month, very light consulting, compared their performance going forward. So the question is, does getting intensive management consulting improve the performance of the firms? Okay, so describe the typical, I guess, factory in this experiment. How big are they? How many employees? And what's happening there every day? What are they doing? What are they making? These factories make cotton fabric. So they make, you know, reams of fabric that is made into shirts or pants, as I guess they're called in the US. They're pretty horrible.

I wasn't around in Dickens' time, but I can imagine if you went back 150 years, these factories are dark, dirty, very noisy, very smelly. A lot of accidents. I'm incredibly unsafe. I nearly broke my finger just walking around one of them. Disorganized, there's a lot of yarn, fabric lying on the ground, broken machines. You trip up over pieces of equipment. Quite horribly unimpressive compared to factories I've seen in the US and Europe. And just walking around them, it's clear you could dramatically improve the performance of the factories by tidying them up and making them more organized.

So Bloom's research group sent consultants to these factories, consultants from an Indian branch of Accenture. They mostly preached basic management practices, inventory control, quality control, regular maintenance of their equipment. Now, for the sake of the experiment, some of the factories got a light version of the consulting treatment, just one month's worth of consulting, and the rest got the full version, five months of consulting plus follow-up monitoring. The big question was this, would the firms that got the much bigger dose of consulting actually perform any better? The answer we found quite simply was yes, massively. So going in and giving these guys intensive consulting led to about a 20% higher productivity and around $300,000 extra profit a year.

Wow. What was the value of the consulting services that you gave them for free? So we spent a couple of million dollars. It was funded by a number of organizations, people like the World Bank, for example, Research Foundations. It would cost the firms probably about $300,000, $400,000 a year. It improved their profits by about $300,000 to $400,000 a year in the first year. So for them, after the first year, they were broken even. So what you were offering here was hardcore operational advice and then kind of monitoring, it sounds like, which had a huge effect, you say. What about, however, the other brand or

kind or flavor of consulting that we think of as more strategic consulting. Can you tell me anything about that and the efficacy or the ROI thereof? Sure. So there are really two types of consulting. There's operational consulting, you know, down on the factory floor in the shop type improvements. That's probably 95% of the industry. Most of it's done by firms you never heard of. And those guys is very much like, you know, seasoned, gnarly, uh, uh, ex, ex manufacturing managers that have spent 20

years working in Ford are real experts. They're now getting paid as consultants to hand out advice. That stuff typically has pretty big impact because you're paying someone to give them, you know, long earned and, uh, advice. And then there's the very small elite end, strategy consulting, about 5%. And that's much more helping CEOs make big decisions. So I'm in charge of a peanut company. Do I enter into cashew nuts? Do I make peanut butter? So this is going to be some senior manager in a big retail firm decides she wants to

extend the brand, maybe move into Mexico. She's used consultants from, say, Bain for the last five years. She's had good experiences. It's turned out to work well. She'll go back to Bain again. Often it's the case that she herself is, you know, ex-Bain is why she started working with them. I think it's very hard. It's like the value of all good advice. When I go to my doctor, I keep going back because I like my doctor. Could I do a scientific valuation? No, not really, but I have my own sense. It's a repeat purchase based on did you like it last time. would you think is most in need of empirical consulting, let's say? Coming in, finding through a randomized set of experiments what best practices actually work, letting consultants do that work, and then implementing them. Where would you love to unleash it if you could? So I would love to do something in healthcare. There's a revolution going on in healthcare now

with lean management. There are hospitals like Virginia Mason up in Seattle, for example, that have reduced patient death rates by about 25%, reduced waiting lists by 50% by putting in place lean management practices. Incredibly successful. And the question is, how can we roll this out? How can we persuade the rest of the industry this works? Now, one would think, however, in an industry like healthcare in the U.S., that these best practices would spread like wildfire. Why, in your view, aren't they? Many hospitals aren't facing that much competition. They're the only hospital in their area. They have a pretty captive audience. It's a bit of effort to improve management practices. It maybe involves

a bit of risk, so why bother? So, Nick, are you saying that a typical hospital, let's say, has a smaller incentive to hire a consultant, therefore, who might spread best practices because that hospital faces less competition than the typical, let's say, auto manufacturer? Yes. If you're an auto manufacturer, if you're making, I don't know, fasteners, you're probably competing with 50 companies around the world. It's brutally competitive. If you're not well run, you're out of business. If you're a hospital, particularly in rural America, you probably have a captive market of people around you. If you're not very well managed, well, you may lose a few patients. But in terms of impact, it's nowhere near as much as your entire business going out. So competition, we see time and time again, tends to drive better practices.

So what have we learned? When it comes to operations, how to actually do things, consultants do seem to earn their keep. But on the high end, strategic consulting, it's tempting to think of it as a bit of a scam, a profession that's not actually a profession. It doesn't even have a college major. It's a setup that lets one firm charge another firm lots of money to tell it what it already knows or already should know. Or maybe it gives ammunition for the CEO who already knows what he wants to do to go ahead and do it but to have someone else to blame it on. Steve Levitt, my Freakonomics friend, who before getting his Ph.D. in economics started out as a consultant at Corporate Decisions, Inc., he thinks it's not as bad as all that. The very first project I got put on by my manager, a great guy named Gene Williams, he gave me a big stack of data and we had a pharmaceutical client and he said we need to help them figure out how to get their new drugs approved faster and as any good ivy league college student would say i i turned to him i said okay so what do you want me to do and he said we're not paying you all this

money for me to tell you what to do you're just supposed to figure it out of all the all the things I learned, I learned a lot of things in consulting. That was one of the most important, which is that you actually are supposed to think. Wait, let me ask you this. What was more surprising, that there was a problem that you actually had to try to figure out or that the solution is being put on the shoulders of you, this 20-something-year-old kid who knew nothing about pharmaceuticals. Well, that too, but it was just the idea that you had to think. Because really, if you reflect back, we never ask kids to really think. The secret to getting good grades in college is to memorize a bunch of stuff. The idea that now actually I had to have an original thought was shocking. Now, again,

I didn't know anything about it. I knew about the process. So I actually did the only thing I knew, which was to run regressions. And so I spent a week and I ran all these, I typed in all this data, I ran these regressions. And when I showed it to him, he explained to me very gently that the only mechanism we had for communicating with clients was on what we would now call PowerPoints. And you had two choices, essentially. You could either have a big bar and a little bar on one slide, okay, and that was one way of communicating with clients, or you could have an x-axis and a y-axis. And he made it clear to me that regressions played zero part in what we would ever be doing or showing to clients. And was this enlightening, humbling, frustrating?

What? Enlightening. So nothing, let me just say, nothing I ever did on that project with data ever proved useful to anyone. But the other thing I learned at consulting, which was incredibly valuable to me, is that I had always been the kind of person who just thought the data could answer any problem. But ultimately, what I learned is that the way I could be most valuable was by just walking the halls and becoming friends with the people in the organization, which, as you know, is completely antithetical to everything I believe in, talking to strangers and being nice to people and having social interactions. So it was very difficult for me to do and very, you know, I wouldn't say unpleasant,

but very not me. But that turned out to be the magic potion is that I learned things just by listening to people. And in some sense, the lower in the organization, the better. That allowed me to understand what was actually going to make the project work or not. And that is a lesson I will never forget because it completely and fundamentally changed my own view of business. And so as I, believe it or not, returned to consulting 20 years later, running a little firm called The Greatest Good, I think I have this incredibly deep appreciation that the people in the middle and the bottom of the organization absolutely know what's going on. A lot of times from the people at the top have no idea what needs to be done.

Okay. So that's about you as a consultant from the kind of sell side. What about from the buy side? Do you think that that firm that you were working for in that project or, you know, subsequent projects or just firms in general that hire consultants? Talk to me a little bit about the value that consultants actually provide. The question is, can a really talented generalist come in and help a bunch of specialists? And I think in general, the answer to that question is probably yes. That my own experience has been that even though I know nothing about an industry,

if you give me a week and you get a bunch of really smart people to explain the industry to me and to tell me what they do, a lot of times what I've learned in economics, what I've learned in other places, can actually be really helpful in changing the way that they see the world. And the implementation is always a hard part. But my own view is that business is so unbelievably complicated. And the tasks are divided into so many tiny pieces that are done by hundreds or thousands of people that there's tremendous scope for improvement. And especially in big firms, you hardly have to improve at all to make the consulting fee look trivial compared to the value that you add. It'd be easy to say that Steve Levitt, based on his own consulting past and present, has a positive bias toward consulting.

There is evidence to suggest that he's right, that consulting really does create value, but truthfully, not very much evidence. And given the nature of the consulting industry, especially in the higher echelons, we're not likely to get a whole lot more evidence anytime soon. But I will say this, management consulting is a perfect fit for our times, for an era in which we increasingly bring in experts and defer to them, whether it's in order to gain legitimate wisdom or just plausible deniability. We seem to like to be told what to do. Now, can I prove this? Well, I believe I can. I'm going to try my own experiment right now. I'm going to tell you exactly what to do, and you are going to do it. Okay, ready? I want you to stop listening to this program right now because it's over. Hey, you did not listen when I told you to stop.

Personally, I applaud your defiance. I don't like being told what to do either. So to reward you, we'll tell you about the next episode of Freakonomics Radio. It is a heartwarming story about a bunch of economists, seriously, economists who volunteer their time to help charities analyze their data. They're in England. They're called pro bono economics. For us, the pitch of pro bono economics is that economists are better with a spreadsheet than they are with a paintbrush. And you should marry them up, those economists up with a spreadsheet to help a charity rather than give them a paintbrush to paint a heart. That's next time on Freakonomics Radio.

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