Freakonomics On Consulting

Me in January on Too Much Consulting?:

Last night I discussed the popularity of law, finance, and management consulting with Tyler and many somewhat-libertarian-leaning others. I was surprised that most were skeptical that firms get their money’s worth from consulting, more skeptical than for law or finance. I was also surprised that most focused on explaining why kids from elite schools work at such firms, rather than on why firms pay so much for this consulting.

My explanation:

The CEO often understands what needs to be done, but does not have the resources to fight this blocking coalition. But if a prestigious outside consulting firm weighs in, that can turn the status tide.

Freakonomics Radio interviewed me about it a bit later, and they’ve just put up a podcast they say was “inspired in part” by my post. In addition to me, they talk to Keith Yost, a former consultant:

Fellow consultants and associates … [said] fifty percent of the job is nodding your head at whatever’s being said, thirty percent of it is just sort of looking good, and the other twenty percent is raising an objection but then if you meet resistance, then dropping it.

and Christopher McKenna, Oxford business historian:

They divide the roles into two parts. 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. … 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 effect they both produce reports, and somebody wins that fight with the help of that extra amount of knowledge from outside.

and Nick Bloom, Stanford economist:

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 ninety-five percent of the industry. Most of it is done by firms you’ve never heard of. And those guys are very much like seasoned, gnarly, ex-manufacturing managers that have spent twenty years working in Ford and are real experts, and are now getting paid as consultants to hand out advice. That stuff typically has pretty big impact because you’re paying someone to give them long-earned advice. And then there’s the very small elite end, strategy consulting, about five percent. And that’s much more helping CEOs make big decisions.

Bloom did a randomized trial in India of the first type of consulting, and found that it gave great value. But on the other type, which is what I think Yost, McKenna, I, and my dinner companions were discussing, the only positive evidence the show offers is cohost Steve Levitt saying that as a consultant he sure felt he added value:

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 how can you argue with data like that?

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  • Siddharth

    “And how can you argue with data like that?” 

    Well played, sir. Well played.

  • Guest

    I worked at a “big three” consulting company (that’s McKinsey, Bain, and BCG) and have to generally agree with Robin’s take. 

    Another factor to consider: many of these firms’ clients – CEO’s, strategy executives – are ex-consultants themselves. Why should that sustain a value-destroying industry like strategy consulting, if it is indeed value-destroying? For one, consultants and ex-consultants not only provide legitimacy, but they also share common pedigree (elite degrees) and, perhaps more importantly, a common language and approach to thinking about business or economics or whatever. Going off of Robin’s point, the consulting company is brought in not only to confirm an idea or strategy, but to confirm it using a language or a set of frameworks which the client is comfortable with. Call this shared language ‘jardon’ or ‘BS’ or what-have-you, my point is that all human beings, top executives included, are more likely to confirm a ‘bias’ if that confirmation comes from a friend or a trusted source, in a trusted fashion.

    Alternatively, or perhaps complementary, the cynical view is that ex-consultants are providing some kind of de facto kickback to their former employers (out of loyalty, or some other kind of ‘pay it backward’ mindset), while at the same time providing legitimacy and confirmation and CYA to a new strategy or idea. 

  • Someone from the other side

    As someone currently working at one of the big three, I will agree with Levitt’s point. And what is generally not appreciated enough by outsiders and not sufficiently stressed by insiders (partially because it sounds so arrogant): people at all of the three firms really ARE very smart (better than most parts of academia, in general) and they are ok with crazy working hours and a lifestyle that is best described as gruesome

    • Oscarcalme

      They are so smart that they work crazy hours with a gruesome lifestyle.  Meanwhile the much dumber academics have a leisurely lifetyle, teach 15 hours per week and go home at night.  In my experience most consutants are best described as xspurts.  Unknown quantities and drips under pressure.

    • echows

      Can you elaborate on what you mean by ‘smart’? From my own anecdotal viewpoint as a science major in college I feel that the people with most prowess in mathematical things and ability to learn stuff quickly went to graduate school while the rest went to consulting, standard engineering jobs, etc. I’m saying this because usually ‘smart’ is defined as something that correlates with the kind of skills you need in science/economics graduate school, not in a consulting company.

      • Michael Vassar

        I’d be astounded if the average standardized test scores and intelligence test scores at the big three consulting companies weren’t MUCH higher than those for a average scientific and engineering PhDs.  
        The faculty of top departments, the people who you think of when you think ‘scientist’ are another matter entirely, and much smarter than either group, but only a small fraction of science PhDs become such faculty.

      • Someone from the other side

         I would argue the main difference between top faculty and top consultants is not so much intelligence (they are probably equal on average) but patience and attention span – and maybe, even though I hate that word, passion for their area vs passion for variety.

        Top faculty has usually been doing the same topic for the past 20 years probably (pushing the frontier of course, but not switching from biology to social sciences and back).

        Consultants on the other hand often thrive on variety and change because they get bored quickly (consultants are overwhelmingly NT in the MBTI framework). More than likely they are also more money oriented than the science crowd (even though even a junior consultant is hard pushed to spend his money on sensible pursuits, the time just isnt there).

      • Someone from the other side

        They will generally be top 10% of whatever school they come from (and its going to be top tier schools). Top3 analysts on notoriously dominate the dean’s lists of the top B-schools (and half of the rest of the dean’s list gets hired by the top3, perhaps less at the heavily finance oriented schools such as Wharton and Columbia) [1]. Personally, after always having at or very near the top of selective schools (with overall very little investment and while running my own business all through highschool and most of university), joining a top 3 firm was a very humbling experience, indeed.

        Furthermore, if consultants do not hold PhDs (and many do) in their field it’s because they did not see the point, not because they would not easily be capable of doing the required work.

        Even after a couple of years at it, I am still occasionally astonished what a small group of very smart, dedicated and highly focused people who are not required to conform to an organizations politics (not initially, anyway) can do in a couple of days to weeks.

        Some people hate us claiming we are arrogant. I certainly cannot fault them if they read the above. However, the quality of talent at any of the top3 is what ultimately makes it worthwile to sustain the gruesome lifestyle – and usually the answer the (at least) monthly question of “why I am still doing this to me?”.

        [1] Having done B-school paid for with one of the top 3 firm’s money this is the environment I am most familiar with. We get a fair share of PhDs as well and I would honestly refuse to rank the MBAs with the PhDs skill wise. A nasty secret I will share however, at b-school (and this is true for all schools for which I have talked to alumns) consultants will occasionally among themselves bemoan the standards of the much of the rest of the class (generally, only top tier IB and PE guys will consistently be of similar quality but usually of a mindset that does not jibe with consultants very well).

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  • Perthagorus

    When I heard the podcast a few days ago (with yourself included as well), was pretty excited… but ended up pretty disappointed with the depth of the discussion.  Hard to believe they pulled in Keith Yost — think he was “let go” after 6 months and wrote a few negative articles about his short experience for the MIT student paper back in 2010.  Not sure I’d classify him as an expert interview subject.

    As someone who’s currently working for one of the Big Three (and has been doing so for several years), think there are two major misperceptions in much of this:

    Misperception #1: Management consultants are strategy consultants.

    While this may have been true back in the ’80s, all of the large firms have grown and adapted — would say that <10% of the work now is "pure strategy".  Don't get me wrong — there's a huge advantage to pitching yourself as a strategy firm, but the work itself just isn't in enough demand to fully occupy the tens of thousands of consultants at McKinsey, BCG, and Bain.

    Most of the work these days is in areas that have much more "quantifiable" value (and allows partners to pitch large teams that make them buckets of money) — running PMOs / PMIs, organisational re-design, sales / marketing effectiveness, pricing optimisation, etc…  While there's a huge advantage to pitching yourself as a strategy firm (and all of these firms do — most aggressively when they're hiring at business schools), the reality is much less exciting… but, probably a lot easier to justify from a value perspective, too.

    Misperception #2: It's all about fresh-faced college students offering advice.

    Most cases are sold on the strength of a few, highly experienced partners.  Firms aren't stupid — they're not going to look at a bunch of Harvard grads and hire them just because of a fancy paper on their wall.  Cases are pitched by partners who have (likely) worked with each of the potential client's direct competitors, and has a page long "resume" of successfully leading projects that are exactly like the one being pitched.

    If the case sells, the level of partner engagement varies, but is often quite high.  The MBAs run around pulling the 80hr work weeks doing grunt work, while the partner engages at an idea level and plays the management role (trickling down to other senior staff).  It's not all that different from academia, to be honest (just on a much more accelerated time scale).  It's a leveraged model.

    • Someone from the other side

       Addressing #1, the top3 have grown large enough to do most topics in business – ultimately they give you some (although not quite as much as they like to claim) leeway in deciding what you want to do.

      Also, while some people live and breath strategy, others quite simply can’t stand it and want to do more operational, tangible work. Aside of that, there is always organization and literally a dozen of other topics such as corporate finance or risk (in my experience, the risks people are probably the smartest ones if you apply conventional standards). Personally, I am bored quickly so give me the tough strategy questions and spare me ops…

      The point where the strategy consultants differ from the management consultants is not necessarily in the work they do, but whom they do it for (and yes, what they charge for it :).

  • Alicemannphd

    Another interesting and hilarious on-the-ground perspective of what management consultants actually do can be found in “The Management Myth” by Matthew Stewart. Before the book, he had a lengthy article published in The Atlantic under the same title.

  • Douglas Knight

    Here the experiment of Bloom et al. Did Robin or Tyler link to this paper before? Here Robin posted on a different Nick Bloom paper.
    This was not “seasoned, gnarly, ex-manufacturing managers” giving “long-earned advice.” It was MBAs distributing book-learning. Maybe the description of operations consulting in the US is correct, but you might expect diminishing returns compared to the experiment.Why did the Indian textiles manufacturers need MBAs to tell them to keep the floor clear, to do preventative maintenance, to computerize inventory, to standardize procedures, to measure quality, to give performance bonuses, etc? Partly it was that they had not heard of such practices. For the practices they had heard of, they thought their firm too small to benefit from the practice. One thing the consultants provided was the knowledge that the firms were not too small. The Indian firms were small, limited by family size. Large American firms might get much smaller productivity increases from consultants, but if they can deploy the advice at scale, it could be worthwhile. The family-limited firms felt little competitive pressure, because well-run firms could not expand. Also, practices could not spread between firms. (Bloom’s other paper talks about national styles of management.)

    The experiment shows that consultants can be quite valuable. But it does not demonstrate that they were valuable for the intuitively plausible reasons Bloom gave in the interview. Also, the fact that they did not think the advice would apply to their firms suggests a difference from firms that think consultants worth paying for. In particular, firms that hire consultants outside of experiments might try to read about this basic tier of advice and have at least tried to implement it. Do they fail and need the consultants to actually implement it? or do they succeed on their own and get completely different advice from the consultants?

  • Bradley Calder

    Thanks for the post Robin, in a completely off topic note, can you write a book about whole brain emulation and the economics thereof.  Just a small request :-) but I (and many others) sure would appreciate it. 

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  • Seb

    I agree with Perthagorus that Yost seemed like a pretty weak pick for an interview. The real data point there is that someone whose perception of consulting is that it’s that trivial was unable to retain a job in consulting.

    I think strategy consultants actually have far more than the two roles that are described in the podcast.

    The roles include
    1) Provide legitimacy for a decision to play out a power struggle, as above. This is probably less common that it’s made out to be.
    2) To provide outside expert knowledge about the field, as above. It’s worth pointing out, by the way, that the big 3 have mega-sophisticated knowledge bases and both formal and informal information-sharing networks. A new graduate hire isn’t just pulling his/her ideas out of a hat – they’re really leveraging dozens of far more experienced people and pulling together their advice.

    3) Communication across silos

    Many large firms are weak when it comes to interdepartmental communication. This can be a major barrier in decision making. It isn’t just because different departments tend not to talk, they are often unable to because of tribal allegiances. By coming in from the outside, consultants are more able to gather important information from several departments and consolidate it in an unbiased way.

    4) Vertical Communication

    In many companies it is relatively hard for information to filter from ground level up to senior management. Good consultants will dig right to the roots of an organisation and can often get ideas implemented that would otherwise die.

    5) Controlling Risk

    Large corporations have a lot riding on their strategic decisions. It’s very valuable to know when other companies are making roughly similar moves to you, and when you’re out of step. Being out of step isn’t necessarily bad or good – but it’s important to be conscious of it and to make that decision carefully. Because consultants sometimes serve many firms in the same industry they can share (anonymised) information about strategic trends in the industry.

    6) Stepping outside of routine

    In a large corporation it’s hard to get a continual feeling of change and improvement. Often the focus comes to rest on keeping on doing what you were doing. Because consultants don’t get used to the routine, they are sometimes more able to come in and spot opportunities for improvement.

    7) Listening

    Genuinely, it can be very difficult to systematically listen to and consolidate what everyone in the organisation has to say about an issue. In many cases the consultants *don’t* bring anything new. That’s not surprising, since the problem the client has might be quite specialised. But simply having someone go around the company systematically gathering viewpoints and information is worth a great deal.

    8) They are also, as has been pointed out, often just quite smart. This can have a pretty big impact on output. It’s actually not even close to decisive though. Being able to empathise with the needs and capabilities of the client company is much more important to getting a workable solution to a problem than simply being able to come up with clever ideas.

    I suspect there are many other important roles that I haven’t thought of. And, full disclosure, I’ve only got a few months of experience working for one of the big 3. But even from this list, it seems clear that there is a lot of room for strategy consultants to add value to their clients. Whether or not they deliver on that is an interesting question, which you’d like to have solid evidence on. I am not aware at the moment of any well conducted studies addressing it.