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?
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 include1) 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.
Let me try again the link to the Bloom et al experiment in India