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Why Do Companies Pay Consultants So Much to Tell Them What They Already Know?



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Tyler Cowen, Arnold Kling, Robin Hanson, and others have been discussing why many smart college graduates want to enter consulting, and what value consultants really add. Consulting is a word that covers a multitude of sins, but in practice the discussion was focused on strategy consulting.

Robin Hanson asks:

The puzzle is why firms pay huge sums to big name consulting firms, when their advice comes from kids fresh out of college, who spend only a few months studying an industry they previous knew nothing about. How could such quick-made advice from ignorant recent grads be worth millions? Why don’t firms just ask their own internal recent college grads?

Tyler Cowen argues that consulting is a way for such very young, but smart, people to add value without the years of apprenticeship that are required in other fields:

The rest of the world is increasingly specialized, so the returns to your general intelligence, as a complementary factor, are growing too, in spite of your lack of widget knowledge.  “Hey you, think about what you are doing!  Are you sure? How about this?” often sounds bogus to outsiders but every now and then it pays off and generates a high expected marginal product.

Strategy consulting is a pretty big industry with thousands of projects every year, so it’s possible to find anecdotes that support basically any theory, but I spent about ten years as a strategy consultant, and none of this sounds very realistic to me.

#more#A consulting team is sized to the project, but a typical team might include three research analysts with 0–2 years of experience each, two associates with 3–5 years of business experience each, an engagement manager with 5–7 years of experience, and a junior partner with about ten years of experience.  Such a team is ultimately supervised by a senior partner who has overall responsibility for the relationship between the firm and the client, reviews the outputs, and attends key client meetings, but does not directly lead the specific project. 

No competent consulting firm is going to have a bunch of unsupervised “kids fresh out of college” standing in front of a Fortune 500 CEO telling him what they think. In a typical CEO-level final presentation, a good senior partner will let the engagement manager do a lot of the meat of the presentation, so that he or she gets experience. The partners lay out the overall recommendations at the start of the meeting, and then fly air cover for the rest of it.  The associates and research analysts sit at the table or against the wall, and answer questions when data or analysis is challenged. The recommendations of a typical consulting project are the product of the 23-year-old research analysts in about the sense that a published biochemistry paper is the product of the graduate students on the research team.

It’s been a very long time since the work product of a good strategy-consulting project has been something like the observation that “No, you’re not in the railroad business, you’re in the transportation business.” The consulting projects that I worked on were usually much nerdier than this. Not all projects add value — like all real activities done by people, they are a mixed bag — but a typical set of recommendations might be something like raising the prices for the following list of products, based on a combination of: (1) historical price elasticity analysis, plus a conjoint analysis piece of market research intended to forecast consumer response; (2) activity-based costing of the integrated manufacturing / logistics economics of the resulting changes to production levels to predict margin change; and (3) competitive analysis to estimate the likely competitor price response based on their production capacity and costs by manufacturing line. This kind of work can sometimes go awry, but usually for the opposite reason: The work becomes an arcane art form that gets too disconnected from practical reality.

A good partner on such a project has done each of these types of analyses many times, supervised them at the engagement manager level many times, delivered them to clients many times, and seen the results play out. Further, he or she probably has lots of general experience in the industries and/or the analytical methods in which he or she specializes. This is why career consultants typically work their way up through these ranks over many years, and are subjected to up-or-out at each stage. As a rule of thumb, you might spend two years as a research analyst after college, then two years doing an MBA, then seven years to partner, and then 10–20 years as a partner, if you are successful. In fact, strategy consulting is a mature industry in which a multi-year apprenticeship is required before you are actually put in control of a project, never mind a client relationship.

Hanson answers his own question with the following theory:

My guess is that most intellectuals underestimate just how dysfunctional most firms are. Firms often have big obvious misallocations of resources, where lots of folks in the firm know about the problems and workable solutions. The main issue is that many highest status folks in the firm resist such changes, as they correctly see that their status will be lowered if they embrace such solutions.

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. Coalitions can often successfully block a CEO initiative, and yet not resist the further support of a prestigious outside consultant.

Big companies, like all human organizations, are much more dysfunctional than our idealized representations. But this specific dynamic is very rare in my experience. To take a practical example, it’s often the case that a CEO wants to institute a new CRM system for the sales force, but the head of sales and her entire team resist this because it will involve them surrendering all of the data they keep in their phones and laptops into a corporate system which makes them more vulnerable, and will also allow more direct management of their time and expenses. That’s a real principal-agent problem. But having McKinsey write a report on the value of the CRM system is unlikely to make the head of sales yield because she just can’t “resist the further support of a prestigious outside consultant.” 

If anything, when a CEO uses a report, in part, to get a stamp of approval, it’s more likely to be for upward management of the board. This isn’t crazy from the board’s perspective, since a long-term successful consulting firm doesn’t want to sell its reputation in return for the fees from one project. This is much like a board paying a good law firm to do a review of some high-stakes internal legal issue, or an auditor to review the books. Again, imperfect, but not irrational.



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