Do What Consultants Say, Not What Other Firms Do

26 May 2008 at 8:55 am 8 comments

| Peter Klein |

McKinsey suggests this strategy: when other firms ignore strategy consultants, earn rents by listening to strategy consultants.

  • Companies don’t react to competitive threats in the way management theory says they should, according to a McKinsey Global Survey.
  • Instead of undertaking extensive, sophisticated analyses when faced with a competitive threat, most companies assess just a few responses, and they often choose the most obvious one.
  • These practices give companies an opportunity to seize a competitive advantage by understanding how their competitors are likely to react to their moves.

The pointer is from the ever-valuable Luke Froeb. Most economists are puzzled management consulting, believing that consultants add little real economic value. I am sympathetic to a signaling explanation with a separating equilibrium in which high-quality firms can afford to signal quality by hiring expensive consultants and low-quality firms cannot. But I haven’t studied this closely. Can anyone recommend literature on the economics of consulting?

Entry filed under: - Klein -, Management Theory, Strategic Management.

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8 Comments Add your own

  • 1. hb  |  26 May 2008 at 12:36 pm

    You might want to take a look at my colleague’s work Mariagiovanna Baccara (2007) Outsourcing, information leakage, and consulting firms The RAND Journal of Economics 38 (1) , 269–289

    Also more history than economics but I found Chris Mckenna’s book “The World’s Newest Profession” useful. The story essentially is that consultants spread industry best practice.

  • 2. hb  |  26 May 2008 at 12:48 pm

    For what it’s worth a couple of thoughts that I’ve not yet done something with but think are worth exploring are

    A somewhat different signaling story: About senior management or CEOs signaling to the internal workforce rather than the product market which is a bit harder for me to believe (when I buy RC Cola do I have any idea that they brought in Bain?)

    Also I suspect that there’s also something useful about making stuff that we all know common knowledge – there’s one thing us knowing that we have to do x, there’s another thing about me knowing that you know that I know … and I suspect that large consulting projects with delivered reports can help construct this kind of common knowledge.

    Never really seen this stuff discussed or written up, so I may be way off-base but at some point would like to go back and think through these things more formally, and would be curious if you’ve come across these ideas elsewhere.

  • 3. Fred Thompson  |  26 May 2008 at 2:08 pm

    Micklethwait, John and Wooldridge, Adrian. The Witch Doctors: Making Sense of the Management Gurus. New York: Times Books – Random House, 1996.

  • 4. Warren Miller  |  26 May 2008 at 6:33 pm

    If there is any published research out there on the economics of consulting, I suspect that the Law and Economics Consulting Group (Nasdaq: XPRT; might have it. As it happens, the founding chair of that company was none other than David Teece, a name I’ll bet you know well, Peter. Now, whether LECG will share such research might be a different question.

    Fred Thompson sighed the Micklethwait and Wooldridge book. Unfortunately, that book doesn’t cite any research. Its six-page bibliography cites only books, except for two HBR articles by Ted Levitt. I skimmed its ten pages of ‘chapter notes’ in hopes of seeing a paper cited from a scholarly journal. As with the bibliography, these were dominated by books. The only articles came from HBR, SMR, and CMR.

    But Teece might be able to help..

  • 5. Peter Klein  |  26 May 2008 at 11:15 pm

    Thanks to all for the feedback. The alternative signaling story and the common-knowledge story sound plausible. A quick note to Warren: Teece would certainly be a good person to consult (pun intended) on this. Did you catch the WSJ front-pager about a year ago on LECG? David has made a staggering amount of money doing this, but his focus isn’t strategy consulting, but expert witness testimony on a variety of economic subjects. But anyway, my question isn’t so much about experts’ willingness to supply consulting services, but about firms’ demand for such services. What do the firms who hire strategy consultants think they’re getting for their dollar (or Euro, or yen, or ruble)?

  • 6. Warren Miller  |  27 May 2008 at 1:32 pm

    Peter, based on what I hear from clients–and also on my own experience when I was the hiror, not the hiree–clients hire folks like me for one (or more) of four primary reasons:

    1. We worked w/them before, they know how we work, and they have no learning curve or risk.

    2. We haven’t work w/them before, but they’ve read about us or heard about us from someone they trust, and the service(s) we offer, they need.

    3. They need outside, objective confirmation of a sticky problem that they might or might not know the answer to, but, either way, they have someone to blame outside the company.

    4. They have a problem that they are incapable of solving on their own, and they’ve read or heard that it’s right up our alley.

    In the case of our particular firm, there is another reason (and the reason an NYSE firm came to us): the guy they talk to (me) is the guy doing the work and the guy they’ll be dealing with. That’s the advantage to them of a small shop, even as it seems like a sometime disadvantage to me when we’re overloaded w/work.

    Segue: We have that good news/bad news arrangement where division of labor is concerned because Dorothy and I decided 17 years ago that parenting and managing have much in common. We had raised our children, they were off the payroll, and we had no desire to get back into the quasi-parenting business. Besides, w/one’s own children, one has some idea of what one is getting. With employees, one might not have much insight if one sticks only to the good old-fashioned job interview, which is demonstrably the most biased, least-effective, and awful way to make hiring decisions. That’s not the way we’d do it if we were going to do it, but it’s still a heckuva risk and a responsibility that we just didn’t want to have if, for instance, demand softened and our expense structure was too high.

    That’s probably a lot more than anyone is interested in, but it’s how it works where we are. We try to bring Booz/McKinsey/Bain-type quality to segments of the market that either never heard of them or couldn’t afford them. We don’t work cheap, but we’re a lot less expensive than they are!

  • 7. Rich Makadok  |  1 June 2008 at 2:23 am

    Kevin and John will present the results of this McKinsey study at the upcoming ACAC on June 13.


  • 8. S  |  13 June 2008 at 6:49 pm

    I just saw your post and wanted to add my 2-cents.
    As a disclaimer I want to note that I’m a consultant in one of the big firms (so some of you might think I’m biased – but I don’t think so :) ).

    Not surprisingly I do think that consultants add value, and those that think that consultants don’t add value actually never worked closely with\in a top management consulting firm.

    As an introduction I want to say that the term consulting is a bit misleading; managements consulting don’t come to your office and tell you “you should do 1… 2.. 3…”. The majority of “consulting” work is actually working side by side with the client people on a specific project and actually doing the work (gathering the data, interviewing many people, analyzing data, workshops etc.)

    And now to my point of view:

    While the signaling story sounds interesting it doesn’t hold a lot of water when thinking about it. Much of the actual consulting work is not public and is hidden from the public markets. If you have money to spend on signaling why not spend it on much more efficient venues e.g. spending it on a big marketing campaign.

    In addition, think about the top management consulting firms clients; these are the leading and biggest companies in the world (smaller companies just can’t afford McKinsey & Company or the others). The top executives in those companies (who make the hiring decision) are not only extremely smart, talented and capable they are also living in a super-competitive world; constantly criticized and measured by the public markets, the board, their customers, their peers, their employees; they can’t afford making mistakes. If they keep hiring and re-hiring the top consulting firms there must be a very good reason for that.

    Here’s why I think people pay hire top management consulting (not ordered by priority):

    1) Stamp of approval – yes I agree, if you want to sell a big project \ or an M&A to your bosses – having the stamp of approval of a top consulting firm really helps. This is very different than signaling; this creates real value because otherwise many of these projects \ deal would not happen. Not many people know today a big part of consulting firms revenues actually come from doing private-equity buyouts where the consulting firms conduct “strategic due diligence” which is basically a stamp of approval for the PE firm to buy the company

    2) Being external to the organization – one of the biggest strengths of consulting firms is that they are external to the organization. A huge chunk of the top consulting firms work is driving organizational change (e.g. org redesign, off shoring and outsourcing, no-compensation cost cutting) – it this is almost impossible to run big change program from within the client organizations which are huge organizations ridden with politics and power struggles; to drive this kind change you must have someone external. In fact, most of the clients of consulting firms actually started with this kinds of project that have very visible impact (e.g. company X that tried and failed cutting it’s product manufacturing costs, brought a consulting firm and was finally able to cut millions)

    A special case worth noting is pre/post merger integration (another big piece of consultants work) – in this type of work the companies doing the integration are legally not allowed to talk to each other before they actually merge (i.e. sales people of company A can’t compare notes with the sales people of company B); when this kind of merger happens they usually hire an external consulting firm to start working on the actual integration way before the companies actually merge

    3) Access to talent and execution – the average top management consultant is more talented than the average corporate guy; it’s just a matter of compensation and incentives structure (i.e. consulting firms pay more and attract better talent). In addition, consultants are incentivizing to come up with results by the end of the project unlike corporate people who usually “have more time on their hands” and don’t necessarily have the motivation \ incentives to end a project on time. Many executives are willing to pay big bucks to “buy” talent people that will execute the project and get the job top with top quality; this is especially true for stuff that is critical for the company (e.g. thinking about product strategy).

    4) Access to knowledge and experience – I agree, there’s a lot of that. But it’s more than just sharing best practices among firms. There’s also a lot of proprietary knowledge these firms develop (its part of their competitive advantage) by benchmarking different firms (e.g. what’s the most effective way to organize your sales force given a certain company type and industry). In addition, companies like to leverage the consulting firm’s experience: if you have a really hard problem, like penetrating the Chinese market, why not hire someone who already helped 20 other companies to penetrate that market and knows all the odds and ends?

    This turned out to be a pretty long reply… and that’s just thing of top of my head :)
    Let me know if you have anything else to add, or other comments.


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