The Future of Consulting (Round 1)

European Straits | Work in Progress

Hi, it’s Nicolas from The Family. Here’s a first round of work trying to devise the future of the consulting industry. Subscribers: Please read and let me know what you think 🤗

1/ Let me tell you a secret: If you want to make a guess about an industry’s future, the surest approach is to study its past. According to Ben Horowitz (as told in this commencement address), this is what inspired Brian Chesky’s long-term strategy for Airbnb. And studying history is what we’re going to do today with consulting. How did the consulting industry come about?

You can learn most of it by reading Christopher McKenna’s The World’s Newest Profession. The whole thing started with the Glass-Steagall Act, which was adopted in 1933 to curb the large banks that were dominating the US economy at the beginning of the 20th century. The new rules forbade two things.

The most well-known provision is that the Act forced the banks to pick a side between two very different businesses: investment banking on one hand and retail (or commercial) banking on the other. Being a commercial bank provided a firm with access to the virtually infinite pool of household savings. But it ended up coming with a serious price tag. First, to attract those savings, it was necessary to operate a vast and dense network of local branches. Second, the sensitive job of holding household money led commercial banks to the ever-tighter regulations designed to preserve their customers’ interests. 

Because of this very high price for operating a commercial banking activity, bankers who had a taste for the high-flying discipline of investment banking had to give up on large consumer markets. They had to renounce having lots of branches, and so the only clients they could serve were corporations, governments, and high net worth individuals. But skipping retail banking meant that from a regulatory perspective they were free to do whatever they wanted—including advising clients on any topic.

However, a less well-known provision of the Act is that banks were now forbidden from cumulating banking activities with advising their clients on managing their businesses. As written by McKenna,

Federal regulation forced investment and commercial banks from 1934 onward to hire outside consultants to render opinions on the organization of a bankrupt company or the prospects of a newly-formed public company. Commercial bankers simultaneously encouraged business executives to hire management consultants since officers inside the banks could no longer coordinate internal organizational studies of their clients. The new institutional arrangements in banking opened up a vacuum into which firms of management consultants rushed.

In other words, this is when investment bankers turned their attention from their clients’ organizations to the safer underwriting securities and working on mergers and acquisitions. Legendary deal makers such as Lazard’s André Meyer rose to fame at that time.  

2/ Meanwhile, another trend was at work. Firms were getting bigger and bigger, giving rise to management challenges that far exceeded, both in scope and in scale, the skills of the most common auxiliaries for corporate executives at that time: accountants. Those overlords of business administration started to drift away, eventually being marginalized for both regulatory and managerial reasons, as told in the book Relevance Lost. They took refuge in the rising category that was external auditing, a discipline that was made more critical by the growing number of public companies.

With bankers and accountants clearing the field of everything related to organizations and their management, the conditions were finally in place for the new profession of consultants to rise to prominence. I briefly told the story of McKinsey, but there were many others. Again, competitors were prevented from talking to each other by antitrust authorities, thus they had to rely on consultants as a third party who could pass information related to operational effectiveness. And because they had to become more competitive, it was critical that they bring in outside expertise to help them find the best strategic positioning—another area where consultants can make a big difference. A first generation of firms prospered from the 1930s onward, with the post-war period becoming the next inflection point.

3/ During the post-war boom, a new wave of decisions by US antitrust authorities led to the deck being reshuffled yet again as regards who was helping large firms to perform better. In 1956, the Department of Justice ruled that IBM couldn’t keep on advising its clients regarding the management of information while also selling them the technology that powered their information system. 

Quite unexpectedly, accountants spotted an opportunity and finally had their revenge. Since consultants were focused on management but didn’t know a thing about IT, and IBM was now focused on selling IT but couldn’t advise how to use it, who could advise the clients on making the most of their newly acquired IT from a business perspective? 

This is when the big accounting firms entered the field of so-called “business and technology consulting”, for instance with Arthur Andersen creating Andersen Consulting (which later became Accenture). For accountants and external auditors, the synergy was quite obvious: deploying technology within their client’s organization made it easier to do the accounting and the auditing. 

In any case, at that time the market was segmented in a rather obvious way. Investment bankers were in charge of everything related to financing businesses. Big accounting firms were in charge not only of the accounting and auditing, but also offered consulting services related to the information system. As for the consultants, they were in charge of all the rest, starting with strategy and management.

4/ Consulting could have veered toward the margins, but instead it rose to prominence by pulling one clever trick: Consultants sealed an alliance with the most prestigious universities, notably business schools:

• As explained in Note #7 on McKinsey, a key part of a consulting firm’s value proposition was that it hired the best and the brightest. For this reason, getting close to business schools was absolutely necessary. Consulting firms had to be present at job fairs, to send senior consultants to teach interesting business cases, and to hire university professors as outside experts.

• Getting closer to universities also helped consulting firms work on topics of substance. They already had a passion for ideas, models, and data. But working with academia brought two additional things: a superior ability to modelize, and the opportunity for consultants to have their work (and, sometimes, their name) quoted in influential research publications.

• It all led to interesting outcomes. McKinsey was already in bed with the University of Chicago, where its founder was once a tenured professor. The Boston Consulting Group was founded in symbiosis with Harvard University. Later, Michael Porter even managed to merge strategy with the much more respected discipline of economics, sending a strong signal in the process.

5/ Something that happened in parallel was the development of investment research. I think that’s worth considering when reflecting on the future of consulting for two reasons.

The first is the returning competition between consultants and financiers for providing their clients with insights on what’s happening on the market. Indeed, for the consulting world, moving from management to strategy also meant moving from operations to competition. As put by Walter Kiechel, “for a couple of decades after the end of the Second World War, the biggest companies (most of which were American) didn’t have to worry about competition”. But that changed in the 1970s. With the new interest in what was happening on the much more competitive market, as opposed to inside the organization, consultants ended up working on exactly the same things as their colleagues in investment banking.

The other reason why the precedent of investment research is worth mentioning is that it inspires one of my hunches as to the future of consulting. To keep it short, with knowledge, information and data processing being increasingly commoditized (yes, by the Internet), clients will likely become more and more reluctant to pay for what consultants have traditionally offered for a high price. Thus consulting firms might have to do what some investment research professionals have done in the past, which is gradually move from agent to principal.

In his masterful Doing Capitalism in the Innovation Economy my friend Bill Janeway tells the story of his drifting from investment research to advising clients as an investment banker to working on so-called “post-venture private placement” to eventually becoming a principal investor. Essentially, if you have the insights, why try to sell them to clients who don’t want to pay because they see it as a commodity, when you can instead use it to allocate your own capital. More on that below! 👇

6/ Indeed, a major trend that will have a big impact on consulting is the commoditization of information. Let me offer two quotes here. The first is from my 11 Notes on Berkshire Hathaway (co-written with my cofounder Oussama Ammar in 2016):

Given [the] exponential flow of information, amplified by the power of social media, it’s become increasingly hard to see what others don’t see. Value investing meant something in the age of scarce information. It has become much harder to implement in an economy in which companies are growing out in the open instead of retaining critical information behind closed doors. If the challenge is to understand tech companies better than the market, we’re not sure if it’s still possible in the age of infinite available information.

The other quote is from a recent essay by Byrne Hobart (in his excellent newsletter The Diff):

It’s good to know how much coffee Starbucks sold  yesterday; it’s good to have a differentiated and correct view on what  the coffee business will look like in ten years. And it’s even better to  interpret every day’s data point in light of that long-term outlook. But as real-time data gets commoditized by efficient markets, more of the residual is explained by longer-term theses.

In other words (translated for today’s topic), consultants won’t necessarily disappear, but they will add value by providing their clients with longer-term theses rather than abundant, comprehensive data.

7/ Here’s a second, important trend: Everyone can be a consultant. It’s become so easy and cheap to share your thoughts and knowledge with the outside world that the competitive pressure has increased a great deal and it becomes more and more difficult to sell high-priced consulting services.

Indeed, why would you hire an expensive consultant to help you with a matter that’s been perfectly documented by some random (yet expert) blogger who’s sharing everything for free (for the sake of marketing some other product)? This is Tim O’Reilly’s Open Source Paradigm Shift applied to professional services. Here’s another quote, this time from my issue on The Future of Education (July 2019) on why cheap but valuable expertise is eating the world:

With so many tech people blogging, podcasting, sharing their knowledge and being accessible, it has become easy for anyone to learn anything that’s related to entrepreneurship, software, and venture capital. An extreme example would be how Harry Stebbings of Stride taught himself to be a venture capitalist by interviewing hundreds of venture capitalists for his Twenty Minute VC podcast. And you might know the example of “YouTube Man”, a.k.a. Julius Yego, who learned how to throw the javelin by watching YouTube videos and ended up winning the Olympic Games. Soon the same approach will exist in every sector.

This is even worse than consultants having to compete with bankers and accountants all over again. Now it’s about competing with literally everyone who has acute expertise and information—and those people are willing either to provide it for free (the open source paradigm) or to contribute as a freelancer facilitated by a platform such as Clarity, Comet, Malt, or Upwork.

8/ Finally here’s a third trend, related to competition in the Entrepreneurial Age, the most important change challenging consulting as a profession these days. First, a reminder:

While innovation is about breaking constraints, strategy is about embracing them.

The nature of competition in the past age of the automobile and mass production (a.k.a the Golden Age of consultants), was mostly about strategy (embracing constraints), not innovation (breaking constraints). The former was a matter of corporate life and death, while the latter was practiced only on occasion, usually by accident (see the Nespresso precedent). Here’s me in 2015:

When the company is dominant, its scale is large enough to keep competition at a distance. Broadcast advertising, preferably through mass media, makes it possible to keep the customers under control. Moreover, the company can use its operations and influence to elevate a barrier to entry that alleviates competitive pressure and forgo any effort to implement radical innovation. This is how it keeps the scientific and technological risk at a low level: by not letting the market reach the stage where radical innovation would be the only way to survive.

Today, however, it’s the other way around. Strategy still matters, but innovation is becoming more of an everyday practice. Here’s another quote (from my book Hedge):

[Today’s] economy is characterized by its ever-growing competitive pressure. Startups never stop entering the market: the cost of founding them is dropping and venture capital is rising as an asset class to fund them. Direct competitors can regain the initiative at any moment, as technology makes it possible to propagate new processes and features within a large organization without much friction. As a result, large tech companies are continuously trying to innovate, if only to sustain their returns on invested capital and consolidate their dominant position on their original market. In the [Entrepreneurial Age], the cards can be quickly reshuffled, which creates an unprecedented incentive in favor of continuous innovation.

The question, obviously, is “Can consultants still contribute when competition makes it all about innovation rather than strategy?” I’m not sure, because innovation in the Entrepreneurial Age is more often about ignoring the competition rather than learning from it. The value that consultants used to create by passing information from one corporation to another is now a thing of the past. Today, value is created by having every corporation innovate and discover their unique way to scale:

In the past, scale (low cost, high distribution) was so difficult that organizations with bad products and great scale could win. And it was so difficult to scale the very best products that they never left the boutique. The challenges of scale are now diminishing rapidly. Scale is now available as a service—see Foxconn (manufacturing), AWS (hosting) or Facebook Platform (distribution).

Thus scale is getting easier and other forms of differentiation are being commoditized. But scale will not be commoditized. It is as important as an organization’s product development capabilities. Why? Because the best products require unique means of scaling. The delivery of the best products is tied into the product itself.

As I wrote a few days ago, maybe McKinsey’s “inductive rationality” can contribute on that front, but it’s still a bad omen for consulting as a profession/industry.

9/ Now, let’s reflect a bit on the value chain in the consulting industry. As those among you who are familiar with my The Five Stages of Denial know, a legacy industry is best analyzed by identifying three links in its value chain—with two of them weak (the extremities) and one strong (the middle). How’s the value chain of the consulting industry? 

• At the top are those owning the essential assets (which, in this case, is the whole corpus of knowledge and know-how that consultants use while working for a client). Contrary to what you may think, the fact that those assets are essential doesn’t mean that this link is strong. Manuscripts are essential in the book industry, but authors are nonetheless weak, and the reason is that they are scattered. It’s the same with all those people – experts, scholars, advisors, senior partners – who own consulting’s essential assets. Bruce Henderson knew perfectly well that there was no value in those, which is why he always refused to copyright his brilliant inventions like the Experience Curve or the Growth/Share Matrix.

• At the bottom are those who have to deal on a day-to-day basis with the end customers. In consulting, that’s clearly the junior consultants that have to spend days/weeks/months dealing with executives and managers within a client’s organization. This is also a weak link because those people’s bargaining power with the large consulting firms is close to zero.

• Again, the strong link is in the middle. And in most legacy industries, that link in the middle is a bundle of designing the product (turning the essential assets into something that customers want) and marketing/distributing it. When it comes to consulting, it’s all about turning knowledge into professional services and then having the brand, network, and salesforce to make sure every large corporation in the world buys those services from you and not the competition. (I think you can easily recognize McKinsey and the Boston Consulting Group. Everyone buys from them rather than from the competition for… no reason other than the fact that they have the best marketing and distribution?)

If you don’t know it, you can go read the whole article (The Five Stages of Denial), but here’s how the story ends: a tech-driven company makes customers realize that they can have a better product at a cheaper price, and then network effects kick in, leading to displacing incumbents up the value chain and redistributing value down the stream.

Still not sure as to what the conclusion is for the consulting industry? Are the new entrants bloggers who share everything for free, with John Hagel’s Scalable Learning enabling corporations to absorb it all? I’m interested in your thoughts!

10/ As a conclusion, one more thing: I think we’re about to witness a convergence between consulting and private equity. I have many signals revealing this trend, but let me just quote two of them:

• When I visited Shanghai in 2017, I was honored to be introduced to David Wei, a former executive at Alibaba and now a successful general partner with his private equity firm, Vision Knight Capital. David’s model was simple—and compelling: he would approach legacy corporations and offer them consulting for free; then, if the ‘client’ was responsive enough, David’s group would make an offer to invest in the company; then they would take control of the business and transform it from top to bottom to make it competitive in the Entrepreneurial Age. (By the way, this is what Mitt Romney was tasked with when he was invited to found Bain Capital back in the 1980s. But then he quickly switched to traditional buyouts, which were much more lucrative back then.)

• The idea that a competitive edge is all about becoming more of a tech company has been central to my thinking for years. I wrote about it many times, for instance in The Family, Business Strategy, and Private Equity Firms and Finance: The Secret Key to Becoming a Tech Company. Our subsidiary Pathfinder has been positioned since its inception in 2014 to become a next-generation consulting firm—not one that sells more of the same to exhausted clients, but one that helps them become more entrepreneurial so as to come out on top in the Entrepreneurial Age. They’ve been making tremendous strides over the past six years, but I’m sure they’re not alone in their category.

How do you see the future of consulting? What firms do you think I should have on my radar? I look forward to reading your thoughts and iterating through the next round.

From Normandy, France 🇫🇷

Nicolas