Duff McDonald’s biography of McKinsey, The Firm, whilst remaining relatively neutral, demonstrates to a large degree the positive influence McKinsey has had on corporate America over the past 90 years since its original incorporation. There is a reason why McKinsey, to this day, remains one of the most respected of management consulting firms in the world. This is despite the allegations it has faced in the past – its associations with Valeant as an example – and despite the opacity of its investment arm and potential conflicts of interest.
Clients throughout the world have endorsed the work the firm has done, and the tremendous impact this work has resulted in. It is therefore worth examining the engagement McKinsey has had with Eskom in a contemplative and thoughtful manner rather than simply casting doubt with a wide net of insinuation. To be clear, the reputational risk that McKinsey faces today owing to its Eskom engagement is high – in fact, it may lead to potential engagements being reassessed. At the time of writing, McKinsey also faces the prospect of potentially having to pay back the ZAR 1 billion in fees that it earned during its six-month period of work at Eskom.
There are several points however that need to be stressed to ensure that sober judgement is made of this particular engagement. The first is that the much-scandalised size of the fee needs to be properly put in perspective. ZAR 1 billion sounds like a great deal of money, but in U.S. dollar terms it is approximately equal to USD 73 million. This represents less than 1 percent of the annual revenue McKinsey earns world-wide on an annual basis. This is not a disproportionate amount if one considers that the South African office has been a long-established stalwart of the McKinsey business for many decades.
McKinsey has a history in this country of providing turnkey strategy interventions and solutions particularly within the mining, manufacturing and state-owned enterprise sectors within the South African economy. If one assumes that the Eskom turnaround project was a major scoop for the local company, then it is reasonable to consider that a ZAR 1 billion project would not necessarily have raised eyebrows at a global level. In fact, it would somewhat have been expected as a reasonably normal services sale.
Much has been made also of the size of the fee relative to the number of McKinsey consultants on the ground at Megawatt Park. Based on indistinct information emanating from whistle-blowers, leaked documents and hearsay, this number of qualified consultants varies from an estimate of 20 to up to 70 for the six-month period in question. If one assumes an average of 50 consultants for the duration of the project, the implied daily rate per consultant turns out to be ZAR 167 thousand.
This sounds extortionate. But, it is worth remembering that, with the decline of the Rand against all major currencies over the past three years, the rate at which international management consulting firms work has inflated tremendously. Other globally recognised management consulting firms, Oliver Wyman, Bain & Co., and Boston Consulting Group (BCG) actually charge similar rates within the borders of South Africa. Rates of ZAR 20 thousand per hour are not unheard of. In U.S. dollar terms, depending on the level of seniority and experience of the consultant, this implied South African rate is approximately USD 12 thousand per day.
Owing to the fact that McKinsey is a privately held company, and owing to its right to not disclose its fees, nor to disclose for that matter any of its tightly-held intellectual property, there are few reference points at an international level against which to compare these rates. However, it is a requirement when bidding for U.S. government work that bidders make their daily or weekly rates and costs transparent online, not dissimilar to the directive from South Africa’s National Treasury, for example, that all South African government consulting work be performed on a daily or hourly rate basis.
The Financial Times in 2011 estimated that it would cost a U.S. government agency USD 164 thousand per week to engage with a team of four McKinsey consultants – one managing partner and three associates. On average this implies a charge of USD 40 thousand per consultant, or approximately USD 8 thousand per consultant per day. The implied Eskom rate therefore seems a little high at USD 12 thousand per day, but is not nearly as voracious as the South African public has been led to believe. Put simply, this is what McKinsey charges and as Andrew Hill so succinctly put it in the Financial Times piece, “prestige costs money”.
The challenge that McKinsey faces is that its own deeply-ingrained principle of client confidentiality means that the media storm, and the leaked documents, provide only one side of the story. We do not know, for example, what the nature of the McKinsey turnaround project was in any sort of detail. We do not know how the cost savings against which the fees were originally to be charged were measured or calculated. We do not know even who performed this measurement and what the criteria were; whether in the form of a McKinsey drafted report on efficiencies achieved, and then signed off by Eskom managers, or a report that justified the fee drafted by an independent firm or by Eskom themselves?
The fee was paid in two payments and in full (after a settlement agreement was reached between McKinsey and Eskom) against invoices raised by McKinsey – but, now that Eskom wishes the fee to be paid back, on what basis can McKinsey defend itself, without divulging the nature and detail of the work, if it believes that it did in fact achieve the tasks it set out to achieve? Notwithstanding the question of whether the work itself warranted the fee, the issue presently being debated, at the time of writing, is whether the contract between Eskom and McKinsey was lawful. As is often the case when corporate relationships sour, the battles are fought over ancillary details, as opposed to addressing the principle question as to whether the South African taxpayer was well-served by the engagement.
The primary rationale for the demand for reimbursement of the fee appears to be owing to the illegality of the contract. The “at risk” model that McKinsey proposed and executed upon runs counter to National Treasury’s directives that all consulting work should be charged on a per diem basis. The fast-tracking of payments and the bullying of finance personnel by those executives at Eskom that contracted McKinsey in the first place seems to be the second motivating factor in the demand for pay-back. And thirdly, public sentiment following the media exposure of the unholy relationship between Trillian and McKinsey, cannot be underestimated.
Undoubtedly, based on the leaked emails procured by investigative journalists, the link between Trillian and the Gupta brothers via Salim Essa, would seem to indicate a myopic stance on the part of McKinsey up to the point that their due diligence processes finally ended the relationship. Much has been made public of the spats between the two firms, as well as of the intervention of Eskom personnel in pushing payments through directly to Trillian, rather than through McKinsey. Recall that it was McKinsey that held a contract with Eskom, be it legal or illegal in the retrospective view of National Treasury. Trillian never put a contract in place with Eskom, thus its fees were paid against no formal documentation.
Irrespective of the detail – surprising volumes of detail, in fact, based on the growing body of evidence that organisations such as amaBhungane have collected – there are three salient and sobering points to be made that go beyond this single Eskom consulting engagement.
Firstly, as the public are the ones whose taxes pay for this work, it is surely incumbent upon Eskom, who contracted the work, to reveal the nature of the work and how it will help the utility to drag itself out of its current deleterious financial situation. Power is a basic service and Eskom is our sole formal source of power within the borders of this country. The power outages of late 2015 – whether a result of poor maintenance for more than a decade as was claimed, or whether the result of a stand-off in the Optimum Coal negotiations between Glencore and Eskom – is evidence of just how fragile the South African economy is in its dependence on Eskom.
The second point to be made is that, in the effort to structurally transform this country following the ravages of Apartheid, government agencies require suppliers in general to be Broad-Based Black Economically Empowered (B-BBEE) firms, as per the directives of the Department of Trade and Industry (DTI). This means that critical skills cannot be shipped in to save state-owned enterprises without there being considerable evidence of black involvement, partnership and ownership in the firms providing these services.
Trillian, it would appear in the case of Eskom and Transnet, has been this chosen partner which apparently had the necessary B-BBEE credentials – although even this fact has now been up for debate. Nevertheless, it is sobering to point out that this was undoubtedly a marriage of convenience. McKinsey, if it wished to work with Eskom, would need a black partner, and Trillian was chosen. Trillian is a relatively young company and had been purchased by Salim Essa and others partly for its Financial Services licence and partly because it would be a vehicle for Eric Wood, ex-partner at Regiments Capital, to bid for work at state-owned enterprises.
Here is the conundrum: a mission-critical utility, at the heart of the South African economy, is in desperate need of help. It contracts the world’s most prestigious and most expensive strategy and management consulting firm on the planet. It needs to do so in compliance with DTI B-BBEE directives and therefore requires McKinsey to have a black partner. Rather than insisting that McKinsey partners with an established firm, in which black ownership and management representation is broadly based, it allows Trillian to be that partner, an inexperienced firm, one that McKinsey itself had low regard for, and one with little to no capacity to execute the actual work.
This is not precisely the fronting problem – in which vulnerable and uninformed black people are co-opted into positions of apparent ownership without any economic or representation benefits being provided – that B-BBEE commission head Zodwa Ntuli is so bent on shutting down. In some ways, it is worse.
Trillian, according to its own managers, was, until July of this year, 60 percent owned by Essa, a known connected person to the Saxonwold Gupta family. And Eric Wood is white, the other significant owner of Trillian. Irrespective of the legality of the McKinsey contract, what seems particularly distressing is that while the Department of Trade and Industry, and Zodwa Ntuli, are working tirelessly to ensure that transformation is genuinely taking place within this country, a tiny, recently purchased firm, with no relevant experience and with no employment equity plan, receives nearly ZAR 600 million in fees for essentially just brokering an arrangement between Eskom and McKinsey and other than that adding no real value. All of this in an effort to circumvent critically important B-BBEE laws that every company within South Africa needs to comply with.
The new B-BBEE codes are specifically designed to ensure that real transformation is taking place, and many companies are currently taking significant steps to meet these requirements. Simultaneously, Eskom, one of the key pillars of basic services in this country, accepts intermediaries that have little to no credibility, and whose intent is only to extract as much as possible in fees, irrespective of value-add.
This brings the argument to its third and final point. The fee to Trillian is often described as a cut that Trillian took from the Eskom engagement. This implies that the rack price for the engagement was split between McKinsey and Trillian on an agreed percentage basis. Even this number – that is the cut that Trillian would take – was muddied over time and involved the intervention of Eskom senior personnel.
The assumption here, however – and almost certainly an incorrect assumption – is that this rack rate was cut into two pieces as one would cut a cake into two pieces. In fact, what was far more likely is that the Trillian fee was added to the McKinsey rack rate. This means that instead of cutting the cake into pieces, Eskom simply provided another, albeit somewhat smaller, cake for the benefit of Trillian. This implies that the taxpayer paid something like a 60 percent premium, amounting to ZAR 595 million, for the purpose of having Eskom, a cash-strapped power utility, receive premium-rated advice from McKinsey. It is impossible to believe that this was what the Department of Trade and Industry had in mind when scripting the B-BBEE laws.
Ironically, were there hypothetically to be no B-BBEE rules in place – in other words were there to be no structural reform efforts underway in South Africa – the taxpayer would have paid significantly less for precisely the same services and benefits. The lack of transparency on the part of all three protagonists – Eskom, McKinsey and Trillian – not only potentially erodes confidence and trust in the consulting profession in general, given that all three parties are now fighting over the fees and legality of the contract. But, precisely because the directive from the National Treasury that all consulting work to government agencies should be charged on a per diem basis was breached, the taxpayer, put plainly, was potentially robbed. Unfortunately, because the details of the McKinsey work, as well as the details of how the success criteria were met, are not publicly available information, we will probably never know.
The deepest of all ironies here is that it was the foreign banks, Deutsche Bank and Citibank in particular – both significant bondholders in Eskom debt – that finally applied sufficient pressure to have those responsible at Eskom suspended. This is the fifth wave of imperialism into Africa. At the end of the day, irrespective of the efforts of foreign-domiciled industry-leading firms – such as KPMG, Bell Pottinger and McKinsey – attempting to profit from the advent and growth of liberal capitalism on the African continent; the international lenders will want to get their money back.
It is ultimately capitalism working at its best: debt obligations must be met; otherwise things will fall apart.