Discover more from European Straits
Moneyball in Consulting Services
Today: Consulting services firms drawing inspiration from baseball to learn the game of capitalism.
The Agenda 👇
Building a consulting services firm was long the easiest way to get rich
But now there are problems on both the demand and the supply sides
Many players are experimenting with new approaches to consulting services
What I think is the right approach: Moneyball for consulting
Capitalism in consulting services is best done within an ecosystem
It’s the only way to leverage these firms’ most precious asset: process knowledge
1/ A client’s high propensity to pay
Firms specialized in consulting services—whether in management, IT, or any other fields—long had it easy. Inspired by Bruce Henderson’s idea of the “experience curve”, large corporations were eager to outsource any activity that required advanced skills and/or frequent downward and upward variations in manpower. And that provided consulting services firms with lots of business.
In addition, these corporations behaved more like clients (“Clients say to you, ‘I need this,’ and if you want to get paid, you make it.”) than customers (“Customers hear you say, ‘here, I made this,’ and they buy or they don't buy”)—to borrow Seth Godin’s words.
Having corporations behave like clients meant that if consulting services firms could provide what was wanted, then these clients were content to pay a high price for the whole bundle. That let those outside firms hire as many people as needed, manage the project so as to deliver on time and within costs, bring in advanced expertise if needed, and provide plausible deniability—as in, “things went bad, but it’s not my fault: it’s that firm we hired, they did a very bad job”.
Finally, in the mature (exhausted?) techno-economic paradigm of the Fordist Age, innovation cycles tended to be very long, thus firms didn’t need to constantly train their workforce to remain competitive. Most professionals could learn advanced skills in their 20s and make a decades-long career out of them. And if there was a shortage of advanced skills in a given field, those lengthy innovation cycles made it worthwhile for firms to train enough people on the job if clients demanded it.
2/ The easiest way to get rich?
The one last thing that made the whole business thrive was the abundance of resources on the supply side. A business that’s about serving clients tends to come with diminishing returns to scale, hence you need to be able to hire more people (input) as your client demands more services (output).
For a long time, hiring more consultants wasn’t that hard. Young professionals found joining such firms quite compelling as it guaranteed a higher salary than counterparts on the client side, frequent changes of scenery, travelling a lot with illimited expenses, building a personal network, coming across various career opportunities, honing advanced skills and being paid for it, and joining a community of like-minded peers which rewarded its members with recognition and a sense of belonging.
As I wrote in my 11 Notes on McKinsey, it’s true that the “Partnership Track” was a powerful motivation for young consultants in the field of strategy consulting. But in other fields such as IT services, many other factors contributed to making people want to join the industry and then work hard to move up. (Plus, most jobs in consulting services aren’t client-facing, so the need to appear to be working hard is not as present as it is in places like McKinsey.)
The ability to attract the best talent in the field made it possible for consulting services firms to manage a key feature of the industry: a very high turnover rate—as in, 20-30% of your talent leaving every year! Such high turnover not only didn’t matter since these people were so easy to replace. It was also a powerful lever for serving clients better and generating profits:
Turnover as a way to thrive across innovation cycles. If serving a given client requires new, different skills, simply replace those who have just left with new consultants with the right skills.
Turnover as a way to escape the adverse consequences of an economic downturn. Consultants are employees, so they are not that easy to fire. But if the economy goes south, simply don’t replace those who leave: the churn on the supply side and the slowing down of business on the demand side makes it possible to maintain profitability!
All in all, it shouldn’t be a surprise that people made fortunes building and operating firms in consulting services. They simply had a magic formula: demanding clients eager to pay high margins, with an infinite supply of critical resources in a market that, unlike the rest of the economy, was growing steadily due to ever more corporations embracing outsourcing and requiring outside consulting services.
3/ Changes on the demand side
Alas (?), the Golden Age of consulting services is now reaching an end for a whole range of reasons, many of which are related to the demand side—what clients want. Here’s what I’ve been spotting:
Clients are not that eager to pay hefty fees anymore. This shift has been happening since at least the 2008 financial crisis, and now players such as law firms and consulting services firms can really feel downward pressure coming from their clients. See, for instance, Big Law Firms in Trouble: When the Money Dries Up (2013, but still timely).
They’re all the less willing to pay since tools and techniques that were long exclusive to consulting services firms, such as in the field of project management, are now commoditized and available for everyone. Think about what the world of open source has contributed to making available, from free libraries to the scrum agile development framework to forums where you can ask the best software developers in the world questions—for free. Why pay high fees when all that is just sitting out there on the Internet?
It’s not only the fees; now clients are holding consulting services firms accountable for the actual quality of their work. There were always favorable clauses in contracts that tended to leave clients with all the problems while consulting services firms took off with the money. Recently, however, more people on the demand side seem to be objecting to making things that easy for consulting services firms. Have a look at 4 lessons from the Hertz vs. Accenture IT disaster.
And it’s not only clients; society as a whole is now holding consulting services firms accountable. Have you seen what happened to McKinsey following their involvement in America’s opioid crisis? They had to pay nearly $600M and saw their brand further damaged in the media. (The repercussions went further, as well, as their most senior executive was denied a new term.)
Finally, there’s the substance of what’s expected from consulting services firms. I mentioned the long innovation cycles of the past, which meant that consulting services firms could count on living off intellectual rent for years, if not decades.
But now that clients demand value for their money and innovation cycles are getting shorter (a key feature of the Entrepreneurial Age), consulting services firms need to invest more heavily in hiring the right people, providing them with proper (and continued) training, staying on top of current trends, and forecasting whatever new thing clients might demand tomorrow, lest they’ll lose the account and see profits disappear.
4/ Changes on the supply side
It already sounds hard enough, but things are also getting harder and harder due to simultaneous changes on the supply side:
High-skilled workers who could join the consulting services industry aren’t stupid. Now that they’re connected with one another through networks of people who share the same skills and work in the same field, they can compare notes and realize two things: how much others are paid for the exact same job and how much their services are billed to clients, with consulting services firms capturing a big chunk for their intermediation.
While some of that might have been whispered about before, professionals can also act on these realizations, which is new! In the past, you had a vague idea of the high fees your boss was pocketing off your work, but there wasn’t much of an alternative. You could switch to the client side if you were willing to consider a pay cut, or you could negotiate a slightly higher salary with a different consulting services firm, but there was no way all that money would end up in your own pocket!
Now things are different because professionals can set up their own shop and become freelancers. Sure, there’s a lot of competition, which brings prices down. But even at a lower price, the absence of a consulting services firm as an intermediary provides an opportunity for the professional themselves to keep most of the money paid by clients.
Don’t misunderstand me: I’m not saying that all consultants and professionals will embrace freelance work. What I mean is that the more tangible possibility of freelance work makes these professionals more difficult to attract and manage from a consulting services firm’s perspective.
Beyond freelance work as an alternative, there are two other things that makes hiring more difficult:
Because it’s the Entrepreneurial Age, most people that would have been attracted to consulting services as a way to reject the traditional, top-down corporate world are now attracted to entrepreneurship. It was easy for consulting services firms to compete against boring, exhausted corporations for the best talent. Now they have to compete against the tech industry as a whole and tech startups in particular, which are a much tougher match!
With remote work, the market for talent has become much larger. For a consulting services firm, it sounds like good news: now you can find the best professionals wherever they are. But in fact, it’s merely more bad news: the probability is high that the skilled professionals you would have hired locally in the past are now working for someone else in a remote setting. Why join the local consulting services firm when you can be hired by a more rewarding employer remotely?
This range of changes on the labor market have turned the consulting services firm model upside down. In the past, they could focus on minimizing downtime for the professionals employed without minding the high turnover: there would always be new talent for hire if needed.
Now turnover has turned from being a solution (people constantly leaving contributed to minimizing downtime and mastering the cost rate) to being a problem (people are still leaving all the time, but they are difficult to replace). The talent pool is drying up for these firms, which means they have to learn to do more with less—and to switch their focus from hiring constantly to retaining the right talent exactly where it's needed. Hence the idea of Moneyball!
5/ Do we still need consulting services anyway?
Before we discuss the Moneyball approach to consulting services, however, we need to make sure a new approach in managing resources and skills is worth it.
Will corporations still require consulting services? Will the market keep growing, as it has over the past decades, or will it reach stasis—with dwindling firms hiring subpar consultants to deliver mediocre services to exhausted and penniless clients? I’d say four things:
The economy is changing. The paradigm shift from the Fordist Age to the Entrepreneurial Age forces every organization to upgrade assets and functions, to experiment with new products and new approaches, to deploy new resources that are not necessarily mastered on the inside. All of this is more easily done with some outside help, which consulting services are able to provide. And the pandemic will only accelerate the transition across many industries!
The new economy is more entrepreneurial. Even if they survive the shift to the Entrepreneurial Age, the new paradigm rewards agile organizations that adjust to the ups and downs of the business cycle while also constantly launching new products and exploring new markets. Consulting services still make it possible to absorb these peaks and take risks without adding fixed costs. Even tech companies rely on outside workers, suggesting the trend is here to stay.
Most workers with advanced skills that make sense in the context of consulting services cannot flourish in one organization only. If the current challenge is to deploy a given enterprise solution across several departments, for instance, a CEO can either decide to invest in training their own people, or hire seasoned consultants from the outside. Clearly in some cases the latter option is the most rational and cost-effective from an executive’s perspective.
Finally, workers themselves are adapting to this more entrepreneurial economy. Many now acknowledge that long-term employment is not the norm anymore, changing their aspirations as a result. They want to switch jobs more often, enjoy flexibility, explore new fields, learn new skills, and constantly move upwards. Most corporations are incapable of dealing with such a demanding workforce, opting to hire consulting services firms instead.
Overall, these structural factors and current trends mean that consulting services is bound to be a fast-growing market over the next years (decades?). In this growing market, it shouldn’t be a surprise that many players are willing to try different approaches to winning new market shares.
6/ New approaches to consulting services
The growing mismatch between supply and demand hasn’t been lost on everyone. In fact, many entrepreneurial agents are trying to turn it into an opportunity, confronting consulting services firms with one the most dangerous strategic challenges they’ve ever faced. I have four examples in mind.
An approach I already mentioned is freelancers being on their own, without even the need to go through a platform. Here I recommend Venkatesh Rao’s excellent Fourth-Wave Consulting (as well as Venkat’s whole Art of Gig newsletter—soon to be turned into an ebook):
Around 2000, a wave of indie consultants hit the market. Like their barista counterparts, indies were unconstrained either by economies of scale or by the reliance on marquee-name airport-bestseller rainmaking. Using small, online personal brands and networks, they were able to find and cultivate a clientele for their fundamentally bespoke, high-trust offerings. Though the third wave had its share of second-wave style faddishness (*cough* lean startup *cough* four-hour anything), most indies tended to play a longer, more self-effacing game, developing substantial offerings over 4-5 years of trial-and-error practice rather than flashy ones piloted as a TEDx Podunk talk, and hastily repackaged into a book. They moved away from both first-wave cynical CYA consulting and second-wave theatrics, and towards genuine business nerdery as a calling. But the price was a sharp limit on scale. Like the early third wave coffee shops, they tended to be too dependent on founder-baristas and struggled to open even a second location.
The next level is these freelancers being gathered by dedicated platforms, about which my wife Laetitia has written a great deal:
Digital work platforms are still a relatively marginal phenomenon, but they are growing amazingly fast. Their rise challenges our definition of the firm. Many workers have fully embraced the digital transition: their hunger for more autonomy, flexibility and purpose leads them to adopt new work models. These freelancers, in particular the most qualified among them, are now in a position to negotiate a new “bundle”, one where work comes with self-fulfillment and autonomy. The challenge for companies will be to take the full measure of what that implies.
There are limits, however. You could have the impression that clients can rely on these platforms to find all the talent they need to handle a given project. But what’s lacking is the management of the project itself, clear rules when it comes to accountability, and access to various complementary resources.
A third approach is...Palantir. I’ve seen many people baffled by the apparent difference between what Palantir professes to be (a Silicon Valley-based company determined to make the world a better place) and what it looks like in reality (yet another consulting services firm hiring skilled professionals to serve corporate clients). My view is that there are two things that Palantir is doing better than others. One is that they actually have a product (meaning they have customers, not just clients), and the other is that they’ve created an interesting cultural buffer to attract people (software engineers eager to change the world) that wouldn’t consider joining a traditional consulting services firm for a second, or even working for any of their clients if it wasn’t for Palantir and its weird Lord of the Rings and Star Wars culture.
A fourth approach is going from agent to principal. What if consulting services firms turned into investors and had a vested interest in the companies they deliver services to? I wrote about the example of Shanghai-based David Wei in The Future of Consulting (Round 1):
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.
And as written a bit later, in The Future of Consulting (Round 2),
It creates a habit from a business executive perspective: instead of paying for advice, you take it for free, and then you have the advisor invest in your company so as to reap the rewards of their services—hopefully with a multiple!
7/ Consulting services are the new baseball
Beyond these experiments, however, I believe the consulting services industry is on the verge of a revolution comparable to sabermetrics in baseball—otherwise known as Moneyball. Per Wikipedia,
Among other things, sabermetrics methods are used for the purpose of providing a useful function of the player's contributions to his team. When analyzing data, one is able to understand the contributions a player makes to the success/failure of his team. Given that correlation, one can objectively sign or release players with certain characteristics.
This sentence echoes a critical but overlooked function in the management of resources in consulting services: what some call “staffing” (“Staffing refers to the process of finding the right individual with appropriate qualifications or experience and recruiting them to fill a position, role, or job”) and others (for instance in the UK) simply call “resource management”.
Getting better at tracking individual characteristics and signing or releasing consultants with certain characteristics would solve three problems for consulting services firms:
They would be able to serve their clients’ needs in a swift and efficient manner, bringing in the right people with the right skills at the right time, thus increasing said clients’ propensity to pay—and, maybe, restoring the high margins of the past on a more solid ground.
They would be able to minimize their employees’ downtime, getting better at tracking who’s working on what at a given moment and who excels at what particular tasks. This, in turn, would make it possible to compensate for the adverse effects of a high turnover rate (and maybe providing a more fulfilling work experience to consultants would help bring down that turnover rate, thus solving some of the problems on the supply side).
Finally, the very fact that firms acknowledge the importance of understanding the contributions an individual consultant makes to the success/failure of a given project means that they’d have to deploy a dedicated infrastructure which they can then leverage for other purposes than staffing itself, including generating network effects and diversifying their revenue streams.
In other words, it’s exactly like in Moneyball: the challenge is not about replacing a departing player with someone else that features exactly the same characteristics; rather, it’s to use every personnel move as an opportunity to gather more data and reshuffle the entire team so as to stay on track.
What do you need to do to deliver on such a promise? Access to a large pool of talent as well as detailed information and track records for each individual in that pool. Right now, this is all done in Excel—if it’s done at all, which means there’s progress to be made!
8/ A new competitive landscape
Once a consulting firm has deployed the right infrastructure to make use of the industry’s equivalent of sabermetrics, there’s another upside: instead of the crowd of freelancers being part of the competition, they can be invited onto the same platform so as to be tracked just like employees, and the firm can then sign or release them when it makes sense from a project perspective.
A larger network of smaller firms and independent contractors makes it easier to tackle many challenges: absorbing peak demand regardless of the amount of resources available on the inside; finding the person with the advanced skills that a client needs at a particular time, thus delivering higher quality; at some point, even turning that person into an employee if it turns out they’re especially valuable and need to be retained on a full-time basis.
I wrote about this approach in my Reinventing Labor: The Sharing Economy as Professional Leverage (writing about ride-hailing, but the same reasoning can be applied to consulting services):
Instead of being the enemy, amateurs brought about by the sharing economy would then serve four goals matching the professionals’ interest.
First, they would facilitate maintaining the professionals’ numerus clausus, thus strengthening the workers’ bargaining power. Second, they would backup the professionals to help keep the consumers happy, thus actually increasing these consumers’ propensity to pay a higher price. Third, by sharing data they would help professional workers gain better, real-time knowledge of the market, making it possible to build a strong and decisive alliance between workers and consumers over the long term. Fourth, amateurs would form a pool in which new professionals could be hired, based on their record as amateur workers, their appetite for becoming professionals, and their support of the values underlying the new social compact.
Isn’t it a simple enough message? If competitors multiply on the outside, rather than entering a war of attrition with them, invite them into your ecosystem, thus securing extra resources and capturing an economic surplus at the aggregate level. Capitalism done right!
9/ Doing capitalism in consulting services
As I wrote last year, capitalist enterprises are all about two things: having a grip over their value chain and pursuing increasing returns to scale. So are consulting services firms capitalist? Not really.
One one hand, it’s true they have a grip on the value chain because they control market and distribution and this makes them stronger than other links in the value chain (notably consultants themselves):
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?)
However, consulting services firms are not exactly capitalists since they don’t generate significant increasing returns to scale. Because they need to hire more consultants as they serve more clients, they’re part of the “market economy” (to borrow concepts from historian Fernand Braudel) rather than “capitalism”. You can make a lot of money as a merchant, especially if clients are ready to pay anything and the supply is infinite, but you’re still a merchant and you’re not enjoying those increasing returns to scale that are a unique feature of capitalist enterprises.
Embracing a Moneyball approach is a revolution because it’s potentially a key contributor to consulting services firms being able to shift from being merchants to being capitalists:
In the past, the more a consulting services firm grew, the costlier it was to serve clients, if only because it was difficult to attract more workers on the supply side. Beyond a certain threshold, even the most operationally effective players had to forego conquering more market share.
On the other hand, using technology to implement a Moneyball approach makes it possible to sustain increasing returns to scale—by minimizing downtime, dramatically improving matching supply and demand, turning competitors into agents in your ecosystem, and more.
There are many signs of this revolution happening on the margins (including with McKinsey embracing a financial model that’s characteristic of a capitalist enterprise). But what will dominant players look like in the capitalist segment of consulting services?
10/ The consulting services firm of the future
I can think of no better way to conclude than quoting Dan Wang’s seminal How Technology Grows (a Restatement of Definite Optimism):
Process knowledge is represented by an experienced workforce. I’ve been studying the semiconductor industry, and that has helped to clarify my thoughts on technological innovation more broadly. It’s easy to identify all three forms of technology in the production of semiconductors: tools, instructions, and process knowledge. The three firms most responsible for executing Moore’s Law—TSMC, Intel, and Samsung—make use of each. All three companies invest north of $10 billion a year to push forward that technological frontier.
The tools and IP held by these firms are easy to observe. I think that the process knowledge they possess is even more important. The process knowledge can also be referred to as technical and industrial expertise; in the case of semiconductors, that includes knowledge of how to store wafers, how to enter a clean room, how much electric current should be used at different stages of the fab process, and countless other things. This kind of knowledge is won by experience. Anyone with detailed instructions but no experience actually fabricating chips is likely to make a mess.
I believe that technology ultimately progresses because of people and the deepening of the process knowledge they possess. I view the creation of new tools and IP as certifications that we’ve accumulated process knowledge. Instead of seeing tools and IP as the ultimate ends of technological progress, I’d like to view them as milestones in the training of better scientists, engineers, and technicians.
The accumulated process knowledge plus capital allows the semiconductor companies to continue to produce ever-more sophisticated chips. The doubling of transistor density every 24 months wouldn’t be possible if these firms didn’t already possess deep pools of process knowledge. It’s not just about the tools, which any sufficiently-capitalized firm can buy; or the blueprints, which are hard to follow without experience of what went into codifying them. The US has many decades of experience in designing and fabricating semiconductors, and it has developed the talent ecosystem that succeeds in pushing Moore’s Law forward. This cluster of talent allows the US to maintain its lead on a critically-important technology.
I believe Dan’s idea of “process knowledge” is key to understanding a consulting services firm’s core business. But as you observe in the quote, Dan points out that capital—and the tools and IP it can secure—is a necessary complement to process knowledge for any firm looking to flourish.
👉 The Moneyball approach I have sketched above is, I think, the most effective for bringing in resources (in this case, experienced consultants whose skills are mapped out at the scale of an entire ecosystem) so as to leverage what ends up being the most valuable asset in the realm of consulting services: the unique “process knowledge” that’s the know-how and experience to conduct a complicated project and deliver it on time and within budget.
What do you think? Do you know of any consulting services firm that has already embraced this approach? If yes, what were the results?
More readings on consulting services, and more:
The Origins of Modern Management Consulting (Christopher D. McKenna, Business and Economic History, 1995)
Consulting on the Cusp of Disruption (Clayton M. Christensen, Dina Wang, and Derek van Bever, Harvard Business Review, October 2013)
How Technology Grows (a Restatement of Definite Optimism) (Dan Wang, July 2018)
Killing Strategy: The Disruption of Management Consulting (CB Insights, October 2020)
11 Notes on McKinsey (me, European Straits, May 2020)
The Future of Consulting (Round 1) (me, European Straits, May 2020)
Launching My Executive Sparring Practice (me, European Straits, May 2020)
Palantir: On Business, Cults, and Politics (Byrne Hobart, The Diff, August 2020)
Fourth-Wave Consulting (Venkatesh Rao, The Art of Gig, September 2020)
The Future of Consulting (Round 2) (me, European Straits, September 2020)
McKinsey's Financial Loops (me, European Straits, January 2021)
If you enjoyed this edition of European Straits, you should subscribe so as not to miss the next ones. To celebrate the launch of this newsletter’s new format, I’m happy to provide all of you with an opportunity to subscribe at a discounted rate: £99 if you subscribe for the entire year! Just click here 👇
From Munich, Germany 🇩🇪