The Origins of Modern Management Consulting

ChristopherD. McKenna• The JohnsHopkins University

In 1993, AT&T spentmore on managementconsulting services than on corporateresearch and development, and AT&T is notalone [8, p. 60]. Wall Street analystsexpect billings for consultingservices to advanceat twice the rate of corporaterevenues over the next decade. Yet, despitethe size, growth,and influenceof consultingfirms, business historians have remained uncharacteristically silent aboutthe origins,development, and impactof managementconsulting, or "managementengineering" asit wasknown before the Second World War. 2 In this paper,I will describethe professional origins of managementconsulting firms at the turnof the centuryand discuss why, after slow, gradualgrowth through the 1920s, thesefirms took off duringthe 1930s. I argue(1) that historianshave wrongly assumedthat managementconsulting arose directly out of Taylorism,(2) that engineers,accountants, and lawyers, often supervisedby merchantbankers, provided counsel that later became the primary repertoire of management consultants,and (3) thatthe legal separation of investmentand commercial banking in 1933drove the rapid professionalization and growth of managementconsulting duringthe GreatDepression. Recent historiansof scientific management,including Daniel Nelson, StephenWaring, and JudithMerkle, have traced the impact of Taylorism on contemporaryinstitutions as diverse as business education, public administration, andBritish industry long after the Progressive-era craze for "efficiency"ended [29, 36, 26]. The proponentsof scientificmanagement, Frederick Taylor, Henry Gantt, Morris Cooke,Frank and Lillian Gilbreth,and Harrington Emerson, consulted with nearly200 businesseson waysto systematizethe activities of theirworkers through theapplication of wageincentives, time-motion studies, and industrial psychology [29, p. 11]. Naturallythen, historians of Taylorismhave assumed that they could describecontemporary practitioners of "industrialengineering," "production

Thisarticle is drawnfrom my dissertation, "The History of ManagementConsulting, 1880- 980."

2The Association of Management Consultants (ACME) defines management consulting as a serviceprovided for a fee by objectiveoutsiders who help executivesimprove the management,operations, and economic performanceof institutions. Since the institutionalizationand professionalization of management consulting occurred within firms, not amongsolo practitioners, this paperfocuses on managementconsulting firms.

BUSINESS AND ECONOMIC HISTORY, Volume twenty-four,no. 1, Fall 1995. Copyright¸1995 by the BusinessHistory Conference.ISSN 0849-6825.

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engineering,""consulting engineering," and "efficiencyengineering," as early managementconsultants. Similarly, management consultants, like ThomasCody, trying to tracethe historyof managementconsulting have assumedthat:

undoubtedlythe most influential factor in the growth of modern managementconsulting was the developmentof the conceptof 'scientific management'by FrederickTaylor .... The concept combinedthe practice of engineeringwith the principlesof economics,and it was out of this couplingthat today'sprofession wasborn [11, p. 24].

But Tayloristsand management consultants actually had very different professional and ideologicalorigins. As Hugh Aitken pointedout in ScientificManagement in Action, those executivesand their advisorsin large scalebusiness who were "concernedwith problemsof formalorganization and control at the administrativelevel," came out of a differentintellectual tradition than the shop management movement from which Taylormade his reputation [1, pp. 17-18]. Tayloristswere largelyconcerned with industrialrelations while early managementconsultants focused on problemsof bureaucraticorganization. While Harrington Emerson's firm of "efficiency engineers"did surviveas a very smallconsulting firm throughthe 1980s,and the British "managementconsultancies" founded in the 1930s were undoubtedly Taylorist,none of the largemodern American management consulting firms have Tayloristorigins [31, 35]. Rather,professionally-trained accountants and engineers, often with backgroundsin law or banking, foundedthe early "management engineering"firms to offer advice to executiveson the organizationof their boardrooms,not on the efficiencyof their shopfloors. The growthand complexityof the largestindustrial organizations in the UnitedStates created a marketat the turn-of-the-centuryfor the professionalfirms of engineers,accountants, and lawyers which offered independent corporate counsel [9, pp. 464-468]. By the 1890s,executives of largemanufacturing companies who neededengineering advice, but did notwant a full-timeengineer on staff,could turn to consultingchemical engineers like ArthurD. Little or electricalengineering firms like Stone& Websterfor technicalknowledge [20; 19, pp. 386-391]. Similarly, in the 1890s, corporatemanagers employed American subsidiaries of the British accountingfirms, like PriceWaterhouse, to provideexternal audits and financial controlsfor theirgrowing companies [ 9, p. 464]. By the 1900s,American-based accountingfirms like Arthur Anderson,Haskins & Sells, Ernst & Ernst, and Seidman& Seidmanwere expanding throughout the country [23, pp. 1-3]. In law, largeNew York corporatelaw firms like CravathSwaine, Davis Polk, and Sullivan & Cromwellprovided legal adviceto businessesheadquartered in New York. At the sametime growingregional firms like JonesDay in Clevelandand Baker and Bottsin Houstonserved local divisions of nationalcompanies [24, p. 22]. The threeprofessions, engineering, accounting, and law, all enjoyedstrong growth in firm numbersand size from the 1890sonward because of thespecialized skills that largerpartnerships could offer their expanding corporate clients. This expandingcorporate clientele enabled younger partners to build practicesof "managementengineering" within older, larger firms or to foundnew specialtyfirms. These youngerprofessionals intentionally borrowed skills and 53

credentialsfrom fields outside their professional training as they struggled to attract clients.For example, the electrical engineering consulting firm of Stone& Webster workedfor J.P. Morgan& Co. afterthe 1893 recession,appraising the valueof electricalutility companiesowned by GeneralElectric [21, pp. 21-24]. Their appraisalscombined engineering expertise and accounting skills as they traded on their Wall Streetcontacts? While engineerswere performingaccounting, accountantsmarketed themselves as engineers.In 1927, JamesMcKinsey, an accountantand lawyer from Chicago,put "accountantsand engineers"on his letterhead,as did Miller, Franklin,Basset & Company,an accountingfirm based in New York [28]. Thisblurring of professionalboundaries was sometimes just a responseto demandbut frequentlyit was the resultof trainingin more thanone profession.James McKinsey was not alonein combininglegal trainingwith managementconsulting; his formerboss, George Frazer, and his protege,Marvin Bower,were both trained as lawyers [17, p. 7; 6, p. 1]. Managementengineers, like othersstruggling for professionalstatus, used multiple professional credentials to supporttheir claimsto specializedknowledge and professionalapproval in their effortsto marketa newand poorly understood service [7]. These engineers,accountants, and lawyersoften worked for merchant bankerswho, in turn,coordinated a wide arrayof serviceswhich were, at the turn of the century,the closestfunctional equivalent in the Americansetting to managementconsulting. 4 Since merchant bankers provided both commercial and investmentbanking services, bankers acted both as internaladvisors to helptheir client companiesand as externalregulators to safeguardinvestors' interests. For example,bankers hired countless engineers, accountants, and lawyers to assistthem in reorganizingthe thirteenlarge railroadswhich failed between1893 and 1898 [14, p. 5]. Bankersfrequently needed to evaluatethe worth, organization,and prospectsof companiesfor projectsas diverse as the valuationof an initialpublic offering,the reorganization of a bankruptcompany, or theadministrative integration of two mergingcorporations. During the 1920s,National City Bank(now Citibank) performedmanagement engineering studies to evaluatethe initial financingof UnitedAircraft, troubled loans at AnacondaCopper, and the merger of six separate businessmachine companies to form RemingtonRand. [2]. To gain a thorough understandingof increasinglycomplex corporations, bankers called upon and coordinatedthe work of bothinternal and external professionals. Investment houses employedengineers for valuationsand organizationalsurveys, accountants for audits and the installationof financial cost controls,and lawyersto serve on reorganizationand bond-holdercommittees. In the 1920s, Arthur Andersen& Companybecame nationally known for its investigationsof "plants,products, markets,organization, and future prospects" of companiesthat investment banks in

3Edwin Webster was the son of a partnerat Kidder,Peabody & Companyin Boston.His father,Frank G. Websterbecame head of Kidder,Peabody in 1905. In 1930,following the stockmarketcrash, Edwin Webster purchased the bankruptKidder, Peabody and installed his son.Edwin G. Webster,Jr., as Kidder,Peabody's new President[21, p. 3, 156].

4 While this paperis not comparative,bankers appear to haveserved as the sourceof organizationaladvice in NorthernEurope and Japan throughout this period• 54

New York andChicago were underwriting[ 3, p. 13-14]. By drawingon a range of professionalservices as they advisedcorporate management on planning, organization,and executivecontrol, bankers provided a rangeof organizational advice,backed by a blue-bloodedreputation, which only managementconsultants would later equal. While managementconsulting services were available from the turnof the centuryonward, the rapid growth,both in numbersand in size, of independent managementconsulting firms did not beginuntil the GreatDepression. It wasn't until the 1930sthat managementconsulting firms grew beyonda few founding partnersand establishedbranches in new cities. In 1926, after twelveyears in business,Edwin Booz employedonly one othermanagement engineer; by 1936, Booz -Allen & Hamiltonhad elevenconsultants on staff [5, pp. 7, vi]. Similarly, JamesO. McKinseyand Company, which McKinsey founded in Chicagoin 1926, had,by 1936,expanded to morethan 25 employeesand had a secondoffice in New York [30, p. 11]. The growthin thenumber of firmsmirrored the expansion of the firmsthemselves. Between 1930 and 1940,the number of managementconsulting firms grew, on average,15% a year from an estimated100 firms in 1930 to 400 firms by 1940 [4, Table 2]. It wasno coincidencethat the economistJoel Dean wrote in 1938 that "unheralded,almost unnoticed,professional management counselhas become an importantinstitution in our businessworld" [15, p. 451]. Duringthe 1930sthe services that management consulting firms providedbegan to increasein importance.In the 1920s,acquaintances in local companieshired managementengineers to analyzelimited, technical problems. But, by the 1930s, hundredsof largecorporations including Armour, Union Carbide,Kroger, Carrier, Sunbeam,U.P.S., Borden, Upjohn, JohnsonWax, and Sears routinely hired managementengineers to improvetheir organization'soverall strategy, structure, andfinancial performance. Consultants later assumed that this growth during the depressionwas a countercyclicalreaction as troubledfirms used management engineersto cut costsand improve operationalefficiency. Yet, management consultantssuffered badly during the 1920-21 recessionand, fifty years later, following the 1973 oil embargo- in bothcases, clients simply put off expensive studiesas their plantssat idle [27, 13]. The growthof managementconsulting in the 1930swas not simplya "natural"market response to the economicdownturn. It was,instead, an institutionalresponse to new governmentregulation. New Deal banking and securitiesregulation propelled the growth of managementconsulting in the mid-1930s. Firms of managementconsultants prosperedas companiesturned from bankersto managementengineers for organizationaladvice. In thislast section of the paper,I will illustratethis process of institutionalizationby describing(1) the reorganizationof U.S. Steelby Ford, Bacon& Davis between1935 and 1938, (2) the careerof managementengineer GeorgeArmstrong, and (3) the developmentof the "generalsurvey outline" at JamesO. McKinsey and Companyin the 1930s. Congresspassed the Glass-SteagallBanking Act of 1933 to correctthe apparentstructural problems and industry mistakes that contemporaries believed led to thestockmarket crash in October1929 andthe bankfailures of the early 1930s. Glass-Steagalldivided the investmentand deposit-taking functions within banks like J.P. Morganand National City Bankinto two separateindustries: commercial bankingand investment banking. J.P. Morgan& Company,for example,chose to remaina commercialbank, but several partners left to formthe investmentbanking 55

firm of Morgan, Stanley& Company. Simultaneously,Congress created the Securitiesand Exchange Commission to regulatefinancial markets and enforce a more open systemof corporatedisclosure [25, pp. 169-171]. These legislative changeswhich reconfigured banking and promoted the rapid growth of independent accountingaudits also shaped the institutionalizationof managementconsulting. SinceGlass-Steagall prohibited commercial banks from engagingin "non-banking activities,"like managementengineering, commercial banks could no longeract as managementconsultants [32, p. 23]. Federalregulators forced commercial banks to ceasetheir non-bankingactivities like insurance,real estatedevelopment, or managementconsulting. And, while Glass-Steagalldid not restrictinvestment banksfrom actingas managementconsultants, S.E.C. regulationsrequired that underwritersperform external due diligenceon securitiesissues and corporate reorganizationsso investmentbanks could not use their internal management engineersto certify new issues. Federal regulationforced investmentand commercialbanks from 1934 onwardto hire outsideconsultants to renderopinions on the organizationof a bankruptcompany or the prospectsof a newly-formed public company. Commercial bankers simultaneouslyencouraged business executivesto hire managementconsultants since officers inside the bankscould no longer coordinateinternal organizationalstudies of their clients. The new institutionalarrangements in bankingopened up a vacuuminto which firms of managementconsultants rushed. The contrast between the old and new institutional order was evident in Ford, Bacon& Davis' reorganizationof U.S. Steel between1935 and 1938. In 1901,J. PierpontMorgan had personally supervised the initialorganization of U.S. Steel,but in 1935,U.S. Steel'sChairman, Myron Taylor, askedhis collegefriend, GeorgeBacon, to overseethe reorganizationof the largestindustrial firm in the country[22]. As Taylor reportedto the stockholdersof U.S. Steelin 1938,

In 1935 we retainedthe firm of Messrs.Ford, Bacon & Davis to go throughall of our properties,methods, personnel and marketsand, in collaborationwith our engineersand executivesto formulate definite recommendations[cited in 18, p. 619].

Ford, Bacon & Davis' studytook three years,cost 3.2 million dollars, and eventuallyincluded 203 separatereports produced in collaborationwith five differentsub-contracting consulting firms, including McKinsey, Wellington & Co [16]. It was the largeststudy ever done by managementengineers, and the recommendationswhich Ford, Bacon, & Davismade on the organization,strategy, and operationsof U.S. Steel influencedthe company'sinvestment, labor, and administrativepolicies through the 1950s. In laborrelations, for instance,the 1937 accordreached with workersoverturned a long-standingantagonistic relationship endorsedby theMorgan Bank which would have immobilized U.S. Steelin thetight labormarkets of the SecondWorld War [34, pp. 15-17]. GeorgeArmstrong, a Vice-Presidentin chargeof industrialinvestigations at NationalCity Bankbetween 1921 and 1932,personified the changes caused by the Glass-SteagallAct. Duringthe 1920s,National City Bankhad Armstrong conduct studiesof theirtroubled loans to theSaco-Lowell Shops, of theproposed merger of Palmolive, Kraft, and Hersey, and (at J. C. Penney'spersonal request) a comparativestudy of thePenney chain stores and their relative expense ratios [2]• 56

In 1932, however, with inside assurancesfrom his uncle that Franklin D. Roosevelt intendedto breakapart commercial and investmentbanking, Armstrong resigned from NationalCity Bank to foundhis own consultingfirm. His timing was shrewd sincelawyers who examinedthe new statuesagreed, in Armstrong'swords,

thatany financing be precededby theexercise of duediligence. This wasinterpreted to meanthe investigationof the subjectby a firm of competentengineering consultants and the review of theRegistration Statementby suchconsultants [2, p. 69].

Armstrong'snew firm, GeorgeS. Armstrong& Companywas successful from its foundingin 1933. The firm workedfor a successionof investmentbanking firms during the 1930s investigatingsuch corporategiants as Jones & Laughlin, Seagrams,Birdseye Frozen Foods, and Philip Morris. GeorgeArmstrong profited from thetransition from bankersupervision of managementengineering studies to theinstitutionalization of managementconsulting even though the typesof studies that Armstrongperformed did not change. GeorgeS. Armstrong& Co. grew rapidly not becauseit offereda new form of organizationaladvice but because Armstronghad founded an independentfirm. The history of James O. McKinsey & Company illustrates the institutionalizationof management consulting after the Glass-Steagall Act. During the 1930s, JamesMcKinsey workedto systematizethe complicatedprocess of solicitingnew clientsand conducting a managementengineering survey. In order to securenew clients,McKinsey methodicallycultivated contacts throughout the financialcommunity. He claimedto havetaken every important banker in Chicago or New York to lunchand, in return,"'nearly every one at one time or anotherhas given me some work....'" [37, p. 42]. PerhapsJames McKinsey's greatest contributionto the institutionalizationof his firm was the "generalsurvey outline," which he draftedin December1931, to give young,inexperienced consultants a model to follow when, as McKinsey specified,they were askedto preparea completestudy of a companythat was in financialdifficulties [30, p. 11]. Marvin Bower,who joined the firm in 1933,has written that the general survey resembled the corporatereorganizations for bondholders'committees which Bower had previouslyoverseen as a younglawyer at Jones,Day [6, p. 17]. Indeed,because consultantsfrequently prepared these general surveys for investmentfirms during the 1930s,the partners at JamesO. McKinseyand Company came to referto them as "banker'ssurveys." The generalsurvey outline survived in modifiedform in McKinseyand Company's training manual until 1962 [30, p. 12]. As early asthe 1930s, JamesO. McKinsey and Companywas profiting from the external impositionof bankingand finance regulation, a transitionit waswell equippedto exploit. The firm alsoprofited from its internalsystematization of clientcontact andreport writing. Theseinternal arrangements allowed McKinsey and Company to overcome the limitations of novice consultants and variable economic conditions as the firm's organizationgrew beyondits founderand expandedthroughout the world. The originsof modernmanagement consulting are in the 1930s. Contrary to popular assumptions,Taylorism was not the predominantinfluence on the developmentof consultingfirms. Rather, managementengineers drew on the practicesof accountants,engineers, and lawyersto offer CEO-level studiesof 57

organization,strategy, and operations.The major changein thisemerging quasi- professiontook place in the 1930s and was primarily a product of political developments.Before the 1930s,merchant bankers coordinated these studies. But, the Glass-SteagallAct and S.E.C. disclosureregulations forced commercial and investmentbankers to abandoninternal management consulting activities even as regulatorsmandated that they commission outside studies. These required studies, combinedwith the increasingacceptance of managementengineers by corporate executives,propelled the rapid growth of consultingfirms from the 1930sonward. New Deal legislationand firm-level systemization catalyzed the development of this particularlyAmerican form of professionalizedcorporate counsel. Sincethe 1930s,management consultants have reorganizedthe largestand most importantorganizations in the world. During the SecondWorld War, the Federal Governmenthired large numbersof consultantsto streamlinecivilian production,reorganize the military, and oversee the rapidexpansion of the Federal Administration. By 1949, Cresap. McCormick & Paget was working for the Hoover Commissionrestructuring the Executive Branch [12]. As consultants worked for the government,they carried ideas betweenthe public and private bureaucracies,accelerating the process of organizationalinnovation and dissemination.Since other countries did notlegislate the separation of commercial and investmentbanking, the institutionalizationof managementconsulting never happenedoutside of the UnitedStates. When Americanmanagement consultants expandedinto Europe in theearly 1960s,they sold American management "know- how"to Europeanmanagers eager to employthe organizational structures that J. J. Servan-Schreiberlabeled "The American Challenge. "• By the 1970s,McKinsey and Companyhad decentralized one-quarter of the hundredlargest companies in Great Britain [10, p. 239]. Whetherreorganizing the Bank of England,Royal Dutch Shell, the Governmentof Tanzania,or even the World Bank, management consultantsdisseminated American management techniques throughout the world. But, it wasthe institutionaland professional growth of consultantsduring the 1930s that wasthe necessaryprecursor to the predominanceof Americanmanagement consultantsthroughout the world and,through them, the ascendancyof American modelsof corporateorganization after the SecondWorld War.

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