Consulting companies, like Anderson consulting,
are also in the internet incubator business.
From the New York Times
nytimes.com
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By DAVID LEONHARDT
or years, McKinsey & Company, the world's most prestigious
consulting firm, had a simple policy on taking an equity stake in a
client in exchange for advice: it didn't do it.
Owning a piece of a company might scare that company's competitors
away from McKinsey, the partners worried. Or, a high-profile blow-up at one
of the companies in which it owned a stake could tarnish McKinsey's
reputation.
So even as Bain & Company, a rival, made tens of millions of dollars by
setting up its own venture capital company in the 1980's, and even through
the bull market of the 1990's, McKinsey's partners stood firm.
No longer.
In the last year and a half, unable to resist the lure of the Internet economy,
McKinsey has taken small stakes in more than 50 clients, in exchange for
lower fees.
Across Europe and North America, the firm is opening eight "business
accelerators," where consultants will spend up to nine months helping start
companies in which the firm could own a stake.
McKinsey's about-face is the most striking example yet of the
transformation of the $55 billion management consulting business, as
virtually every large firm rushes to own a piece of some of its clients. Like
tradition-bound investment banks that start offering online services, or
individual investors who add dot-com stocks to their blue-chip portfolios, the
partners at the largest consulting firms are changing to avoid being left out of
the Internet.
In the process, they are opening themselves up to new risks, from losing
money on bad investment bets to losing the confidence of clients. But the
firms' executives are confident they can avoid those pitfalls. Besides, they
say, the need both to sell their expensive services to smaller companies
and to attract talent left them with little choice but to switch course.
They are doing so with gusto. Andersen Consulting, the world's largest
firm, has invested in nearly 150 companies since 1996. Booz Allen &
Hamilton will soon announce it has set up incubators, similar to
McKinsey's accelerators, in the United States, Asia and Europe.
Less-established firms are often even more aggressive.
The trend represents a profound shift for an industry that touches virtually
every large company around the globe. Once thought of as outside experts
who independently evaluated a business, as an accountant or lawyer might,
consultants are becoming more like bankers whose fortunes are closely tied
to those of their clients.
The switch "repositions us from being consultants and advisers to being
business partners and really being capitalists," said Mary A. Tolan,
Andersen's managing partner for growth and strategy. At Andersen, she
said, the practice has spread beyond Internet work, and the firm has
forfeited fees of as much as $20 million in exchange for equity.
"It is an absolutely huge change," said Jackson L. Wilson, the head of
Andersen's new $1 billion venture-capital fund.
The investments are usually minority stakes, typically worth a few million
dollars. The recipients range from small start-ups to newly created
businesses at large existing clients. Andersen, for example, owns part of
Snowdrops.com, a Swedish site selling beauty products. The Boston
Consulting Group, during an assignment at Whirlpool, decided to help the
company set up brandwise.com, a separate company that sells appliances
over the Web.
The explosion of electronic-business consulting -- advising companies how
to advertise, distribute and sell in cyberspace -- the last two years has
driven the trend.
At some concerns, it will soon be the single-largest moneymaker. In order
to build a reputation as Internet experts, the consultants say they must
work with start-ups that cannot afford their high fees -- rarely below $1
million for a project -- but can offer equity.
The investments are also crucial to restoring the consulting firms' luster
among employees and recruits. At the top business schools, many
graduates are shunning consulting, the most popular career path in the
1990's, for options-bearing dot-com start-ups. Even George Shaheen, the
chief executive of Andersen until last year, bolted to join the Internet world,
taking the top job at Webvan, a small online grocery service. "Recruiting
people right now is very problematic," said Andrew Zimmerman, the head of
the e-business unit at PricewaterhouseCoopers.
Indeed, in an effort to mimic stock options, Booz Allen and others are now
studying how to offer junior consultants a share of the investments that the
firms make.
Above all, the consultants hope, the moves will bolster the bottom line when
some other forms of technology consulting are slowing.
"It's pretty simple: we're doing this to make money," said Mr. Wilson, the
head of Andersen's new venture fund, who transferred from a job as
supervisor of thousands of workers to go to Silicon Valley as the boss of 20.
The consulting firms are confident that the investment gains from their
winners will more than offset lost fees. For example, Bain, which set up a
venture-capital unit five years ago, says the returns on its investments since
then have averaged better than 50 percent a year.
But the new strategy could create problems. First, it substitutes
investments for cash revenue. "Obviously, this is very attractive so long as
everybody's stock goes up," said Mr. Zimmerman of Pricewaterhouse, which
has invested in Web companies that are its partners, but very few that are
its clients so far. "But I'm not sure consultants are the best-equipped people
to determine how successful these companies are going to be."
Most consulting firms, Mr. Zimmerman added, lack the experience that
established venture-capital firms have in analyzing the quality of a start-up's
management or the strengths and weaknesses of its competitors.
Still, Mr. Zimmerman said, he expects that Pricewaterhouse will begin
investing more frequently in its clients in the next two years.
If the trend seems unstoppable, it also raises thorny conflict-of-interest
issues that will not go away, either. Accountants and lawyers, after all, are
generally barred by law from being part owners of clients. For years, the big
consulting firms generally followed suit. They have also built fire walls of
silence around projects, forbidding consultants to talk with colleagues about
them. This confidentiality enabled them to work for rival companies
simultaneously. Andersen, for example, currently does work for Federal
Express, the United States Postal Service and United Parcel Service.
But when the consultants own a part of a client, rivals could become more
reluctant to trust those fire walls. The consulting firms, in turn, may then
have to make clearer decisions about which companies they work with.
The increased acceptance of equity stakes "will put pressure on consultants
to pick their spots a little bit more carefully," said James M.
Citrin, a former McKinsey consultant who is now the managing director of
the Internet practice at Spencer Stuart, a large executive search firm.
Acknowledging those concerns, many firms, including McKinsey, say they
plan to sell the investments within a few years, to avoid becoming too
closely aligned with a client. "In no case do we ever want to become a
long-term stakeholder," said Andreas H. Biagosch, a director in McKinsey's
Munich office.
Even so, skeptics say such close links between advisers and clients create
many potential problems. In the 1980's, for example, Bain, which once
refused to work for two firms in the same industry and would send dozens of
consultants into a single company, suffered a major hit to its reputation
when consultants who had taken on formal titles at Guinness were
implicated in a British stock scandal.
The new arrangements will make similar situations more likely, said Lewis
Pinault, a former partner at Coopers & Lybrand who also worked at Boston
Consulting and Gemini Consulting. They will also give clients new reason to
doubt the fire walls, which he said often come down after a project has
ended. "The history of fire walls before this e-commerce boom is not really a
healthy one," said Mr. Pinault, the author of "Consulting Demons," a critical
look at the industry, which is soon to be published by HarperBusiness.
The issue is particularly sensitive at the consulting units of the large
accounting firms. The Securities and Exchange Commission bars those
firms from investing in companies they audit or in companies whose other
part owners they audit. Scrutiny is likely to be high. This month, the S.E.C.
released a report saying that more than 50 percent of Pricewaterhouse's
partners had violated rules prohibiting them from holding personal
investments in companies the firm audits. A federal agency is now
investigating whether the problem is widespread at other firms, as well.
Consulting executives said many of the questions about conflicts of interest
are not new. "Clients have always lived with us dealing with their
competitors," said Scott Hartz, the top consulting executive at
Pricewaterhouse.
To avoid new problems, consultants said they would choose their
investments carefully and establish clear rules within their firms. "We will try
never to invest in or have in our portfolio companies that compete with one
another," Mr. Wilson of Andersen said. But, he acknowledged, "that's very,
very hard to do; it's inevitable that there will be collisions down the road."
"We'll solve that problem when we get there," he said.
nytimes.com
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