<p>To be fair, I never said that the world should not have any external financial or consulting service firms at all. I can certainly agree that some of them do offer some value, for example, in terms of providing financial intermediation services or potentially providing key knowledge transfer and managerial innovation across industries. </p>
<p>However, the question is regarding exactly how much value do consulting and financial services firms add and whether it justifies the nose-bleed fees they charge. As evidenced by the financial crash, much of the ‘innovation’ that the banks embarked upon in the last decade consisted of synthesizing financial products, the behavior of which nobody really understood, including the banks themselves. Elite consulting and banking firms are also notorious for employing and unleashing upon clients fresh graduates who often times not only lack work experience within the industry in which they are now supposedly providing advisory or financial expertise, they may lack work experience of any kind altogether.</p>
<p>Consider the words of Matthew Stewart, formerly of BCG.</p>
<p>*During the seven years that I worked as a management consultant, I spent a lot of time trying to look older than I was. I became pretty good at furrowing my brow and putting on somber expressions. Those who saw through my disguise assumed I made up for my youth with a fabulous education in management. They were wrong about that. I don’t have an M.B.A. I have a doctoral degree in philosophy—nineteenth-century German philosophy, to be precise. Before I took a job telling managers of large corporations things that they arguably should have known already, my work experience was limited to part-time gigs tutoring surly undergraduates in the ways of Hegel and Nietzsche and to a handful of summer jobs, mostly in the less appetizing ends of the fast-food industry.</p>
<p>The strange thing about my utter lack of education in management was that it didn’t seem to matter. As a principal and founding partner of a consulting firm that eventually grew to 600 employees, I interviewed, hired, and worked alongside hundreds of business-school graduates, and the impression I formed of the M.B.A. experience was that it involved taking two years out of your life and going deeply into debt, all for the sake of learning how to keep a straight face while using phrases like “out-of-the-box thinking,” “win-win situation,” and “core competencies*</p>
<p>[The</a> Management Myth - The Atlantic (June 2006)](<a href=“http://www.theatlantic.com/doc/200606/stewart-business]The”>The Management Myth - The Atlantic)</p>
<p>Consider the recollections of Michael Lewis, formerly of Saloman Brothers (now Citi), and author of Liar’s Poker and Moneyball.</p>
<p>*To this day, the willingness of a Wall Street investment bank to pay me hundreds of thousands of dollars to dispense investment advice to grownups remains a mystery to me. I was 24 years old, with no experience of, or particular interest in, guessing which stocks and bonds would rise and which would fall. The essential function of Wall Street is to allocate capital—to decide who should get it and who should not. Believe me when I tell you that I hadn’t the first clue.</p>
<p>I’d never taken an accounting course, never run a business, never even had savings of my own to manage. I stumbled into a job at Salomon Brothers in 1985 and stumbled out much richer three years later, and even though I wrote a book about the experience, the whole thing still strikes me as preposterous—which is one of the reasons the money was so easy to walk away from. I figured the situation was unsustainable. Sooner rather than later, someone was going to identify me, along with a lot of people more or less like me, as a fraud. Sooner rather than later, there would come a Great Reckoning when Wall Street would wake up and hundreds if not thousands of young people like me, who had no business making huge bets with other people’s money, would be expelled from finance.
…
In the two decades since then, I had been waiting for the end of Wall Street. The outrageous bonuses, the slender returns to shareholders, the never-ending scandals, the bursting of the internet bubble, the crisis following the collapse of Long-Term Capital Management: Over and over again, the big Wall Street investment banks would be, in some narrow way, discredited. Yet they just kept on growing, along with the sums of money that they doled out to 26-year-olds to perform tasks of no obvious social utility. The rebellion by American youth against the money culture never happened. Why bother to overturn your parents’ world when you can buy it, slice it up into tranches, and sell off the pieces?*</p>
<p>[The</a> End - News Markets - Portfolio.com](<a href=“http://www.portfolio.com/news-markets/national-news/portfolio/2008/11/11/The-End-of-Wall-Streets-Boom/]The”>http://www.portfolio.com/news-markets/national-news/portfolio/2008/11/11/The-End-of-Wall-Streets-Boom/)</p>
<p>Hence, it begs the question, why are companies requesting high-level managerial advice from somebody with no actual work experience and whose expertise consists of a PhD in German philosophy - and paying $500k a year for the privilege (as was BCG’s bill-rate for Stewart)? You could probably hire the entire philosophy department at many schools for that sort of largesse. Similarly, why are clients entrusting their assets to a guy like Lewis who had never even had any personal savings of his own to manage? Exactly how much value did they really add in their old jobs?</p>
<p>Now, to be fair, one possible counterargument is that the value that consultants and bankers such as Stewart and Lewis provide may stem not from their individual expertise relevant to the task (of which they freely admitted they had none), but rather to the institutional support from their employers. Maybe BCG provided Stewart with an excellent training system and institutional knowledge base by which Stewart quickly developed useful tools with which he indeed provided value to his clients that justified his high bill-rate. Maybe Saloman Brothers really did have an excellent risk management and valuation system with which Lewis could discover profitable opportunities for his clients, regardless of his lack of knowledge of finance. Maybe. But if it’s then really the system and not the individuals, then that begs the question: why pay those individuals so much? Stewart was paid $75k a year to start, an impressive sum at the time (in the 90’s) for somebody with a PhD in philosophy, and more than many full professors of philosophy are paid even today. Lewis was paid hundreds of thousands of 1980’s dollars for reasons he still has yet to fathom. If no real expertise is truly needed for those jobs, and all of the value is derived from the consulting/banking firm itself, then the employees should be paid far less. If BCG can pick up any reasonably smart and presentable guy off the street and train him up to be as credible of a consultant as Stewart was, then why don’t I just do that while paying that guy an average wage? </p>
<p>But at any rate, the bottom line is that as long as consulting and (especially) banking firms pay so well, the best and most ambitious students are going to want to work there rather than at regular companies. The finance industry may be sundered now, but if and when it ever does recover - which is probably just a matter of time - many of the best MIT engineering students will take it in lieu of engineering jobs. </p>
<p>The irony is that those firms will end up paying those students anyway. The only question is whether they pay them directly by hiring them onto the payroll, or indirectly through fees that the consulting and banking firms who those students hire into. The major difference is that those fees are padded at gross margins in the multiples to account for overhead and profit (i.e. BCG paid Stewart $75k a year, but billed him out at $500k a year). </p>
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<p>That begs the question - why are you engaging in restructuring or M&A in the first place? Often times, it’s because your product portfolio is lacking or, especially in the case of restructuring, your financial performance has been subpar. If you had been developing better products, you probably wouldn’t need to restructure or merge. </p>
<p>But more importantly, restructuring and M&A are fee-generating businesses, which means that the financial services firms are paid regardless of the worthiness of the transaction in question. You may benefit from a restructure or merger, or you may suffer, but the advisory bank is paid either way. That goes double for an M&A: both the buy-side and the sell-side advisors are paid regardless of the viability of the merged/acquired unit. </p>
<p>What would make far more sense to me is if the investment banks were paid in the form of restricted stock or hybrid security contingent upon the future success of the transaction, so that if the transaction later sours, they should be paid less. However, as it stands, advisory fees are paid in cash, which means they have every incentive to promote every possible deal, however unworthy it may be. When Daimler acquired Chrysler, a transaction which all parties now agree was an unmitigated disaster, the bankers were all paid in cash and they’re not giving any of it back. </p>
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<p>But they don’t really do that either. Numerous academic studies have confirmed that most newly IPO’d companies leave substantial capital on the table. Heck, most Ibanks will attempt to make IPO equity ‘pop’ on the first day of trading - and clients will acquiesce - but that’s actually terrible for the client as an IPO pop represents funding that could have been allocated to the client, but is instead being pocketed by first-day traders (which usually includes the Ibank itself). *What a client should actually want is the stock price to actually drop from the IPO price because that means that you garnered the maximum capital possible, but that’s somehow considered to be embarrassing.}</p>
<p>Now, don’t get me wrong. I agree that if Ibanks actually accomplished all of the goals they are supposed to, then maybe they would be worth their high fees. But they don’t. IBankers seem to be experts in enriching themselves at the expense of their clients. To paraphrase an old joke, I can see the yachts of the bankers, but where are the yachts of their clients? </p>
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<p>Which begs the obvious question: why doesn’t the company just simply fire the incompetent internal employees and replace them with top people? It’s hard to believe that that would be more expensive than engaging high-priced consultants. </p>
<p>Or even better, why even hire incompetent people in the first place? </p>
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<p>Yet the consulting firm was surely paid anyway. So why did the company even engage them at all? Why pay for advice you’re not actually going to take? </p>
<p>But again, at the end of the day, as long as consultants are paid so well despite often times not having any discernable expertise (reference Stewart above), people are going to continue to want to be consultants.</p>