The firm that built the house of Enron

McKinsey refocused the energy firm. Now it fears collateral damage from the coll
apse, says Jamie Doward
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Can masters of the universe catch Enronitis? It is a question growing louder eac
h day as the fallout from the world's biggest bankruptcy spreads around the glob
e.
With Andersen, Enron's accountants, on the critical list and Wall Street looking
decidedly sick for its part in ramping Enron stock, questions are being asked a
bout whether McKinsey is about to suffer collateral damage.
Enron is the house that McKinsey rebuilt. The brightest minds at the world's mos
t prestigious consulting firm helped turn the lumbering old-economy gas distribu
tion dinosaur into a new-economy success story envied by every corporation in Am
erica.
The transformation earned the McKinsey mob a strong following in Enron. 'I found
them very bright thinkers and just good people,' recalls former Enron employee
John Allario, founder of the satirical Enron site Laydoff.com. 'They took a very
objective view of business. They could gauge the potential for success or failu
re pretty quickly.'
McKinsey thinking helped Enron switch, seemingly overnight, from being a company
that simply piped stuff around the US to a giant market place in which companie
s could 'cherry pick' commodities such as oil and gas contracts, seeking out new
suppliers and cheaper prices over the web. Enron made its money from trading on
their behalf and offering a range of additional high-margin services, which bro
ught in far greater returns than its old, vertically integrated model of produci
ng and shipping gas.
McKinsey called the process 'atomising'. In one of its influential quarterly rev
iews it gushed: 'Enron has built a reputation as one of the world's most innovat
ive companies by attacking and atomising traditional industry structures. Enron
no longer produces oil and gas in the US, no longer owns an electric utility, an
d has never held a large investment in telecom networks. Yet it is a leading val
ue creator in each of these industries.'
Margins stretched massively, and Enron revenues exploded. During the first nine
months of 2000, Enron profits rose by 45 per cent to $919 million as revenues do
ubled to $60 billion. It was consistently voted one of the most admired companie
s in the world - and one of the best to work for. Even the staff's daily Starbuc
ks' fix was subsidised. But no one was allowed to rest on their laurels.
Each year Enron's combative chief executive, Jeffrey Skilling, a Harvard Busines
s School graduate who worked for McKinsey between 1979 and 1990, would hire 250
MBA graduates. And each year the lowest-performing fifth would be ruthlessly jet
tisoned, a practice known as 'rank or yank'.
Those who remained were given the freedom to invent ingenious new ways of maximi
sing profits. It was a McKinsey way of working, based on the consultancy's belie
f in the 'loose-tight' management model, which decreed that certain aspects of t
he business, like budgets, should be kept under central control while staff shou
ld be given a huge amount of freedom to 'think outside the box'. There were mist
akes, but as Skilling observed: 'No shots, no ducks'.
Such thinking was based on the seminal management book In Search of Excellence b
y former McKinsey employees Tom Peters and Bob Waterman. Enron employees read it

avidly. They were also big fans of another book, The War for Talent, by McKinse
y consultants Ed Michaels, Helen Handfield-Jones and Beth Axelrod, which used En
ron as a textbook example of how to incentivise staff. The ideas germinated.
'Skilling brought in a lot of McKinsey employees and the cream of the Harvard Bu
siness School,' says Julian Birkinshaw, associate professor of strategic and int
ernational management at the London Business School. 'The processes and principl
es he allowed were very McKinsey. The consultants used Enron as their sandbox.'
McKinsey declined to talk about its relationship with Enron other than to confir
m it was a client. However it is known that McKinsey used the firm on 20 differe
nt projects. In addition, one senior McKinsey partner, Richard Foster, author of
yet another Enron bible, Creative Destruction, is reported to have attended six
Enron board meetings between October 2000 and October 2001.
Questions are also being asked about the ties between Enron and a former McKinse
y consultant, now commissioner with the Texas-based company's chief regulator.
It has emerged that Brett Perlman, who was appointed a commissioner of the Texas
Public Utility Regulator by George W Bush, worked for McKinsey for five years,
during which time he helped Enron build its electronic trading system.
Enron and McKinsey also appeared together at prestigious energy conferences - su
ch as the annual Interactive Energy jamboree in Houston - with the former talkin
g about how it was transforming its business model while the latter talked about
how such moves would pay huge dividends.
Enron's faith in McKinsey surprises few management experts. 'McKinsey has a repu
tation for having the smartest, brightest people,' Birkinshaw says. 'Some of the
other consultancies are into relatively standardised offerings, but over the pa
st few years the fresh ideas are coming out of McKinsey.'
The links between the two go back to at least the mid-1980s, when the power gian
t was created through the merger of InterNorth and Houston Natural Gas. McKinsey
and Skilling, then its head of energy consulting, advised Enron on how to smoot
h gas prices through the creation of forward contracts.
This was the first step in Enron's journey to become America's biggest gas and o
il trader. Chief executive Kenneth Lay was so impressed he brought Skilling into
the company, with a remit to think the unthinkable.
But the loose-tight culture McKinsey and Skilling engendered carried the seeds o
f its own destruction. The pressure to continue the Enron transformation success
story created new tensions. Says Birkinshaw: 'It ratcheted up the risk-reward p
otential. People could get phenomenally rich, but they didn't see the by-product
. If you give people a lot of money, they will break the rules. They will bend t
he margins where nobody is going to look.'
It appears McKinsey did try to rein in some of Enron's more unrealistic ambition
s, but with little success. 'McKinsey people at Enron fell out of favour with ce
rtain Enron business leads,' says former employee Allario. 'I heard McKinsey con
tributed greatly to the early establishment of a good portion of the broadband d
ivision. Once the business gained momentum, most of their ideas were ignored in
favour of current Enron management directives. It may have been that Enron liste
ned only when it suited them.'
Scores of McKinseyites, among them David Berberian, managing director of Enron N
etworks, and Stephen Abbanat, a director with its broadband division, left Enron
to join start-ups as the giant started to stumble.

So far McKinsey has managed to distance itself from the Enron dbcle. The 7,000- s
trong partnership has consistently denied that it gave Enron advice on financing
issues or that it had suspicions the company was using improper accounting meth
ods. Nor has it been summoned before the Department of Justice to explain its ro
le. But Enronitis is virulent. As Allario says: 'Enron has become the laughing s
tock of the entire world. It has become a detriment to have it on your resum.'
McKinsey might agree.