August 2006 THE RELATIONSHIP BETWEEN

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Published in: Academy of Management Best Paper Proceedings; August 2006 THE RELATIONSHIP BETWEEN CLIENTS AND MANAGEMENT CONSULTANTS: AN EMPIRICAL ANALYSIS ANSGAR RICHTER European Business School 65375 Oestrich-Winkel, Germany SANDRA NIEWIEM European Business School INTRODUCTION Management consultants are an important feature of today’s economy. However, it is not entirely clear why, and under which circumstances, clients buy services from external consultants, rather than to use their own internal resources for the initiation and execution of management projects. Even those organizations that have set up in-house consulting units or similar project organizations often continue to involve external consultants in their projects. The objective of this paper is to analyze clients’ decisions in favor or against the involvement of external consultants in management projects from a comparative contracting perspective. Thus, our aim is to identify the conditions under which clients choose a more “internal” versus a more “external” solution. The theoretical framework on which we base the empirical analysis is the transaction cost economic theory in which the distinction between “markets” and “hierarchies” as two alternative forms of organizing economic activity was first developed (Williamson, 1975). CONCEPTUAL FRAMEWORK Management consulting can be defined as the process of advice and assistance rendered by a consultant to a client on matters of business administration (Kubr, 2002). The provision of consulting services often involves a joint effort, a “co-production” of clients and consultants. At a minimum, clients need to outline the issues that they wish to see addressed in a consulting project, and consultants need to communicate their findings and recommendations to their clients in one form or another. In most projects, however, the interaction between clients and consultants goes significantly beyond such an arms length relationship. We focus on the intensity or closeness of the relationship between consultants and clients from the client perspective. Clients may either decide to use internal resources from their units in order to carry out particular projects; we consider this option to be the default case for most management projects. Alternatively, they may involve in-house or external consultants for this purpose. Furthermore, they may influence or even determine variables that affect the intensity of the relationship between the client organization and the consulting firm, such as the exact composition of the team and its primary working location. According to transaction cost economic (TCE) theory, transaction costs arise as a result of three classes of conditions under which economic activity takes place. First, economic actors are subject to particular behavioral conditions, specifically bounded rationality and opportunism. Second, economic activity occurs under general environmental conditions, namely uncertainty and complexity. Third, contractual relationships are characterized by phenomena such as asset

Published in: Academy of Management Best Paper Proceedings; August 2006 specificity. According to Williamson (1975), it is the combination of these conditions that gives rise to transaction costs. Empirical tests of transaction cost economics have largely focused on asset specificity as an important determinant of integration or disintegration decisions (Boerner & Macher, 2001). Most empirical studies confirm the hypothesis derived from transaction cost economic reasoning that – holding other factors constant – the greater the need for relationship-specific investments, the greater the likelihood of integration. However, some other hypotheses that can be derived from the TCE framework have not found unanimous empirical support. In addition, empirical research on TCE has largely focused on industries involved in the production and distribution of physical goods. Relatively few studies so far have tested TCE predictions in the context of professional service industries. On a conceptual level, various authors (Canbäck, 1998; 1999; Armbrüster, 2006) have applied institutional economics to the question of why the provision of management advice is often outsourced by clients to outside service providers. In their view, if clients were to develop the specialized knowledge and experience required for the provision of consulting services, they would not be able to fully exploit the economic value of that knowledge, due to the inefficiencies associated with transacting information-intensive assets. Dedicated management consulting firms have developed mechanisms to keep the transaction costs associated with their dealings with clients within reasonable levels. At the same time, they exploit the economies-of-scale properties of information, knowledge and experience more fully than individual clients could do by aggregating demand from a cross-section of clients. TCE suggests that clients will favor internal providers or advisors with whom they already have an established relationship over consultants with whom they do not have such a relationship for the execution of projects that are highly sensitive in nature and require utmost confidentiality. The theory proposes that by choosing a more “internal” solution, a client would seek to safeguard against the risk that a purely external service provider would opportunistically exploit his (i.e. the client’s) dependence. Similarly, TCE suggests that the ease with which a project can be specified in advance and its execution monitored ex post influence a client’s choice between more “internal” and more “external” options for carrying out the project. EMPIRICAL STUDY We conducted semi-structured, personal interviews with decision-makers in 34 companies. The interviews focused on clients in the German-speaking region of Germany, Austria and Switzerland. The sample of companies in which we conducted the interviews included large, for-profit organizations from 16 industries. Nine of the companies in the sample had an in-house consulting unit. In the 34 companies, we conducted interviews with one or more executives who were involved in and had at least partial responsibility for making decisions for the execution of managerial projects. We expected our interview partners to have taken part in decisions regarding the involvement of external consultants or internal resources with respect to at least five projects, and received confirmation that they met this minimum threshold. We asked our interviewees to identify and discuss with us one or more managerial projects with respect to which they had been responsible for defining how and with whom the project should be carried out. We then discussed the nature of each project and the process through which they had decided as to how the project should be carried out. We did not ask our interview partners to justify the choices they made. In total, we were able to discuss 86

Published in: Academy of Management Best Paper Proceedings; August 2006 managerial projects, which constitute the primary database of our study. The clear majority of these projects (41 per cent) were either in operations management (including supply chain management), or in strategic management (36 per cent). The third largest segment (18 per cent) contained projects related to IT issues, e.g. systems integration. Four projects (almost five per cent) were in HR management. For the evaluation of our results, we used two types of content analysis (supported by the software NVivo), namely conceptual analysis and relational analysis. Conceptual analysis aims at furnishing evidence on the empirical basis of particular constructs, generally represented by words or sentences. For example, interview passages were allocated to so-called content categories and frequency counts were used to assess the importance of these categories. Relational analysis seeks to explore the relationships among different constructs. We used relational analysis in order to analyze any potential associations between the extent to which consultants were involved in project work on the one hand, and a battery of independent variables on the other. In order to assess the statistical significance of the relationships uncovered, we conducted chi-square tests and tests on the significance of the correlation coefficients. RESULTS The conceptual part of our analysis yielded two major results. First, the clients we interviewed had a clear preference for cooperating with external consultants with whom they had an established relationship, rather than with providers of consulting services with whom they had not worked with before. Of those projects carried out with the help of outside consultants, 78 per cent were carried out by consulting firms with whom clients had worked together at least on an occasional basis before. Although clients were open to considering new consulting service providers with whom they had not cooperated before, when making decisions about which consulting firm to engage for particular projects, in the clear majority of cases they still decided in favor of those consulting firms with whom they had a long-standing working relationship. Second, for many clients the procurement of consulting services from an in-house consulting unit did not appear to constitute a viable alternative to the cooperation with external providers of consulting services. Even in situations where the option of working with an in-house consulting unit existed, clients procured the majority of their project services from external consulting providers. Our data suggest that procuring services from an in-house consulting unit primarily serves as a substitute for the services of internal staff or line managers, rather than for external consultants. In the perception of those clients who did have an in-house consulting unit, the in-house consultants were considered similar to internal line or staff managers, rather than as external consultants. We analyzed a total of 61 conditions as to whether they influenced clients’ decisions to procure project services from external or internal providers. Of these, we found 18 conditions to be at least moderately strongly associated with such decisions. The results suggest that our interview partners decided to procure services from external consultants primarily in three types of situations. First, they chose to involve external consultants in the execution of projects that required functional or industry-specific knowledge which was not available in the client organization when the need arose. In several interviews, clients said that they had searched for individual consultants with particular “knowledge profiles” who would be able to provide the functional or industry-specific expertise deemed necessary for the execution of a project.

Published in: Academy of Management Best Paper Proceedings; August 2006 Second, highly politicized project conditions tended to favour the involvement of external consultants. In projects that had the potential to alter the power structure within organizations, clients sought the involvement of external advisors for their ability to guide the process and “work through” the politics involved. External consultants were particularly sought after with respect to projects that involved numerous units in the client organization, such as corporate strategy projects dealing with various divisions or restructuring projects that affected the staff allocations in all units across the organization. Interestingly, clients had little hesitation to involve external consultants even if the information that the external advisors may have received access to was highly sensitive or proprietary in nature. Third, clients procured services from external consultants for their ability to absorb the additional workload involved in the execution of particular projects. Even in situations in which the internal execution of a project would have been an option, client decision-makers decided to involve external consultants if the latter had clearly devoted significant time and resources into the development of a project proposal, thus indicating that sufficient capacity to carry the extra workload associated with the execution of the project was readily available. In addition, the data suggest that market conditions had a bearing on clients’ decisions whether to involve external consultants or not. Specifically, the greater the number of external service providers deemed appropriate for providing consulting services with respect to a given project, the greater the likelihood that clients actually chose one of these external providers, rather than to carry out the project with their own in-house resources. The data also point to situations in which clients preferred to use internal resources over those of external service providers. First, projects that required a significant amount of firm-specific knowledge and the existence of ready working relationships within the organization were more often carried out by in-house consultants, line or staff managers than by external consultants. External service providers were at a particular disadvantage in situations in which an existing network of trustbased relationships with a large number of individuals in the organization was regarded as critical for the success of a project. Whereas external consultants were often expected to play a role as “impartial process managers”, in-house consultants or internal managers were employed in order to leverage the breadth and depth of their personal networks within the organization. Second, clients often resorted to internal staff when the type of activity required by a project was complementary with the regular responsibilities of the people chosen for project execution. Client decision-makers also assigned internal staff to projects in order to ensure that as little friction as possible would take place between the completion of the project and the ongoing business of the firm. In many cases, clients assigned internal staff to projects with external consultants in order to provide their staff with learning opportunities and to ensure that the insights generated through the project would remain in the organization after project completion. Several clients were hesitant to employ “purely external consultant teams” as they often regarded them as unable to ensure that the organization would be able to benefit from the project beyond its completion date. They saw internal staff as important bridgeheads between the project and the general operation of the company. In addition, the results suggest that the propensity of clients to involve the help of external consultants was moderated by the clients’ prior experience with external consultants and their subjective image of the consulting profession. Several managers said that after successive “bad experiences” with external consultants, they were more hesitant to work with them, and more discerning in their choice of consulting providers. These “negative experiences” related almost exclusively to the perceived inability of consultants to support the implementation of their

Published in: Academy of Management Best Paper Proceedings; August 2006 recommendations, rather than flaws in their analytical and diagnostic work. In several instances, clients expressed disappointment in junior consultants’ inability to instil “change readiness” in the organization and take responsibility for the implementation of the project results. DISCUSSION AND CONCLUSION Our results paint an image of the consultant-client relationship that is characterized by its closeness. These findings confirm prior analyses of consulting services that emphasize their personal, relationship-intensive and idiosyncratic nature (Dawson, 2000; Schein, 1998). In the language of the transaction cost economics, the mode of cooperation typically found between clients and consultants can be characterized as an intermediate mode of governance between procurement from the market and an integrated, “hierarchical” solution. Although clients and consultants are formally members of different organizations, consultants are often so closely integrated into the companies of their clients that the boundaries between the organizations become easily blurred. Baker (2002) describes the nature of the projects that clients and consultants undertake as client-consultant joint-ventures. Kehrer and Schade (1995) argue that clients often take “make-or-also-buy decisions” in their relationship with consultants. Although they formally procure project services from “external” consultants, clients tend to retain the same consultants on a repeated basis, and remain actively involved in the provision of these services. Our findings suggest that in the management consulting sector quasi-integration (Monteverde & Teece,1982) is the prevalent form of governing contractual relationships between service providers and buyers. Our findings with respect to the role of asset specificity are consistent with the predictions of TCE. The greater the importance of firm-specific assets, such as knowledge about the client organization, the greater the comparative advantage of internal resources, i.e. in-house consultants or line / staff managers, as compared to external service providers. Our data suggest that the effect of firm-specific knowledge on integration is driven by the difficulty associated with transferring firm-specific knowledge to outside parties, especially since this type of knowledge is often tacit (Polanyi, 1966). We draw mixed conclusions with respect to the TCE argument that the integration of economic activities acts as a safeguard against the possibility that one of the two parties may opportunistically exploit the other party’s dependence. In accordance with the theory, our data show that those projects which require strong personal bonds and rapport with key decisionmakers of the client organization, favor the internal execution of managerial projects. Our interviewees were well aware of the fact that the procurement of consulting services from external providers put them (the clients) in a position of vulnerability that they did not want to see abused. At the same time, our interviews indicated that highly political and sensitive project conditions favored the involvement of external consultants. In these situations, the desire to obtain the guidance of an independent advisor who was not entangled in the daily politics of the organization appeared to override the concern that the advisor might exploit the client’s dependence to his own advantage. Overall, our data do not provide unanimous support for the proposition that the desire of one party to an exchange to safeguard against the possibility of opportunistic behavior by the other party drives the integration of economic activities into firms. Future research should both extend and complement our approach. First, researchers should enlarge the sample of projects on which the type of analysis presented in this paper can draw. They should also include projects in organizations which were outside the scope of our

Published in: Academy of Management Best Paper Proceedings; August 2006 analysis, e.g. projects carried out in public institutions and in non-profit organizations. Second, future research should complement our work by using methods that permit generating data on a large scale (e.g. surveys). More empirical research on the work of management consultants and the interaction between clients and consultants is urgently needed. REFERENCES Armbrüster, T. 2006. The Sociology and Economics of Management Consulting. Cambridge: Cambridge University Press (forthcoming 2006). Baker, P. 2002. Color your judgment. Works Management, 55 (12): 26-28. Boerner, C. S., & Macher, J. T. 2001. Transaction cost economics: an assessment of empirical research in the social sciences, Working Paper. Georgetown University, Georgetown; University of California, Berkeley. Canbäck, S. 1998. The logic of management consulting (part one). Journal of Management Consulting, 10 (2): 3-12. Canbäck, S. 1999. The logic of management consulting (part two). Journal of Management Consulting, 10 (3): 3-12. Dawson, R. A. 2000. Developing knowledge-based client relationships: the future of professional services. Woborn: Butterworth-Heinemann. Furusten, S. & Werr, A. (Eds.). 2005. Dealing with Confidence. The Construction of Need and Trust in Management Advisory Services. Copenhagen: Copenhagen Business School Press. Kehrer, R., & Schade, C. 1995. Interne Problemlösung oder Konsultation von Unternehmensberatern? Ein Rahmenkonzept zur sukzessiven Entscheidungsfindung auf transaktionskosten- und organisationstheoretischer Basis. Die Betriebswirtschaft, 55 (4): 465-479. Kubr, M. 2002. Management consulting: a guide to the profession (3rd ed.). Geneva: International Labor Office. Monteverde, K., & Teece, D. J. 1982. Appropriable rents and quasi vertical integration. Journal of Law and Economics, 25 (2): 321-328. Polanyi, M. 1996. The Tacit Dimension. Garden City, New York. Schein, E. H. 1998. Process consultation revisited. Building the helping relationship. Reading: Addison-Wesley. Williamson, O. E. 1975. Markets and hierarchies: Analysis and antitrust implications. A study in the economics of internal organization. New York, London: Free Press.