Evan Vitale Consulting: Boston Consulting Group and McKinsey & Co blow China numbers in a big way

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by Angus Grigg

The number of high net worth families across China halved in just two months if you believe Boston Consulting Group.

But that’s the problem. By its own admission, you can’t believe the numbers generated by the top tier firm.

In a somewhat ironic twist, this column has discovered even consulting firms which continually preach the need to break-down corporate “silos” appear to have very large ones of their own.

BCG’s problems in China began on June 16 when the firm put out a weighty report on the financial health of the world’s top 1 per cent and declared China a nation of four million millionaires [those with more than $US1 million in private wealth].

It was a suitably precise number which ranked China second only to the United States, which had 7 million high net worths – to use the firm’s jargon.

This figure stood unchallenged until mid-August when BCG, in a separate report, declared China was now a nation of just two million
millionaires.

So which number is correct?

‘Clearly both reports can’t be right’

BCG weren’t immediately certain. First, its China team cited differing “methodologies” and “data adjustments” to explain the 50 per cent variation.

That is plausible given the many assumptions made in building such models, but was clearly not palatable for a firm whose business is built around the integrity of such modelling.

So by August 21 the firm had come clean and admitted an error.

“Clearly both reports can’t be right,” said Nick Glenning, an Australian partner at the firm.

But BCG was still not sure which number was right and asked for more time to investigate, finally deciding on a number last week.

“The two million number is right,” declared David Kessler, BCG’s managing partner in Switzerland. “That’s the number to go with.”

His colleague in Hong Kong, Tjun Tang, explained a “one line” error in the global model was the problem and that the two million figure was “definitely correct”.

The whole thing was explained away as a simple error, when it reality it should highlight the futility of trying to construct accurate models on a country as large and opaque as China.

Rubbish modelling

A more likely explanation for the discrepancy is that BCG’s global and China teams were operating in their own “silos” and forgot to check what base assumptions the other was using.

This produced the “one line error” and a 50 per cent variation in the final number, which should demonstrate that such modelling is rubbish in the first place. History has shown this to be correct.

Remember the bold prediction that Chinese steel production would peak at around one billion tonnes in the years between 2025 and 2030?

This equally round and convenient number, which was adopted by both Rio Tinto and BHP Billiton, was the by-product of a giant model constructed by McKinsey.

As The Australian Financial Review has previously reported, this number was the basis for billions of dollars in capital expenditure by the big miners and was even used by the Australian federal government to underpin spending decisions.

The assumption drawn from the model was that iron ore prices would stay at historically high levels as Chinese steel production would grow by 60 per cent from its 2010 level.

The McKinsey assumptions now look fatally flawed as Chinese steel production declined by 1.3 per cent in the first half of this year.

Rather than reach the magic one billion tonnes, the latest data indicates Chinese steel production may have peaked last year at around 800 million tonnes and will now begin a long, slow decline.

McKinsey model out

BHP took the first step in admitting as much last week, cutting its long term forecast for Chinese steel production to between 935 million and 985 million tonnes from one billion to 1.1 billion tonnes.

At the top end of the range the McKinsey model is therefore at least 10 per cent out and is likely to be the subject of further downgrades.

That’s better than BCG’s effort on China’s rich, but hardly a strong endorsement of such modelling.

While embarrassing for both firms it’s also a problem for shareholders the world over, as the likes of BCG and McKinsey are often the ones advising multi-nationals on their China strategy and the opportunities on offer in the world’s second biggest economy.

And so while BHP and Rio used the McKinsey model to justify massive increases in iron ore production, BCG will presumably use its freshly corrected wealth report to tout for business among insurers, fund managers and private banks wanting to tap into China’s newly minted millionaires.

Hopefully its targets will be suitably wary of whatever large round number BCG presents.

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