On the face of things, it doesn’t make much sense to hire someone to tell you how to do your job. Ostensibly, the CEO of a company knows more about the business than any outside person. Plus, to the average person it may seem like consultants just offer tired advice (“Work more as a team! Find synergies!”)
However, it’s becoming clear that despite what economists say, firms aren’t really that efficient. Lots of times, managers may be unaware of strategies that would save them money, or boost profits, or they may be unaware that they are unaware. For example, Reenen and van Bloom went to India and offered strategy tips to a sample of textile manufacturers. The firms that implemented the strategies boosted profits by 15%. Why didn’t they implement that stuff earlier? The primary reason they cited was they just didn’t know about the management tools. This is one example of how consultants can be useful. It’s their job to keep abreast of the newest and best practices in management, strategy, and human resources and then impart that information to clients.
To that end, consulting firms do a significant amount of research, and knowledge sharing. Individuals within a consulting firm have access to wide databases and the accumulated knowledge of their peers, which means that there are probably increasing returns to scale among consulting firms. They also publish lots of research, to convince clients that they’re smart and can help out the firm.
There’s another reason firms hire consultants, however; to tell them things that they already know. Consulting firms can reliably signal authority and intelligence; bosses may hire consultants to confirm that they’re correct. To cite one recent example, the US Postal Service hired two consulting firms so that they could go to Congress and implement a restructuring plan. Another example is the firm that has to cut ten percent of staff. Maybe the manager knows which 10% he’d like to cut, but he would also like to maintain a good reputation as someone who is not ruthless, or cruel. So he could hire a consultant to tell him what he already knows, e.g. whom to fire and whom to keep on.
In sum, consultants facilitate knowledge transfer, but there’s also a signaling answer – that firms, or bosses, hire consultants to give credibility to a specific decision or strategy.