US risk managers advised S.African utility to stop paying McKinsey

JOHANNESBURG - 4 October 2017: A U.S. risk management firm advised South Africa's state energy utility last year to withhold tens of millions of dollars in payments for advice from McKinsey, because the global consultancy's "very unusual" payment model allowed it to charge fees in excess of market rates.

Despite the warning by U.S. management consultancy Oliver Wyman, Eskom continued to make payments to McKinsey, two sources with direct knowledge of the matter told Reuters.

Privately-held McKinsey, the world's largest management consultancy, is under parliamentary investigation in South Africa for fraud over a $130 million contract to advise energy utility Eskom from late-2015 until July 2016.

A third of the fees were paid by Eskom to a firm called Trillian, controlled at the time by members of the Gupta family, billionaire friends of President Jacob Zuma who were accused by South Africa's anti-corruption watchdog last year of using control over state agencies to siphon public funds.

Eskom says it paid the fees to Trillian at McKinsey's request, but McKinsey says it only worked alongside Trillian and they never had a subcontractor relationship.

Trillian, a junior local management consultant, said it supported McKinsey with its work.

McKinsey says a letter written by one of its directors authorising Eskom to pay Trillian as a McKinsey subcontractor "inaccurately characterised" their relationship.

McKinsey says it is cooperating with the authorities and has ordered its own investigation into the operations of its South African office. The Guptas and Zuma deny wrongdoing.

The full payment terms of McKinsey's contract with Eskom have not previously been made public.

They were examined last year by Oliver Wyman, which was commissioned by Eskom to investigate the deal. Reuters has reviewed the Dec. 15 report containing the findings and recommendations.

Oliver Wyman told Reuters it was not legally permitted to comment on the contents, but it "stands by the findings and recommendations contained in the report".

McKinsey said it was aware Oliver Wyman had carried out a review of its work at Eskom, but it had not been told there was any dispute over the impact of its work or what it was paid.

"The fees we charged at Eskom are in line with similar projects we, and other firms, undertake in South Africa and elsewhere around the world," spokesman Steve John said.

Eskom said it would not comment further, pending its own investigation into the affair.

Trillian told Reuters it was not involved in the commercial negotiations between McKinsey and Eskom and had not seen the Oliver Wyman report.

"VERY UNUSUAL"

When Oliver Wyman drafted its report in December, 950 million rand of McKinsey's billings of nearly 1.8 billion rand ($130 million) had already been paid to McKinsey and Trillian, according to the report.

Of the outstanding balance, Oliver Wyman advised Eskom to withhold payment of 45 percent, equivalent to nearly $30 million, and subject the rest to a legal review and closer analysis to see if it could be reduced.

They described the basis for payments to McKinsey as "not transparent" and "poorly documented".

Two sources familiar with the case said Eskom made the remaining payments to McKinsey and Trillian for the full amount anyway, despite Oliver Wyman's advice to withhold the funds.

Why these payments were made will make up part of Eskom's investigation, the utility says. Eskom suspended its chief financial officer Anoj Singh last week and said it would carry out a disciplinary hearing over his possible role in the payments.

Singh could not be contacted for comment.

McKinsey was hired by Eskom to carry out a 'Turnaround Plan' which involved saving the utility money through improving efficiencies, including at power stations.

Under the terms of the deal, McKinsey worked 100 percent "at risk", meaning it was not paid a flat fee but received a percentage of savings Eskom achieved as a result of its advice.

Oliver Wyman criticised this model, saying it resulted in Eskom paying far more for work than industry norms.

"Projects where fees are 100 percent at risk are very unusual, particularly of such contractual magnitude," the report said, recommending a legal review of the deal.

"An uncapped incentive fee could mean Eskom ends up paying for a theoretical value instead of true bottom line impact."

Some of the incentive fees paid were based on targets that assumed that performance at power plants would deteriorate, which meant that McKinsey and Trillian would earn payments even if there was no improvement, the report said.

"Terms of the contract appear to favour the supplier," the report said, referring to McKinsey and Trillian.

In one case it found that McKinsey and Trillian appeared to have double billed for improvement at one plant, and then to have billed again for estimated future improvements at the same plant after the contract was terminated.