McKinsey 'lost the plot' in business case for Transnet locomotives, inquiry hears

Global consulting firm McKinsey & Co did not fully understand its mandate when it was brought in to strengthen the business case for Transnet to acquire 1064 locomotives, a former Transnet official has said. 

Francis Callard, a former electrical engineer at the state-run freight rail operator, on Monday continued his testimony before the judicial commission of inquiry into state capture.

The commission, chaired by Deputy Chief Justice Raymond Zondo, is investigating allegations of corruption and mismanagement at several state entities. 

Callard was testifying about the business case for the acquisition of 1064 new locomotives, which was drawn up in 2013 for approval by Transnet's board. The contract has been mired in controversy over cost inflation and allegations of corruption after it ballooned from R38.16bn to R54.5bn

Callard told the commission that he understood that McKinsey had been brought in to further develop the business case for the 1064 locomotives. But McKinsey appeared to fixate on minor issues instead of the main focus, which was making a case for replacing locomotives reaching the end of their economic lifespans and doubling general freight volumes within a seven-year period.

Transnet Freight Rail's investment committee had initially approved the business case on March 9, 2012, Callard said. The initial estimated cost was to be R38.16bn.

Strained relations

Callard was part of a team set up to advise Mckinsey on what Transnet wanted to achieve by acquiring the 1064 locomotives.

But the relationship between the team and the consultancy was not good. 

"The key point is that the core team had a strained relationship with McKinsey," Callard said, adding that the consultancy was not taking direction from the freight rail team.

The team, said Callard, had raised their concerns with Transnet executives in an email to say that they did not believe McKinsey was focusing on its mandate to enhance the original business case. 

28 000 jobs

According to Callard, McKinsey's 'enhanced' business case for the board's approval proposed that 28 000 direct and indirect jobs would be created via the acquisition of the 1064 locomotives. This would also have a R50bn positive impact on the economy through local supplier development.

Callard said he had discussed the matter with Transnet's former chief procurement officer Garry Pita. "I disagreed with his (Pita's) interpretation of the 28 000 jobs," Callard said.

According to Callard, the creation of one full-time job requires $1 000 of investment. "I could not correlate that body of knowledge in the investment we sought in locomotives to those jobs… We had an extensive debate on that, but he won."

When asked by Advocate Mahlape Sello if the R50bn economic impact resulting from the acquisition can be explained, Callard responded that he did not know how McKinsey arrived at this conclusion. "I cannot explain it… I don’t know how they arrived at that figure." he said.

He also confirmed to the commission that approximately 40% of the locomotives would be produced in China.

The freight rail locomotive team, McKinsey and former chief financial officer Anoj Singh met on April 17, 2013, to iron out their differences on the business case.

According to Callard, both the locomotive team and McKinsey had made modifications and an agreement was reached on the final business case.

"All our inputs were agreed to," Callard said. The estimated total cost was set at R38.16bn. 

'Deliberate misrepresentation'

Callard told the commission the original business case accounted for foreign exchange price escalation in the R38.16bn. But the business case presented to the board appeared to have been changed. It was made to appear that the R38.16bn did not consider escalations and hedging.

Zondo asked Callard if the misrepresentation of the cost was a result of negligence.

Callard responded that the altering of the final business case which excluded forex hedging, forex escalation and other escalations was a "deliberate misrepresentation" and "cannot be an accident".

"It may be purely incidental that a R50bn figure was mentioned in one of the upfront statements by McKinsey in the initial part of the business case. The connection may be highly speculative, I grant you that, but it is there," Callard said.

A reasonable official would have returned the business case without certainty on the estimated total cost, said Callard.