John Kay is stepping down as chairman of consultancy London Economics and stepping into controversy as director of Oxford's school of management studies. Romesh Vaitilingam reports on the Tony Blair guru known for his adversarial style.

This month, London Economics, one of the first consultancies in Britain to sell economic research to the private sector, marks its tenth anniversary. But even while celebrating the success of its first decade (and the pursuit of his first million) founder John Kay is contemplating a new challenge. At the beginning of next year he will step down as chairman to become director of Oxford University's school of management studies.

The appointment comes at a time when the school is planning a huge step forward in its management education programme. Kay will be the public face of that effort, in particular aiming to ensure that Oxford's first MBA course is the exceptional product needed to compete in an extremely tough market. Leslie Hannah, acting director of the London School of Economics, calls it "a stunning appointment", and there seems near universal agreement that Kay is perfect for the post.

That is not to say there will not be considerable difficulties. The recently announced Pounds 20 million donation from entrepreneur Wafic Said to build a new business school in the heart of Oxford remains controversial. And although the establishment of a business school was agreed in 1990, the contentious issue of whether management is an academically respectable subject is likely to surface again in early November when dons are due to debate and vote on the Said donation.

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Kay recognises the need to give a proper intellectual dimension to the study of business behaviour. He also understands why many academics think management theory is little more than a series of virtually contentless airport bestsellers. Indeed, he has been highly critical of such books, with devastating attacks on the ideas of prominent marketing and strategy gurus such as Theodore Levitt, Michael Porter and Gary Hamel. But, Kay argues, it is a mistake to say that because a lot of nonsense is written, there is nothing of intellectual substance you can say about business.

He makes an analogy with the pre-scientific stage of medicine 100 years ago when nonsense was also a popular currency. As with medicine then, we actually know a lot about business but we still seek a structure to put that knowledge together, to sort out good analysis from bad. Part of Kay's new role will be to explain that project and demonstrate its intellectual value, particularly to Oxford sceptics.

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Kay admits to mixed feelings about establishing the credentials of management science: excited at the opportunity but depressed at how little has been achieved. Part of the solution, he is sure, is to use the rigour of neoclassical economics, and his appointment coincides with publication of his book, The Business of Economics, which does just that.

But management demands a more eclectic range of approaches than just economics. Here Kay again uses the analogy of medicine, an applied discipline founded on the fundamentals of physics, chemistry and biology. Similarly, he contends, management is an applied discipline that must be embedded in economics, sociology and psychology.

In his 1993 book, Foundations of Corporate Success, he analysed the corporation as the central institution of modern economies. In his view, a firm is not just a bunch of shares but a collection of relationships between its various stakeholders: employees, customers, suppliers, shareholders. Each firm has distinctive characteristics or "capabilities" derived from its history, and these must be its sources of competitive advantage.

This framework is a powerful organising theme, not only for thinking about management but also for analysing the ways economies function more broadly. Kay's portrayal of the firm as a social institution rather than a capital market vehicle has important implications. Most significantly, he claims, it is possible to believe that competitive markets are an efficient system of economic organisation but simultaneously to reject the individualist value system that applauds selfishness and glorifies private property. In fact, Kay goes much further, arguing that the only way to create a market economy that commands wide support is to dispose of the notion that the functioning of markets depends on base and contemptible aspects of human behaviour. We must reconnect business values with the broader values of our daily lives, he believes.

This is the stakeholder view of society so central to New Labour thinking, and Kay has become known as one of Tony Blair's gurus. While it is unlikely that Kay would support a minimum wage or the social chapter, he is happy to sign up for the Blair project in this broad intellectual sense.

Kay's life as an Oxford intellectual started extraordinarily early. Arriving in 1969 as a graduate of Edinburgh, his hometown university, he was appointed a fellow of St John's College within a year, and had published his first article in the Economic Journal by the age of 22.

In the mid-1970s, Kay worked for the Institute for Fiscal Studies on James Meade's committee on direct taxation. Two other leading economists who have subsequently divided their time between the ivory tower and policy-making were colleagues: John Flemming and Mervyn King, chief economist at the Bank of England. Shortly thereafter, Kay and King collaborated on The British Tax System, a book, now in its sixth edition, which is still the standard work on the economics of taxation.

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Towards the end of the 1970s, Kay took on a more permanent role with the IFS, aiming to turn it into a full-scale public policy research institute. At that time, the influence of economic research on policy was considerably weaker than today. But Kay quickly made a splash in policy circles, notably with analyses of the budget, his 1984 book, The Reform of Social Security, written with Nick Morris and Andrew Dilnot, and the promotion of fiscal neutrality, the idea that the tax system should support free markets and avoid distorting people's behaviour.

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In 1986, Kay left the IFS to take up two new challenges: the directorship of the Centre for Business Strategy at the London Business School, and the launch of London Economics. Both these ventures were based on the assumption that if economic research with an emphasis on communication could be done in public policy, it could also be done in business policy. And, Kay reasoned, if there is a valid application of economics to business policy, there ought to be a market for selling economic research.

Having successfully launched one small enterprise in the shape of the IFS, this time Kay wanted an equity stake in his creation. And over the ten years of his twin track activities at the Centre for Business Strategy and London Economics, what he calls the market test of economics' business relevance certainly seems to have taken precedence.

There is no doubt that Kay has acquired considerable "real world" credibility from building a successful business and recruiting such figures as former prime ministerial adviser Baroness Hogg, who will succeed him as chairman of London Economics. In a sense, he has addressed the traditional business world's taunt of academics - "if you're so smart, why aren't you rich?".

He confesses that part of the motivation for his consultancy was the dominant value system of the 1980s. At a time when intellectual life tended to be regarded with contempt and where success was judged by how much money you had, he found it gratifying to demonstrate that, without necessarily sharing those values, his academic skills could reap significant rewards in the real world.

Still only 48, Kay has no regrets. He describes himself as someone who is not especially good at developing fundamentally new ideas but rather at assimilating and communicating them. Certainly, he is most unusual in that several of his key contributions are books in a discipline whose denizens tend to undervalue them. He is also an unusually good writer with a regular newspaper column to his credit.

Communication is particularly vital in restoring the link between economics and business. Kay notes how few economists are teaching business, how many have yet to adapt from a public policy standpoint, and how economics and business strategy, so seemingly related, are so distinct. This he ascribes to the formerly dominant paradigm of industrial economics. In the structure-conduct-performance framework, the industry is the unit of analysis. Unfortunately, this means that the central business problem, why firms in the same industry perform differently, cannot be addressed.

Interestingly, Kay points out, the new industrial economics of games, contracts and information has much relevance to real business behaviour. But it has been developed far from business circles and in a difficult mathematical language. Translation and reconnection are essential and an important part of Kay's agenda. So can he bring all these skills to bear on his latest challenge? There is obviously no question about his intellectual or communication credentials. What may be an issue is the absence of Nick Morris, his right-hand man at the two great success stories of IFS and London Economics but who will remain at the consultancy. In common with many an academic entrepreneur, Kay has been accused of being a difficult manager, hands-on but with fingers in too many pies. It is likely he will need effective deputies.

Another issue may be Kay's reputation for being adversarial, whether in intellectual debate or the often bureaucratic politics of academic institutions. But in a telling remark, he describes his intellectual mentor, Nobel prizewinner Jim Mirrlees, as having the perfect combination of an absolute insistence on intellectual rigour with a complete lack of arrogance. You can challenge people's ideas, Mirrlees taught him, without calling them stupid. Some would say that it took Kay a long time to learn this lesson, but the consensus is that he has now definitely taken it to heart.

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Romesh Vaitilingam is a writer and consultant, who studied economics at St John's College, Oxford.