The brutal economics of contingency recruiting

As a founder or hiring manager at a growing startup, a huge portion of your time is dedicated to finding the best people for your team. You’ve made your first few hires from your network and from referrals, but after about 10–15 hires, you start to exhaust your network.

At this point, you have a few options. You can source candidates yourself, but it will be tedious and time-consuming, and even with the abundance of tools that are out there. You can also start building out a recruiting team, but this comes with its own challenges — starting a recruiting search from scratch will take months, and you still won’t be any closer to making the key hires you initially sought.

The third option is to partner with an external recruiter. However, most of the time, misaligned incentives drive up recruiting fees many times over the actual cost of the hire.

Contingency recruiters to the rescue

Since you need to make these hires quickly and don’t have time to do it yourself, you decide to work with an agency. Agencies work on either a retained or a contingency basis — “retained” just means you will pay a fixed, monthly fee, whereas “contingency” means you only have to pay them when you hire one of their candidates.

On the surface, it seems like the incentives are much more aligned in the contingency model. You don’t have to pay until you make a hire, so it’s essentially risk-free.

You reach out to one of your VCs and get a referral for a recruiter named Dave. After a 30 minute meeting with Dave, you enter a contingency agreement with him.

Under the hood of a contingency search

Dave helps companies in San Francisco hire senior engineers, and over the years, he’s established contingency agreements with a few dozen startups. He reaches out to engineers every day, checks in with his old connections to see if they’re ready for a job change, and tries to have a few phone calls a day to pitch new candidates on his companies.

The engineers he targets have an average salary of $150k, and Dave charges the industry standard 20% contingency fee, so he makes $30k if he succeeds in filling a role. Here’s why it’s so expensive:

• Contingency recruiters are a company’s last resort. By the time a company brings on Dave, they’ve often already tapped into a suite of recruiting channels, such as referrals, inbound interest, job boards, and other contingency recruiters. As a result, they already have a couple of candidates that they’re having active conversations with. They may hire one of these candidates shortly after contracting with Dave.

• Contingency recruiters upcharge to cover their losses on other searches. Dave is lucky if one in three searches he conducts leads to a hire. Since he’s only successful a third of the time, Dave needs to charge three times as much as it costs to fill a role. Each search costs Dave $10k to run. If he wastes $20k of his time working on two unsuccessful searches, he’ll need to charge $30k to recuperate his losses.

With these dynamics in mind, we can start to see the real incentives at play.

Misaligned incentives

After entering the contingency agreement with Dave, you start to receive candidate resumes. Every day you get a handful to review, and a couple of trends emerge.

Most of the candidates that Dave is sending are a poor fit and are low quality. You send Dave some feedback and send him the job description again to remind him of what you’re looking for in this hire. But little changes over the subsequent weeks.

Once in a while, Dave sends over a candidate that matches what you’re looking for. You tell Dave to make the intro, but you find out that the candidate is already interviewing with four other companies and that you need to move extremely quickly.

You’re experiencing this for a couple of reasons:

• You’re not the contingency recruiter’s customer — the candidate is. Dave doesn’t care which company ends up hiring his candidates, only that his candidates get hired. In fact, when Dave finally finds a strong, active candidate, it makes sense for him to introduce that candidate to each and every one of his companies.

• For the contingency recruiter, speed is more important than quality. Dave is in a race against you, as you might fill your role through another channel. He’s also in a race against the candidates he’s working with, as all of them are also looking for jobs through other means. As a result, Dave will make sacrifices on quality of the candidate fit and company fit in the interest of speed.

• The contingency recruiter just needs to find a candidate, not the best candidate. Dave wants to take more shots on goal by sending you as many resumes as possible. Even if each candidate is not a great fit, he doesn’t lose anything by introducing them to you.

After sifting through dozens of resumes and interviewing a bunch of people, Dave introduces you to a reasonable candidate. After hiring the candidate, Dave sends you a bill for $30,000. You pay Dave, but gosh does it feel expensive, and the experience wasn’t that great either. He found you a mediocre candidate and you still ended up doing a ton of work to hire them.

The problem with contingency recruiting is that misaligned incentives drive up the cost.

An alternative path

By shifting from the contingency model to a retained model, you can correct for these misaligned incentives. Imagine if you had hired Stacy, a retained recruiter, paying her a monthly salary. Her incentives will be better aligned with your own:

• You would be Stacy’s customer, not the candidates.

• Stacy wouldn’t be incentivized to send you low-quality candidates.

• Stacy could charge a fee that’s more in line with the direct cost of working for you, $10k.

The best way to reduce the cost of recruiting is to create the right incentive structure. A retained search may not be perfect for all cases, but a retained model will change your expenses from the expected cost to the actual cost of the search.

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