Productivity Costs of External Hires

Productivity Costs of External Hires
Productivity Costs of External Hires
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A LinkedIn survey of 4,000 corporate talent acquisition leaders, (at the manager level or higher), across 35 countries revealed that 83 percent of those surveyed state that talent is the number one priority in their organization. In addition, 56 percent of leaders say that their team’s hiring volume will increase throughout the next year and that in order to measure success they are focusing on how long a new hire stays at the company as well as the hiring manager satisfaction, and the time to fill the position. But finding the required talent from within or without is one of the greatest challenges facing hiring managers today.

Although successful companies know that the hunt for top talent is an almost continuous process, organizations must give careful consideration to whether they recruit internally or externally. Many employers prefer to conduct internal recruitment first, turning to external recruitment only if internal efforts are unsuccessful. Out of the billions of dollars businesses spend on human resource vendors in the US, $20 billion goes directly for the cost of hiring. Regardless of the decision of where the candidate comes from, there are costs involved in either selection. Costs vary depending on what position is being hired, but for senior leaders the typical (median) cost of turnover is 21 percent of an employee’s annual salary, according to a study by the Center of American Progress.

According to a University of Pennsylvania’s Wharton Business School study, higher-level jobs used to be almost entirely entered by promotions or internal transfers, but those jobs are often now entered by external hiring as well. In the study, Paying More to Get Less: The Effects of External Hiring Versus Internal Mobility, author Matthew Bidwell examined the various characteristics of the performance of, and the impact made, by both internal and external hires. Bidwell found that although firms may seek to give prospective hires a clear description of their job, internal hires are likely to have more direct knowledge about the nature of the job and how well they will fit in the position. Internal candidates should also have a clearer understanding of how they fit the culture and values of the organization (Chatman, 1991), and should be a good fit for the organization; otherwise, they would have left the organization already (Schneider, Goldstein, and Smith, 1995).

In a recent Society for Human Resource Management (SHRM) article, Steve Hrop, Vice President of organizational development services at Caliper, a Princeton, N.J.-based company that specializes in employee assessments and talent management, states that, “Research clearly shows that promotions from within have a much higher probability of success than hiring from the outside. The superiority of internal promotions over external hires increases at the highest levels of the organization, even though there is a natural tendency to believe external hires are usually superior.”

Getting to Know You

In the courting process of luring external candidates, the firm knows very little about the external hire and unfortunately, external hires know even less about the firm. According to Bidwell, “Given the difficulties of comparing jobs across organizations (Baron and Bielby, 1986), external hires may sometimes apply for and accept jobs for which they are overqualified. Though under-qualified applicants are likely to be screened out by the employer, overqualified candidates may end up being hired. Because internal candidates are less likely to apply for jobs for which they are over-qualified, such effects would also lead external candidates to have stronger observable indicators of ability than internal movers.”

Candidates hired internally for a senior role typically acclimate faster into the new position than external candidates because they already have established connections, possess the knowledge of the company’s inner workings, and have a good grasp of what is expected in the new role. Often, to make up for the risk of a poor fit, external hires may demand more pay. The study conducted by the University of Pennsylvania’s Wharton School found that while external hires were paid 18% more than internal hires, the outsiders brought in had worse performance reviews during their first two years on the job. According to the Wharton study, although external hires should benefit from that higher pay, their lack of firm-specific skills and uncertain fit create costs for them too, in the form of higher rates of voluntary and involuntary exit than internal hires.

More than the concrete costs of filling a senior position is the productivity costs associated with bringing someone from outside to fill a vacant role. Research in a Harvard Business Review article found that on average, outside hires take three years to perform as well as internal hires in the same job, while internal hires take seven years to earn as much as outside hires are paid. Outside hiring also causes current employees to spend time and energy positioning themselves for jobs elsewhere, thus reducing productivity and decreasing engagement. Additionally, hiring externally disrupts company culture and burdens peers who must help new hires figure out how things work.

Getting to Know Us

When recruiting external talent, the recruiting function is very similar to the marketing function, in that the organization is promoting both itself and employment opportunities to potential candidates. All of the costs involved in marketing, recruiting, screening, interviewing and so forth are costs typically associated with external hiring—internal candidates have already been vetted.

The Wharton study found that when workers receive rank promotions, they are expected to take on new responsibilities over time. External hires need to learn about their new work context. Though the effects of such changes in job-specific skills may often be less than the effects of moving to a new firm, they may still influence performance. In addition, the firm already has a historical record, or starting point to assess the internal hire. There is a history of sorts the firm can fall back on when evaluating performance that makes it easier for the firm to become “acquainted” with the candidate. However, in assessing external candidates, the firm lacks information about externally unobservable attributes, at least at the start. The hiring managers must assume that external candidates are, at best, average on those unobservable dimensions. As Bidwell states, “We would therefore expect internal hires to have stronger externally unobservable attributes than external hires.”

The Costs for Talent

A SHRM report found that replacing a $100,000 per year candidate after only six months of employment can cost the firm up to $250,000. Additionally, a recent survey by Robert Half showed that one-third (36 percent) of 1,400 executives surveyed felt the top factor leading to a failed hire, aside from performance issues, is a poor skills match. Even after evaluating and interviewing an external candidate, the firm cannot know for certain that the candidate will perform up to the firm’s standards. If an external hire doesn’t work out, the cost to replace that person, including all productivity costs, can be enormous.

Then there is the costs associated with replacing internal positions due to employees, particularly millennials, leaving because they received a better job offer from another company (30 percent), their career goals weren’t aligned with their company (27 percent), or they saw a lack of career opportunities within the company (13 percent), according to Millennial Branding. Another significant stat found in, Chasing Stars: The Myth of Talent and the Portability of Performance, Boris Groysberg examined the careers of more than a thousand top analysts and found that in most cases, those who change firms suffer an immediate and lasting decline. It was discovered that their strengths depend to a large extent on their former firms’ resources, networks and colleagues. Of course, there were exceptions, but most top analysts performed much worse after changing jobs.

The cost function involves more factors including:

  • Conducting a more intensive or extensive search imposes direct costs
  • Having unfilled vacancies leads to potential lost productivity producing non-linearities in the cost function
  • Delaying hiring may lead an organization to lose strong candidates who take positions elsewhere

There is a cost to trying to bring in superstars from the outside. As Bidwell and others have found, it pays to nurture and develop those already on the team and to strive to promote from within whenever possible.

Action Steps to Reduce Costs

As we’ve seen in the studies mentioned above, the productivity costs associated with external hires can be enormous in upfront monetary costs as well as productivity and performance costs due to the effects on morale and employee engagement. Some of the recommended steps to take to reduce these costs can be simply a matter of reversing the thought process for hiring from external to internal and relying on “home-grown” or candidates brought up organically through the firm. Consider these six steps for filling key positions in your organization:

  1. Consider internal mobility through promotions-According to the Wharton study, “Perhaps the most common type of internal mobility is promotion. Other studies show that promotions often occur when individuals are judged to have the skills needed for the higher rank, regardless of whether there is a vacancy.”
  2. Lateral transfers-This occurs when individuals remain within the same vertical rank but move to a different organizational unit or a different kind of job. Although transfers also reflect organizational attempts to match workers to appropriate jobs, the circumstances that lead to such transfers are likely more diverse than the circumstances triggering promotions (Wharton).
  3. Gather complete information-Looking at just the external qualities of a candidate reveals only their past experience, education, and some generic character references. Seek to gather performance reviews, peer evaluations, customer reviews and more. Obtaining this information is easier for internal candidates but requires more sleuth work on the external ones.
  4. Offer Equal Compensation-The Wharton study that on average, external hires are paid more, but they know less about the organization and the organization knows less about them, than internal candidates, when hiring from the inside, make compensation the same as if it were an external candidate.
  5. Consider Assessments-You can cut costs in the long run by paying to assess candidates. Assessment tests abound in many categories and by first assessing a candidate, you can reduce the expenses associated with recruitment and hiring manager costs while reducing your candidate pool to a short list of only qualified candidates.
  6. Create or Update succession plans-Be prepared in advance. If a key position such as a CEO or upper level management position, needs to be filled, begin the process while the current position is occupied. Work with HR to produce a succession plan that includes job description and candidate requirements as well as key players who may be next in line for promotion to that position.

Conclusion

Cultural fit, familiarity with the inner workings of the organization, and experience of how the position contributes to the overall success of the company, are all great qualities that offer evidence for the argument of hiring internally over externally. But when all internal candidates have been exhausted, the search must go outside of the firm. The cost of hiring from the outside is great, but with careful analysis and spending the time to research all aspects of the candidate, including conducting multiple interviews, the right candidate can be found. The key is to make the cost justify the hire by doing due diligence during the search, courting, and screening phases. 

A LinkedIn survey of 4,000 corporate talent acquisition leaders, (at the manager level or higher), across 35 countries revealed that 83 percent of those surveyed state that talent is the number one priority in their organization. In addition, 56 percent of leaders say that their team’s hiring volume will increase throughout the next year and that in order to measure success they are focusing on how long a new hire stays at the company as well as the hiring manager satisfaction, and the time to fill the position. But finding the required talent from within or without is one of the greatest challenges facing hiring managers today.

Although successful companies know that the hunt for top talent is an almost continuous process, organizations must give careful consideration to whether they recruit internally or externally. Many employers prefer to conduct internal recruitment first, turning to external recruitment only if internal efforts are unsuccessful. Out of the billions of dollars businesses spend on human resource vendors in the US, $20 billion goes directly for the cost of hiring. Regardless of the decision of where the candidate comes from, there are costs involved in either selection. Costs vary depending on what position is being hired, but for senior leaders the typical (median) cost of turnover is 21 percent of an employee’s annual salary, according to a study by the Center of American Progress.

According to a University of Pennsylvania’s Wharton Business School study, higher-level jobs used to be almost entirely entered by promotions or internal transfers, but those jobs are often now entered by external hiring as well. In the study, Paying More to Get Less: The Effects of External Hiring Versus Internal Mobility, author Matthew Bidwell examined the various characteristics of the performance of, and the impact made, by both internal and external hires. Bidwell found that although firms may seek to give prospective hires a clear description of their job, internal hires are likely to have more direct knowledge about the nature of the job and how well they will fit in the position. Internal candidates should also have a clearer understanding of how they fit the culture and values of the organization (Chatman, 1991), and should be a good fit for the organization; otherwise, they would have left the organization already (Schneider, Goldstein, and Smith, 1995).

In a recent Society for Human Resource Management (SHRM) article, Steve Hrop, Vice President of organizational development services at Caliper, a Princeton, N.J.-based company that specializes in employee assessments and talent management, states that, “Research clearly shows that promotions from within have a much higher probability of success than hiring from the outside. The superiority of internal promotions over external hires increases at the highest levels of the organization, even though there is a natural tendency to believe external hires are usually superior.”

Getting to Know You

In the courting process of luring external candidates, the firm knows very little about the external hire and unfortunately, external hires know even less about the firm. According to Bidwell, “Given the difficulties of comparing jobs across organizations (Baron and Bielby, 1986), external hires may sometimes apply for and accept jobs for which they are overqualified. Though under-qualified applicants are likely to be screened out by the employer, overqualified candidates may end up being hired. Because internal candidates are less likely to apply for jobs for which they are over-qualified, such effects would also lead external candidates to have stronger observable indicators of ability than internal movers.”

Candidates hired internally for a senior role typically acclimate faster into the new position than external candidates because they already have established connections, possess the knowledge of the company’s inner workings, and have a good grasp of what is expected in the new role. Often, to make up for the risk of a poor fit, external hires may demand more pay. The study conducted by the University of Pennsylvania’s Wharton School found that while external hires were paid 18% more than internal hires, the outsiders brought in had worse performance reviews during their first two years on the job. According to the Wharton study, although external hires should benefit from that higher pay, their lack of firm-specific skills and uncertain fit create costs for them too, in the form of higher rates of voluntary and involuntary exit than internal hires.

More than the concrete costs of filling a senior position is the productivity costs associated with bringing someone from outside to fill a vacant role. Research in a Harvard Business Review article found that on average, outside hires take three years to perform as well as internal hires in the same job, while internal hires take seven years to earn as much as outside hires are paid. Outside hiring also causes current employees to spend time and energy positioning themselves for jobs elsewhere, thus reducing productivity and decreasing engagement. Additionally, hiring externally disrupts company culture and burdens peers who must help new hires figure out how things work.

Getting to Know Us

When recruiting external talent, the recruiting function is very similar to the marketing function, in that the organization is promoting both itself and employment opportunities to potential candidates. All of the costs involved in marketing, recruiting, screening, interviewing and so forth are costs typically associated with external hiring—internal candidates have already been vetted.

The Wharton study found that when workers receive rank promotions, they are expected to take on new responsibilities over time. External hires need to learn about their new work context. Though the effects of such changes in job-specific skills may often be less than the effects of moving to a new firm, they may still influence performance. In addition, the firm already has a historical record, or starting point to assess the internal hire. There is a history of sorts the firm can fall back on when evaluating performance that makes it easier for the firm to become “acquainted” with the candidate. However, in assessing external candidates, the firm lacks information about externally unobservable attributes, at least at the start. The hiring managers must assume that external candidates are, at best, average on those unobservable dimensions. As Bidwell states, “We would therefore expect internal hires to have stronger externally unobservable attributes than external hires.”

The Costs for Talent

A SHRM report found that replacing a $100,000 per year candidate after only six months of employment can cost the firm up to $250,000. Additionally, a recent survey by Robert Half showed that one-third (36 percent) of 1,400 executives surveyed felt the top factor leading to a failed hire, aside from performance issues, is a poor skills match. Even after evaluating and interviewing an external candidate, the firm cannot know for certain that the candidate will perform up to the firm’s standards. If an external hire doesn’t work out, the cost to replace that person, including all productivity costs, can be enormous.

Then there is the costs associated with replacing internal positions due to employees, particularly millennials, leaving because they received a better job offer from another company (30 percent), their career goals weren’t aligned with their company (27 percent), or they saw a lack of career opportunities within the company (13 percent), according to Millennial Branding. Another significant stat found in, Chasing Stars: The Myth of Talent and the Portability of Performance, Boris Groysberg examined the careers of more than a thousand top analysts and found that in most cases, those who change firms suffer an immediate and lasting decline. It was discovered that their strengths depend to a large extent on their former firms’ resources, networks and colleagues. Of course, there were exceptions, but most top analysts performed much worse after changing jobs.

There is a cost to trying to bring in superstars from the outside. As Bidwell and others have found, it pays to nurture and develop those already on the team and to strive to promote from within whenever possible. 



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Louis Carter
Louis Carter is CEO and founder of Best Practice Institute, social/organizational psychologist and author of more than 11 books on leadership and management including his newest book just released by McGraw Hill: In Great Company: How to Spark Peak Performance by Creating an Emotionally Connected Workplace. He has lectured globally in the U.S., Middle East, and Asia on his work and research in organization and leadership development and is an executive coach and advisor to CEOs and C-levels of mid-sized to Fortune 500 organizations. He was named one of Global Gurus Top Organizational Culture Gurus in the world and was chosen to be one of 100 coaches to be in the MG100 (Marshall Goldsmith) out of 14,000 people as one of the top 100 coaches in the world .

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