Recruiternomics

By Philip Carrigan, representative director, Morunda Japan

How are recruiting fees determined? Why do candidates reject offers when (from a logical standpoint) the decision doesn’t appear to make sense? How does opportunity cost factor into the recruiting process, and how do recruiters allocate resources? Behavioral economic analysis offers some psychological insights into the economic decision making of recruiters and candidates.

Recruitment fees

The interplay of supply and demand is a fundamental concept of economics, and this determines the fees for contingency-recruiting (contingent searchs are remunerated only upon the successful completion of the search — typically when the candidate accepts the position) companies. Demand refers to the quantity of a particular type of candidate that is desired by corporations. Supply refers to the quantity of that type of candidate available in the market. The correlation between price and how many candidates are available in the market is known as the supply relationship. The fees charged by recruiting companies, therefore, are a reflection of supply and demand. The average fee for a contingency search in Japan’s pharmaceutical market is around 30% to 35% of base salary and all guaranteed bonuses, while in South East Asia, it is around 20% to 25% of base and bonus. The difference between the two markets is 33% to 40% which, from a supply side analysis, indicates that it is significantly more difficult to find candidates in Japan than in South East Asia. This discrepancy in fees is only apparent for contingency searches. Retained (up-front fee to perform a specific search)  searches remain consistent at 30% to 33% of base and bonus across markets.

Incentives and Cost-Benefit Analysis

When a company finds a search difficult, they may choose to increase the fee in the belief that the monetary incentives will provide the adequate motivation for recruiters to fill the position. However, it is not so simple. Recruiters are looking to maximize their return on the investment regarding time spent on a particular search. In addition, there is a tradeoff between short-term advantages at the expense of long-term gains. If the particular search is outside the area of competency of the recruiter, then no matter how high the incentive, it may not make long-term sense to recruit outside his/her specialty area. Many companies fall into the trap of believing that remuneration is the only factor to consider in allocating resources to a given search.

Recruiting firms are constantly analyzing positions and companies based on cost-benefit analyses.

The benefits of a given search or working with a particular company are calculated, and then the costs associated with working on that position with the client are subtracted. Companies may find it is easier to recruit a senior person than a junior employee simply because the benefits of working in a senior role are significantly higher than in a junior role. Opportunity cost also plays a significant role in deciding what position a firm works on. The cost of an alternative search must be forgone in order to pursue another search.

Why candidates reject offers?

In economics, utility is a measure of preferences over a set of goods and services. Utility is an important concept in recruiting; it represents the satisfaction experienced by the candidate in a particular job. Candidates look to maximize their utility based on criteria that are only known to them. If candidates were completely logical and the labor market was completely open, then there would be no need for recruiters.

The problem with economics is that it is meant for the perfectly rational person, possessed of infinite calculating ability. In truth, people base their decisions largely on emotion rather than logic, and loss aversion can play a significant role in this. The phenomenon of loss aversion leads candidates to evaluate outcomes that comprise similar gains and losses since people prefer avoiding losses to making gains. The pain of loss is so great that it can outweigh the gains.

A candidate may be offered a 20% salary increase, a better title, and more attractive career prospects. In such a case, the candidate would be maximizing their utility by moving to the new company. Every recruiter in the world can tell stories of loss aversion counteracting the facts. Aversion to loss can be so strong that the endowment effect can create a rosy view of the candidate’s present company.

An understanding of behavioral economics can lead to a better understanding of why companies and candidates behave the way they do. With this understanding, companies and recruiting firms can communicate more effectively.

Bio: Philip Carrigan is representative director at Morunda Japan, a pharmaceutical executive search firm.