Headhunters

Yesterday I had a really interesting lunch with Charlie O’Donnell. He is looking to expand his startup, Path101, and mentioned that his inbox was inundated with offers from headhunters. He couldn’t fathom their exorbitant fees. I can certainly understand the sentiment. Headhunters have an industry standard fee – 20% of the first years salary. Thats incredibly expensive in a world with monster, linked-in, theladders, and hundreds of other nitch job posting sites, not to mention vertical job search sites like indeed and simplyhired. So how do headhunters get away with those massive fees? Collusion? Cartels? Mafia-like market failures?

I didn’t give Charlie a great answer yesterday, so I thought I’d lay out my thoughts here. The first and most obvious answer is that the viability of online tools varies by industry and experience level. It could be that executives with experience in Global Operations and Logistics might not use job postings as much as recent college grads and Web Developers. That explanation has some weaknesses. It provides no structural or fundamental explanation as to why headhunters exist, and especially why they can charge such high fees. There has got to be a better reason than ‘older people aren’t web savy’ and ‘high-powered people won’t spend time sifting through job postings.’

I believe the stronger explanation has to do with the marginal product of labor. Lets assume a key executive at a large and hierarchical company quits. The projects and peopled managed by that executive will quickly lose their direction and leadership. They might be able to function independently, but they will certainly be less effective. In a large organization, and for a high level executive, this may amount to significant declines in productivity for the entire company. Thus, the cost of leaving that position open is very high. Here, a headhunter, “Executive Search Firm”, steps in and uses its contacts, specialized experience, and familiarity with the industry to quickly fill that position. They garner a large commission for providing a very valuable service by minimizing that costly leadership gap. (The contingent marginal product of labor argument is also my favorite explanation for high executive pay)

When it comes to startups this certainly isn’t the case. They are not large, hierarchical institutions. On the contrary, they have cultures that praise ‘bootstrapping’ and flexibility. Thus, the marginal productivity of a particular employee is far less than that of the corporate executive. Starups can afford to use cheap, but time intensive online hiring methods because the cost of hiring tomorrow is relatively low.