Are Firms Doing a Lousy Job in How they Hire?

In a lot of economic models, firms decide to hire based on whether they need more workers to meet the demand for their products; in the lingo, labor is a "derived demand," derived from the desired level of output. Beyond that, economic models often don't pay much attention to the details of how hiring happens, assuming that profit-maximizing firms will figure out relatively cost-effective ways of gathering and keeping the skills and workers they need. But what if that hypothesis is wrong?

Peter Cappelli thinks so, and writes "Your Approach to Hiring Is All Wrong" in the May-June 2019 issue of the Harvard Business Review.  He writes:

Only about a third of U.S. companies report that they monitor whether their hiring practices lead to good employees; few of them do so carefully, and only a minority even track cost per hire and time to hire. ... Employers also spend an enormous amount on hiring—an average of $4,129 per job in the United States, according to Society for Human Resource Management estimates, and many times that amount for managerial roles—and the United States fills a staggering 66 million jobs a year. Most of the $20 billion that companies spend on human resources vendors goes to hiring.

One big change that Capelli emphasizes is a shift from filling job vacancies internally to filling them externally. The old working assumption was to hire from within, but in the last few decades, the working assumption seems to be that hiring from outside is preferable. Capelli writes:

In the era of lifetime employment, from the end of World War II through the 1970s, corporations filled roughly 90% of their vacancies through promotions and lateral assignments. Today the figure is a third or less. When they hire from outside, organizations don’t have to pay to train and develop their employees. Since the restructuring waves of the early 1980s, it has been relatively easy to find experienced talent outside. Only 28% of talent acquisition leaders today report that internal candidates are an important source of people to fill vacancies—presumably because of less internal development and fewer clear career ladders. ... Companies hire from their competitors and vice versa, so they have to keep replacing people who leave. Census and Bureau of Labor Statistics data shows that 95% of hiring is done to fill existing positions. Most of those vacancies are caused by voluntary turnover. LinkedIn data indicates that the most common reason employees consider a position elsewhere is career advancement—which is surely related to employers’ not promoting to fill vacancies.

There doesn't seem to be evidence that hiring from outside is better. What evidence does exist seems to be that internal hires get up the learning curve faster, and often don't need as much of an immediate pay bump. If you persuade someone to leave their current employer by offering more money, what you get is a worker whose top priority is "more money," rather than on work challenges and career opportunities. ("As the economist Harold Demsetz said when asked by a competing university if he was happy working where he was: `Make me unhappy.'”)

A common emphasis of modern labor markets is to have a big "funnel," with lots of people applying for jobs but only maybe 2% eventually getting a job. But making the funnel as big as possible means that you face the costs of sorting through a very large number of applicants. And it turns out that lots of managers who are perfectly fine at running a business aren't necessarily all that good at evaluating job applicants.

It turns out that college grades aren't a great predictor of future job performance. Interviews by managers aren't a great predictor, either. There tend to be lots of biases about who the interviewer would choose as a friend with shared interests and cultural background, but not necessarily who will turn out to be the best managers. There are lots of newfangled machine learning techniques that purport to guide hiring, but they are recent enough that it's not clear what kind of workforces they ultimately end up producing. 

So what does work? 

1) Actual tests of skills that will be useful in the job. 

2) Think about promoting and filling positions from within. 

3) Giving applicants a realistic preview of what the job actually involves. This is old-style advice, but some companies like Google and Marriott Hotel have set up online games that give applicants a sense of the kinds of decisions and tasks they would need to make. 

4) Evaluate hiring by following up on how employees perform. Yes, employee performance in big organizations can be hard to measure, but some basic approaches are available and underused. Which employees quit? Which employees are absent a lot? Which employees qualify for performance-based raises? Or just ask the supervisor if they would hire that person again. 

In a nearby article in the same issue of HBR, Dane E. Holmes of Goldman Sachs describes how they hire 3,000 summer interns each year, thus collecting a talent pool they hope will drive the company in the future. Rather than having many different people try to carry out many different interviews at many different locations, Holmes describes a different approach: 

"[W]e decided to use `asynchronous' video interviews—in which candidates record their answers to interview questions—for all first-round interactions with candidates. Our recruiters record standardized questions and send them to students, who have three days to return videos of their answers. This can be done on a computer or a mobile device. Our recruiters and business professionals review the videos to narrow the pool and then invite the selected applicants to a Goldman Sachs office for final-round, in-person interviews. (To create the video platform, we partnered with a company and built our own digital solution around its product.)"

This approach allows the company to reach out to a broader group of applicants, to standardize the interview process, to give applicants a sense of the sorts of issues that arise at this employer, to test the ability of applicants to respond to these sorts of issues, and to allow the first round of applicants to be being evaluated in the same way. Goldman Sachs can also use the results to help match applicants to appropriate roles within the company.

We seem to be living in an economy with very low unemployment rates, and where lots of jobs are being advertised, but where actually being hired is often a costly process for both applicants and employers. Moreover, it's an economy that seems relatively full of outside options for shifting to other employers, but relatively light on inside options for expanding skills and building a career with one's current employer. A job market in a dynamic economy will always have some element of musical chairs, as people shift between jobs, but it should also encourage lasting matches between an employee and an employer when the fit is a good one.

A version of this article first appeared on Conversable Economist.