Here’s Why Referral Bonus Systems Don’t Work

One of my favourite, and also the least successful, ideas in online recruiting has been the referral bonus system.

Almost 50% of hires are referrals (65% according to CareerXroads’ recent 10th Annual Sources of Hires Report).

This was true a century ago, it’s true today, and it will probably be true a century from now. “Word-of-mouth” advertising, implied endorsement, and the resulting social pressure to perform in the workplace and not let your peers down, all combine to make referrals a very effective means for staffing any company.

While most companies have an internal system for handling employee and internal referrals, the thinking goes, wouldn’t it be so much more powerful to tap into the broader networks of contacts that we all have and reward them when we hire somebody?

As a result, entrepreneurs in the internet recruiting marketplace periodically strike upon the idea of building a third-party referral marketplace – a way to reward anybody who suggests a new employee to a company with a big payment, thereby encouraging lots of effective referrals.

The reason the idea is so attractive is that by putting $5,000 or $10,000 bounty on the table for a hire, it is imagined that an army of referrers will be put to work on the hiring company’s behalf. And as the company only pays when it hires, the thinking continues, there’s no cost and no risk to them.

When I first came across the idea, I, too, was a big fan. I imagined it would work really well in cases where a third party had very good knowledge of the capabilities of a group of potential employees – say, for example, a graduate student teaching assistant in computer science, or a Meetup organiser of brand marketing experts. She could make referrals to a number of companies of her students / members and make a tidy sum when the magic happened and a connection was made.

Alas, it doesn’t work this way in practice.

A typical recruiter can make 24 placements in a year. This number ranges from one to 10 dozen, depending on the level of effort, difficulty of the position, frequency of the position, etc., but let’s use 24 for now.

That means a typical placement requires two weeks full-time work – sourcing candidates, calling them, qualifying them, setting up appointments with the hiring manager, doing follow up debriefings, negotiating offers, and closing. All of those activities really add up.

Providing the name of a potential hire is useful, but represents just a fraction of the overall workload. So from a company’s standpoint, the correct referral bonus to offer for a name is far lower than $5,000. Further, managing these suggestions, which would vary in quality across referrers, would take time and money on the company’s part.

From the referrer’s standpoint, the small number of times a placement occurs from this type of recommendation system – perhaps 1 in 1,000, means that, on average, the typical referrer will earn zero dollars for his efforts, thereby making word-of-mouth work against the system.

So while it’s a brilliant idea that always sounds good on paper, and has been implemented by some of the smartest people to enter the online recruiting business, the economics of the third-party referral system make it a business model that does not work.

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