One of the first things I do when I introduce myself to a new candidate is explain how I am getting paid. I have found that there are a lot of misconceptions about this. Why would this recruiter do all of this work if I don’t have to pay them? There are a lot of very smart and cautious people out there that are unwilling to put their career into someone else’s hands unless they know exactly what the score is. After all, as the saying goes, if you aren’t paying for the product, you are the product!
The answer is simple: Recruiters always get paid by the company. You should never pay a recruiter! I have never heard or met a recruiter that was paid by the candidate that wasn’t scamming people. It doesn’t matter how rare your skill set is, if you have a criminal background, or if you are talking to a super networked person in your industry. If you have to pay someone to get you a job, they are scamming you. Plain and simple.
So how does the company pay me? Well, it depends on the nature of the hire. There are two main ways to structure it.
Contract to Hire
This is also known as temp-to-perm. I have heard other versions too (“Employee Leasing” was a particularly gross way of saying it) but the basic idea is the same. Essentially what happens is you are hired as an employee of the staffing firm or agency that is running the contract. You are their employee, and be on their benefits (if they have any). Your paychecks will say ‘ABC Staffing Company’ on them rather than the ‘real’ employers name. You will then be placed on an assignment at the company you are going to be working at, and will be given job direction by a supervisor there. This puts the Staffing Agency and the company you are actually working at in a ‘co-employment’ situation where they are jointly responsible for making sure all employment law is followed during and after your tenure of employment. Co-employment is a really funky aspect of the laws surrounding this stuff and is probably appropriate fodder for another one of these blog posts.
If the position is a contract position, your employment will be terminated at the end of the contract period, and the staffing firm will ‘end your assignment’ (I.E. you will be laid off). This means the staffing firm can deploy you again on another assignment if they have one. Usually they won’t have anything lined up and you will be on the market again.
If the position is Contract to Hire, after a set amount of time (typically counted in days or work hours) you will be eligible to convert to the company payroll. At that point you become a full time employee of the company you are working at. The length of the contract period is negotiated between the agency and the company – in my experience you will not have much, if any negotiating power in getting the contract length reduced. Average contract to hire length ranges from 3 months to 1 year with the median being around 6 months.
So how does the agency get paid?
When you submit your hours to the agency (whether it’s by emailing your boss, filling out a time card, or downloading the agency’s App on your phone and logging hours that way) the agency will pay you your hourly rate, and then bill the company per hour your work. There are two ways they can calculate this bill rate:
- Example A: The agency can simply tell the company what the cost is. I.e., it will cost you $45 per hour to employ this person. In this case, the company will not have any idea what you are actually being paid. They will just pay $45 and be done with it.
- Example B: The agency can charge a ‘markup’ on your hourly rate. So if you are making $30 they might charge a 50% (also known as 1.5) markup (which is industry average where I live in Minnesota) and bill the company 45$ per hour. These markups can change dramatically. I have seen some as low as 1.3 and some as high as 2.0.
One thing to keep in mind is that the difference in how the agency bills out can make a pretty significant difference in how you should be negotiating your pay.
- In Example A it is in the agency’s best interest to pay you as little as possible to maximize their margin. If you are willing to take $25, they will earn $20 per hour (45-25=20), but if you ask for $35 they will only earn $10 in margin per hour (45-35=10).
- In Example B, the more that you negotiate in the interview the more both you and the agency make. If you are able to get the company to agree to pay you 35, the agency will bill out 1.5*35, which is 52.5, and will earn $17.5 in profit. If you make $30 they will earn $15.
It can be difficult to tell which approach the agency is taking, but you can get a hint by seeing how helpful your recruiter is. If they are willing to help you earn as much as possible you are probably in a Example B situation. If they are trying to persuade you to take less money, Example A. It is possible to get a strong offer for yourself in either scenario, but it just changes whether you are negotiating with the company or with the agency. You can read more on how to negotiate money here.
Direct Hire
Also just called ‘perm’ (as in ‘I need to be hired on perm’), Direct hire is considered to be the more desirable hiring approach because it is simpler. In this model you are just hired on by the company and are on their payroll and benefits day 1. The pay rate you negotiate in the interview process is your pay rate and that’s that.
Recruiters are paid on Direct Hire searches by one of the following methods:
- A flat rate of X Dollars (negotiated up front between the agency and the company). Cheaper, less experienced agencies are willing to do this most commonly but sometimes a more expensive firm will agree to it in exchange for a large amount of business.
- A percentage of the candidates anticipated 1st year salary. Average for this is about 25% nationwide, although I’ve done searches as high as 30% and as low as 20%.
In a Flat Rate situation, the agency could care less what you get paid. It doesn’t matter to them – they just want it to be enough that you take the job and are happy with it. They probably have very little interest in helping you negotiate more, but also aren’t going to be trying to talk you into making less. They just want to close the deal.
In a ‘percentage’ scenario, your interests and the recruiter’s interests are aligned. They want you to make as much as possible because it increases the billable percentage. A good recruiter will be trying to position your negotiation in the most advantageous way so that they can earn more commission. This is how I personally structure my searches. It’s how I would feel most comfortable if I was in the candidate’s position.
Let’s See Some Numbers!
Using the example above (someone making $30 per hour):
- Contract to Hire: Someone earning $30 per hour with a bill rate at $45 will provide a margin of $15. But not all of that margin is actual profit. Because the agency has to pay for payroll taxes, unemployment insurance, work comp insurance, your benefits, etc, the actual profit is likely to be cheaper. The exact amount varies depending primarily on the work comp stuff (more dangerous jobs cost more to insure) but usually we are looking at somewhere between $3-6 per hour. Let’s say it costs the agency 4.50 to pay these costs – their actual profit would then be 10.50 per hour. Stretch this out over the course of, lets say a 6 month period (or about 960 hours assuming you are doing 40 hours per week), gives us a total all in cost to the company of $10,080. There may or may not be an additional conversion fee to hire you on permanently but that depends on the agency.
- Direct Hire: This is much simpler. Someone earning $30 is earning 62,400 per year. 25% of this is 15,600 and that is what the company pays.
You can see why many employers prefer to run as many people through contract-to-hire as possible – not only do they save 5k, they also get to try you out for 6 months without any strings attached!
Does it ever make sense to take a Contract Job over a Direct Hire job?
Usually, no. Contract to Hire is structured the way that it is so that the company doesn’t need to give you good benefits and can let you go at any time without having to pay out unemployment. The agency carries those costs instead, which is why agency benefits are notoriously terrible. But depending on your situation and the company, it may make sense to take a contract position. I will sometimes suggest that people consider long term (1+ year) contracts if the company you are working at is desirable or hard-to-get-into enough. I have a friend that is moving his family to California to take a 2 year contract at Facebook as a Project Manager. It’s a contract, but it’s long enough to be worth the move, and pays well too. And, well, it’s Facebook. But for most people in most situations, direct hire is preferable if you can get it.
Either way, your main focus should be on the job. If I take this job, where will I be in a year? Will I enjoy it? Does it pay well enough? Those should be your first questions – the exact nature of the hire is something you can work out with the recruiter and the company. Ultimately, if it doesn’t make sense or you have a bad feeling about something, don’t be afraid to disengage. You will never regret trusting your gut on something like this!