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Professional Search Firms

Many readers of this text will find themselves working at a professional services firm, perhaps in consulting, investment banking, accounting, or marketing. Competition in these sectors exhibits some common features, which are exemplified by professional search firms.

Market Definition

When businesses want to hire talented managers for corporate or midlevel jobs, they often outsource the search to independent professional search firms. Some professional search firms compete globally, helping large multinational firms fill senior management positions. Smaller clients usually confine their search nationally or regionally, and often retain smaller search firms with greater local knowledge and experience.

Most of the “production” of professional search firms is done by their search consultants. Search consultants usually begin their careers as employees; in time, they may become partners and enjoy a share of their firm’s profits. A successful search consultant must know who is working where, what they are getting compensated, and what it will take to get them to switch employers. Search consultants are experts in judging corporate talent and learning about key personnel movements within an industry before Wall Street analysts or even the senior executives of the organization housing the individual. They must possess the persuasion skills required to convince talented performers to leave their current employer (and their current home, school district, and so forth) for the client organization. Search consultants must track compensation packages given to other job changers and have a sense of the “compensating differential”—the dollar value of the difference in the attractiveness of different jobs.

Internal Rivalry

Professional search is a $10 billion industry, and, like other professional services industries, it is highly fragmented. There are around 4,000 search firms, with an average of just 2.5 search consultants per firm. The top 10 search consulting firms have a combined market share of just 11 percent, and more than 80 percent of search firms collect less than $2 million annually in professional fees. Two of the largest firms in this industry are publicly traded firms—Heidrick & Struggles and Korn/Ferry International. The three most prominent private firms are Spencer Stuart, Russell Reynolds International, and the UK firm Egon Zehnder International.

Search firms set “prices” through a retainer policy. Firms receive one-third of the position’s first-year salary (including any stock and other bonuses), and they often receive this fee regardless of whether the position is filled. Given the highly fragmented market structure, one might expect intense price competition, with search firms asking for a reduced retainer with the hope of gaining market share. But clients link price and quality, perhaps because price has an important incentive effect. In particular, clients may fear that a search firm working for a cut-rate retainer might devote less effort to the search.

Search firms are differentiated geographically and by industry. Larger firms like Korn/Ferry address the concerns of large international clients seeking to attract senior executives. These search firms have deep knowledge of what is happening in the executive suites of the world’s largest businesses. Smaller search firms may specialize in specific industries or regions. For example Hazzard, Young and Attea specializes in helping U.S. public school boards find superintendents, while FGI serves global clients in the aerospace and transportation sectors and PSS focuses on search in India.

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Entry

In a $10 billion business where a single successful placement can generate hundreds of thousands or even millions of dollars in revenue, there are clearly profits to be had in professional search. Given that anyone with a cell phone can develop contacts and call themselves a search consultant, it is not surprising that there are thousands of firms competing for their share of the pie. To some extent, competition in this industry resembles the monopolistic competition model described in Chapter 5. Recall that in a monopolistically competitive market, firms are differentiated but face entry costs. As a result, prices exceed marginal costs, yet entrants should not expect to turn a profit. Indeed, it can take a new search firm 18 months to establish relationships with employers and potential search targets. It is not enough to have a lengthy contact list. The firm must also have a demonstrated ability to match managers to employers. The resulting advantages of incumbency are especially large for executivelevel search because the stakes are higher and the search firm may need to know about potential candidates around the world across a range of industries.

Substitutes and Complements

A client could use its in-house human resources department to fill senior job vacancies, but this is not likely to generate the best list of candidates. An in-house HR department would not know about eligible candidates at other firms, so it would have to advertise job availability and prescreen responding candidates. This process is likely to identify candidates who are unemployed or unhappy with their current employment position, not exactly what the company would want. In contrast, the search consultant relies on longstanding personal relationships to identify successful managers who might be lured to a new position; many of these managers are not actively seeking a new job when contacted by the search firm and would never learn of an HR department job posting.

Employers have two additional reasons to outsource search. Search consultants can provide the kind of discretion that the HR department could not: the fact that the firm is searching can be kept secret until appropriate candidates have been identified. This can also partially insulate the employer from internal or external challenges related to hiring decisions.

Management consulting firms already working with a client on another matter could be substitutes. Indeed, the industry developed out of such consulting efforts. (McKinsey starting doing executive search in 1957.) However, management consulting firms generally lack the specialized knowledge and focus of search firms. Other potential substitutes include specialist human resource firms, such as Manpower, and even some Internet-based employment listing firms, such as Monster.com. While these have the potential to compete against lower-level locally based searches, they as yet have not proven themselves to be viable substitutes for major executive search firms, largely because they deal with different pools of job candidates.

The globalization of the economy increases the frequency of contacts between potential clients, potential hires, and the search firm. This should make search even more efficient. However, as interconnectedness increases, it might be difficult for the largest search firms to maintain their advantages that were built on years of personal relationships in a less connected world.

Supplier Power

The “traditional” suppliers to the search consulting industry are individuals who choose to become search consultants. They pose a threat only to the extent that they can start up their own competing firms. This threat is minimal when it comes from

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new consultants who lack the contacts required for successful search. The threat is considerable when successful search consultants in incumbent firms strike out on their own or threaten to join a different firm. Star consultants can take with them their specialized knowledge of clients and potential hires, coupled with their track record of success. Search firms can minimize this threat through legal restrictions (“noncompete clauses”), but these are not binding in many places. Otherwise, firms may have to pay their stars a high enough wage to deter them from leaving, with the result that the stars end up with the lion’s share of the profits.

We should also consider the pool of prospective prospects to be suppliers because search firms cannot meet their clients’ needs without them. At any time, the best prospects may be speaking with several search firms. This may force the search firms to spend more time cultivating their prospects (for example, through additional phone calls and meetings), which drives up the cost of doing business.

Buyer Power

In general, buyers have power when they can lower the industry margins by demanding a higher level of service or lower prices. Because 85 percent of senior executive search fees are derived from repeat or referred business, larger employers that are likely to fill multiple positions can wield considerable power. Employers searching for CEOs have a lot of power because the CEO is likely to replace subordinates and will probably be partial to the same search firm. Powerful employers may not insist on lower retainers (see the earlier section, Internal Rivalry) but may instead ask for incentives for quality service, such as penalties for failure to identify candidates in a timely fashion or bonuses if the hire proves to be successful.

Conclusion

What kind of industry is this? There are thousands of small firms selling to sophisticated buyers who require specialized knowledge; low barriers to entry, especially by successful consultants in established firms, and a potential in-house substitute. It is no surprise that the vast majority of firms struggle to survive, even as a few large industry leaders sustain their success for decades.

How can a firm succeed? Entry and competition is a sort of trial-and-error process. Entrants are attracted by the prospect of charging high retainer fees. A few entrants will establish the personal connections required to land clients, and a few of these will have a series of successful placements. As a result, a small percentage of entrants will grow and enjoy sustained success, while most stay very small and remain at risk to exit. The successful firms must take care to keep their star consultants happy. At some point the stars will earn enough that they become a breakeven proposition for the firm. It is the profits generated by the up-and-comers, relying on established networks and reputations as they attempt to build their own, that allow search firms to prosper.

Table 8.4 summarizes how these forces affect industry profitably.

TABLE 8.4

Five-Forces Analysis of Search Consulting Industry