Promote From Within or Hire Externally: How to Decide

Laurence J. Peter and Raymond Hull gave the workplace the Peter Principle, and people still repeat a variation of it: managers tend to "rise to the level of their incompetence". Alan Benson, Danielle Li and Kelly Shue later tested the idea on sales staff at 214 firms, in a study summarised by the National Bureau of Economic Research (NBER), and found evidence that it is real.

It is easy to read that as an argument against promoting from within. It is not one. Read together with a second study, on what happens when you hire from outside, it points to a narrower question you can answer before you open a search: has anyone here already seen this person do the work the new job needs?

What happens when you hire from outside

Matthew Bidwell of the Wharton School compared people who entered similar jobs by promotion with people who were hired into them. His data, published in Administrative Science Quarterly, were the 2003 to 2009 personnel records of the US investment banking arm of a financial services company.

The external hires were initially paid around 18 percent more than the promoted workers, and they arrived with more experience and more education. Yet the people promoted into the job performed significantly better for their first two years than the people hired into similar jobs. The promoted workers also had lower rates of both voluntary and involuntary exit: they were less likely to quit or to be let go.

The hires caught up: after the first two years the performance of the two groups converged, and the hires were also promoted faster. But the title of the paper, Paying More to Get Less, sums up the trade: more pay from the start, lower ratings for the first two years.

The insider's edge depends on the job, not only on the person

Bidwell found one group of internal movers who largely lost the edge. People who were promoted and transferred to a different part of the organisation in the same year performed worse than other internal movers; the penalty often left them performing similarly to the external hires. The company still knew them. What changed was the setting: a higher rank and a different unit in the same year.

The study summarised by NBER points the same way from another angle: it looked at people promoted from within. It covered more than 1,500 sales employees promoted into management, in manufacturing, information technology and professional services. High-performing sellers were more likely to be promoted: doubling a salesperson's sales raised their chance of promotion by 14.3 percent relative to the base rate. But doubling a new manager's own sales before the promotion was associated with a 7.5 percent decline in the sales of the people they then managed. Selling and running a team of sellers are different jobs. On average, the people who had sold in collaborative teams, rather than alone, produced better results as managers.

Put the two studies side by side and the internal candidate brings two things: the know-how of this company they already have, and the fact that you have watched them work. Both count for most when the new job is close to the work you watched.

The test: have you already seen them do this work?

Before choosing between the person on your team and a search, write down the three or four things the new team lead job will take most of the week. For each one, ask whether the internal candidate has already done it here, in front of people who can say how it went.

If most answers fall under "Points to promoting", promote, and put the money a search would have cost into the parts of the job they have not done yet. If most fall under "Points to hiring outside", the person you know may still be the right choice, but your evidence for them is about another job. That is the case for looking outside, and for asking the internal candidate to compete on the same requirements.

If you hire from outside, plan for the first two years

• The pay gap. In Bidwell's data the external hires started on more pay than the people promoted into similar jobs. Decide in advance how you will explain that to the team.
• The first two years. The promoted workers outperformed the hires for their first two years. Judge the new hire's first reviews with that gap in mind, not against the last person you promoted.
• The internal candidate. Tell them before the new person starts, and say what they would need to show for the next opening.
• The cost of getting it wrong. A wrong outside hire is expensive too; we broke that down in the real cost of a bad hire.

You can run both at once

The choice does not have to be made blind. An outside search can run while the internal candidate is considered, as long as they know it is happening. A shortlist shows you who the market offers next to the person you already know, and the decision is then made on the same requirements for everyone.

Where our recruiting practice fits

Our recruiting practice starts from what the role has to do, not from keywords on a CV. We search the Ukrainian and wider Eastern-European market, and internationally, and our first shortlist arrives in 7-10 business days. We work on a flat fee, paid when someone is hired. If the test above points to the person already on your team, promote them: no search is needed.

Sources: Matthew Bidwell, Wharton School, Paying More to Get Less: The Effects of External Hiring versus Internal Mobility, Administrative Science Quarterly; NBER, The Digest, The Peter Principle Isn't Just Real, It's Costly, a summary of Working Paper 24343 by Alan Benson, Danielle Li and Kelly Shue.