Contract-To-Hire vs. Direct Hire: A Comprehensive Guide

When an organization needs to fill a skills gap, many options are available to find and engage qualified talent. Two common approaches include initiating contract-to-hire relationships and making direct hires.

Contract-to-hire engagements and direct hires each offer several advantages and drawbacks. Depending on your company’s specific talent needs, contract-to-hire may be the most effective solution for some positions while direct hires are a better fit for other roles.

In this guide, learn more about contract-to-hire and direct hire, differences between the two, hiring strategies for each, and how to navigate legal considerations.

Table of contents:

• Understanding contract-to-hire
• Understanding direct hire
• Contract-to-hire vs. direct hire
• Contract-to-hire strategies
• Direct hire strategies
• Navigating legal considerations

Understanding contract-to-hire

A contract-to-hire job is a short-term relationship between an employer and an individual, with the possibility of turning into a long-term, permanent position. Contract-to-hire roles enable both workers and companies to try out working with one another and decide whether the working relationship is the right fit for a long-term engagement.

Rather than overseeing the process internally, organizations often partner with a recruitment agency or staffing agency to source and evaluate individuals for contract-to-hire roles. Many agencies also manage onboarding and related paperwork, including payroll and benefits, for the duration of the worker’s contract. When a contract worker converts to a permanent role, payroll, benefits, and other administrative responsibilities shift from the agency to the organization.

Some pros of contract-to-hire include:

• Faster time-to-hire. Agencies typically have a talent pool ready to engage and complete many of the upfront steps, and the hiring process for contract-to-hire arrangements is often less extensive than the process for permanent workers. This is beneficial when your team needs to fill an urgent skills gap or kick off an immediate project.
• Decreased fixed costs. Contract-to-hire workers are technically employed by the agency and not your company, which can help decrease fixed costs and administrative tasks related to hiring, training, salary, and benefits.
• Increased flexibility. Because contract-to-hire workers aren’t permanent team members, your organization has more flexibility to determine the length of the contract period and how many hours are needed based on your budget and business needs.
• Opportunities to assess the fit and need for the role. Before considering a permanent position at the end of the contract, your organization can evaluate whether the individual is the right fit for the team and determine whether enough work is available to justify a long-term role.
  

Cons of contract-to-hire include:

• Less control. Organizations have less control over the hiring process for contract-to-hire positions because the agencies typically source, evaluate, and hire candidates. This can lead to missing out on individuals who may have been qualified or engaging workers who aren’t actually a good fit.
• Increased hiring costs. While fixed costs may decrease when engaging contract-to-hire workers, agencies aren’t always the most cost-effective option. Pricing models vary by agency, but may include a finder’s fee and a certain percentage of each worker’s pay rate, which can add up as you bring in more workers.
• Steeper learning curve. Any worker outside of your internal team will require ramp-up time and may not immediately understand the ins and outs of your business. To support smooth relationships with contract-to-hire workers, ensure the job responsibilities and specific project objectives are clearly communicated from the start.‍
• Decreased loyalty. Some individuals may not feel like part of the team and see contract-to-hire work as a sign that the company isn’t fully invested in their long-term potential and job security. This mindset can cause a decline in loyalty and engagement.  

Understanding direct hire

Direct hiring is the traditional process of hiring a permanent worker. Direct hires are usually full-time employees with benefits, but positions may also be part time.

With a direct hiring approach, in most cases, a company’s internal recruiters and talent acquisition teams handle the process of finding and engaging qualified talent. In some instances organizations may involve recruitment agencies in the process. Direct hires are employed and paid directly by the organization, rather than by an agency.

Advantages of taking a direct hire approach include:

• More control over hiring. Unless your organization engages an agency, your team has complete control over the direct hiring process. This enables your team to promote open roles on the most effective sourcing channels and evaluate all prospective workers to select the most qualified individual.  
• Opportunities to develop future leaders. By providing direct hires with talent development resources, your organization can help workers improve their skills and develop new ones. As individuals grow in their roles and your organization continues to evolve, you can build a long-term leadership pipeline, which can help with succession planning and other talent management strategies.
• Increased loyalty and engagement. By investing in workers’ long-term potential and development, direct hire employees are likely to be more engaged and eager to continue making positive business contributions. This can help improve productivity and reduce turnover.
• Cost savings on agency fees. By managing the direct hiring process internally, your organization doesn’t have to pay finder’s fees and other costs associated with engaging a recruitment agency.
  

Disadvantages associated with direct hire positions include:

• Lengthier hiring process. Managing the entire direct hiring process internally can increase time and resources spent on hiring. The process also often involves more steps than contract-to-hire, such as conducting additional rounds of interviews and administering talent assessments.
• Increased fixed costs. Direct hires are employed, paid, and given company benefits by the hiring organization, rather than an agency. Costs associated with direct hires can add up and may include salary, benefits, training, and paid time off, among other expenses.
• Less flexibility. Because direct hire roles are permanent, they likely aren’t the best option for project-based or seasonal work as business needs shift. Scaling your business and workforce up and down as needed can be more challenging if you’re exclusively relying on direct hires.‍
• Increased risk of a bad hire. While your organization can choose not to extend a contract if a temporary worker isn’t the right fit, managing or replacing a direct hire who isn’t the best fit can be costly and time-consuming. Some sources estimate the cost of replacing a full-time employee is as much as two times their annual salary.

Contract-to-hire vs. direct hire

Once you have a general understanding of contract-to-hire and direct hire, recognizing key differences between the two and when each approach may be the best fit can help your organization build an effective workforce.

Differences between contract-to-hire and direct hire

Factors to consider when choosing your hiring approach

Many organizations have a mix of contract-to-hire, direct hire, freelance, and other positions on their teams. Some factors to consider when determining whether to bring in a contract-to-hire worker or a direct hire include budget, hiring timeline, and skills needs.

For example, if you need to access specialized skills to quickly begin a project, a contract-to-hire role may be preferred because the hiring process tends to be faster. Or, if you’re looking for a new manager with a specific skill set to lead a team, a direct hire is likely the right approach because a permanent employee can build long-term, trusting relationships with team members.

Consider the following questions when determining whether contract-to-hire or direct hire is the right fit for a given role or skills gap:

• What is your budget?
• How urgent is the hiring need?
• Which skills and responsibilities are required of the role?
• Is enough work available at this time to require a full-time position?
• Will the skills be needed at your organization on a project-based or long-term basis?
• Will the individual begin working on a project right away or need to complete internal training?
• Are resources available internally to train and develop the worker?

Contract-to-hire and direct hire examples

Determining whether a position should be filled using a contract-to-hire or direct hire approach requires thoughtful consideration. While some roles may be a fit for either option, in some cases, one option is more effective than the other.

The following examples will help you better understand which approach is right for certain roles.

Contract-to-hire:

• Testing a new vertical or target audience. Focusing your business offerings and target audience is a best practice to become a market leader. Moreover, expanding offerings can open additional revenue opportunities—and contract-to-hire talent can help you get started. For example, if you currently sell products to enterprise-level organizations and want to start selling into small businesses, engaging small business sales experts through a contract-to-hire agreement can be beneficial. If the new revenue stream is successful, you can offer workers permanent roles.  
• Expanding an existing team. If your organization experiences significant growth and you need to hire additional workers across departments, your recruitment and talent acquisition team may need additional support to manage an increased workload. Engaging contract-to-hire workers can help expand your team’s bandwidth while ensuring existing team members don’t get overworked. If you recognize a need for a larger recruitment or talent acquisition team long term, you can convert top-performing contract-to-hire individuals into permanent employees.
  

Direct hire:

• Filling a leadership role. Management and leadership team members have in-depth knowledge about the company and are responsible for driving the long-term business strategy and engaging workers. Finding a new leader can be costly and time-consuming, and the hire faces a steep learning curve. Because of this, when a leadership team member leaves the organization—or a new position is added—a direct hire is the best approach to fill the open role. A direct hire enables your team to bring in a qualified individual who is committed to staying with the organization long term. ‍
• Hiring individuals with advanced qualifications. If a role requires a doctorate, master’s degree, or other advanced qualifications, organizations often use direct hiring strategies to attract top talent and discuss the individual's research or other experience in more depth during the hiring process. This approach is common among medical professionals and workers in science, technology, engineering, and mathematics (STEM) fields.

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Contract-to-hire strategies

Because external agencies often recruit and evaluate individuals for contract-to-hire positions, partnering with an agency that understands your organization’s specific goals is essential. Depending on the engagement, with some partnerships, the agency oversees the entire process. In others arrangements, the organization that engages the agency takes more of a hands-on approach with the hiring process.

Consider the following steps to find the right agency and ensure an effective contract-to-hire strategy:

• Identify which roles are the best fit for contract-to-hire positions
• Determine the scope, timeframe, and number of hours required for each initial contract, along with any relevant milestones along the way
• Research employment recruitment agencies including employment agencies, staffing firms, temp agencies, talent marketplaces, and specialty agencies
• Select the agency that best aligns with your business needs and sign a contract
• Collaborate with the agency to develop a job overview or description
• Evaluate top candidate profiles following initial screening by the agency
• Make a final hiring decision
• Work with the agency to develop an employment contract and extend an offer

Direct hire strategies

Implementing and following a standardized process for direct hiring can help your organization stay organized, decrease time to hire, evaluate all individuals on an objective scale, and support an engaging candidate experience.

Here are some steps to consider in your direct hiring strategy:

• Define business needs and identify which roles are best suited for direct hiring
• Write effective job descriptions
• Promote open roles across diverse talent sourcing channels, such as your company careers page, job boards, social media channels, and professional networking groups
• Screen candidates with initial phone interviews and talent assessments
• Conduct candidate interviews with the hiring manager for the role and other team members
• Complete reference and background checks
• Extend an offer
• Prepare to onboard the new employee

In addition to following an effective hiring process, think outside the box and leverage innovative recruitment strategies such as launching creative social media campaigns, driving applications with QR codes, and leveraging AI-powered recruiting assistants to keep job seekers engaged.

Navigating legal considerations

Whether your organization engages a contract-to-hire worker, direct hire, or any other type of professional, keeping legal considerations in mind and maintaining compliance is essential.

Here are some legal implications to weigh with contract-to-hire and direct hire roles:

Proper classification

Contract-to-hire workers are typically classified as employees—not independent contractors—of the recruitment or employment agency and the agency is responsible for payroll and benefits. Direct hires are classified as employees and receive compensation and benefits from the hiring organization.

If an agency or organization misclassifies an employee as an independent contractor, the employee may be entitled to back pay and benefits. The organization or agency may also be subject to penalties. Effectively converting contract-to-hire workers when they transition to full-time work is also important to ensuring proper classification.

Compliance with labor laws

Because both contract-to-hire workers and direct hires are classified as employees, complying with labor laws is critical. While labor laws vary by jurisdiction, in the United States, organizations must comply with the Fair Labor Standards Act (FLSA) that defines minimum wage and overtime standards, Equal Employment Opportunity Commission (EEOC) anti-discrimination laws, and Occupational Safety and Health Administration (OSHA) workplace safety laws.

Contract terms

The terms of the employment contract between the organization and the contract-to-hire worker or direct hire should be clearly written and address all relevant legal issues. Terms may include but aren’t limited to the scope of work, working hours, compensation, benefits, confidentiality and noncompete clauses, and the termination and notice period.

Simplify the contract-to-hire process

If you’re looking to add contract-to-hire roles on your team, simplify the process by engaging skilled talent on Upwork.

Through Upwork’s end-to-end full-time hiring solution, you can seamlessly initiate contract-to-hire working relationships. This approach enables your team to find, vet, hire, onboard, and pay experienced professionals from more than 180 countries and across more than 10,000 skills. Quickly fill skills gaps, engage workers for a trial period, and decide whether to move to a full-time, permanent relationship.

When you’re ready to convert workers to full-time positions, we help clients convert Upwork contracts. From there, your team can use Any Hire to classify and pay workers or move new hires onto your internal talent management system. Learn more and start engaging contract-to-hire talent today.

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This article is intended for educational purposes and should not be viewed as legal or tax advice. Please consult a professional to find the solution that best fits your situation.