With this question, your interviewer is trying to find out whether you can focus on the needs of the employer without humiliating the candidate. You don't want to send the employer candidates who are clearly unsuitable, but you want to try to preserve the applicant's confidence, too. One way to answer that question is something like this: "I know this company pretty well, and I just don't think you'd be a good fit for each other. I'll look through all of our other open positions and see if there's a better match. In the meantime, you may want to consider doing X (something that provides either further credentials or additional experience)."