Merit increase

The degree to which employees feel recognized for excellent work can significantly influence their decision to stay with an organization or pursue other opportunities. This dynamic might sound like employee retention 101, but some employers misunderstand or misuse performance-based recognition. They rely solely on promotions as a motivational tool without considering what their people actually want. An alternative incentive that resonates more effectively with some employees is the merit increase.

What is a merit increase?

Raising an employee’s hourly wages or annual salary based on performance is known as a merit increase. It can help employers improve employee productivity, engagement and retention. To be eligible for a merit raise, workers usually must meet or exceed certain pre-established criteria or goals, e.g., a sales quota.

Merit increase vs. raise

Merit increases are generally based on an employee’s performance or other established criteria. Pay raises, in contrast, may be awarded when an employee changes positions or approaches a length of service milestone.

Cost of living adjustment vs. merit pay increase

Cost of living adjustments are increases in pay or benefits not contingent on performance. They are typically issued to adjust employee wages for inflation or to more adequately compensate an employee who relocates to a region where the cost of living – housing, fuel, food, etc. – is high.

Is a merit increase the same as a promotion?

Merit increases and promotions both can be used to reward employees for high performance. However, the two don’t always go hand-in-hand. A merit increase without promotion is a lateral incentive, whereas a promotion is always a vertical incentive.

Why do merit increases matter?

Increased turnover, employee dissatisfaction and lack of engagement can occur when an organization does not effectively reward high performers. Conversely, employers who use merit increases as part of their compensation strategies may be able to retain top talent and prompt poor performers to improve or discover different opportunities.

Pros and cons of merit-based pay models

Merit increases can motivate employees to perform their best each day, but they can also lead to competition within the workforce. Employers should be careful not to let performance-based incentives hinder their teams from collaborating on shared business goals.

Advantages of pay for performance

• Employees who know they will be rewarded for achieving their goals are typically more likely to go the extra mile and be more productive.
• Offering high-performing employees merit-based pay raises may increase their job satisfaction and entice them to stay with the organization.
• When touted publicly, pay for performance may attract hard-working candidates looking for jobs with progressive monetary incentives.

Disadvantages of pay for performance

• Pay for performance can increase stress and frustration among employees who miss their goals, potentially leading to higher turnover.
• Merit increases sometimes create an atmosphere where employees only focus on their own performance and not the bigger picture, i.e., shared company objectives.
• Even if pay-for-performance is based on objective criteria, managers typically have some discretion in how much employees are rewarded and could exhibit bias.

How to implement merit increases

Rolling out a successful pay-for-performance program comes down to balancing competition and collaboration. It’s not always easy, but these tips may help:

Design effective competition

Instead of competing against each other, employees should be encouraged to compete against their own performance. For example, workers might receive a financial reward when they exceed previous success rates, e.g., sales closed, goods produced, etc.

Set different expectations for different departments

Monetary incentives may make sense for some departments more than others, e.g., sales vs. public relations. It may help to survey employees from different teams to see whether they’d prefer more or less pay-for-performance incentives.

Measure program effectiveness

When launching an incentive program, employers should identify what they want to accomplish and track progress against a clear benchmark. If turnover starts to increase, it could be a sign that the competition has gotten too stressful.

Use compensation benchmarking

Compensation benchmark data can offer insight on how to manage merit increases. By leveraging real-time information, employers can identify the appropriate market rate for each internal position.

Self-audit pay practices

Employers may also want to review how much discretion managers have in determining an individual employee's pay raises and apply checks and balances to promote pay equity.

Communicating merit increases

It’s essential to document the rationale for merit increases and ensure that employees understand how their performance impacts their compensation. Including surveys in the communications can help employers gather employee feedback about the pay structure and make improvements.

Pay for performance can also be touted publicly in marketing materials and job postings as a recruitment tactic. Doing so may attract candidates who want to work for an organization that recognizes people for outstanding efforts with competitive compensation.

How to use technology to manage merit increases

Software solutions with compensation management features can help employers fine-tune their pay-for-performance strategies. Depending on the provider, capabilities may include the ability to:

• Define merit increase guidelines that reflect the organization’s compensation philosophy
• Drive a pay-for-performance culture by linking employee performance with compensation
• Reward top performers accurately and easily using percentage increases or lump sums
• Set and manage compensation budgets via a “bottom-up” or “top-down” approach
• Give managers access to the compensation planning progress for all direct and indirect reports
• Communicate merit increases quickly and easily through employee self-service

Alternatives to merit increases

Promotions are another common method of recognizing employees for performance. However, employers must be careful not to upset the status quo of employees who enjoy their work and want to continue to excel in their current roles. Rewarding them with a new position that fundamentally changes their day-to-day could cause dissatisfaction and turnover.

In some cases, competition amongst employees – be it for a merit increase or promotion – isn’t desired. The alternative might be to offer non-monetary incentives or group rewards, like an office party. This way, employers can motivate employees without the intense pressure that occurs when raises or promotional titles are at stake.

How to calculate merit increases

Employers can create a matrix for calculating merit increases. It may account for the following:

• Compensation budget
• Benchmark data
• Compa-ratios
• Rating scales
• Performance reviews

Frequently asked questions about merit increases

Who should get a merit salary increase?

Merit increases are designed to reward employees who meet or exceed pre-established performance goals. They can be an effective motivational tool for departments where performance is easily quantifiable, e.g., sales.

Who is usually involved in merit increases?

Merit increases involve more than just employees and the managers who directly assess their performance. HR professionals usually play a role in designing pay-for-performance rewards, and accounting or finance departments may be consulted on compensation budgets.

This article is intended to be used as a starting point in analyzing the merit increase meaning and is not a comprehensive resource of requirements. It offers practical information concerning the subject matter and is provided with the understanding that ADP is not rendering legal or tax advice or other professional services.