To keep a company running smoothly, you need the strength and initiative of all employees, managers and teams. As an HR leader, the importance of your organization’s people may feel obvious. But with the day-to-day responsibilities of running a company, it’s easy to get wrapped up in the big picture or long-term goals. You’re employees are the reason your company is up and running — so how can you show them gratitude?
Money isn’t the only way to say thanks, but merit based pay increases are a tangible way to reward your employees for their hard work.
What Is Merit Pay?
“Merit pay is another way to say, ‘pay for performance’,” said Kristi Hummel, chief people officer at Boston-based edtech company SkillSoft. “Merit pay can be reflected as an increase in base salary. It can also be administered as a bonus.”
Merit pay isn’t just a meaningful way to recognize your employees’ past performance — it can also be a powerful motivator. Recent studies show that around 70 percent of younger employees say merit-based rewards would keep them at their current roles for another year. If you’re struggling with higher than normal turnover rates, a merit pay program could help you attract and retain loyal employees. Merit pay is also perhaps the most direct way to show your employees that you value their efforts and what they bring to your company.
“Merit programs are very popular,” Hummel said. “They’re a way to extend loyalty to employees, reward those that are driving value, and ultimately help an organization meet its goals.”
Handing out rewards for good performance might seem pretty straightforward, but adopting a sustainable and successful merit pay model requires a lot of moving parts. Here’s how leaders in HR recommend getting your merit pay program started.
What Is Merit Pay?
When it comes to compensation, plenty of factors are at play. There are company budgets, federal and state regulations, and market rate standards to consider. Salaries can be adjusted to meet cost of living increases and a raise in base wages, but they’re also decided by how well an employee does their job.
“Traditionally, merit pay is synonymous with pay for performance,” said Gia Ganesh, VP of culture at Atlanta-based healthtech company Florence Healthcare. “A higher performing employee is rewarded more than an average or low performer.”
Unlike market or equity adjustments, the terms of merit pay increases are determined mostly by the employer. The merit pay model gives managers a lot of freedom to decide why and how they reward good performance, as well as what good performance looks like. Promotions, salary bumps and bonuses are all types of merit pay, which employers can offer as a thank you to folks who exceed expectations.
“There isn’t a set standard, but if an organization is adopting a merit-based philosophy, there should be differentiation between performers — otherwise they are not applying their philosophy the way they intend,” Hummel said.
Determining Merit Pay
Rewarding achievements is a no-brainer, but figuring out the intricacies of allocating equitable merit pay can get complicated. To build a merit pay system that truly works, here’s what you should keep in mind.
- Set expectations: Let your employees know exactly what good performance looks like so they know what they’re striving for.
- Analyze the market: Determine your company’s budget, market rates for certain roles, and the cost of living index so you can factor them all into your merit pay system.
- Be fair: Train your managers and conduct compensation equity audits to reward merit fairly.
- Crunch numbers: Create a system for different performance tiers and find appropriate percentage increments to match them.
- Communicate with employees: Show your employees how their performance factors into their merit pay and let them know how they can improve.
Merit pay models give leaders a lot of leeway to define and measure good performance but they still need to be able to explain what their expectations are and how employees can live up to them. The first step in adopting a merit pay system is letting employees know what they can do to earn merit recognition.
“Success in a role needs to be clearly articulated up front,” said Hummel. “If team members don’t know how their performance is being measured, how can they truly focus on high performance?”
Informing your employees about what constitutes success in their role means that you must not only explain the tasks and projects expected of them, but also keep them aligned with greater company goals and objectives. Numbers and quotas are a great concrete way to measure performance, but just as important are how employees embody company values and how they contribute to company culture. These are all factors that come into play when determining whether an employee has earned a merit increase or not.
“You cannot pay for performance without establishing what good performance looks like and reviewing performance,” said Hummel. “Transparency, education, and expectation management are key here, and employees should be fully aware of the company strategy.”
Analyze The Market
As mentioned above, merit pay is only one component of an employee’s overall compensation package. It may be distinct from market or equity compensation, but it cannot be decided in a vacuum. People leaders have to incorporate an understanding of market rates, as well as their own limits as a company, in order to fairly determine merit pay.
“If you are not paying at market — introducing merit may not have the intended impact,” Hummel said. “An employer needs to set their total budget and then make a determination of how they are going to differentiate that budget across performance levels.”
According to the Department of Labor, the Fair Labor Standards Act doesn’t have any requirements for companies looking to adopt merit pay, but keeping market standards and regulations in mind will make sure that you distribute merit increases fairly. Ganesh adds that keeping track of market compensation and cost of living trends helps employers keep their merit pay plans sustainable and reasonable within their budgets.
“Although these components are different, oftentimes they can be clubbed together and administered at the same time,” she said. “This may be done to reduce the complexity of frequent pay adjustments.”
Merit pay shows gratitude for a job well done, but it does have its pitfalls. Critics of merit pay say that, because the system isn’t standardized, it leaves a lot of room for bias.
If certain people get more recognition for their performance than others, internal politics and equity issues will be exacerbated. For instance, a study by the University of Illinois Urbana-Champaign showed that among 400 companies, the gender compensation gap was greater at organizations with merit-based employment practices than at companies without.
“A company’s DEI strategy needs to be rooted in all aspects of employment practices,” Hummel said. “Taking both market based objective research and communicated merit standards into consideration also helps to make sure your decisions are rooted in equitable practices.”
If you’re considering implementing merit pay at your company, prioritizing equity is crucial. Conducting a pay equity audit and training your managers to center DEI in their leadership practices are good first steps to head off any bias that might occur in a bonus or merit raise program.
Once the plan for merit pay has been decided upon, leaders and managers will have to work together to determine the terms of eligibility and the appropriate increase rates. Ganesh recommends introducing a three point structure to sort employee performance: exceeding expectations, meeting expectations, falling short of expectations. Each tier correlates to a percentage pay increase. For example, employees who exceed expectations might see a seven percent increase, while those who only meet expectations will receive a five percent salary increase.
The managers get to determine how to distribute the amount allocated to them based on individual performance of team members,” Ganesh said. “Then they work with payroll to get the raises or bonus amounts handed to employees.”
Communicate With Employees
After evaluating your employees’ performance and determining that they qualify for a merit increase, the next step is to inform them about the adjustment. Usually the ideal time to do so is during the review period — you’ve had several months or even a year to assess their performance and can tie their potential pay increase explicitly to how well they’ve met expectations.
“Merit pay increase is to recognize strong performance — the conversation should be a positive, encouraging message,” Hummel said. “It is helpful for employees to understand how their performance was measured, so they can sustain and continue to work towards achieving performance. It’s also important to share with all employees how their performance will be measured in a merit system.”
Offering merit-based compensation can be a way to reward employees for their impact at the company. But bonuses and paycheck increases aren’t the only way you demonstrate gratitude. Recognizing your employees for their hard work should happen year round, not just during performance reviews or salary conversations.
“While merit pay is important, components such as belonging and inclusion must be taken into consideration,” Hummel said. “Leadership and HR support is critical here. An organization is only as effective as its managers.”