The Advantages and Disadvantages of Merit Pay

Merit Pay Rewards Employee Performance and Contribution

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Merit pay is an approach to compensation that rewards the higher performing employees with additional pay or incentive pay. Merit pay has advantages and disadvantages for the employees and the employer.

But, all-in-all, merit pay is the best way to reward the employees that you most want to keep. Merit pay sends a powerful message about what you want to recognize and reward employee efforts and contributions.

Making the range of the available merit pay public allows your employees to see where their increase falls in the merit pay ranges established by your company pay plan. This reinforces the actions and the behaviors that you want to see more of and increases the likelihood that employees will strive for the best merit increase for the next company year.

When employees hold conversations with their supervisors about their top merit increase, they learn all of the contributions and actions that are most valued by the organization. This is tremendously affirming and reinforcing.

With employees who received less than the top increase, the supervisor has the opportunity to describe and discuss exactly how the employee will need to improve his or her performance to qualify for the top merit increase during the next cycle of raises.

Here's more about why you might want to consider merit pay and the disadvantages and challenges inherent in a pay system that focuses on merit increases.

Advantages of Merit Pay

These are reasons why you might want to consider merit pay.

  • Merit pay helps an employer differentiate between the performance of high and low performing employees and reward the performance of the higher performers. This is a retention effort because no employer wants to lose the organization's best performers.
  • Merit pay, unlike profit sharing or similar bonus pay schemes, allows an employer to differentiate between the performance of the company as a whole and the performance of an individual. While many merit pay programs also provide an overall reward that is distributed to all employees, to promote such values as teamwork, coworker positive relationships, and effective customer service, a portion of the available compensation is reserved for strong performers.
  • Merit pay also provides a vehicle for an employer to recognize individual performance on a one-time basis. This is useful for rewarding employees who may have participated in a one-time project such as implementing a new HRIS or opening up a new sales territory.

Disadvantages and Challenges Inherent in Merit Pay

These are the challenges employers experience with merit pay.

  • There is no way, with 100% accuracy, to differentiate the performance of various employees to determine who is most deserving of merit pay. The most desirable accomplishments and contributions are almost never measurable so the manager's or supervisor's opinion remains a constant in determining merit pay. If you use only items that you can measure, you're not considering the most important aspects of your employees' jobs.
  • The amount of time and energy that organizations invest in an attempt to make performance measurable for merit pay, including developing competencies, measurements, baselines for performance, and so forth, is better spent on delivering service for customers. I have seen documents with several hundred pages that lay out what merit means in various jobs. How can this be a good use of your time?
  • Given the limitations of metrics, the ability of the supervisor to communicate to each employee the value of his or her contribution, and what superior performance worthy of merit pay entails, is an ongoing challenge. Some supervisors communicate better than others and communication about what entails superior performance is easier in some jobs than in others.

Even with the limitations that exist in the awarding of merit pay, merit pay is your best opportunity to ensure that your outstanding performers remain with your company and continue to make their astonishing contributions.

No system is ever a perfect system.

Training you managers and supervisors in how to document performance, how to communicate a pay increase, and in how to set clear expectations is the best place to start to create a fair merit pay system.

But, remember, most importantly, nothing demotivates a high performer faster than knowing that the employees who have contributed much less in the organization, have received the same pay increase or bonus. Don't go there.

Also Known As variable compensation, variable pay