Why merit pay

In the early s, scientists realized that even though people are rational and make their own decisions, incentives and deterrents can influence their actions. The first time this theory was applied to employee compensation was in Newton, Massachusetts in Through the following decades, employers used various ways to determine pay increases—usually some combination of seniority, merit and predicted increase in living costs.

By the s, merit pay had become a common way for employers to manage employee raises. A company using merit pay establishes a set of criteria to measure employee performance.

The company also creates a schedule for reviewing employee performance against those benchmarks, usually with check-ins scheduled at monthly or quarterly intervals leading up to the review date. Employers also determine the dates when merit pay increases go into effect for each fiscal year. For merit pay to be a successful compensation approach, a company must be able to produce accurate, detailed data to measure employee performance.

Related: What Is a Reasonable Raise? Most companies establish a percent scale for merit pay. They usually offer employees a small percentage of their existing salary or pay rate. It's common for a department or business unit to allocate its overall percent increase according to employee performance during their merit evaluations.

The only way to know if a potential employer offers merit pay is to ask. Once hired, employees can access the specific policies and procedures a company has in place about merit pay increases in their employee handbooks. Since companies may test different approaches for pay increases, employees should always stay current in their knowledge of their company compensation policy.

Companies may choose merit pay as their compensation model based on its potential benefits. These advantages include:. While merit pay can have many benefits, there are also a few potential drawbacks, such as:. Find jobs. Company reviews. Find salaries.

Upload your resume. They are especially important for retaining top performers. Merit pay is also a key factor in recruitment. A good merit pay program gives employees the tools, incentive, and feedback to strive for results and improvement. That translates to stronger results and a stronger company.

Merit pay also has many drawbacks that can reduce or even erase its benefits. Here are four disadvantages to consider when weighing merit-based compensation. While some goals can be boiled down to measurable key performance indicators KPIs , many aspects of performance are subjective. Soft skills such as communication and teamwork are not measurable, yet they're just as critical to your company's success as technical competence. Finding objective ways to reward those skills can be challenging.

Employee performance is even harder to properly quantify and measure. All too often, employees feel their ratings are arbitrary, inaccurate, or unfair. Inconsistency from manager to manager can further call the fairness of your system into question. Many companies have addressed this by eliminating numeric ratings from performance evaluations , but the bottom line still comes down to numbers when you translate all that feedback into merit-based raises.

Merit pay can encourage employees to focus too tightly on the goals they're being rewarded for. This can limit their ability to explore new ideas and develop their full potential. For example, a shop floor supervisor whose merit increases are tied to productivity could overlook opportunities to improve safety or quality. Competition can be healthy. It can also destroy a team or a department. An annual trip to Cancun for your top salespeople is great, but employees who miss the mark may feel cheated.

Is their territory less desirable? Are they getting an even chance at the best leads? Even private performance reviews can become a point of contention if employees compare notes on their raises. We're only human; coming in second, or tenth, hurts. On the flip side, rewarding poor performers at the same level as other employees can demotivate high achievers. Studies confirm merit pay and other PFP programs can improve employee performance, so, imperfect as it may be, linking pay to performance makes sense.

Tying employee goals to company performance is a proven tactic for enhancing performance and building faith in your pay practices. Use measurable KPIs where you can. For example, instead of rating customer service from "outstanding" to "needs improvement," you could set a bar for positive reviews received or tickets closed within 24 hours. Your system won't be perfect — they never are — but the more you can connect performance to measurable company goals, the better it will be received. Are you investing in employee training and development?

Employees want to learn and grow at work. Giving them opportunities to upskill and improve is critical to helping them achieve company goals. Performance reviews should consist of a cycle of check-ins and feedback throughout the year, not just an annual summit. Employees who receive frequent feedback are more likely to stay on track and to feel their reviews are fair.

Managers also need coaching and development. Many front-line supervisors are promoted into those positions with little experience in performance management, yet they're the foundation of your program.

Make sure your leaders are equipped to use your pay program consistently and fairly to drive their teams' performance. If your pay system is too complex, it will be cumbersome to administer and confusing to employees.

Focus on a handful of goals to connect to compensation. Your pay scales and raises also need to be finely calibrated: differentiated enough to reward high performance, yet not so broad as to feel unfair. Involving employees in setting goals and KPIs for their positions encourages buy-in to your performance management system. It's also a great strategic exercise. As with any human resource HR practice, your system needs enough flexibility to allow for manager discretion.

Some companies have implemented innovative variable compensation plans in lieu of simple merit awards. Using HR software such as Zoho People to administer pay and performance management can save managers and HR staff time on routine paperwork. It can also enhance the accuracy and fairness of your performance review system.

Software makes it easy to send out surveys and gather feedback efficiently. HR software can also provide workforce analytics and other insights to inform your pay strategies. For all the talk about ditching performance reviews and annual merit increases, it's hard to imagine a system to connect pay with performance that doesn't rely on some version of these time-tested practices.

But those tools are yours to adapt to fit your company's unique culture and goals. The key is to get input from your staff, look for new ideas, and keep on tweaking until your system truly serves your employees and your company. Knowing how to build a strong virtual team is more important today than ever -- and there are six critical things you must do to succeed. That's why we've created this ultra-timely page report on what you should be doing now to set your virtual team up to win.

Easily save this report to your computer or print it using the link below. You will also receive an email with your download. The Motley Fool has a Disclosure Policy. Zenefits offers a good mix of advanced HR functionality, modern design and user experience, and an easy to navigate user interface. Are you paying more in taxes than you need to?

Every dollar makes a difference, and you can save more of them by taking ALL the tax deductions available to your business. Without detailed and accurate data available to measure the performance of employees, there is room for subjectivity. However, this data vital to fairly assess and compensate your team. When there is not clear and objective data to assess performance, the evaluation is often left to the discretion of a manager.

This can lead to employees feeling that they are not rewarded fairly or discriminated against. The system should have clear and measurable objectives. This makes performance evaluations more accurate and fair. It also makes it less likely for an employee to want to or be able to dispute a performance evaluation. Even when there are performance metrics established, there may be room for subjectivity, which lend room for error, or outcomes to be challenged. Ultimately, it can lead to a considerable amount of time taken and resources spent to find an accurate and measurable program for merit pay.

Some businesses may not be conducive to supply and manage the amount of data necessary, to measure competencies and baselines for performance. It is important to consider each unique business structure and whether it is possible to implement such a system.

Merit pay must be communicated effectively to ensure the purpose of the system. The company goals, mission, and objective must be communicated along with individual or team goals.

It is also vitally important that the reward structure is clearly understood, including potential payouts, KPIs key performance indicators of success, the timelines in which the goals must be made, as well as the methods of which the payouts are calculated.

As the rules and parameters are rolled out and implemented, managers must make sure that they are effectively communicating all aspects of information and changes that are made. This can be done through one on one meetings and performance reviews, the company website or database that employees can have access to, through new staff orientation, and all staff meetings.

A continual conversation about the program as well as allowing for an employee review of the performance assessments will lead to overall higher morale. It is imperative that each individual is heard and has all the potential questions answered.