What Is a Merit Increase and Why Does It Matter?

It’s important to show your appreciation to employees for a job well done. One of the best ways to show your appreciation is with a pay increase, but not all raises are created equal.

From incentive bonuses to yearly pay raises, there are a lot of ways to give your employees a raise. None are as effective at driving employee performance and thanking them for their hard work as a merit increase.

Performance and compensation management often go hand-in-hand, which is where we come in. At PerformYard, we know a thing or two about using performance management software to determine merit raises.

Interested in learning more? Here’s everything you need to know about what a merit increase is, how it works, and how to implement merit increases in your business.

What is a Merit Increase? 

A merit increase is a type of salary increase that's used as a reward for high performance. It is given to those who meet a certain set of criteria as a way to reward them for their hard work and motivate them to continue working hard.

A merit raise also has the potential to be competitive, as only the highest-performing employees may receive the raise. It doesn’t have to be competitive, though. For example, if each employee has their own goal and everyone meets that goal, they could all receive a merit raise.

It is important to mention that a merit pay increase is different from other types of pay increases, even if the result of giving more money to employees is the same.

For example, cost-of-living adjustments (COLAs) are given to employees to ensure their pay keeps up with the rate of inflation or if they relocate to a more costly area for work. It is not tied to performance.

There are other types of performance-based pay increases, but they aren't tied to salary. Equity grants are often issued as stock options that encourage employees to help the company grow because in doing so, the company's stock price will increase. Incentive bonuses are one-time payments made to employees for a job well done.

You can also offer skill-based increases. Instead of being tied to the outcome of performance, it is tied to the acquisition of new skills.

An annual pay raise is a common strategy among businesses that want to simplify the process of giving out raises. Instead of basing a pay increase on performance, it’s based on time spent at the company. In this case, everyone on the team may receive the same salary increase after annual reviews are complete.

Why Start a Merit Increase Program?

With so many different types of raise options to choose from, why opt for a merit increase?

There are a few reasons why companies choose a merit increase program which include:

• Reward employee achievement
• Promote skill development
• Boost morale and productivity
• Retain talent

Reward employee achievement

According to Gallup, the importance of getting an increase in pay among employees has risen from the number four spot in 2015 to the number one spot today. Giving a merit increase is a great way to reward employee achievement with something they want—a pay raise.

Although there are many ways to recognize employees for doing a good job, few are as appreciated as an increase in their current salary. It’s a tangible way to thank them for achieving their goals and encourage them to continue achieving their goals in the future.

Promote skill development

The world of work is evolving at a rapid pace. To stay competitive, employees have to keep up, which means learning new skills.

You can encourage them to continue learning and evolving with merit-based increases in pay. When employees know they will receive a merit increase after meeting certain goals, they will be encouraged to learn the skills and acquire the knowledge they need to meet those goals.

Boost morale and productivity

A merit-based pay increase is a great way to boost employee morale. It can increase employee satisfaction too. In one study, 87% of employee respondents reported that meaningful recognition impacts their job satisfaction. It also improves their engagement and productivity. 

When employees are recognized for their contributions, and they are recognized in a way they appreciate with an increase in their pay, they are more likely to do their best every day. It also has the potential to create a culture of achievement. Employees know that if they show up and do their best, they will be rewarded for their efforts.

Retain talent

Employee retention is important because turnover is costly. It can cost up to twice an employee’s annual salary to replace them. Not to mention the impact a high turnover rate can have on morale and employee satisfaction.

When more pay is the top reason why employees look for another job, it becomes obvious how powerful merit increases can be. When employees know they have control over their income and will receive a pay increase for doing a good job, they are less likely to look around for a new job.

How Does a Merit Increase Work?

So, how does a merit increase work? It's pretty simple. If it's determined that an employee has earned a merit increase, you simply increase their base salary by a certain percentage. For most businesses, the average merit increase is somewhere between three and four percent.

How much you settle on will depend on a couple of factors:

• Experience
• Seniority
• Role significance
• Industry standards
• Company budget
• Performance

Experience

First, you'll want to consider experience. Even if you have new employees, if they bring a lot of experience to the table, you'll want to consider giving them a higher merit increase so they aren't tempted to look for a new role with a different company.

Seniority

You don’t want to base a merit increase solely on seniority, as it doesn’t reflect performance, but it’s still something you should consider. There is a lot of value in having an employee on your team who knows the ins and outs of your business. It’s important to consider their contribution over the long haul when deciding on a merit increase.

Role significance

Some of your employees have a more direct impact on your bottom line. Without them, your company simply wouldn’t be successful. Because of the importance of their role, you might decide they deserve a higher merit increase than entry-level positions.

Industry standards

You’ll want to consider industry standards too, so your merit raises are competitive. It’s a great starting point if you have no idea how much to offer, but it can also help reduce turnover. When employees can expect a decent raise while working at your company, they won’t be looking to work for another company that offers bigger raises.

Company budget

Your budget is also an important consideration. Keep merit raises flexible instead of choosing a rate and sticking with it long-term. For example, you might have to choose a lower rate of one or two percent until profits go up and you can increase merit pay to three or four percent.

Performance

And of course, a merit increase is tied to performance. Performance review software can make this easier. It helps employees track their performance to see if they're in the running for a merit increase, and it can help them determine what to do if they're not.

It is also helpful for human resources. With HR analytics software, you can track the numbers and make sure everyone who deserves a raise according to your criteria gets one.

Pros and Cons of Merit-Based Pay Models

As is the case with any system or strategy, there are some cons to a merit-based pay model.

Demotivation can be a problem, as low performers will feel like they’re being left behind. It can breed resentment and end up encouraging lower performance instead of high performance, as some employees may feel like they aren’t going to get a raise anyway, so why bother working hard?

You have to be careful about subjectivity during performance evaluations. You don’t want a merit increase based on a manager’s opinion of those they manage. The criteria have to be based on subjective measurements so employees don’t feel like their managers are playing favorites.

Planning for and executing the elements of performance management can be time-consuming. It requires a lot of resources to implement an effective and evolving performance management strategy. When you have the right strategy in place, though, the benefits of performance management and implementing a system of merit increases far outweigh the cons.

The pros of merit-based pay models include:

• Focus on performance: Employees want to feel like the company values their contributions. Because a merit increase focuses on performance, eligible employees who receive the raise will know their efforts are appreciated.
• Rewards high performers: Your highest performers have the biggest impact on your business. You can reward them for all their hard work, encouraging them to continue working hard, with a merit increase.
• Transparency and fairness: Having a system of merit pay promotes transparency and fairness. Employees know exactly what goals need to be achieved within a certain time frame to receive the pay raise.
• Talent retention: Employees know that if they work hard, they will receive a merit increase for their efforts. When they know their hard work will pay off, they don’t have to look for another place to work that will better appreciate their contributions.
• Cost-effectiveness: Annual and seniority-based raises can be costly when those raises go to low performers, especially if raises are handed out across the board. Merit increases enable you to focus on increasing pay for your highest performers only, making it a cost-effective strategy.

When you strategize carefully, the advantages of a merit increase far outweigh the drawbacks. The trick is to figure out a strategy that works for your organization and implement it carefully.

Guidelines for Implementing Merit Increases

Just offering merit increases isn’t enough. The process for earning and receiving a merit increase has to be strategically designed to get the most benefits.

A merit increase is more likely to be effective when you plan for:

• Clear communication of criteria and process
• Consistent application of criteria
• Transparency in decision-making
• Avoidance of favoritism or bias
• Establishment of an appeal process
• Offering support
• Software to keep track of performance

Clear communication of criteria and process

For merit increases to work, the criteria employees have to meet to get that merit increase have to be extremely clear. The process should also be laid out clearly. When there are no surprises, employees are less likely to be disappointed if they don’t earn a merit raise. They will instead look for solutions so they can receive a merit raise next time.

Consistent application of criteria

No matter what the criteria are, it must be applied fairly and consistently, regardless of the employee. It means employees are more likely to trust the process, and it ensures that the merit increases you offer to employees are fair.

Transparency in decision-making

Employees should know that merit raises are on the table, as well as exactly how much they could earn, but they should also be filled in throughout the decision-making process. If only a certain number of merit increases will be handed out, explain why. If amounts will vary depending on performance, explain your reasoning. You want the decision-making process to be clear so there is no confusion or misunderstanding.

Avoidance of favoritism or bias

By creating clear criteria and applying them consistently, you can help avoid favoritism or bias. It can also be helpful to have another manager or a member of HR compare employees to criteria to avoid potential favoritism and bias from direct managers.

Establishment of an appeal process

No matter how well laid out and transparent your process is, there will likely be employees who feel they were unfairly denied a merit increase in their salary. Make sure you establish an appeal process so those employees have an outlet. Then, make sure they’re fairly heard and the reason for the decision includes factual information to back it up.

Offering support

It’s also a good idea to have a plan in place to offer support. That might mean offering support during the process to help employees stay on track to earn their merit increase. You might also come up with a plan of support for employees who didn’t earn a merit increase but want help to earn it next time. Strategies could include professional development opportunities, or you could set up an employee mentorship program.

Software to keep track of performance

Performance is closely tied to merit increases. Using performance review software can be helpful because it enables you to accurately track performance which can impact whether or not an employee earns a merit increase. It also gives employees the chance to check in and see how they’re doing so they can adjust their performance accordingly.

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The PerformYard Advantage

If you're looking for software that will help make the merit increase process easier, look no further than PerformYard's performance management software. It includes features that will help you manage merit increases, like:

• Performance evaluation tools that let you track certain behaviors and goals over time
• Budget allocation and tracking to help you determine merit increase amounts
• On-platform messaging that offers transparency to employees

It's a flexible platform too. Its continuous feedback software ensures employees are in the loop about their performance in real-time. You can also develop effective self-review questions so employees can offer their input about their performance.

Want to see how it works? Download the PerformYard demo and give it a try today!

Ready to Create a System for Offering Merit Increases?

Implementing a system of merit increases can be a great way to reward employee achievement, boost productivity, and retain your best talent, as long as you create a fair and transparent system.

You can do that with PerformYard. Check out some of our performance review examples that will help you assess performance so you can offer merit increases fairly. Then, learn more about PerformYard to discover exactly how our software can help you create a system for awarding merit increases.

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