Compensation

How to Use Merit Raises in Your Compensation Strategy

April 10, 2023
November 7, 2023
  —  
By 
Sarah Lindenfeld Hall
Lattice Team

Retaining high-performing employees requires a series of strategies, from strong learning and development initiatives to competitive compensation. In a Pew Research Center survey of US workers about why they left a job in 2021, 63% of respondents cited low pay as a major or minor reason why they left. When it comes to improving pay, one integral tool at organizations’ disposal is the merit raise, giving employees the chance to earn more money as they work toward their goals.

However, there are some essential points to consider when awarding merit raises — as well as crucial pitfalls to avoid. Here’s what you need to know to effectively use merit raises in your compensation strategy.

Key Takeaways:

  • Merit raises are financial rewards for high performance.
  • Merit raises can be impacted by bias if not done correctly.
  • Merit increases help employees feel valued for their work.
  • Planning and communication are essential to implementation.

What Is a Merit Raise?

Merit raises reward employees’ high performance over a set period of time. Merit pay increases should be based on an employee’s performance and role and are usually awarded as a result of an individual’s performance on goals established during their previous annual performance review.

There’s typically some variance when distributing merit pay increases. For example, an organization’s annual merit pool — the amount of money available for pay raises across a company that year — might be 3%. However, top performers who have exceeded every goal might earn 4%, while average performers may get the average merit increase of 3%, and lower performers may take home 2%.

Plenty of employers confuse merit raises with other pay increases, including cost-of-living adjustments (COLA) and pay bumps required to shore up internal pay equity. But these types of pay increases are not the same and need to be approached and calculated differently. Here’s an explanation of each:

  • Merit raise: A merit pay increase is typically issued following the performance review cycle to reward an employee for their hard work over the course of the year.
  • Cost-of-living adjustment: A cost-of-living increase is intended to help counteract inflation, so employees can continue to afford their daily expenses as the price of consumer goods rises.
  • Internal equity raise: A salary increase to ensure internal equity typically comes after a pay equity audit that has uncovered that one class of workers is earning less than another.

While these types of pay increases can all have a place in an organization’s compensation planning, merit raises are a good choice for those looking to implement a pay-for-performance plan. But before implementing these practices, managers and people teams need to be mindful of both the benefits — and bungles — of doling out merit raises.

Pros and Cons of Merit Raises

According to a Gallup workplace survey, workers who feel they aren’t “adequately recognized” for all that they do are twice as likely to quit within a year. A merit pay system is one way to recognize and reward workers’ performance, which can boost employee morale at your company and lead to better employee retention.

“As long as you’re using the merit [raise] appropriately and it’s transparent, it can definitely boost productivity [and] performance,” said Jodi Brandstetter, founder of and lead facilitator for By Design Brainery, an online learning platform for HR and talent professionals. “It’s something that employees are excited to get.”

Merit Raise ProsMerit Raise Cons
  • It can boost productivity and feelings of recognition. Rewarding high performers helps retain them.
  • Unconscious bias can influence decisions.
  • Without a process, runaway pay disparities can emerge.

But unfair distribution of raises can reduce the efficacy of this merit pay model. If managers aren’t deliberate with their evaluations, unconscious biases might lead them to dole out merit increases unfairly. For instance, managers may unconsciously favor people who look like them. Moreover, recency bias could result in a manager awarding a better merit increase to an employee who just finished a complex project than to someone who completed a similar project earlier in the year.

“As HR professionals, we’ve got to reach out and make sure managers are aware of those biases and teach and talk to them about them,” said Courtney Berg, founder and owner of HR consulting firm CourtSide Consulting. If biases aren’t addressed and corrected, merit raises could be used unfairly to reward employees for things other than their work performance.

Merit Raise Methodology 

Once you’ve made managers aware of the pitfalls that can crop up with performance evaluations, you’ll need to ensure that they’re fairly and equitably evaluating employees. Here’s how to scrub as much bias from the equation as possible and get your merit raise methodology right.

1. Determine eligibility.

An organization’s compensation philosophy may not involve distributing raises in the same way to every employee. Some senior employees may earn stock options based on the growth of the company they helped lead in the past year. Others, such as salespeople who earn compensation beyond a base salary, may earn a higher sales commission for strong performance. And others, such as individual contributors or junior-level employees, may qualify for merit increases without having to ask for a raise.

Eligibility policies can vary widely, depending on each organization’s roles and needs. But whatever your policy is, it’s essential to clearly spell it out.

2. Establish merit metrics.

Employees are typically evaluated on both objective and subjective criteria, and performance reviews usually include specific targets that individuals must meet or exceed to earn a merit raise. For instance, key performance indicators (KPIs) for a salesperson would include hitting specific sales numbers, while a recruiter, Brandstetter noted, may be evaluated on the length of time it took them to fill roles. On the more subjective end, the salesperson may need to demonstrate that they can communicate effectively internally, while a recruiter might have to improve their relationship with a hiring manager

When Brandstetter was a manager, she used a scorecard, or performance management system, that included metrics, feedback, survey insights, and other data to monitor employees’ performance, accolades, and missteps. Brandstetter said that reviewing the scorecard monthly with employees helped enable consistent communication and keep direct reports apprised of whether or not they were on track to hit their goals.

Then, once it was time for their performance reviews, employees already had a good idea of how well they’d done. “It wasn’t a shocker if someone scored a two instead of a three or four on something,” Brandstetter said. “They already knew they were going to score that because we had that consistent dialogue.”

3. Grade the goals.

Once goals are set, it’s important to connect them with how they’ll impact a merit raise. When evaluating employees, Berg likes using a 100-point scale, assigning points to each goal. If the employee earns 100 points, they get the highest raise available. If they earned 75 points, they get 75% of the raise available, and so on. 

How points are assigned to an employee will depend on the role. For a salesperson, 90% of their merit raise might be based on achieving their objective goals, and 10% would be distributed based on how well they met subjective goals, Brandstetter said. For other roles, the subjective goals may be weighted more heavily.

4. Check for fairness and consistency.

To ensure that merit raises are distributed fairly, assign an individual, often an HR leader who is aware of how biases can creep in, to review all merit raise decisions, advised Berg. That individual can evaluate whether one manager gives higher raises across the board than another, for instance. This review process could also uncover biases that lead to certain classes of workers receiving higher raises than others, she said. Berg pointed out that having this type of oversight in place will help avoid biases in the merit increase process — or at least, identify and correct them as soon as possible.

Explaining Merit Raises to Your Team 

Discussions about money can be tricky to have with employees and can lead to concerns about unfair pay practices if not handled correctly. That’s why it’s critical to inform all employees about your company’s processes and policies around merit increases. Here’s how to explain merit raises to your team.  

1. Include it in your company’s compensation philosophy.

Every organization should have a compensation philosophy that explains the guiding principles behind how employees are paid. And, while there are a lot of factors to include in any compensation philosophy, how employees can earn bonuses or raises shouldn’t be overlooked, said Kimberly Prescott, founder and president of human resources consulting firm Prescott HR.

Compensation philosophies are generally based on company goals. So, for businesses that signal through their goals that they aim to reward top talent for their hard work, a merit raise naturally fits in with this objective. A “really clear and transparent compensation philosophy,” Prescott said, is an important way to explain the reasons why companies make any compensation decision — including merit raises — to team members.

2. Put it in writing.

Clearly explain the basis for making merit raise decisions and any metrics that are considered, beyond how well an individual employee is doing. This might include a disclaimer that merit raises aren’t always guaranteed, and are only offered when the business is doing well, said Shannon Curtis, a human resources business partner for HR consulting firm Employers Advantage.

“If you’re going to create a scenario where you’re offering employees merit raises, I would recommend writing out the reasoning [and] decision-making behind it, so you can reference that any time you’re considering whether or not to offer someone a merit increase,” advised Curtis.

This will not only help managers make fair decisions but will also help employees understand why decisions were made. If an employee is dissatisfied with their merit increase (or lack thereof), their manager can point to specific, documented policies that informed the decision.

3. Keep the conversation going.

It’s important to keep an employee’s progress toward their goals at the forefront of regular check-in conversations between employees and their managers, Berg explained. To keep merit raises in mind during one-on-ones, managers could ask their direct reports questions like:

  • “What accomplishment are you most proud of since we last met?”
  • “What goal have you achieved or moved toward in the last week or month?”

If an employee’s performance review goals have been part of ongoing conversations during weekly one-on-ones with their managers, no merit raise decision will be a surprise because it’s been top of mind all year.

It may take some additional effort, but making sure to have clear communication about merit raises and how well employees are doing throughout the year pays off in the long run. With happier and more motivated workers, there’s a return on investment for the company, too. “You’re going to have increased employee engagement [and] increased employee satisfaction,” Berg said. “And [your employees are] going to see all this transparency and see that you’re doing everything you can to help them succeed. And that’s going to increase employee loyalty.”

‍Need an effective way to tie job performance with compensation and drive employee engagement and retention? Request a demo of Lattice Compensation today.