How to Start a Merit Increase Program

Any company wants its employees to perform their best. When they do, all business processes are smoother, productivity improves, and revenue grows. Merit increases are important because they reward top performers and incentivize employees to work hard.

Like any type of compensation, a merit increase requires careful planning. It needs to be correlated with performance, but also with the market, and your budget. It differs from a pay raise, which can be given to any employee at any chosen time. So let’s take a closer look at merit increases, why they are important, and how to create a good program.

Why are merit increases important?

Merit increases are important because they encourage and incentivize employees to meet performance and productivity targets. They also show that your company values and rewards strong performance, thereby creating a culture that values good work and results. By doing so, you motivate employees to perform better, which in turn yields better revenue, employee retention, and engagement.

Merit increases reward top performers for their hard work. But employees aren’t the only ones who see the benefits. They become a real asset for companies as well, helping them in various ways. They can:

• Encourage productivity;

• Help you track progress and business impact;

• Increase employee engagement;

• Improve retention. 

Let’s dig into each of those benefits in more detail.

Track progress and business impact

To award a merit increase, you first need to track progress and business impact. You’re not only looking at who works the hardest. You want to see who can exceed company goals and by how much. Often, this percentage is taken into account when calculating the merit increase. 

If you’re not already tracking various HR metrics related to employee performance, this is a good place to start. You’ll want to look at both individual performance metrics and people data, but also at the overall business impact.

Encourage productivity and workplace effectiveness

Knowing that a merit pay increase policy exists within the company will motivate employees. It will encourage them to be more productive, reducing procrastination and increasing effectiveness.

Plus, a transparent merit increase program makes it clear what expectations the company has for its employees. People no longer need to guess if their performance is good enough or if they’re going over or under the company goals. 

A quick look at the criteria for merit pay will help them understand what is expected of them.

Increase employee engagement

Employee engagement is one of the key elements in talent retention strategies. A merit increase program can help with that. 

When employees know what goals they need to be working towards, they’re more likely to be active participants in various company activities. This ‌boosts performance and increases productivity.

Improve retention

Last, but not least, merit increase programs improve retention. When you show people recognition and appreciation for a job well done, they’re less likely to leave. Employees stay with companies that value their hard work.

Who should get a merit increase?

Merit increases reward good performance. But does that mean any and every employee who performs well should get one? Not necessarily. There are a few things to factor in:

• The company’s budget allows for merit pay;

• The performance reviews show the employee’s work exceeds expectations;

• The employee’s current salary is within the pay range for their position.

In other words, it is up to the company to decide what they define as a performance worthy of a merit raise. Remember that a merit increase is not the same as a pay raise. 

Pay raises are given at certain intervals to employees regardless of their work performance. They can be related to the cost of living or other factors. Merit increases, on the other hand, are tied to performance and goal attainment.

6 tips for starting a merit increase program

Starting a merit increase program requires careful planning. You need to:

• Analyze metrics to spot stellar performances;

• Define the criteria for merit raises and the number of raises you’re willing to give to each employee over a certain period;

• Establish the formula you’ll use to calculate the merit increase;

• Create a strategic compensation strategy and include merit raises in it;

• Share the program with your employees.

Let’s take a more in-depth look at each step.

1. Track performance metrics

You can’t have a merit increase program if you don’t track any HR metrics. Many feel that looking only at individual performance is enough. While that one metric is great, you might miss the bigger picture. So when analyzing performance, look at metrics such as:

• Productivity;

• Absenteeism;

• Average performance rating;

• Engagement rating;

• Individual employee performance;

• Time to productivity.

Together, these metrics will help you form a comprehensive and objective picture of individual employee performance and that of your wider workforce.

2. Create a strategic compensation strategy

Strategic compensation helps you ensure pay equity and transparency. It helps you stay competitive, attract top talent, and reduce turnover rates. 

Compensation is more than the paycheck. It includes bonuses, overtime pay, vacation days, and any other bonuses. Merit increases must be part of this strategy as well.

Can you have a merit pay program without a strategic compensation strategy? You could, but you’ll face a high risk of failure. Strategic compensation helps you make sure your merit pay strategy is competitive and effective.

3. Define the criteria

The next thing you should do is define the criteria for the merit increase. You don’t want to make it impossible for people to achieve these goals. If the requirements are too difficult to fulfill, people will soon feel you’re asking too much. This will increase dissatisfaction and might even lead to attrition.

Respect people’s work-life balance and don’t set requirements that might force them to work overtime if they want merit pay. You want to set goals that motivate, not ones that lead to disappointment.

4. Plan the maximum number of merit increases an employee can get

The budget is the most telling factor at this stage. It goes back to the importance of strategic compensation. If you include a merit increase in that strategy, you’ll have a good idea of how many times you can offer one to each employee.

It will also depend on how often you plan to evaluate performance. Do you plan on analyzing KPIs monthly or quarterly? Or would you rather stick to one annual performance evaluation? 

The criteria might come into play too. If the goals refer to quarterly metrics, for instance, you’ll be able to give a maximum of four merit increases per year per employee. 

The rest will depend on the company’s budget and its compensation management plan.

5. Decide how to calculate the merit increase

The average merit increase is 3%, but it’s not uncommon to offer merit pay of 5% or more.

The exact way to calculate will vary from business to business. One way would be to look at the return on investment. You have an employee who is performing excellently. Can you estimate how much that increases your profit? Some like to use that percentage as the basis for their merit increase. 

You could also take into account how often an employee is exceeding expectations and how many times you’re offering the merit raise. For instance, you may have chosen to evaluate only based on the annual performance review. That means merit increases are offered yearly at most. 

But when conducting the evaluation, you notice an employee has had a stellar performance each month. Another one exceeded expectations throughout the year, but not monthly. In this case, you can reward the first person with a higher merit raise, of 5% for instance. The second will still get a raise, but only by 2%.

6. Share the program with your employees

The last thing to do in order to have an effective merit increase program is to share it with your employees. You need to communicate details about the criteria and make sure they understand how often they can expect such a raise.

Transparency is key to a healthy working environment. Plus, the goal of merit increase programs is not to take top performers by surprise when you offer them a raise. It is to motivate all employees to work harder and be more engaged. 

Key takeaways

Merit increases reward excellence in the workplace. They help motivate employees, reduce voluntary turnover, and increase productivity. A good merit increase program should be part of your compensation strategy. 

Remember that merit increases are not the same as pay raises. They do not include the cost of living, seniority, or training level. 

Make sure your program is transparent, and the criteria are accessible to everyone. Merit raises should motivate, they shouldn’t create a barrier between employees.