Using the right rewards and incentives can aid in boosting employee performance, engagement, and job satisfaction. Merit increases are one of them. A merit salary increase rewards employees for their hard work and professional development. It not only gives employees something of material value; it also conveys their value to the company, which further enhances loyalty.
In this article, we’ll discuss how a salary increase based on performance differs from other types of pay raises. Then, we’ll review best practices for offering and managing merit increases, along with the benefits of doing so.
Table of Contents
- What Is a Merit Increase?
- Difference Between a Merit Increase and Other Types of Raises
- How Merit Increases Work
- Benefits of Merit Increases for Employees and Employers
- The Role of Performance Management in Merit Increases
- Best Practices for Managing Merit Raises
- FAQs on Merit Increases
What Is a Merit Increase?
A merit increase is a rise in pay based on the enhanced quality of an employee’s work. As employees grow more experienced, the value of their work tends to rise. When they demonstrate higher productivity or stronger quality of work, their employer might boost their pay as a reward.
Difference Between a Merit Increase and Other Types of Raises
Let’s examine the main types of raises to compare them with a salary increase based on performance.
Merit Increase vs. Cost-of-Living Adjustment
Companies periodically make cost-of-living adjustments (COLAs) to account for inflation. A cost-of-living adjustment is a slight increase to keep pace with current prices and salary trends. It doesn’t depend on merit; these adjustments should be made for all employees. When making cost-of-living adjustments, you might also update pay ranges for all roles.
Merit Increase vs. Pay Raise
Organizations issue pay raises for different reasons, such as length of employment with the company. An employee may automatically receive an increase at certain time intervals, like after completion of a training period. Maintaining a satisfactory performance may be a prerequisite for these raises, even though they’re not based primarily on merit.
Merit Increase vs. Bonus
A bonus is a one-time payment, in contrast to a base pay raise that will affect future earnings. Companies sometimes provide lump-sum merit payments instead of a base pay raise. Essentially, a lump-sum payment is a one-time bonus rather than a monthly salary increase.
Merit Increase vs. Promotion
In a promotion, a person accepts a new role, which often comes with a higher salary. The salary increase usually falls within the typical pay range for the new role. While merit certainly factors into promotional decisions, it influences the salary boost indirectly. The increased salary that a promotion may bring compensates an employee for taking on additional responsibilities, like managerial duties.
Merit Increase vs. Equity Increase
With an equity increase, HR aims to ensure employees are receiving fair pay. The equity increase can raise the salary of anyone who was underpaid, addressing any wage gaps. This helps create a more fair and inclusive workplace.
How Merit Increases Work
Now, let’s explore how and when companies distribute performance-based raises.
Who Qualifies for a Merit Increase
Companies often offer merit salary increases to their high-performers. They’ll base these decisions on job performance, tenure, and contribution to company goals. For example, a star employee who successfully managed a project may have earned a merit increase.
Merit increases could also be issued when an employee reaches a higher educational level. Such milestones enhance the value they can deliver.
Typical Merit Increase Amounts
Performance-based raises average about 3–4% of an employee’s salary. According to MarketWatch, they averaged 3.8% in 2023. Many companies follow the 3% rule, writes Anna Baluch in Forbes. So, someone who earns $85,000 might receive a $2,550 increase of their annual salary.
Timing of Merit Increases
Merit increases often happen in conjunction with performance reviews. We recommend considering the performance evaluation to determine whether you’ll issue a merit increase, but holding a separate conversation to discuss pay. Talking about raises and promotions in a performance review can undermine the focus on personal growth. While the two are related, discuss them separately so you can give your full attention to each of them.
How often are merit raises given? Companies might consider merit raises on an annual basis. It’s helpful to make decisions on merit increases during one specific time window (like after your year-end performance reviews). That way, you can ensure that everyone receives the same consideration.
Benefits of Merit Increases for Employees and Employers
Incentives like merit increases can strengthen engagement. “Employees who say they are paid fairly are 85% more engaged and 62% more committed to their organization, as compared to employees who believe they are paid unfairly,” Mercer found in its 2023 Inside Employees’ Minds study. While different factors may influence engagement and job satisfaction, fair compensation seems to be a prerequisite.
“One of the most effective ways to retain top performers is to reward them based on job performance,” MIT Human Resources agrees. Employees feel motivated to reach toward higher goals when they know they have a chance of earning merit-based pay. And after earning merit pay, employees are more likely to stay with the company due to the recognition and financial rewards they’ve received. They also feel more highly motivated and have greater job satisfaction due to the appreciation they’ve been shown.
In turn, merit-based pay strengthens organizations by allowing them to keep their top performers. By improving retention of star employees, merit pay enhances productivity, innovation, goal alignment, and organizational momentum. Ultimately, all of these benefits allow businesses to reach a higher level of success.
The Role of Performance Management in Merit Increases
Using performance management tools will support you in making fair merit increases. Using a system that lets you log the results of performance evaluations, you can compare how an employee has progressed from one quarter to the next.
Performance management tools can also guide your merit increase decisions. Use goal-tracking tools to analyze how often employees have hit their targets. Consider whether they’ve been achieving more ambitious goals and KPIs, too.
Look at the projects they’ve completed and contributed to as well, with the help of such tools. Think about the value these projects have delivered to the company when issuing merit increases.
Best Practices for Managing Merit Raises
Poor management of merit-based pay can backfire, causing employees to feel they’ve been treated unfairly. Using the right strategies, like conducting a salary review and creating clear metrics for raising pay, will help you manage merit increases effectively.
Establish Transparent Merit Pay Policies
Create a clear policy and protocol for issuing merit raises. By using consistent practices—and maintaining transparency about them—you’ll avoid feelings of frustration. Plus, you’ll increase employee motivation. “Visibility into how pay decisions are made provides employees with clarity about the link between performance and compensation,” writes Mercer. “They are able to become more engaged, motivated, and committed to achieving their goals.”
Today, many organizations are implementing pay transparency policies to avoid bias, build trust, and boost their employer brand. This often involves publishing salary data in a company database. Full transparency around merit pay raises will further strengthen trust.
Conduct a Salary Review
HR should periodically conduct salary reviews to ensure pay equity. During this process, you’ll determine whether existing salaries for all levels and roles are fair. As you conduct a compensation analysis for each role, calculate its average rate for an employee in your field. Set a typical pay range for the role based on this data. Then, consider factors like the employee’s education and experience, time in the company, and your location. Does the employee’s pay fall toward the high or low level within this range, when considering this data?
Tie Merit Increases to Clear Performance Metrics
For most companies, the process of identifying suitable merit increases is highly inefficient, Mercer found. Too often, managers and HR determine raises in a subjective manner. Using sets of objective standards will increase fairness and the efficiency of the process.
Set specific criteria defining what constitutes excellent and above-average performance. This will help you make fair, unbiased decisions about merit pay. Then, use tools that help you analyze performance objectively. Managers’ observations can still factor in, but you can make sure they’re backed by concrete evidence.
Analyze the Market
Look at current salaries for employees in your industry. Consider salaries in your geographic area (or across the country, if you have an all-remote team). If you can afford to raise salaries of high performers, this can help you remain competitive.
Plan for Future Increases
It can be quite awkward to realize a high-performing employee has already reached the maximum salary you can afford to pay. Avoid this scenario by planning out the potential sequence of pay increases well in advance. Otherwise, your star performers may feel they’ve hit a glass ceiling within your company.
If you can’t afford to provide a pay increase just yet, explore other options. Offering a one-time merit-based bonus or additional paid time off (PTO) are two ideas to consider, says the Society for Human Resource Management (SHRM). For many employees, non-monetary benefits like PTO will enhance quality of life and are just as welcome as a salary boost.
FAQs on Merit Increases
Here are a few common questions on merit increases, and our answers.
What types of data should you consider for a merit increase?
Look at performance review results, as well as performance management data. While 360 review data are valuable, they shouldn’t be directly used to assign pay. Managers should make recommendations to HR on who deserves an increase, based on their observations, evaluations, and performance data. HR, in turn, should review this data for all employees to make sure no one has been unfairly left out.
How do you make merit increases competitive?
Look at databases that compile salary data for various industries. For example, Payscale and the Bureau of Labor Statistics compile a high volume of data on pay rates. If raising pay, make sure you do so in a sustainable way—you don’t want to hit a ceiling down the road.
Should you make merit increases public?
Publicizing merit salary increases boosts transparency and strengthens the incentive behind these raises. So, we advise sharing them with the whole team. You can also publish salary data in a database that all employees have access to.
A salary increase based on performance can grow employee engagement, when following best practices. Planning performance-based raises carefully will build trust and motivation among your team. By being thoughtful and transparent about merit pay raises, you’ll strengthen your employer brand and enhance employees’ loyalty to your company.
To learn more about how HR solutions can support your team’s performance, demo our performance management software!
