Salary Increase Planning

Merit Increases

The vast majority of companies administer their base salary increases based on merit or pay for performance. Delivering increases to pay based upon performance attainment continues to be the most prevalent way to manage annual salary increase planning.

Companies commonly have a performance management program and then administer merit increases based upon individual performance ratings. This is called pay for performance.

Here’s an example using a 4% merit increase budget:

In this example, the merit increase guidelines are calculated by using the top of the "Meets Standards" performance level (4%) with the merit budget baseline at 100%. "Far Exceeds Standards" is 200% of the merit budget. "Exceed Standards" is 150% of the merit budget and "Sometimes Meets Standards" is 50% of the merit budget. A distribution such as this ensures true pay for performance while giving a manager flexibility in applying the guidelines within a range. Actual performance distribution should be considered when developing a matrix for a company. Recommended guidance will support an organization managing to a desirable performance distribution.

Companies also commonly apply 150% of the merit budget for top performance, e.g., 6.0% for top performers where 4% is at the budget baseline and applied to average performance. This approach does not always provide the funds to truly recognize top performance.

Here is another example which recognizes merit opportunity based upon performance as well as current compensation compared to the salary range midpoint.

Although a bell-shaped curve is desirable for a performance distribution, the reality is that it is very difficult to attain a traditional bell-shaped curve. The above distribution is closer to common performance distributions in organizations.

To find out how to set up a performance-appraisal system, see DLC Course 77: Pay-for-Performance.

Advantages of Merit-Based Pay:

• A merit pay program recognizes high performance. Employees are incented to grow, develop and deliver organizational results.
• Valued competencies can be rewarded through a merit increase program.
• A merit pay plan is relatively simple to administer.
• A merit increase plan can recognize and reward attainment of essential responsibilities and occasionally goals and objectives.
• A merit increase plan can recognize efforts to grow and develop outside of the job.
• A well-designed merit increase plan can recognize both performance and placement within a salary range - delivering higher increases to lower paid employees for comparable performance than high-paid employees.
• When properly designed, a merit increase plan can be defensible in a court of law.
• Supports the retention of high performers.

Disadvantages of Merit-Based Pay

• Low merit budgets do not allow for great discrepancy between different levels of performance.
• Merit pay can become a fixed cost and without a strong connection to performance takes on similar characteristics to general increases.
• Merit pay can be accompanied by a time-consuming, complicated performance management program.
• A merit pay program is frequently managed through a bell-shaped curve requiring a forced distribution of performance ratings within a company and/or department. This can require management to make difficult decisions that may not always be popular or supported by employees.

Merit pay is delivered as a lump sum. Lump sum increases are not a fixed cost and may be used in lieu of increasing employee's base salary. Lump sum increases are commonly used to recognize and reward employees whose pay is high compared to the labor market (e.g., over the salary range maximum).