How to Create a Merit Raise System

How do you create a pay raise system that both rewards and motivates? Merit raises, rather than cost-of-living increases across the board, provide an opportunity to reward your best employees while sending a message to poor performers.

Merit raise systems (also called pay-for-performance) vary depending on the size of the company, the state of the economy, the type of job and amount of responsibility that goes with it, as well as the local wage scale of that particular job in your area. Generally, the bigger the responsibility, the larger the merit raise available for top performance.

Determining who does and does not deserve a merit raise also requires a hard look at the performance review system. Employees must have fair and measurable goals to meet so they know exactly the criteria for the raise. If your employees, for example, must produce a product, it may be relatively easy to create those goals, which can relate to productivity and quality of work. It’s much more difficult if their jobs are less quantifiable. Nonetheless, creating clear job descriptions and annual goals that are reviewed twice a year by the employee and the manager together can help the employee know what steps to take to achieve the highest possible merit raise. 

Merit pay can come in a variety of forms, from casual rewards such as movie tickets or a $50 bill, to something more elaborate. However you choose to reward employees, make sure you clearly state the reason for the reward and what they did to earn it. It’s not enough to say “Because you’re doing a great job.” Instead, use measurable, clear language, such as “Because you brought in six new clients this month, meeting and exceeding the goal by two.” Announce that the rewards are available to all employees and what they need to do to earn them.

For more structured incentives in your pay system, answer the following questions:

• Do you currently have annual performance reviews for all employees? How are they handled? Do you use some kind of instrument, such as a 360 review, to determine how well employees are doing?
• What kinds of behaviors do you value in your employees? How do you communicate that to employees?
• Do you have a performance management tool to use?
• What is your overall budget for merit raises?

Once you answer these questions, you can choose from several merit raise plans:

• Fixed increases based on performance: This gives the manager flexibility to determine pay-increase amounts based on performance ratings, as long as they are within the budget of the pay program.
• Varied increases based on performance, internal/external equity: This plan is good for companies with highly skilled workers who may be tempted to jump ship.
• Across-the-board increases plus merit: All employees who are meeting performance expectations receive an across-the-board increase. Additional money is available for performance that exceeds expectations. This plan is useful because it is relatively simple to budget for and execute.

While creating a complicated pay-for-performance system may not work for some small businesses, even something simple such as providing a cash bonus or incentive for meeting stated goals is an effective way to motivate employees. Companies that pay for performance, or at the very least offer some kind of reward for going above and beyond, consistently show better results than those that don’t. And remember, it’s the little things that make the biggest impact. Sometimes two tickets to the movies for your hard-working employee is all it takes.