The first merit matrix was introduced in the early 1970’s. At that time merit pay was seen as a great way to manage employee performance and it seemed to work well with pay increases in the double digits. Today is a different story, trying to incorporate a performance element when budget increases are 2 or 3% is difficult at best. A merit matrix allocates budgeted dollars to employees based on two factors: 1) their performance; and 2) their salary’s position in the salary range and/or in the market. However, the merit matrix may not be in line with your compensation philosophy nor meet your salary administration needs by allocating dollars to where you need them most.
Many companies do not have a separate budget for market adjustments and rely on merit increases to remain competitive. However, employee pay can quickly fall behind market if the merit budget is 3%, and the market is increasing at a greater rate. When merit increases are not keeping step with the market, pay compression may result. You may be faced with having to hire new employees at higher rates than current employees.
In spite of the potential drawbacks, merit increases are still prevalent, and are the primary ‘pay for performance’ vehicle in many organizations. Changing the merit pay ‘mindset’ and employee expectations can seem like a monumental task. But there are many organizations considering other ways to pay for performance such as carving out a portion of the salary budget for key contributors. Since ‘average’ performers represent the majority of your employees, they are designated to receive ‘average’ increases, and this allocation accounts for the majority of your budget.
Some organizations are moving from the merit matrix to multidimensional decision tools that use several factors adding further differentiation especially among the ‘average’ population. These factors can include such things as long-term potential, sustained performance over time and specific skill sets. The factors can also be weighted differently. When selecting factors, ensure they align with the organization’s HR strategy, job value, and compensation philosophy. Variable pay plans can be added and some organizations have even replaced merit pay completely with variable pay, but this can increase the risk of losing top-performing employees. However, variable pay plans that include an individual component can be an effective reward for top performers. Another more radical approach is to tie nonmonetary elements within the total rewards package to individual performance. For example, flexible work arrangements, additional paid time off, and career development.
For the near term, merit budgets are expected to remain small; therefore, organizations that plan to continue with merit pay systems should minimally look for ways to improve their current system. Organizations that take the time to develop and use methods and tools other than merit pay should see a return on investment.
WageWatch, Inc. is the leading compensation survey provider for the lodging and gaming industries with 6,000 properties participating in its PeerMark™ Wage Survey. WageWatch also conducts compensation surveys for other business and industry segments including healthcare and non-profits. The PeerMark™ Wage Survey is the only Web-based custom survey tool that allows individual survey participants to select their competitive set for comparison purposes.