Are Annual Merit Increases the Right Approach to Pay for Performance?

In my work with clients on strategy for their employee recognition programs, we dive into the various ways they express to high performers that their exceptional work is noted and they are appropriately compensated for that level of continuous performance. A challenge we often discuss is the problem of performance-based merit increases.

One of the most common methods today across organizations is merit increases. But the news around merit increases this year (as in many years past) is abysmal. Merit increases this year are expected to be the highest since 2008 – at a mere 3%.

Towers Watson tells us in the U.S. top performers (fives on a five-point scale) will receive 4% increases, next-level performers will receive 3.4% increases, and those who simply meet expectations will receive 2.5% increase.

Where’s the differentiation in that? As inflation rises will those merit increases even be noticed? And even those increases for top performers are reliant on a largely failed annual performance review process. How many of you have dealt with the manager who says:

“I give all my team members the same ranking year after year. Their performance doesn’t change that much. It’s easier, and I hit my targets for the appropriate number of employees at each level.”

Or perhaps this:

“I just give all my team members the same merit increase. It’s too hard to differentiate them and trying to do so leads to too many problems. I just don’t want to choose.”

Of course this is an abdication of managerial duty and something that should be addressed by other means, but the fact remains. Many managers are simply terrible at differentiating employees, especially when merit increases are on the line.

So what’s an alternative? I propose year-round rewards commensurate with year-round recognition of employee efforts. Those who perform at a higher level are naturally more frequently recognized and rewarded for those efforts.

Does that mean “raises” become a thing of the past? Of course not. They just take a different form, the most likely being:

• A standard annual cost of living or inflation increase for all employees to keep salary levels in line with industry norms
• Promotion-based raises

This is a controversial topic. A lot is invested in performance appraisal systems tied to merit increase adjustments. I’m looking to hear from the experts so I can offer a more informed perspective to the senior leaders I meet with.

What do you think? Are merit increases truly the best way to reward employees? Is differentiation strong enough to support this?

As Globoforce’s Head of Strategic Consulting, Derek Irvine is an internationally minded management professional with over 20 years of experience helping global companies set a higher ambition for global strategic employee recognition, leading workshops, strategy meetings and industry sessions around the world. His articles on fostering and managing a culture of appreciation through strategic recognition have been published in Businessweek, Workspan and HR Management. Derek splits his time between Dublin, Montreal and Boston. Follow Derek on Twitter at @globoforce.

Comments

[E. James (Jim) Brennan]

No, merit increases are merely ONE of many reward and reinforcement tools to be used. They never used to be expected every year, until the rampaging inflation of the 1970s triggered a whole new level of expectations. The events of the past few years have proven that annual merit increases are neither essential nor practical in all cases. Career-wise, the greatest increases in pay come from promotions and job changes, anyway.

[Derek Irvine, Globoforce]

Exactly, Jim. Your point about the 1970s setting a new level of expectation is on target.

[Dan Walter]

I find it funny and a bit vexing that Merit Increases had a paradigm shift almost 40 years ago that we have not been able to properly correct.
Equity Awards had a paradigm shift from 1988-1999 that has also been, as yet, unrecoverable. I know there are at least 10 other examples like this. (maybe we should list them in an upcoming Compensation Cafe posting)
Maybe compensation pros should look at these "new paradigms" or expectations as blips on the radar, sort of the the Flip Camera. Great idea for a specific point in time that must either evolve into something that remains relevant and useful (ex. video cameras on smart phones) or forever be tossed into the scrap heap.

[Dan Walter]

One other thing: Why d we still call these "merit" increases?

Definitions of Merit:
Verb: Deserve or be worthy of (something, esp. reward, punishment, or attention).

Noun: The quality of being particularly good or worthy, esp. so as to deserve praise or reward

[Jeffrey L Tucker]

I believe merit/P4P systems should and must have a place in our work environments these days. Without it we have employees working at half pace with the automatic expectations they will receive the standard increase for their minimal efforts to tread water. I want a staff who swims and swims hard against the current.

[Derek Irvine, Globoforce]

Great points, Dan. I like very much your analogy of "blips in time" -- it served a purpose, but is now outdated and time to move on.

[Derek Irvine, Globoforce]

Jeff, I disagree. I believe it's time to rethink the pay for performance habit we've fallen into. One option in such a model is that, to secure a real raise (more than the 3% "merit increase" people are getting now that, let's face it, is a COLA) people must either be promoted into a new role or take on additional tasks outside of their assigned duties. Those who seek to do more are rewarded for it.

Of course, we can't forget the opportunity - outside of P4P - to constantly recognize and reward stellar efforts, regardless of role or pay grade.

[JPM]

Just Curious

what do y'all think of the cost of turnover?

go tell your entire crew that they can expect to make essentially what they make now for the the forseeable future. 5 years? more?

how many of your best performers will start nosing around to see waht else is out there?

if they are worth keeping, they are worth compenstaing

maybe that long lost employee loyality would still exist if they did not have to make a job change to get the jump in pay they are looking for

id the employees that are worth it

pay them accordingly

long run it saves money

thank you for your time

[Derek Irvine, Globoforce]

JPM: "if they are worth keeping, they are worth compensating" -- AGREED.

But fair compensation is just the base. If they are worth keeping, recognize them and reward them above and beyond, appropriately.

That doesn't necessarily fit in with current P4P practices or "merit" based pay that is now proven to be biased (see this news here...perhaps the basis of my next post on Compensation Cafe: http://bit.ly/k8iO6f

[E. James (Jim) Brennan]

Derek: The research, although interesting, is neither shocking nor conclusive. The findings are not limited to merit pay, because the same biases occur in recruiting, promotion and future assessment decisions. Love to know more about the volunteers surveyed, like if they were students or managers, for example. Look forward to your next post taking those caveats into account.

Bottom line, rewarding merit (while difficult and problematic, like democracy) remains far superior to most alternatives.