The Advantages and Disadvantages of Merit Pay

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Merit pay is an approach to compensation that rewards higher performing employees with additional pay, sometimes called incentive pay. Merit pay has advantages and disadvantages for both employees and employers.

Before implementing such a system, it's a good idea to review the advantages and disadvantages of each.

Advantages

A merit system is most applicable when there is detailed data available to measure the performance of employees. Consider how that data can push employees to achieve more, padding their own paychecks, as well as the company's bottom line.

  • Communicates company objectives: Merit pay sends a powerful message about how you want to see employees perform and what you want to see them contribute. It confirms what you most value from employees. Merit pay also provides a vehicle for an employer to recognize individual performance on a one-time basis. This is useful for rewarding employees who may have participated in a one-time project.
  • Let's employees know where they stand: Making the range of the available merit pay public allows employees to see where their increase falls in the merit pay ranges established by your company pay plan. It can be a good way to reward the employees that you most want to keep. When employees receive less than the top increase, supervisors have an opportunity to describe and discuss exactly how the employees will need to improve their performance to qualify for the top merit increase during the next cycle of raises.
  • Aids in employee retention: Merit pay can help an employer differentiate between the performance of high and low performing employees and reward the performance of the higher performers. This can aid in retention because no employer wants to lose the organization's best performers.

Disadvantages and Challenges

Some businesses are not conducive to measuring employee contributions so clearly and definitively, making it difficult to establish an effective means for merit pay. Consider whether or not you might be trying to force such a system into an office where it won't work.

  • Concerns about favoritism: In many offices, the value of any particular employee is subjective and ultimately determined by a supervisor. Without clear measurables, others easily could dispute the outcomes when merit pay is determined. Even in offices where there are measurables, outcomes can be challenged. For example, some might argue that the salesperson with the best sales had an advantage because he had the best sales territory.
  • Uses time and resources better spent elsewhere: The amount of time and energy that organizations invest in an attempt to make performance measurable for merit pay, including developing competencies, measurements, baselines for performance, and so forth, is better spent on delivering service for customers. Organizations have generated documents with several hundred pages that lay out what merit means in various jobs. Often, the benefits just aren't worth all that time and effort.
  • Communication troubles: Given the limitations of metrics, the ability of a supervisor to communicate to each employee the value of his or her contribution, and what superior performance entails that makes it worthy of merit pay consideration, is an ongoing challenge. Some supervisors communicate better than others, and this means the effectiveness of merit pay sometimes can vary wildly from one department to the next based on the communications skills of supervisors.