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Compensation #2

QUESTION: What are the pros and cons with Merit Pay?  What are the alternatives?  Do most companies in Jacksonville use merit pay or another form of reward?




I hope all is well.

I love these kinds of questions because there is no easy answer.

I am a firm believer in merit pay systems.  However, to be effective, they must be implemented properly with a large enough difference in either percentage or dollar volume of raises between the higher achievers in your organization and the mediocre performers.  With smaller merit increase budgets, there is a smaller pie to split among all of the employees.

There are a couple of ways to implement a merit pay plan.

One is to equate certain scores on a performance appraisal to a corresponding salary increase.  For example, if the performance appraisal is on a 1 through 5 scale with 1 being unacceptable performance, 2 being needs improvement, 3 is meets standard, 4 exceeds standards and 5 being walks on water, your distribution of increases may look something like this (assuming a 4% merit increase budget):

  • Overall score of 1 or 2 – no increase.
  • Overall score of 3 – 2% increase.
  • Overall score of 4 – 4.5% increase.
  • Overall score of 5 – 6.5% increase.

A second way is to be a little more sophisticated with the distribution of increases depending on the employee’s performance AND position in the salary range. Assuming that the midpoint of the range is the rate at which an employee performing the job is fully functional, any payment beyond the midpoint should be slowed down a bit.  Using the above performance appraisal distribution, two employees scoring a 4 with one paid below the midpoint and the other above the midpoint would get different percentage increases.  The one above the midpoint may get a 3% increase whereas the person below the midpoint may get a 5% increase.  Another way to look at this is the dollar amount of the increase.  Even though the percentages are different, both may get a $1,000 per year increase.

Another way is to tell the department manager that she/he has “x” dollars to split among her/his employees – but must justify each with a corresponding performance appraisal.

Merit pay systems reward higher performers and, therefore, are good for the organization.

The downside of merit pay systems include the difficulty many managers have in quantifying performance standards, giving realistic reviews, differences in managers’ definitions of performance factors, and one manager being a tough reviewer while another being a softie.

To be effective, the standards of performance for each position and each performance factor should be defined prior to the review period.

Other pay plans include across the board or cost of living increases (a big YUCK as far as I am concerned).

You can also have step systems in which an employee gets a specified raise either over a specific period of time or by accomplishing certain objectives.

There are skilled-based pay systems and knowledge-based systems that pay people differently depending on what skills or knowledge the employee brings to the organization.

As for what employers in Jacksonville do, I would venture to guess that most say they have a merit system, but as to how well they are implemented and delivered to the employees is another story.

Thanks for Asking Bob and I apologize for such a long-winded answer.

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