A Step-by-Step Guide to Building a Successful Employee Merit Program

A successful employee merit program is built on a transparent compensation philosophy. Read our step-by-step guide.

November 27, 2023
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Managers today understand the importance of nurturing a happy and productive workforce – operations just run more smoothly when employees feel valued and taken care of. Part of this means rewarding those who go above and beyond in their duties and drive company success with their efforts. 

This is where merit pay comes in. It is a great way to compensate your best performers at work. However, like any type of compensation, merit pay requires careful planning. This step-by-step guide is all you need to build a successful employee merit program, driving employee satisfaction and productivity. 

What Is Merit Pay? 

Sometimes called “incentive pay” or “pay-for-performance”, merit pay is a type of compensation awarded based on employee performance. This compensation could take the form of a simple pay raise, bonus, or promotion. Merit pay is based on a set of standards and goals created by the individual workplace – it is different from usual pay raises given based on the cost of living or other factors. 

two men in business wear facing each other and shaking hands

Why Is Merit Pay Important?

Merit programs reward top performers for their hard work – but they also help the company in a variety of ways. Here’s how:

They Encourage Productivity and Engagement

Knowing that a merit pay policy is at play is enough to help motivate employees. Rather than blindly guessing whether their performance is sufficient, employees can look at the criteria to find out exactly what is expected of them, and how they must improve to earn extra pay. This clarity and transparency means that employees will be more motivated to perform at their best.

And how do you measure workplace motivation? The change should be evident when you look at employee satisfaction surveys, workplace incidents, and progress on projects. Ultimately, you should see an increase in workplace effectiveness. 

Engaging your team via a merit program is another great way to boost performance and retention. When employees have clear and actionable goals, they are more likely to actively participate in company activities – therefore further boosting productivity. 

They Help You Track Progress Toward Business Goals

By measuring and analyzing performance metrics, managers can identify key contributors who exceed company goals, and allocate merit increases accordingly. Merit increases, then, are a tangible outcome of the tracking process. They incentivize employees and provide recognition for exceptional performances.

Beyond individual performance evaluations, there are other benefits to tracking HR metrics and trends. A comprehensive understanding of HR metrics enables managers to make data-driven decisions in various aspects of business operations. 

They Improve Employee Retention

All these benefits mean that employees are less likely to leave. Employees generally stay with companies which recognize their efforts, value their hard work, and show appreciation for their successes. Improving employee retention is important from a business standpoint, as high turnover rates mean spending money constantly onboarding and training new recruits. 

Long-term employees are a valuable resource when it comes to company knowledge and mentoring newer team members. For example, existing employees will be familiar with the processes and solutions preferred by the company.

6 Steps to Create a Successful Employee Merit Program 

man standing in conference room leading meeting. Employees have goodie bags
  1. Develop a Compensation Philosophy

A successful employee merit program is underpinned by a well-thought-out compensation philosophy. This essentially means a statement covering two things:

  • What your company is trying to achieve through employee compensation
  • How you intend to get there.

This philosophy will determine the structure of the program, and inform how you make decisions – such as how, why, how much, and when merit pay is awarded. 

There are many factors to consider when developing your organization’s compensation philosophy. For example:

  • Market trends: What level of pay is typical in the industry? How much do your competitors’ employees get paid? What bonuses are expected? 
  • Your position within the market: Decide whether your goal is to match the market, or lead in terms of merit pay. 
  • Location: Are you location-dependent or location-agnostic? Are location-based salaries a factor?
  • Differences in roles and departments: Work out how compensation might vary across different roles and departments. 
  • Different work setups: Will hybrid, in-person, and remote employees be compensated equally? Remote communication comes with its own challenges – will this be reflected in the way you motivate and reward employees who work from home?
  1. Define the Criteria 

Next, you need to define the criteria that employees have to meet to earn a merit increase. It’s all about balance: you don’t want to make the goals too easy to achieve, but they shouldn’t be impossible. If employees would need to work overtime to earn merit pay, then you demonstrate a lack of respect for their work-life balance. 

Think about what characteristics you want your employees to have. These should align with the wider vision and values held by the organization. What does displaying this characteristic look like in practice? And how can it be translated into a specific, measurable goal?

Create an easily-accessible document explaining the internal processes and eligibility criteria you decided upon. It’s important to ensure that merit increases are rewarded fairly, consistently, and transparently. 

  1. Track Performance Metrics 

With your finalized criteria in mind, think about which HR metrics you’re going to track. If you aren’t measuring success in any quantifiable way, how will you know who qualifies for merit pay? When analyzing performance, you could look at key performance indicators (KPIs)  like:

  • Productivity
  • Absences
  • Average performance rating 
  • Individual employee performance
  • Time to productivity. 

Use one or more metrics to form a comprehensive picture of employee performance, both on an individual level and looking at your team(s) as a whole. Platforms like Vonage make tracking KPIs easy with reporting and analytics dashboards displaying key metrics. 

You could also implement 360° reviews to keep track of personal attributes which matter to you.

Screengrab of a joinassembly workflow for a 360 degree review template. The question reads 'does Robert take initiative to seek clarification on things they don't understand?' and the options range from '1: never' to '5: always'.
Image sourced from joinassembly.com

By tracking and analyzing performance metrics, you can spot stellar performances and award them with a merit increase when the time comes. 

  1. Set Limits

It is also important to plan the maximum number of merit increases any one employee can get. The budget is a key player in this decision. How often will you evaluate performance? Will merit pay be awarded monthly or quarterly? 

  1. Decide How to Calculate the Merit Increase

Now it’s time to crunch the numbers. The exact calculation will vary from business to business. The aim here is to create a system for different performance tiers and find appropriate percentage increments to match each one. For example, say you have some employees who exceeded goals every month, and some who exceeded goals overall but not monthly. You might choose to award the former group a 5% merit raise and give the latter a 2% merit raise. 

Another way to think of it is in terms of return on investment. If an employee is performing exceptionally well, can you estimate by how much that increases your profit? This percentage is a good basis for deciding on an appropriate merit increase. 

On a logistics level, you also need systems in place to pay the selected employees the correct amount when they earn a merit increase.

  1. Share the Program with Your Employees

Lastly, you’re ready to launch your employee merit program by sharing it with your team. Be sure to communicate details about the criteria – and make it available as a document – so they know exactly what is expected of them. 

Again, transparency is everything. The more open and organized the program is, the more likely it is to motivate and engage your employees. 

happy employees gathered around a laptop

Potential Challenges 

There can be disadvantages associated with merit pay. To build a successful merit pay program, keep these potential problems in mind. 

Subjectivity 

It can be difficult to apply the criteria evenly across different departments and individuals. Different managers may define success differently and therefore award merit pay differently. This is why it’s so important to be transparent about what is required, and make sure the same rules apply to everyone. 

Perceived favoritism 

Because merit pay can often be subjective, it may end up being a problem when employees start to feel that managers’ preferences for other employees are influencing decisions more than their performance reviews. 

This could happen on an interpersonal level, or there could be larger structural issues. For instance, remote employees might feel that the office workers are receiving disproportionately high merit pay, as they have the advantage of face-to-face interactions with the boss and easy access to resources. Consider a remote desktop connection manager download to level the playing field, making it easier for employees to access the company network remotely. 

Competitiveness

Friendly competition amongst colleagues is a good thing, right? To some extent, yes. Playful rivalry can be great for boosting productivity. However, in some workplaces, this competition may be less healthy. You don’t want team members to be discouraged, resentful of others, or unwilling to collaborate. It’s important that everyone works together in the company’s best interest. 

Final Thoughts 

Now you know what merit pay is, why it is so important, and how a successful employee merit program is built. It should be a reflection of employee performance, but also take into account the market, and the goals and budget of your organization. As long as you are clear in your plans, thorough in execution, and transparent about the process, your employee merit program will be a great asset to your organization’s success. 

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