Understanding the Power of Merit Increases

Mar 01 2024 | Einblicke
Man sat at his computer in an office with his headphones on, in front of a wall sign that says 'grow greatness'.

What are Merit Increases?

A merit increase (or raise) is a boost in pay given to employees in appreciation and recognition of exceptional performance – a financial incentive. They also work well as an incentive for other employees to perform well and in helping improve talent retention.

Whilst they might share some similarities, merit increases and pay rises aren’t one and the same. A merit increase is solely based on performance and achievement. A pay rise on the other hand might not necessarily be associated with the work of an employee; it could be down to years of service, to adjust for inflation or a change in what is deemed a ‘fair’ salary within your industry.

What are the benefits of a merit increase?

Merit increases can bring a host of benefits to your company, including:

  • Showing employees that they’re appreciated

Recognising the good work of employees is key to showing that you care and that you appreciate the work they’re doing. Studies have shown that employees who feel appreciated in their workplace perform better, leading to lower rates of turnover. 63% of employees who quit their jobs in 2021 did so due to low pay, so providing pay that is relative to performance is an important factor to consider.

  • Helping to boost workplace morale

Offering employees well-deserved benefits for their hard work can be a useful method for boosting morale. However, be mindful of any potential downsides to this. If you’re too generous with merit increases or are praising individuals’ merely adequate performance, it can lead to mediocre results and decreased morale amongst high achieving employees.

  • Boosting performance

The opportunity for a merit increase, typically averaging at a 3% annual increase in salary, presents a great incentive. Knowing the possibility is there to achieve, boosts motivation to reach goals and strive for excellence. Plus, achieving one can be incredibly motivating in itself!

  • Improving talent retention

By compensating your talented, high-performing employees, you’re likely to increase your retention rates, which can reduce unnecessary recruitment costs that come with turnover. These employees can also make significant differences in returns based on high performance.

Are merit increases fair?

Whilst merit increases might seem like a fairly basic way of recognising good results, the concept of ‘fairness’ is very important to employees, and whether a reward is perceived as fair – relative to what others receive - can be even more important than the actual reward itself.

Merit-based increases are thought to be a fair way to reward performance, but we overestimate how fairly these decisions are made. Firstly, there isn’t always a clear definition of what good performance looks like, and some job roles are not as clearly tied to organisational and business outcomes. It can also be subject to bias. In 2012, a well-known study revealed significant biases based on race and gender in merit-based performance evaluations, which need to be reduced through improving diversity and inclusion practices in the workplace.

How to increase fairness in merit increases

It's important to stick to an established set of guidelines in order to achieve fairness within merit increases. Having clear policies that define what good performance looks like (specific to different roles) is an important factor in allowing every employee an equal chance of achieving that. Clear communication about how merit increases are allocated can help to alleviate concerns and provide the opportunity for employees to provide feedback.

When it comes to inclusivity, research shows that increasing accountability and transparency in the performance review process can reduce racial and gender pay gaps in performance-based reviews.

How to determine when to give merit increases.

Merit increases can be a great tool for boosting employee morale and performance, but they also have a way of providing quite the opposite effect. As previously noted, if employees undeserving of a merit increase are given one, it can be both demoralising for other hardworking employees, and it can lead to more insufficient work being produced (because you rewarded it, right?) and a drop in performance.

So, understanding when to give merit increases is key. Use our pointers to make sure you’re identifying the right employees at the right time.

1. Think, does an employee’s performance positively financially impact the business?

2. Objectively assess performance with set policies and procedures.

3. Determine whether merit increases will work – would a promotion be more appropriate in increasing retention?

Merit increases as part of a bigger strategy

Merit increases can be motivating when implemented correctly, but money only motivates so far and should be used alongside career development support and other benefits to help your employees grow and improve retention. Ideally, merit increases should be planned into broader strategies to make the most of them. One example is ensuring merit increases and compensation planning go hand in hand.

What is compensation planning?

The process is the development of a compensation strategy, planning rewards including salaries bonuses, insurance, leave, and other benefits.

How do merit increases work within compensation planning?

Rather than hoping that there will be budget to provide merit increases to those that most deserve it, why not combine your people analytics with your HR’s compensation planning. That way, you can have a dedicated budget to providing yearly merit increases, helping with the process of improving high talent retention, and allowing managers to make informed decisions about them.

How to explain merit increases to your team

Making sure you’re transparent about salary, increases in pay and merit increases is vital to maintaining a good working environment. So, it’s important as a leader to be open and honest about employees achieving merit raises, or not.

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