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.

Thanks to CompensationCafe