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Tie Merit Increases to Goal-setting and Employer Objectives

November 1, 1996
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Related Topics: Compensation Design and Communication, Featured Article
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Patricia A. Bubb, assistant vice president and compensation manager at Chubb & Son Inc. in Warren, New Jersey, says:
The term standardized merit increases is a contradiction in terms. True merit increases are nonstandard because they reflect factors that vary from person to person. These include:

  • Achievement of business and personal growth goals
  • The reality of salaries in the outside market for people with comparable skills and experience
  • The current level of pay based on the salary range or band assignment relative to skills and experience
  • Eligibility of variable pay as an ingredient in total cash compensation.

In a pay-for-performance environment, we expect true differentiation based on these types of factors. Managing a performance-based salary program requires a strong commitment to goal-setting and measurement. Many companies now also are rewarding demonstrated growth in competency in their base salary programs.

This commitment to recognition of more individualized roles rather than standardized jobs is leading to design changes in many salary programs. Specifically, broadbanding is one way some companies are responding to this shift. This change from traditional ranges containing midpoints and quartiles moves us farther away from formula-driven merit grids. Instead of relating exact increase amounts to a position in range and performance category, today’s programs tend to be more focused on paying each person correctly.

Jeannine Schlie, human resources manager at Maryland Cable in Lanham, Maryland, says:
A few years ago, HR learned that many employees in our company felt merit increases were given arbitrarily. The relationship to individual performance wasn’t clear. We then decided not only to standardize the system but also to communicate the changes to all levels in the organization.

We began by adopting a strong pay-for-performance principle, tying the merit increase percentages directly to the overall rating the employees receive on their annual performance reviews. An overall satisfactory rating received a merit increase roughly equal to that of the inflation rate for the previous year. Rating above (or below) satisfactory resulted in higher (or lower) merit increases. The scale was communicated to each individual along with an illustration of how their rating was determined.

The overall rating is determined by using individually weighted objectives. These objectives are prepared for the coming year and are revisited with a formal six-month review as well as the final year-end review. This allows the supervisors and employees to determine the primary functions—which are specific to that person’s position—rank them in terms of importance and list which measurements will be used. This helps the individual identify which functions are most important. Then a high rating in that category will more greatly influence his or her merit increase than a high rating in a less important objective.

Standardizing the merit increase process and not the individual objectives has allowed our company to clearly illustrate how the merit increases are determined and how each individual can influence his or her overall rating.

Evelyn Khinoo, human resources manager at Catalytica Inc. in Mountain View, California, says:
The base salary merit increase budget under our current program is approximately 4 percent, which is fairly typical of many companies. The merit increase is based on individual performance, since individual contributions and rewards are still very important in our company.

The workforce is made up mostly of scientists and engineers who are constantly striving to achieve greatness. Their ambitions help the company, in the long run, reach its goals. So some rewards for individual performance are important. With a 4 percent overall merit budget, it’s difficult to reward the highest performers an 8 percent to 10 percent increase because it would mean that the not-as-high performer (although still very good) would possibly receive only a 2 percent increase to keep within the 4 percent budget. Sure, we could give the 2 percent to a good performer, but so far our company hasn’t been able to bring itself to do so. So how do you reward your high performers without taking away a lot from the good performers? We’ve done this in the form of cash awards based on team accomplishments and the potential impact certain levels of employees are expected to make on the bottom line of the company’s success. This is the second part of the compensation bonus awards.

Cash bonus awards are based on team goal accomplishments, and higher bonus amounts are awarded to higher levels (more direct impact to bottom-line results).

The strategy behind the two parts is to enable the company to meet its business goals and be successful. The leveling process within the merit increase segment and the cash bonus segment have more closely met employee needs (high-base merit increases for lower levels) and created incentives to accomplish tough goals (especially for higher level positions). Standardized merit increases can work if there are other forms of awards.

Salary increases in the past have been considered an entitlement (always receiving a substantial merit increase such as 6 percent). One of the major pros of the cash-bonus system based on goal accomplishment is that the entitlement syndrome could be eliminated or certainly diminished. A standardized merit plan can work if there is an additional form of incentive, such as a cash bonus.

In establishing merit increase programs or any other cash bonus incentives, companies should keep in mind the type of workforce they have, what the competition in their industry is doing, what the company philosophy is—and have a strong plan in place to set company goals and ensure all business units or departments of the organization are clear about the goals. Goal-setting has become one of the most important elements for our company in its quest to be successful.

Martha Jo Chalmers, regional trainer for the California Department of Social Services in San Bruno, California, says:
The State of California employs more than 195,000 people throughout the state. All hiring and promotions are based on merit practices established by the state legislature and monitored by the state Personnel Board in Sacramento. My agency, Social Services, employs 4,052 full and part-time staff.

I believe merit increases based on performance are fine, but they don’t go far enough for government employees. There should be a salary increase awarded every two to three years to employees who perform well at the top of their salary range.

I’ve watched employees struggle with a capped salary year after year. Because they receive no monetary reward for doing a good job, they look for work elsewhere—creating a talent drain within the public departments of highly trained, competent staff.

The cost of replacing those excellent employees exceeds the amount of money that would be spent to increase their salaries and keep them motivated and in their current positions.

In addition, there should be a way for supervisors and line staff to be eligible for decent year-end bonuses based on performance criteria established by legislation and funded out of the general fund.

Personnel Journal, November 1996, Vol. 75, No. 11, pp. 109-110.

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