What is a merit increase and why does it matter in HR?

For numerous employees, there’s nothing quite as gratifying as receiving recognition. Conversely, when appreciation is lacking, employees tend to depart. As organizations confront the emerging challenge of the Great Resignation, it becomes crucial to proactively explore effective tactics for retaining top talent. Among these strategies, merit increases stand out prominently.

In this blog post, we’ll delve into merit increases and underscore their significance. Additionally, we’ll outline the distinctions between merit increases and pay raises. Let’s get started!

In compensation, the intricacies of various pay raises can significantly impact employee morale, company culture, and even shareholder perception. In April 2023, the news showed how different pay raise strategies can evoke varying reactions, mainly when they come to the forefront of public attention. For example, we faced the situation of Google and its CEO, Sundar Pichai. Sundar Pichai provided himself with a substantial pay raise despite company-wide cost-cutting measures. As a result, employee morale at Google was low.

Thus, understanding the nuances of different pay raises is crucial for employers and employees. While merit increases recognize individual performance, other raises address broader company and economic factors. The recent news involving Google’s CEO compensation serves as a reminder that compensation decisions should reflect business needs and the workforce’s and stakeholders’ expectations and sentiments. By striking the right balance, companies can foster a positive work environment and maintain a harmonious relationship with their employees.

Merit increase hinges on a segment of the total salary under review. Typically, this figure hovers around an average of 3%. Nevertheless, various employees might be granted varying percentage hikes, contingent upon their respective contributions to the company’s accomplishments.

A merit increase is a pay raise requiring employees to meet specific performance requirements. Merit increases rely on manager evaluations or team feedback to determine how much more an employee may earn. Unlike cost-of-living raises, which maintain an employee’s buying power by adjusting their salary for inflation, merit increases give employees a direct financial reward for bringing success to the company.

One of the most significant differences between merit increases and other pay raises is the metrics and requirements employees meet to receive merit increases. While merit increases have some flexibility, they follow performance guidelines, giving employees a clear path to increasing their earnings. They are more likely to understand when some employees get raises and others don’t. Merit increases also help businesses pay their employees a competitive wage based on the value of their skills within the job market.

Upon initial observation, merit increase and pay raise might appear interchangeable, yet they hold discrete connotations. A merit increase finds its foundation in an employee’s performance and achievements, reflecting their significance to the organization. Conversely, a pay raise encompasses a broader scope, encapsulating a range of salary adjustments that may not hinge on an employee’s performance.

A merit increase is based solely on performance and doesn’t inherently factor in adjustments for the cost of living. Cost of living adjustments (COLAs) are designed to counteract inflation, ensuring that employees’ purchasing power remains constant. While a merit increase recognizes an employee’s contributions, a COLA aims to uphold the actual value of an employee’s salary amidst economic fluctuations.

A cost-of-living adjustment (COLA) entails raising salaries to mirror the rise in the cost of consumer goods and services that an average individual typically buys. This increase could be a one-time adjustment or an overall addition to an employee’s annual salary.

Determining when COLAs and merit increases come into play can be challenging, as they are distinct from the two main drivers of salary growth: market price and internal value. Nevertheless, COLAs impact your salary, representing a pay raise intended to reflect the inflation affecting the costs of goods and services. Consequently, this has a long-term influence on an employee’s salary increase.

Deciding on the appropriate merit increases for each employee is a crucial task requiring careful planning. Neglecting this aspect could lead to the organization exceeding its capacity to maintain standards or satisfy all employees.

Ideally, a merit increase is budgeted at around 3%. However, more recent trends project potential increases of up to 5%. This adjustment accommodates the current volatile economic conditions and the upward trajectory of inflation rates.

In response to impending labor shortages, organizations are adopting proactive strategies, including enhancing employee benefits to retain their workforce. According to a recent survey by Grant Thornton, more than 50% of HR leaders indicated that their organizations are considering budgets with potential increases of up to 5%. This range surpasses the conventional average of 3%. Another survey suggested a likelihood of a 3.9% increase for most organizations.

As an organization, aligning your priorities when reviewing your merit increase budget is crucial. Many employees seek new job opportunities in pursuit of better compensation. If retaining top talent ranks high on your agenda, ensuring that the incentives bring employees’ compensation as close as possible to the maximum pay bracket is advisable.

As we gaze into the horizon of 2022, that figure is likely to transform. The Great Resignation (or the Great Reshuffle) has ignited fierce competition for skilled individuals. With an unprecedented number of employees parting ways with their current positions, enterprises are pulling out all the stops to retain their valuable workforce.

The extent of merit increases varies, contingent on factors like job role and departmental affiliation. Certain organizations evaluate specific departments’ contributions to the overall company objectives. Furthermore, an individual’s existing salary (particularly the established compensation range) also plays a pivotal role in the decision-making process.

While both are forms of advancement, a promotion involves an elevation in job title, responsibilities, and, often, compensation. On the other hand, a merit increase focuses solely on recognizing an employee’s contributions without necessarily changing their job role.

Calculating merit increases requires a well-defined and transparent process. Utilizing people analytics can help streamline this process, ensuring fairness and consistency. Here’s a step-by-step guide:

• Step 1: Determine financial impact. Evaluate whether an employee’s performance directly impacts the company’s financial success.
• Step 2: Objectively assess performance. Use data-driven metrics to evaluate an employee’s performance objectively. This might include productivity, quality of work, leadership, and teamwork.
• Step 3: Determine suitability for merit increases. Consider if the employee’s contributions align with the company’s goals and values.
• Step 4: Model the pay increases. Use data analytics to model different scenarios for merit increases based on performance assessments and available budgets.

Let’s analyze a specific example of how to calculate merit increases.

Imagine, there’s Alex, an employee at XYZ Corporation. The company is considering a merit increase for Alex based on their performance over the past year. We’ll follow the steps of calculating merit increases mentioned previously. So,

• Step 1: Determine financial impact. XYZ Corporation should evaluate how Alex’s performance has contributed to the company’s financial success. Assume they find that Alex’s innovative ideas have led to a 10% increase in revenue for his department.
• Step 2: Objectively assess performance. Using data-driven metrics, XYZ Corporation assessed employee performance. HR managers evaluated Alex’s productivity, quality of work, leadership skills, and teamwork on a scale of one to five, with five being the highest. Alex scores an average of 4.5 across all categories.
• Step 3: Determine suitability for merit increase. Considering Alex’s contributions align with the company’s goals and values, XYZ Corporation concludes they deserve a merit increase.
• Step 4: Model the pay increases. XYZ Corporation uses data analytics to model different scenarios for merit increases based on Alex’s performance and the available budget. They consider a range of possible merit increases, with the maximum increase being 7% of Alex’s current salary.

Given Alex’s performance score of 4.5 and their significant impact on department revenue, the company has decided to grant him a merit increase of 6%.

Calculation:

• Current salary: $60,000
• Maximum merit increase: 7% of $60,000 = $4,200
• Merit Increase: 6% of $60,000 = $3,600

Thus, Alex will receive a merit increase of $3,600, which brings their new salary to $63,600.