What Happened to Merit Pay Programs?

Early in the last century while labor organizations were convincing employees to join unions for "decent pay and benefits," companies decided that there needed to be programs that reward performance and pay more to the employees who contribute to the success of the organization. A new concept titled "pay for performance" became the rage. This pay for performance philosophy was also known as "merit pay." These programs were designed to provide salary increases based on employee performance. The concept was that the higher the level of employee performance, the larger the salary adjustment. This seemed an ideal methodology to recognize employee value.

Organizations determined what their target pay level was to be and developed policies to manage from this target. Some companies used a relative position to a defined labor market and others used systems of internal progression. To ensure that employees were paid "properly," but not extravagantly, complicated ratings tools, matrices comparing pay position to performance, and other quantitative means were devised to define the size of the salary adjustment. The concept was outstanding: finally, employees would be paid at levels based on their performance.

Problems became evident in short order. First, in situations where salary adjustments were not tied directly to performance, every employee received an "average" salary adjustment to cover the "cost of living." This left no funds to recognize outstanding performance and superior performers received only slightly higher increases. For example, if a salary adjustment budget was determined to be 4%, all employees received 4% regardless of performance. Outstanding employees received 4?% or 5%. This system did not truly "pay for performance."

Employees soon realized that performance above the "average" level did not yield significantly larger increases, so they tended to perform at the "average" level since there was no perceived benefit to working harder or smarter. Organizational performance did not increase but became stagnant. Organizational performance increases became a factor of technology, not employee effort and performance. When companies attempted to tie salary adjustments to performance ratings, managers adjusted performance ratings so that the lowest rating became "average." After all, what supervisor wants to give an employee the bad news that he or she is not going to receive a salary adjustment?

~ Managers also began devising ways to provide more money to their most valuable employees. Where there was once a single level Accountant job, soon entire career families were developed such that one would find a hierarchy similar to this: Accountant 1, Accountant 2, Accountant 3, Senior Accountant 1, Senior Accountant 2, Senior Accountant 3, Lead Accountant, etc. The differences between levels were almost impossible to distinguish, but managers felt that employees would value these higher levels as recognition and the higher levels would warrant higher salaries. In some organizations these hierarchies became such an art form that as new technologies were introduced, everyone in the organization had to be upgraded. Unfortunately, this system led to an entitlement mentality shared by both employees and management that everyone should receive salary adjustment each year regardless of performance, ability to pay, etc.

With the need to be more cost competitive, companies cannot afford to absorb cost increases. What can organizations do to retain their key employees? Companies need to rethink their pay for performance programs and not allow them to continue adding cost without offsetting performance increases. Companies should determine their market position through careful analysis and compare their actual pay position to the desired pay position.

Once this variance is determined, strategies should be developed to allow salaries to drift to market position over time. These strategies could include performance-based salary adjustment programs including adjustments based on skills acquisition, objective-based performance measurement, or other measurable performance factors. To retain employees who are not able to acquire new skills, lump sum salary adjustments and bonuses based on specific performance factors can be utilized. The key to success is not to allow these programs to fall into the trap of becoming entitlements.