Does Merit Pay Really Work?

The idea seems simple. If you pay high-performing workers more than low-performing ones, the former will stay and keep producing at a high level, while the latter will leave or have incentive to improve.

From surveying thousands of employees of natural retailers over the years, I’ve concluded that most strongly desire the chance to improve their income through their own efforts. Yes, they like having some guarantee that their pay will rise with the cost of living. Nevertheless, it’s very important to these employees that not everyone receive the same raise, because they believe not everyone contributes at the same level.

The catch is that most people assume their own performance would warrant higher pay. But would their supervisors and coworkers share their self-assessment? Would their performance warrant the maximum under a merit pay system?

And would denying others a raise or giving them a smaller-than-expected raise do anything to improve their performance? Do employees who receive less than they expected resolve to work harder for the whole next year? Or do they become demoralized and slack off?

Performance reviews are often a casualty of merit pay systems. I don’t believe reviews can simultaneously fulfill their potential as vehicles for both determining pay increases and for establishing future goals. The former tends to overshadow the latter. The goal-setting function of the performance review gets lost in the employee’s anxiety about the amount of the anticipated raise. Or the evaluation criteria are not job-specific enough or the rating scale too vague (one person’s “5” is another person’s “3”) for the employee to be clear on exactly what he or she needs to improve in order to earn a higher raise.

Moreover, the idea that a merit raise based on past performance can motivate future behaviour is unfounded. When using performance reviews to determine pay increases, you are looking backward, rewarding the employee for what has already been done. Social scientists have long noted that to motivate behaviour, a reward must be perceived to be a direct consequence of that behaviour. Employees need a “line of sight” between their pay increase and the performance that earns it.

In studies of employee motivation, the impact of a pay raise is said to average eight weeks — two weeks in anticipation of the raise and six weeks after receiving it. If you want to motivate employees to their best level of performance for the long haul, you need a forward-looking mechanism that encourages people to work toward a reward.

Separation is the solution

There is a solution to this dilemma – separating the performance review from the pay review. For example, on the six-month anniversary of hire, employees get a performance review with feedback on their strengths and areas for improvement. At the end of the review meeting, manager and employee both agree to a limited number of specific goals. A strong performer could have goals such as cross-training in a new area, researching and training coworkers on a relevant topic or documenting department practices in a manual. For uneven performers, the goals would include addressing a performance problem as well as developing a new skill or taking on a project.

Six months later, on the one-year anniversary of hire, employees receive a pay review. At this meeting, the manager informs the employee of the amount of her or his raise, based on progress observed toward the pre-established goals.

Yes, this means meeting twice a year face-to-face with each person you supervise. But isn’t that a reasonable investment of time in the people who are the face of your business to the world? •

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By |November 8th, 2013|Categories: Articles, External Articles|Tags: |

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