What is a merit increase? Everything managers should know

People-focused organizations don’t need to be told that financial rewards are a great way to keep their employees happy. They understand that a lack of appreciation is a common pain point for professionals, with three in four workers acknowledging that they want more recognition and feedback from leadership. (1) They also know that employees are up against rising inflation and increased living costs, thus counting on pay raises and bonuses to help them navigate choppy economic waters. (2)

A merit increase is one of the most meaningful ways to show team members that their work matters and retain them long-term. After all, fewer employees may be leaving their jobs right now (3), but those looking for new opportunities are doing so primarily because of inadequate pay. (4)

Still, introducing a merit-based raise without a strategic plan can cause more problems than it fixes To help you avoid this, we’ll unpack the concepts behind merit increases and how your company can benefit from them. We’ve also included a straightforward five-step plan to introduce a merit increase pay policy at your organization.

1. Leapsome Workforce Trends, 2023
2. Reuters, 2024
3. Bureau of Labor Statistics, 2023
4. Achievers, 2024

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What is a merit increase?

A merit increase is a performance-based pay increase that adds to an employee’s overall salary. Organizations use them within a compensation management plan to reward high performance and exemplary work. Merit increases take many forms — including bonuses, pay raises, and temporary salary increases. They may be part of a promotion, but not necessarily.
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Merit increase vs. pay raise

So, what exactly is the difference between a merit increase and a pay raise? Both serve a similar purpose, but it’s important to differentiate them.

Merit pay increases are solely based on an employee’s performance. A team member might receive a merit increase as a reward for exceeding targets or supporting company growth in other ways. People may also get a merit increase for exceptional circumstances, like working “unsocial hours” or absorbing extra responsibilities in an emergency. As an example, some companies gave out temporary merit-based raises to employees who couldn’t perform their duties from home and had to go to the office at the height of the pandemic.

By comparison, pay raises are based on factors like tenure, promotion, seniority, or cost of living adjustments. For instance, a worker may receive a pay raise for transferring to a branch in a more expensive town. Pay raises like Cost of Living Adjustment (COLA) are also necessary for employees to maintain a standard of living. They’re not rewards, and employers shouldn’t treat them as such.
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What is an average merit increase vs. a good merit increase?

Many companies provide a standard annual 3% to 4% merit increase to reward high performers for consistently great work, but that’s not above average. Some employers may offer up to a 10% merit salary increase for a senior leader or executive who takes charge of a major project — think of a CFO who oversees a merger or a CTO who leads a product launch. 
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Why should you care about merit increases?

In other words, why not keep using standard pay increases?

Merit salary increases matter because rewarding great work has a powerful effect on your employee’s performance. Let’s look at how merit increases can contribute to your company’s success.
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Encouraging good performance

Merit increases link high performance to recognition and rewards. By doing so, they motivate employees to go beyond just meeting expectations. Studies back this up: According to Great Place to Work, 37% of employees would produce great work for more recognition.

Whatever route you take, you’ll find merit raises positively affect performance. If companies reward entire departments, this will inspire teamwork. And if organizations reward top-performing employees, people might feel encouraged to excel.

This doesn’t just apply to the top performers, either. All employees benefit from a performance-based model. A culture of celebrating success at work incentivizes employees to work harder and fosters innovation.
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Nurturing engagement

Merit pay boosts employee engagement. This is invaluable because, as a report by Gallup revealed, highly engaged employees are much more productive than their unengaged colleagues.

Traditional pay raises are also beneficial but don’t have the same impact on engagement. If done incorrectly, they can even lower engagement levels: Nobody enjoys a job where they watch an underperforming colleague get rewarded for tenure while they are working hard, but their salary is stuck.

The advantage of a merit increase vs. a raise is that employees must earn them. Managers only have so many raises to give out per year, depending on their company’s merit pool. Merit pay allows them to choose the most deserving candidates. Other employees might not receive a raise, but they are less likely to begrudge their successful colleagues. In fact, they may try to emulate them and improve their own performance.
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Improving employee retention

Money tops the list of reasons why employees stay at a job; when the PwC asked people why they would look for a new job, over two-thirds said fair compensation. Beyond making you a more attractive employer, merit pay can play a critical role in employee retention.

When it comes to your top performers, merit-based salary increases are a worthwhile investment. The highest performers tend to be more productive than their colleagues, and a slight salary boost could buy you more years of that extra output. The expertise and the rapport they’ve built with your clients are yet another benefit of retention.

A raise based on merit can also save you from the cost of replacing your talent. That’s job ads, HR hours, background checks, and sign-on bonuses, which can add up to thousands. After all that, it takes six months before a new employee reaches the same productivity levels as the previous one. Considering all these costs, a 5% merit bonus looks like a bargain.
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How to successfully implement merit increases

Successful merit increase implementation requires strategic planning. Follow the steps below to guarantee a fair, consistent reward process.
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1. Evaluate your current compensation plan

Before you get started, consider one crucial, often-neglected question: Does your company need merit raises? Your current compensation plan and salary structure may work just fine. Maybe other factors are impacting engagement levels and turnover. So, be sure to take a holistic approach and check how your compensation plan aligns with your organization.

Start by collecting a pool of data on your employee engagement levels —  for instance, you can use anonymous pulse surveys to get your employees’ honest opinions. You can also examine your company values and business model to decide whether linking compensation and performance suits your organization.
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2. Develop a merit increase policy

Next, figure out the specifics of your merit raise policy. The first question is whether merit increases will be standard or offered in exceptional circumstances. If you found more pressing concerns in step one — perhaps a lack of career growth or burnout is responsible for driving your people away — then put your resources towards solving those problems first. Save merit increases for isolated cases like employee promotions or making a counterproposal when your top performer gets a tempting job offer elsewhere.

To standardize merit bonuses, find an objective, measurable way to assess each employee. Look at everything from performance reviews to goal achievement, but keep in mind that, in this case, how you assess is even more important than what you assess. This means that everyone must go through the same assessment process; whichever performance metrics you use, they must be consistent — or your people will become mistrustful. 

If you use reviews, do a performance review calibration to ensure the rating scale is consistently followed across the company. Train managers and human resources on how to avoid unconscious bias, too, so they interpret each review fairly. Be sure you’re rewarding performance and nothing else.
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3. Calculate merit pay increases

Time to define merit increases. The amount you offer largely depends on how competitive your industry is, your location, and how much you can set aside for a merit pool.

During your calculation process, decide which departments and positions are business-critical — meaning that some jobs might be harder (and more expensive) to fill if people leave, so a merit-based raise can be particularly strategic.

Still, don’t forget your goal should be retaining the highest number of people, rewarding employees fairly, and keeping them happy. Consult with your accounting department and model each merit increase to see if it’s sustainable.
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4. Implement your merit increase salary policy

Once you have everything in place, explain your new reward system to your employees. Everyone needs to understand it and know who to turn to if they have questions or feedback.

Once you’ve put your merit raise policy into action, use analytics to track its impact. For instance,  you can monitor quantitative data like retention rate, eNPS (employee Net Promoter Score), and business growth. You should also consider more qualitative data from employee surveys. With people enablement software like Leapsome, you can automate data collection, accessing powerful analytics and actionable insights.

Additionally, consider developing a career path framework to show employees what skills to focus on and how to improve performance and reach the next career stage. Show your people exactly what they need to do to get a merit increase. Otherwise, they won’t know your expectations and may stop trying.
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5. Get feedback and amend

Despite all your hard work and preparation, your first merit increase model likely won’t be perfect. When you conduct compensation reviews, you’ll need to revisit your merit increases based on employee feedback and issues you’ve observed, so keep an open mind and be willing to make necessary adjustments.

Although you may sense what needs changing, send out another round of pulse surveys to collect focused feedback. This information will help you make a fully informed decision about what to do next.
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How Leapsome makes data-based merit increases easy

A merit increase seems simple: You just need to identify your top talent and increase their salary. Right? Not really. Merit pay increases are much more complex in practice. How can you evaluate each employee without turning your job into an endless series of assessments — while keeping salary and performance reviews unbiased? 

Leapsome’s full range of people enablement tools lets you easily implement incentive programs. Engagement surveys give you deep insights into what makes each employee tick so you can figure out underlying problems and present them in an intelligible way. Our performance review tool helps evaluate who qualifies for a merit increase, and Leapsome Compensation automates compensation and promotion processes. Not to mention that, throughout the whole process, our competency framework and learning tools set your people up for success. 

Leapsome features interconnect for seamless compensation management, resulting in a well-planned program tied to hard data that rewards employee efforts but doesn’t compromise your company goals.
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