What Is a Merit Increase? (Complete Guide) (2024)

A merit increase is not a typical raise. The employee is not getting a promotion to a higher position, and they are not getting an adjustment to account for an increase in cost of living. It is a reward for their high performance.

A merit increase offers a host of benefits for the employee as well as the employer. At its core, a merit increase makes the employee feel valued. When they feel valued, they stick with the job and company and continue to produce quality work.

The average merit increase hovers around 3% or 4%, according to Mercer. It was 3.8% in 2023, and Mercer predicts it to be 3.5% in 2024. This is not a one-size-fits-all number, though. Use it as a starting point to come up with an increase that is fair for employee performance, company financial health and industry norms. Regardless of the increase you land on, your human resources department must effectively communicate the reasoning behind it.

In the previous section, we touched on a few of the reasons why merit increase amounts differ. Here is a deeper dive into them.

Performance Review

A performance review includes a lot of anecdotal proof on how the employee performed during the last six or 12 months. At the end, it usually turns these examples into an overall rating. You can use this rating to decide whether or not to offer a merit increase. For instance, maybe you give salary increases to employees who score four out of five or higher.

Experience and Seniority

Employees who have dedicated years to your company or have years of experience in their field may receive higher merit raises. This acknowledges the value and commitment they bring to the organization.

Role

Positions that are vital to the company’s mission or require specialized skills may be eligible for more or higher merit increases. This ensures that these critical roles remain competitive and attractive, enabling the company to retain talent where it matters most.

Company Budget

Every company should have a line on their budget for compensation. Any merit increases should fit within that budget. Companies that are meeting or exceeding their financial goals are going to be able to offer higher merit increases.

Industry Standard

Conduct research on your industry to see what is normal in terms of salaries and increases. If you compensate your employees fairly, they won’t be tempted to leave for more money from your competitors.

Merit increases serve several purposes:

Rewarding Employee Achievement

If anyone deserves a pay raise at your company, it’s the employees who have worked the hardest and produced the most quality work. Rewarding your top-performing employees in this way makes them feel recognized and valued, which leads to other benefits we discuss later on in this section.

Promoting Skill Development

If an employee sees their coworkers get merit increases, they may set out to develop new skills themself to be eligible for the next one. It can also motivate already-rewarded employees to continue growing to get future ones. This creates a culture of learning and development, which is how workers advance in their careers.

Boosting Morale and Productivity

A merit pay increase serves as an acknowledgment of an employee’s value to the company. It gives the employee an energy boost, motivating them to continue delivering work that meets or exceeds expectations.

Retaining Talent

In a competitive job market, keeping talent is crucial. Merit increases ensure that employees are paid well and feel valued, eliminating the necessity to look for outside opportunities that meet these needs.

Aligning With Company Goals

Merit increases link employee rewards to company objectives. By only giving out raises for reaching certain goals, an employer can promote the employee behavior that will lead to company-wide success.

Clear communication is the key to ensuring your employees understand how merit increases work. Below are some recommended practices to follow when you’re informing your employees about their merit increases.

Timing

It is a common practice to communicate the merit increase during the performance review. This allows for a discussion about the employee’s performance and how it aligns with the merit increase.

Transparency

Employees must understand the metrics you used to determine who got increases and how much they got. Explain the specific criteria you followed. For instance, maybe you give sales representatives who met their sales quotas all four quarters a 3% increase. And, representatives who surpassed their quotas by at least 10% all four quarters get a 4% increase.

Method

Performance reviews should happen face to face either in person or over video. Since we recommend having the merit increase discussion during the performance review, it will also happen face to face. Additionally, you can send out a team-wide email explaining the merit increase process and reasoning. That way, employees who don’t get an increase stay informed as well.

Not every company offers merit increases. Here are some pros and cons to consider as you decide if this pay model is right for you.

Advantages of Merit-Based Pay Models

• Drives performance excellence: This model promotes excellence by linking compensation to performance. It motivates employees to deliver quality work, fostering a culture of productivity and improvement.
• Retains top talent: Employees want and expect to be rewarded for their hard work. If you fail to give them a raise, they are more likely to seek out a new opportunity.
• Rewards strong contributors: Only strong contributors get merit increases. This keeps them motivated to continue working hard while motivating their team members to start.

Disadvantages of Merit-Based Pay Models

• Multiplies costs: Merit increases typically happen all at once at the beginning or end of the year during performance reviews. This puts a massive strain on your budget if you haven’t accounted for the additional cost.
• Leads to salary compression: Salary compression is when a newly hired, less-experienced employee has a similar base salary to a highly experienced veteran employee. If you do not ensure that your merit increases are on par with industry pay standards, then you can get salary compression.
• Hurts culture or morale: The concept of merit pay might encourage employees to prioritize their own interests over what is best for the company. They may start focusing solely on their individual performance metrics at the expense of collaboration, teamwork and overall company success.
• Leaves room for inequity: As humans, it’s natural for us to have biases. However, we can’t let them get in the way of doing what’s best for the business and its employees. Do your best to create objective criteria for performance reviews and merit increases. Otherwise, you risk leaving out an employee who deserves a raise.

There are other ways to acknowledge your employees if you don’t want to use merit increases. They include:

• Cost-of-living adjustments (COLAs): COLAs increase salary based on how much the cost of living has gone up. It keeps up with inflation in the cities and states your employees live in.
• Incentive bonuses: Incentive bonuses are payments that employees get for meeting or surpassing their performance targets. They’re a performance-based model like merit increases except they’re one-time payments.
• Equity grants: Equity grants, such as stock options, give employees a stake in the success of the company. Employees want the company to do well because then the price of the company stock goes up and they can sell their shares for more. Therefore, they work as hard as they can to ensure that the company succeeds.
• Skill-based increases: Skill-based increases reward employees for acquiring new skills and using them for the company. They create an environment of continuous learning, like merit increases, but without the competition.

Merit increases are not only about rewarding accomplishments; they also serve as strategic tools for encouraging future productivity and commitment. However, you have to create your merit pay policy with care to ensure that all employees have a fair chance of getting one.