The Return of the Moderate Merit Budget – Wreaking Havoc on Pay for Performance
January 7, 2021
With the economy now on steadier ground, most organizations have returned to administering a merit budget to the pre-recession levels of 3 to 3.5%. In the years immediately following the economic downturn, many merit budgets were eliminated entirely or were reduced significantly and reserved for a select segment of the employee population.
Pay for performance has become a necessity for many organizations that are expected to accomplish more with fewer resources. I often get asked: "How can I truly award my top performers with such a limited budget? Should I do so at the expense of my ’Meets Expectations’ performers? What if I need to retain my ’Meets Expectations’ performers and giving them 0% to 2% increase puts me at great risk for turnover? But if I don’t recognize my top performers, don’t I risk losing them...?"
These are difficult questions to answer, however you can determine the best solution for your organization by considering the following:
- Are your employees paid at market pay levels?
- Is your organization’s performance management process mature?
- Does your organization have other compensation programs in place to reward top performers (e.g. variable pay)?
If turnover is a concern, and your organization needs to maintain ’bench strength’ in order to achieve its strategic objectives, your biggest priority should be to ensure that you are paying your employees at market pay levels. Why? Historically, as the labor market strengthens, organizations become vulnerable in terms of losing people. Hiring and onboarding replacement talent is not only costly to the organization, but can also cause dissension among existing employees since new hires may be getting paid more. Be sure to stay abreast of market pay levels and trends, and use the merit budget to correct disparities.
Performance Management Process
Organizations vary significantly in terms of the maturity of their performance management process. Closely examine your organization’s process and look for ways to improve it. If there is a perception that one management team is an ’easier grader’ than the others, the process is inherently flawed and any pay for performance program will not be viewed as credible and fair by employees. A good place to start is to get a calibration process in place and communicate broad guidelines on expected distribution ratings.
Variable Pay Programs
Variable pay programs (e.g. bonuses) have become increasingly more popular across all industries and career levels. These programs provide the opportunity for employees to share in the organization’s success while not adding to fixed payroll costs. Some plans have an individual performance component which can be a very effective means to recognize top performers. However, in order for this type of program to be successful, individual goals and targets must be well documented and communicated. Again, this is largely based on the maturity of the organization’s performance management process which takes time to evolve.
What are the best steps to avoid wreaking havoc on your pay for performance process?
- First ensure your pay levels are keeping pace with the market
- Continue to evolve your performance programs with calibration among managers and a rigorous goal setting process
- Promote variable pay plans to reward high performers without adding to fixed pay roll costs
It’s not always an easy journey but, in the end, it’s best to use a measured approach that is based on business needs and a realistic assessment of your current programs and processes.