No results, no raise: denying poor performers merit increases can pay off

HR Magazine, May, 2005 by Susan J. Wells

The term "merit increase" should mean that an employee is getting a pay increase based on merit. All too often, however, employees get salary increases regardless of whether their performance over the previous year was meritorious. In fact, many employees who don't meet the minimum requirements of their job collect "merit" increases year after year.

Even if those increases are marginal, experts say, giving them to all employees regardless of their results sends the wrong message--both to poor performers who are being rewarded for less-than-stellar achievement and to top performers who get a smaller piece of the salary-budget pie.

Culturally, however, managers may not be ready to stomach the seemingly harsh practice of giving poor performers no merit increase at all. They may find it is easier to spread rewards around to all employees to avoid the conflict that withholding pay increases from some workers could unleash. Or, HR may view withholding merit increases as unfair to employees who may be held back from reaching their full potential by circumstances beyond their control.

It's clear that employers' compensation systems aren't making the grade. Only 10 percent of organizations describe their merit pay programs as "very effective," according to an employee attitude survey conducted in 2002 of 335 companies by Hay Insight (the research and survey arm of Philadelphia-based HR consulting firm The Hay Group), WorldatWork and Loyola University of Chicago.

By contrast, adopting--and enforcing--the get-tough approach to merit pay has clear advantages: It doesn't waste increasingly precious salary-budget dollars, it sends the right message that improvement is imperative, and it doesn't fund underperformers at the expense of high-performing employees. (For a legal reason to implement this system, see "The Legal Danger of Rewarding Poor Performers," right.)

Making 'Tough Love' Work

The problem for many organizations is that the budget for pay increases is small--on average 3.5 percent, according to research by Hewitt Associates. That leaves little room to differentiate pay between top performers and mid-level performers--much less bottom performers.

And that's not an effective way to spur performance. "You cannot get entrepreneurial results from a communistic approach--that socialistic feeling that everybody gets something," says Chuck Coonradt, founder and CEO of The Game of Work, a management consulting company in Park City, Utah. "In my opinion, it's a practice we ought to scrap."

Coonradt believes a lot of what he calls "merit fear" comes from lack of courage on the part of managers to deny rewards to the undeserving.

But, when companies spread pay raises around to all employees, something unintentional happens, says Larry Reissman, New England practice leader for The Hay Group. "Long-tenured low performers penetrate the top portions of salary ranges, while high performers change jobs so often that they never get to those ranges at all," he says.

This wouldn't happen at one investment firm Reissman worked with that gives new meaning to the term "tough love." There, merit dollars are given to eligible employees who consistently--year after year--exhibit exceptional performance. In general, top performers are funded at the expense of lower performers and nonperformers.

In fact, even average performers at the company generally get less than the average salary increase budget number--which can pose a communication challenge for managers, he says.

Communicating Your Policy

The trick to making a compensation system like this work is to combine clearly defined goals, good communication, and a fair and frequent performance review system.

"It's futile to try to establish a pay-for-performance culture without openly discussing goals, how to accomplish them and what it means to an employee's pocketbook," says Paul Shafer, business leader in the broad-based pay practice for Hewitt Associates in Lincolnshire, Ill.

Employees also need to know what the consequences are for not meeting performance expectations, including a clear statement in the employee handbook and at performance reviews that they're not automatically entitled to an annual merit increase.

Regardless of whether times are flush, that statement alone can send a powerful signal from management that the company is serious about everyone's performance. The top performers get more. Those holding back the organization get less--or nothing.

That's exactly the message employees hear at SecureWorks Inc., where the company's CEO gets involved in every employee's compensation review, says Kerry Solomon, vice president of HR at the 103-employee Internet security services provider in Atlanta.

After an employee self-evaluation, manager assessment and input from Solomon, a proposed evaluation and pay recommendation is presented to the CEO. "The CEO reviews and blesses" the recommendation on whether the employee should or should not receive a pay increase.

And when the company implemented a new pay-for-performance plan in 2002, it was communicated in writing, in person--and over and over again throughout the year. "Our CEO and department heads repeat the message continually," Solomon says.