From #107, July-August 2003

Does Merit Pay Really Work?

B Y   C A R O L E E   C O L T E R

The idea of merit pay seems simple enough. 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. And it can work like that-if employees are clear on exactly what it takes to earn a higher raise, if there are no other factors but performance in pay decisions, if there are enough funds to pay out significant differences in raise amounts, and if managers have the confidence to "bite the bullet," be honest, and stand up to emotional pressure.

If, if, if....still, based on the experience of several co-ops and independent natural food stores I've worked with, I believe that under the right circumstances, merit raises can fulfill their promise.

The eye of the beholder

Edward Lawler, one of the most respected and prolific academic experts in human resources of the past 30 years, describes the conditions that permit the effective use of money as a motivator:

• employees attach a high value to pay,
• employees believe good performance will result in higher pay,
• employees have enough control over the job that their own efforts can have a material impact, and
• superior performance leads to more positive than negative results (e.g. more acceptance than rejection by coworkers).

Notice how much these factors depend on the "eye of the beholder." Employee attitudes have a lot to do with the success of merit pay programs. Perhaps comments I've gleaned from employee surveys can shed some light.

In workplaces where non-management employees earn raises through seniority only, there is always a faction calling for merit raises. Frederick Taylor, founder of the school of scientific management, wrote, "The common tendency to 'take it easy' is greatly increased by bringing a number of men together on similar work and at a uniform standard rate of pay...When a naturally energetic man works for a few days beside a lazy one, the logic of the situation is unanswerable. 'Why should I work hard when that lazy fellow gets the same pay that I do and does only half as much work?'" A century later I hear that sentiment expressed in practically so many words by co-op employees. But would their supervisors and co-workers share their self-assessment? Would their performance warrant the maximum under a merit pay system? And would denying a "lazy" coworker a raise or giving her/him a smaller raise do anything to improve performance?

Fighting over crumbs?

I wish the employees who long for merit-pay paradise could hear the complaints of employees at co-ops where a merit pay system exists. They might hear about vague or subjective criteria, alleged management favoritism, disparities between departments, late evaluations and therefore late raises, and demoralization from fighting over "a lousy 15 cents per hour." This last may be the most serious obstacle to realizing the purpose of merit pay.

The paltry amount of money at stake in many co-ops' merit programs is due to factoring seniority and cost of living when determining the size of the total raise. If your co-op has experienced high turnover, you may feel that longevity is worth paying for. You may wish to reward the people who come to work every day, even if their performance leaves a lot to be desired. You may also wish to protect employees from the impacts of the rising cost of living, especially housing, which may make it hard for them to afford to live within commuting distance of the store. These are reasonable aims for a pay program. But by taking up so much of a pay increase budget, and by diluting the message of a raise, they blunt the potential impact of merit pay.

For example, if all employees are guaranteed a raise of at least $.25/hour with top performers getting raises of up to $.50/hour (a common formula I've encountered in co-ops), the difference between a high performer and an acceptable performer comes to three percent for an employee earning $7.50 an hour. Maybe the symbolic reward of knowing they are regarded as a high performer and therefore got the highest possible raise is enough for the employees who earn it. But what about all the others? Were they expecting a 50 cent raise, too? What will happen to their motivation over the next year?

Automatic "merit" raises

Then there are the workplaces (and they are legion) where so-called "merit raises" are actually automatic. Employees come to expect the maximum and are outraged to receive any less. Managers may succumb to rating inflation on performance reviews. While sometimes this is due to cowardice or inertia, some managers feel that the pay is so low, they need to give their people the top allowable increases just to keep them.

I am reminded of something one of my earliest mentors told me 20 years ago: Merit pay only works when people are already making enough to meet their basic needs. If employees are just barely making ends meet, they won't be motivated to higher performance by merit pay. They'll only be dissatisfied not to get the maximum possible raise.

Performance reviews are often a casualty of a not-well-thought-out merit pay system. I don't believe that performance reviews can simultaneously fulfill their potential both for determining pay increases and for establishing future goals. The former role 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. Furthermore, the evaluation criteria may not be job-specific enough or the rating scale may be too vague (one person's "5" is another person's "3") for employees to feel fairly treated. While this ambiguity would not be a problem if a rating were only a platform for discussion, it becomes a very big problem when it is the basis for denying an employee a raise of the size he or she expected.

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 behavior, a reward must be perceived to be a direct consequence of that behavior. 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.

Separate performance and pay reviews

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 performance goals. For strong performers, the goals could be more developmental than remedial. 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 goals.

This approach prevents the tendency I've observed for annual goals to be set and then forgotten. Perhaps not incidentally, I've noted that in co-ops with separate pay and performance reviews where I've done employee surveys, I don't hear grousing about how pay raises are awarded. Throughout this article I've been focusing on non-management employees. For management and other professional jobs, merit pay seems well accepted and easier to implement. People in these positions are usually higher-paid, and their "line of sight" is likely to be annual, not just from one paycheck to the next. Also, the difference between good and poor performance in these jobs can significantly impact the whole co-op.

My conclusions

If you can't afford significant pay differences between high and low performers, or if you believe that your staff is underpaid in relation to the cost of living in your labor market, I suggest that you postpone the implementation of merit pay for non-management employees. Instead, give everyone predictable seniority raises and reward the high performers with positive feedback, new responsibilities, and promotions. Put your managerial time and attention into better coaching and counseling of employees with performance problems, and more timely corrective action, including removal of poor performers who demoralize the rest of the workforce. It won't bother employees so much that everyone is earning the same raise if no one is visibly screwing up and making everyone's job harder.

If you do implement merit pay, separate the performance and pay reviews by at least several months. At the time of the pay review, base your pay raise decisions on progress observed toward the goals set in the performance review. Also, make sure your pay ranges are wide enough to allow for significant differences in amounts of raises.

There is no pay system on earth that will satisfy all your employees. But you can have a pay system that supports your goal for a high-performing and motivated staff.

Carolee Colter is a consultant to cooperatives and community-based organizations.

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