Putting Merit Back in Merit Pay

With all the focus on executive compensation these days, its nice to see a bit of attention paid, particularly by CFOs, to the challenge of rewarding top performers of the nonexecutive variety.  This month's CFO magazine features a great article titled Just Rewards (by Roy Harris) which examines the steps that companies are taking in this tightening labor market to redesign their nonexecutive pay programs in order to better attract and hold on to top performers.

In addressing this topic, the article takes a well-deserved shot at merit pay, a program which the author asserts "represents a missed opportunity for rewarding top employees".

Rather than allocating money according to well-defined and carefully reinforced achievement rankings, many companies simply apportion merit raises evenly (or close to it) across the entire eligible population.  The reason?  'Managers aren't interested in doing things that are going to have a negative impact on people's morale,' so they rate employees higher than they should, says David Sirota, founder of Sirota Consulting and co-author of The Enthusiastic Employee (Wharton School Publishing, 2005).  The national average for merit-increase budgets is less than 4% of payroll, making the actual amounts at stake relatively small.  'Still, the reaction of top people is to ask why, after all their excellent work, they get, say, only 2 percentage points more [than the average],' he adds.

The article describes steps that three major corporations (Excel Energy of Minneapolis, True Value Company of Chicago, and Agilent Technologies of Santa Clara) have taken to improve the performance of their merit pay programs -- as well as the overall link between top performance and rewards.  At True Value, the CEO himself took the organization's pattern of "rating inflation" to task:

Things began to be reassembled in 2005, when veteran Sears executive Lyle Heidemann became True Value's CEO.  Joining the company during midyear performance reviews, he saw how ineffective the system was.  'His message to employees was the he himself had often been rated as a 3 [strong contributor], and he wasn't ashamed of it,' says Mysel [Senior Vice of Human Resources].  'He said that in his entire career he'd worked with only a couple of 5's.  That sent a strong signal.'

Sometimes it takes a strong message from the top of the organization to convince managers to take the performance assessment process more seriously.  What's at stake is no less than the organization's ability to reward its top performers. 

Of course, adhering too strictly to a "bell curve" mentality can backfire, too.  I have worked with organizations where managers are telling their eager employees things like "nobody here can earn a '5' (or whatever the top rating happens to be) - we don't give them out unless an employee is perfect, and no employee is perfect".  Isn't that a motivating message?  Better to set that bar high - really high even - and then say "I'd love to see you take a shot at accomplishing that - what can I do to help you get there?"

Putting merit into their merit pay program remains a challenge -- but, I'd submit, a worthy one -- for most organizations.  Check out this article to learn more about how a few organizations are facing that challenge head on.