Merit pay is a system, where one is paid on the basis of the achievement of targets by an individual. These are done on a metric basis where the individuals are evaluated on the targets and levels achieved in the metric and are paid or compensated accordingly.
For example, suppose there is a company which has salesmen and the salesmen are to be rewarded on a merit pay basis. The appropriate metric for the salesmen’s compensation will be the number of sales done in a particular period, and a appropriate percentage of each sale is given to them as commission. As an example, if a sales man is responsible for 100 rupees revenue, he is given 10 rupees out of the 100 sales done. Hence based on his merit the more sales he does, the more he earns. This is a particular example for merit pay system.
There can be other forms of merit pay system for example, number of defects an coder fixes in a given month, plant efficiency for plant managers, employee retention rate for HR people in an organization etc. can be linked to monetary values and form a merit based pay system.
For many employees, financial incentives form the crux of performing up to set standards at work, and the concept of merit pay draws on this very fact. It rewards individual performance, and not group performance. Hence, it draws a very clear picture of how an individual is contributing towards the organisation, and being compensated fairly. This will motivate him to continue good performance in the future as well. For designing an effective merit pay system, it is essential that it fulfils two conditions. Firstly, the changes in employee performance level must be clearly identified and measures. Also, the supervisors must be aided with tools to determine appropriate rewards to the right employees.
There are several advantages of this system. It enables the employer to differentiate the high performers by giving them a higher pay. Also, if an employee contributes to a significant task that is not often performed, like implementation of a Core Banking System in a bank; He can be rewarded fairly. However, there are several criticisms as well. It is argued that merit pay system is subjective and hence it is often biased. Another disadvantage is that the employees develop a tendency to expect consecutive pay raises. Hence, in order to be effective, the merit pay system should ensure that the rewards for high performers are substantially more than the average performers. Also, those employees whose performance has slipped from the past should not be given pay raises at all.
An example of the merit pay system is a salesperson getting a 2% rise for achieving sales target over and above the company’s expectations. His pay will be permanently increased under this system.