If you’re like most HR leaders today, record inflation and a looming recession have you prioritizing retention over recruitment. But how do you keep top performers in a labor market where 1 in 3 employees are considering quitting and there are nearly two jobs for every job seeker? One impactful way is to double down on something you’re probably already managing: merit cycles.
This doesn’t mean supersizing merit increases. Chances are, no matter how hard you stretch your budget, you won’t come close to meeting the 8% inflation rate. Salary increases for 2023 are expected to average just over 4%.
Instead, leveraging merit cycles to boost retention and pay equity is about creating a data-driven, consistent, and transparent process that rewards fairly and motivates employees to keep growing at your company. Before we get into how to do this, let’s review the basics.
What is a merit cycle?
A merit cycle (aka focal reviews or annual reviews) is the process of determining salary adjustments based on performance. They usually follow or coincide with the performance review process. Adjustments can be in the form of promotions, bonuses, or additional equity grants. These adjustments are separate from annual cost-of-living increases.
Why merit cycles matter
Because merit increases recognize employees for their contributions, they can play an important role in retention and pay equity when done right.
According to a Gallup-Workhuman study, employees of companies who prioritize recognition are:
- 56% less likely to be looking for new jobs
- 3x as likely to feel loyal to their organization
- 4x as likely to strongly agree they would recommend their organization as a great place to work
- 5x as likely to see a path to grow at their organization
“The overall objective of a merit cycle is to communicate pay data in a way that helps employees understand why they’re paid the way there are, and makes them feel appreciated and respected. And it gives them context about how they can make more money. What does that look like for the next merit cycle?” says Jamy Conrad, senior director of people, TrustRadius.
So how do you design a merit program that empowers a loyal workforce and supports pay equity? The following nine best practices can set you on the right path. When you’re done, read about how you can boost retention with career pathways and pay transparency.
Prefer video? Get all these retention tips and more from our on-demand webinar, “3 Things HR Leaders Must Know About Retention in 2023,” featuring:
9 merit cycle best practices
Best practice #1. Be specific about eligibility criteria
Don’t begin a merit cycle until you know exactly which employees qualify. For example:
- Is eligibility based on hire date?
- Are certain roles excluded?
- Is it only for the top 25% of performers?
- Are part-time employees eligible?
Best practice #2. Get buy-in from leadership on behaviors the company rewards
The achievements you reward during a merit cycle reflect a company’s culture and vision. Confirm your merit cycle plan with leadership before rolling it out to make sure you’re encouraging behaviors that support the company’s goals.
Best practice #3. Determine frequency
Merit cycles are conducted annually, twice a year, or quarterly. The more often you have merit cycles, the more work is required for all involved. But frequency also affects the message you send to employees and job candidates about what your company values, so consider the cadence carefully.
“Consider who you’re competing against,” says Ashley Brounstein, OpenComp’s head of people. “If you’re a small or younger company and you’re competing with a FAANG, you may need to do a merit cycle more than once a year.”
A frequent cadence gives you more opportunities to talk about performance. Meanwhile, an annual cycle means you need to get it right every time. Otherwise, you may see turnover.
Best practice #4. Know your budget
Make sure you and your finance partners are working off the same numbers.
“If finance says your budget is 3%, ask 3% of what?” says Matt Toeller, vice president of total rewards at Harness. “Is it based on salaries for all of those who are eligible? Or is it based on all employees as of a specific date?”
Best practice #5. Take time for compensation benchmarking
Regular compensation benchmarking will help you keep track of the current market. “If you don’t take time for this step, you risk being behind the curve,” says Conrad of TrustRadius. Pay data matters!
However, keeping the pulse of market shifts doesn’t mean you have to adjust your pay bands every quarter. “Respond to trends over time, not just in a single quarter,” she says.
Best practice #6. Have a communication plan & talking points for managers
Share the merit cycle plan and criteria with employees well before they meet with managers, and train them on how you collect pay data. And look for ways to take some of the communication responsibilities off the shoulders of your managers.
“Get in front of everyone at an all hands meeting and explain the criteria and process,” says Brounstein. “Own message on behalf of your managers.”
In addition, train managers on how to talk about compensation and the merit process in a way that employees can understand easily — while making them feel valued and appreciated. That’s a tall order, so give managers all the tools and support they need.
“The more you can communicate as an organization, the easier it will be for managers to have those conversations,” says Conrad.
Best practice #7. Don’t skip performance calibrations
During performance calibrations, executives and/or managers meet to review performance ratings for individual employees. This allows participants to get aligned on how they’re rating employees, check for biases, and make necessary rating adjustments based on what they’ve learned.
Best practice #8. Conduct a pay equity analysis
Before you distribute merit awards, conduct a pay equity analysis to identify pay gaps.
Once you’ve identified a gap, look for the reason. It may be because an individual was promoted off-cycle and is in the lower part of a new pay band. Even if you don’t need to make adjustments, it’s good to know where the gaps are.
Best practice #9 Budget for adjustments
If you’ve identified a pay gap that exists without a fair or logical reason, make the adjustment as soon as you can. If you don’t have the budget to make adjustments right away, have a plan for phasing in the adjustment over time.
One strategy for budgeting for adjustments is holding back a percentage of your overall merit cycle budget. If your budget is 3%, you might reserve a quarter point.
“By doing that, you have a small budget built and you’re not asking for more money,” says Toeller. “In the end, if you don’t use it, it doesn't go away, but goes into another operating expense.”
Employees will appreciate the effort you’ve made to make things right. According to a report by industry leader and HR analyst Josh Bersin, companies who make reward fair and equitable are:
- 5x more likely to accomplish outstanding people outcomes (retention and engagement)
- 5x more likely to have outstanding financial and customer service
- 6x more likely to innovate and adapt well to change
Run faster and more accurate merit cycles
If you’re managing merit cycles through spreadsheets, it’s only a matter of time before errors and biases creep in. Replace stale pay data and manual processes with real-time compensation data and intelligent HR technology for faster and more accurate decision-making to prevent attrition, keep things equitable, and help managers and people leaders navigate difficult conversations.