The Advantages of Merit Compensation

Many businesses, governmental agencies and nonprofits use grade-based pay to compensate employees. Organizations in competitive labor markets use jobs-based pay to attract and retain top talent. Merit-based pay allows organizations to reward employees who perform above expectations and gives motivation to staff members to work harder than they normally might.

All of these methods of paying employees have advantages and disadvantages, and employers should know how all of them work before deciding on using any one. Understanding these different methods of compensating employees, including the advantages of merit-based pay, will help you set the compensation levels that work best for your small business.

Motivation is Key

One of the primary advantages of merit-based compensation is the fact that it can motivate employees to perform at an optimal level. Employees who have the potential to earn high salaries because of their performance are more likely to take all of the steps necessary to perform at the highest level possible.

Although top-performing employees are often self-motivated, the potential for greater compensation can be a driving force in an employee's job performance. Even when employees aren't motivated by extra money, not being offered a bonus or other recognition for hard or superior work can be a slap in the face, lead to morale problems and cost a company key employees.

Helps Identify Top Performers

Merit pay can differentiate between high-performing employees and those who perform poorly, explains Those who do the best will, of course, receive more compensation. Merit pay also allows identifies who is pulling their weight when the company appears to be underperforming.

When sales goals are not being met, production numbers can be examined to identify the dead weight in the company. Companies can pinpoint areas of improvement by determining which employees are performing best.

Promotes Self-Determination

The employee who participates in a merit compensation system ultimately determines how much he is paid based on his own performance. This goes hand-in-hand with motivation, as it requires the employee to be self-motivated and a self-starter. Employees who do not quit and who are motivated to reach their own personal goals, however, can determine the limits of their own income.

Helps Manage Payroll

A merit-based compensation system that pays employees solely on performance makes it possible for the employer to pay the employee only what he actually earns. Systems where employees are paid high base salaries in addition to bonuses can put undue stress on an employer's payroll, making it necessary for the employer to pay the employee whether he produces or not. When employees are paid based entirely on commission or the merit of their work, the employer is only on the hook for the percentage of the profit that they owe the salesperson.