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Pros and Cons of Merit Pay

written by: Vikas Vij•edited by: Jean Scheid•updated: 3/4/2011

Considering performance pay as a motivation tool for your employees? Evaluate the pros and cons of merit pay carefully before implementing a performance-linked pay system.

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    Advantages and Limitations of Performance-Linked Pay

    Incentive Pay The issue of merit pay has remained a subject of considerable debate in both the private and public sectors. A business organization must evaluate the pros and cons of merit pay carefully while devising its pay policies for the employees. Conventional wisdom in business has usually favored the existence of merit or performance linked pay. However, the downside of this pay system often gets ignored. Each organization is unique and it must evolve the best pay method that matches its needs in the best possible manner.

    Photo Credit: svilen001

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    Time-Tested Tool of Employee Motivation

    Merit pay has traditionally been one of the most effective tools of motivating employees to perform to the best of their ability. It is recognition for the employees who achieve the highest productivity and results for the business. A monetary reward in terms of a better pay is the strongest incentive for an employee who is working with a greater enthusiasm, commitment and skills than the other employees around him.

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    Healthy Competition among Employees

    A healthy competitive spirit among employees can propel them to achieve superior results for the organization. Competition is a natural human instinct, and merit pay capitalizes on that instinct to extract the best performance from the employees. Employees like to be recognized as achievers, and performance based pay is one of the best ways to award that recognition.

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    Helps to Attract and Retain Top Talent

    In absence of a merit based pay system, there is the risk of non-motivation for the highest performing employees. Talented employees are aware of their strengths and like to accept the challenges of a performance linked pay. If they find that all employees are awarded a uniform pay without any regard to individual merit, there is a risk of the best performing employees leaving and joining other organizations that are willing to recognize their exceptional talent.

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    Difficult to Evaluate Performance Objectively

    Despite the obvious advantages of performance linked pay, the pros and cons of merit pay should be evaluated carefully before implementing such a pay system. Performance evaluation can be a highly subjective issue in many areas of the business. Therefore, enforcing a system of merit pay regardless of the nature of job may prove to be counter-productive for the organization.

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    Higher Employee Conflict and Non-Motivation Issues

    Some employees may believe they deserve to be included among the meritorious candidates for higher pay. If such employees are ignored for any reason, it may result in a higher degree of employee conflict within the organization. Some employees may feel let down by the system, and may begin to lose their motivation if they are not considered deserving of merit based rewards.

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    Emphasis on Individual Performance and Compromise of Team Spirit

    If on one hand merit pay leads to healthy competition, on the other hand it may also lead to a compromise of the team spirit of a unit or division that is working together on a project. Pay differentiation may result in dampening of the enthusiasm to work together as a team, and not as rivals. Individual goals may tend to take precedence over group goals, which may do more harm than good for the organization in the end.

    Reference: The Pros and Cons of Performance Based Compensation (Solmon & Podgursky) retrieved at