Article: Merit Modeling
Harvinderjit Kaur
by Robert Buckley
In today’s fast-paced world, the only constant is change. Organizations must be nimble, flexible and adapt easily to shifting business requirements. Because each organization is unique, there is no one-size–fits-all approach to talent management. The behaviors and competencies that fuel successful outcomes are arranged differently, even in companies that compete head to head. Because of this, merit pay is getting another look by corporate HR/compensation departments.
Merit Pay Administration vs. Merit Modeling
Merit pay administration is the process of linking desired results or outcomes to the reward system that drives specific behaviors. Merit modeling is the science of manipulating merit pay to help the organization pursue a stated objective or strategy. It balances organizational gain while rewarding the employees who execute on a daily basis.
Leading organizations link pay to performance and use merit modeling to create a meritocracy in which pay advancement is marked by achievement. Once exclusively the domain of variable pay programs, the meritocracy is expanding to a fixed pool of base pay as companies seek to retain high potentials and top performers that create core competencies and competitive advantage.
Much has been written about companies that link pay to performance effectively, with a high percentage of “at-risk” pay. Companies that use pay in this way are estimated to have a book-to-market value five to eight times higher than comparable companies that don’t. Thus, companies that don’t link pay and performance now endeavor to do it, while companies that do want to improve efficiency, decision making and analysis.
To understand exactly how merit can be leveraged as a source of competitive advantage, consider the process. By definition, merit pay can be any component of a total rewards strategy when it deals with advancement, achievement and ability. However, it generally is used by compensation practitioners to mean increases to salary, variable pay and performance-based stock. Merit modeling balances the finite cash resources across different components of employee compensation, such as salary, promotion, lump sum, variable incentives and stock, so that the mix, when optimized, encourages and reinforces desired behaviors.
Before an effective strategy for merit administration can be implemented, some overarching points must be clarified. This is the easy part. Cash compensation is a component of a total rewards strategy, which is part of a company’s talent management strategy, which in turn supports the go-to-market strategy, and ultimately the strategic initiatives of the corporation. Each element should be in alignment, and talent managers or compensation specialists must understand senior management’s commitments to corporate strategies to create an effective merit model that supports the business.
It is not enough to have the right people in the right place: They also must be doing the right things at the right time. To determine what performance receives what recognition in the merit model, a list of competencies or key skills that yield competitive advantage and secondary skills are tracked objectively in the organization’s performance management system.
Performance Management Connection
Companies with a meritocracy make an effort to rate their employees’ performance. The system itself could be as simple as a listing of employees, with the best employee being first, to something as sophisticated as a balanced scorecard or Six Sigma.
If an organization has not surrendered to straight entitlements that spread a merit pool like peanut butter across groups, it probably uses a series of matrices to make recommendations based on performance, location in salary range, comp-a-ratio and some other criteria. A good technology solution can help managers import business rules into the new solution.
To identify high potentials and top performers from the general employee population, companies sometimes use a forced distribution to rank employees. This philosophy is normally represented in a bell-shaped curve.
As employees improve, their positions and rankings on the curve will shift to the left. With every standard deviation in shift, there is an incremental boost of shareholder value that surpasses the dollar adjustment the employee will be given.
This is the essence of an effective merit modeling strategy. However, there is a problem with the pay-for-performance model in the context of merit modeling. Total rewards authorities such as Dr. Edward Lawler of the University of Southern California’s Marshall School of Business have stated “pay is still the best way to drive behavior,” but this carrot can be temporary because it comes after the fact.
The next generation in merit modeling and pay for performance is predictive behavior and predictive pay, which examine how employees can be influenced through the use of predictive pay, or laser-focused merit pay, in advance of an event that triggers a decision and behavior. Predictive behavior clarifies the consequence of the right choice that supports corporate objectives and mission. Imagine the incremental value that could be created for customers, bonuses for employees and value for shareholders if an entire organization made better choices by 0.5 percent, 1 or 2 percent of the time?
Consider, in a company with a customer-centric focus, the competencies, skills and behaviors supporting good customer service are measured and managed in the performance management system and rewarded seamlessly in direct alignment between outcomes and rewards to hit the talent management marketplace. Technology solutions can facilitate the desired outcome by enhancing decision making and analysis throughout the process.
The benefits across a unified talent management strategy are ubiquitous. On the retention side, when merit modeling and administration is done properly, there is a perception of internal and external fairness. If employees perceive they are not being treated fairly with regard to pay — whether internally on a job-to-job basis, or externally to similar jobs in other markets — voluntary turnover is a consequence.
Consider the following example. A financial publisher’s business is expanding, but its margins are shrinking. Careful, in-depth analysis reveals that the environment, merit policies and inability to isolate the problem are costing the publisher in market share and profits. Merit modeling solutions are implemented.
Voluntary turnover drops from 16 to 6 percent, and merit modeling and planning cycle times are reduced from 13 weeks to five. One of the primary reasons for the success of the company’s initiative is its enhanced ability to model merit pay and redistribute finite pools of resources for better use by the company and its high-performing employees.
Merit modeling also is integral to recruitment as a part of an overall talent management strategy. To understand the job market and know what it will cost to get top talent, compensation practitioners need to inform hiring managers of changes in the job market. Offering creative combinations of the merit mix may lessen the cash drain of a candidate hired at too high a premium outside the salary range. These new hires could negatively affect organizational culture and incumbent employees if their hiring terms are made public, and this information always gets out. It could be devastating to the most senior and key people.
Merit administration is central to accomplish organizational goals and objectives. Technology helps, especially as employee numbers rise, but it is not a replacement for a sound strategy. More often than not, better merit modeling will lead to a decrease in voluntary turnover while increasing morale and engagement when employees’ perception of procedural fairness is understood and appreciated.