Merit Planning
This lesson describes the merit planning processes. Specifically it addresses the merit planning process,
gives a merit planning example, and provides a visual comparison.
Most companies use merit raises to reward performance by the professional workforce.
Focused and Disbursed Merit Plans
The merit plan can be administered as a "focused" plan where all raises occur at the same time or as a
"disbursed" plan where raises occur on employee's employment anniversary or according to merit plan
algorithm. Corporate guidelines and regulations exist, for example, the minimum time between raises and
the maximum raise percentage.
Merit Planning Process
The typical process is the company determines total merit pool as a percentage of the total payroll. The
merit pool is planned for distribution amongst employees based on relative salary and relative
performance, which is often a computerized process or guidelines are provided. A report is produced for
each supervisor indicating the recommended merit increase for his or her employees. The supervisor will
review the computer-generated report and update it to reflect most current performance of his or her
performance. If redlines total more than merit budget allocated to the supervisor, the supervisor must
seek additional funds from the department manager. If the redlines total less, the supervisor returns funds
to the department. The department manager must balance adjustments and then submit the modified
plan to the administering organization. This process occurs annually, but most organizations allow for
mid-year corrections.
Relative Salary and Relative Performance
Large corporations usually subscribe to a salary survey service. Each subscriber provides salary
information for applicable job families and levels and receives average salary information based on all
submissions for job families and levels. Data can be requested for specific geographic regions and
specific business domains, e.g., DoD contractors, Mid-Atlantic region, software engineers. The relative
salary relates the average salary within a job family for a specific employee level as shown in the table.
Job Family Average Salaries
Level
Associate
Specifications
BS + 0 to 2
years
Software
System
Configuration
"xyz"
EngineerAdministrator Management
$62K
$50K
$48K
Etc.
Engineer
BS + 2 to 5
years
$73K
$58K
$55K
Etc.
Senior
BS + 5 to 10
years
$85K
$67K
$63K
Etc.
Staff
BS + 10 to
15 years
$100K
$78K
$74K
Etc.
Senior
Staff
BS + 15 or
more years
$120K
$92K
$88K
Etc.
Note 1: MS degree is equivalent to 2 years experience, e.g., engineer requires MS + 0 to 3 years
Note 2: Salary figures are fictitious
Corporations can compare each employee to the industry average to determine their current "relative
salary." For example, John Doe is a Senior Software Engineer currently earning $82,000 per year. Based
on the survey data, the industry average is $85,000. John Doe is earning 96% of the industry average
($82K / $85K). Sally Smart is an Associate System Administrator earning $54,000 per year. Based on the
survey data, the industry average is $50,000. Sally Smart is earning 108% of the industry average ($54K /
$50K).
Salary consideration is not the only factor considered when determining merit increases. Companies also
take into account its fringe benefits, which may include medical and group insurance, vacation and paid
time off schedules, education benefits, retirement and pension plans, bonuses, and profit sharing. Also
employee specific factors may play a part including type of education (what majors you have and where
they are from), levels of education (what degrees you have), and years of work experience in this field.
Employees are ranked against their peers. The resulting ranking is broken into quartiles giving the relative
performance. It is certainly possible for everyone in the organization to be rated highly yet when the
ranking occurs, employees fall into all four quartiles.
Relative salary and relative performance are the primary inputs to recommended merit adjustments as
shown in the table.
Each year this table is updated, based on cost of labor, inflation, and cost of living. The cost of labor is the
cost of wages paid to workers plus taxes and benefits that is the cost of that employee as opposed to the
cost of living is the cost of maintaining a certain standard of living. As an example, for a given employee
whose relative salary is in the 95% and whose relative performance is in the 2nd quartile, the
recommended salary increase using this table is 5 to 7%. You should note that as the relative salary
increases over 100%, that is the employee is being paid more than the market bears the percentage of
the merit planning increase decrease. Likewise as the employee's performance decreases, the merit
planning decreases. In some organizations, the 4th quartile in relative performance and the 110% to
120% in relative salary are set to a 0% increase. Let's run through a merit planning example.
The company has 70 employees. The payroll is $3.5M with an average salary of $50K. The organization
offers a 5% merit increase pool company wide. You will notice that some sections are allocated more or
less merit budget. You are the manager of Section C1 and you are allocated a $25,000 merit budget to be
used for your 10 employees. The computer generated the proposed merit plan. You must redline the
suggested plan and present your updates to your manager.
You evaluate that C. Greene's performance since the recorded evaluation of 1st quarter has slipped to
2nd quarter. You revise recommended increase from 6% to 4% and the dollar increase from $3900 to
$2600, thus returning $1300 to the department.
C. Mustard's performance has improved drastically and Mustard completed the requirements for a
Master's degree. You revise the recommended increase from 5% to 9% that is updating his salary
increase from $2300 to $4050. This requires an additional $1750.
The net effect of these redlines is you need (returned $1300 - required $1750) $450 more dollars for the
department's merit plan. As the supervisor of section C1, you must request and receive additional merit
budget allocation from the C department. If you do not receive this additional funding, you will need to
adjust your department's merit increase and shave off an additional $450.
Visual Comparisons
Visual comparisons can be useful to ensure you are properly rewarding your employees in terms of years
of experience, education, and performance. In general, employees in the same job family who have more
years of experience, higher education, and a higher performance rating relative to others in the company
should be paid more.
It is easy to plot dollars earned each week but education and experience can be a challenge. Let's look at
two employees: Employee A and Employee B as shown in the chart.
Comparing years of experience: Employee A has 10 years of experience with seven years in the Air
Force and three years in private sector, while Employee B who also has 10 years of experience but in
different venues, 5 years in the commercial sector and five years in aerospace and defense industries.
Both employees have 10 years of experience.
Comparing universities and associated grade point averages (GPA): When looking at Employee A,
she has a BS degree with a high GPA from a mediocre university while Employee B has a lower GPA
from an exceptional university. Both employees have solid degrees but their value to the organization
may vary.
Comparing activities throughout university and GPA: Now let's assume both employees went to the
same university, but Employee A finished the degree in seven months while holding a part-time job and
Employee B took the "normal semester" load and worked only in the summer. Does it matter to your
organization that Employee A earned a lower GPA? These facts must be considered when evaluating
years of experience and level of education. It should also be noted that once in the job, informal on the
job training can influence experience levels.
The chart below shows this visually. AF and AE have equivalent education and years of experience, yet
AF is making $300 more per week; it is important to justify and understand why AF is more highly
compensated. Similarly it is important to understand why AL who has well over 12 years of experience is
not being paid competitively with his or her peers namely AJ, AK, and AM. If you can justify these
differences, there should be no problems. The issues occur when you cannot concretely justify the
differences.
Other visual comparisons such as observing salaries for males versus females or race differences can
ensure that you are paying your team fairly. Again it is not that these salary differences are not allowed;
however, you must be able to justify why the differences exist. A senior manager or auditor may ask.
Alternatives to Merit Increases
Some organizations use other methods of increasing salary including profit sharing, bonus programs, or
improved fringe benefits. Let's examine the advantages and disadvantages. A bonus program or profit
sharing looks attractive. Who would not want a lump sum increase? It can motivate employees'
performance, it does not affect company rates, and company performance determines the bonus, but it
does not improve your pension or salary-matching program such as the 401K, so it is not part of your
base salary. Lastly it is highly dependent on the company's performance not your individual performance.
Given a choice of a lump sum salary increase or a merit based salary increase of the same amount, it is
generally better to take the merit increase since it increases your base salary. Of course if the comparison
is not equal, then the bonus or profit sharing can be extremely lucrative. Look at those individuals who
were at AOL or Microsoft at the right time and became multimillionaires almost overnight!
Fringe benefit increases are low in cost to administer and offer a big bang for the buck with group rates
but it offers less control for individual employees and is difficult to base on performance. The table below
summarizes these differences.
This next table shows the effect of multipliers on salary and rates. Here we show three fictitious
companies: a large, a medium and a small sized contractor each with annual salary, hourly rates, fringe,
overhead, G&A, and the loaded or fully burdened rate that is charged to the customer. As you examine
the table below you will see that changes to each of these multipliers can significantly impact the loaded
rate. For example, an employee making $75,000 at a small company may have a loaded rate of just
$61.33 whereas at a large company, it may be able to charge a loaded rate of $76.39 for a similar
employee. Fringe benefits are usually lower at a large company since it can obtain better group rates, but
overhead and G&A are more expensive at large companies.
Typical large size contractor with significant overhead and G&A
Avg Annual
Salary
Hourly Rate
Fringe
Overhead
G&A
Loaded Rate
75,000
36.06
0.32
0.5
0.07
76.39
Typical medium sized contractor with moderate overhead and G&A
Avg Annual
Salary
Hourly Rate
Fringe
Overhead
G&A
Loaded Rate
75,000
36.06
0.4
0.25
0.05
66.26
80,000
38.46
0.4
0.25
0.05
70.67
86,500
41.59
0.4
0.25
0.05
76.42
Typical small sized contractor with minimum overhead and G&A
Avg Annual
Salary
Hourly Rate
Fringe
Overhead
G&A
Loaded Rate
75,000
36.06
0.45
0.15
0.02
61.33
80,000
38.46
0.45
0.15
0.02
65.42
85,000
40.87
0.45
0.15
0.02
69.51
93,400
44.90
0.45
0.15
0.02
76.37
Note: multiplier differences exaggerated to emphasis the point
Conclusion/Summary
In summary, the merit planning process is significant in how it is approached, planned, and implemented.
Every employee is affected either positively or negatively. It is important to implement your merit planning
program consistently and fairly.
Merit Planning Process
Engineering for Professionals
Impacts on Your Salary
Disbursed Merit
Plan
Bonus Program
Focused Merit
Plan
Type of Educa1on
Years of
Experience
Your Salary
Fringe Benefits
Profit Sharing
Level of Educa1on
Rela1ve
Performance
Engineering for Professionals
Rela1ve Salary
Relative Salary and Relative Performance
Engineering for Professionals
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