For 2007, employers again anticipate a "merit" or base-pay increase budget of slightly less than 4 percent, according to various published compensation surveys, according to Sibson. And, once again, organizations are asking themselves:

" "Can this 'little package' of merit increase dollars really allow us to differentiate among employees?"
" "Is it worth the time and effort to do so?"

Indeed, some organizations have fallen into the habit of answering, "no" to both questions. For these organizations, 2007 increases in an individual's wages will not be the outcome of superior, on-the-job individual performance and skill-building. Instead, almost everyone, regardless of individual performance, will get essentially the same annual base pay increase. As a result, these organizations squander an opportunity to "make merit matter."

Pros and Cons of the "One-Size-Fits-All" Approach
The "one-size-fits-all" approach to base salary increases, which is reminiscent of the cost-of-living increases that merit pay was designed to replace, scores points for administrative ease and convenience. There are no tough conversations between the supervisor and employee, no need to differentiate among individual performance levels and no games to play with inflated performance evaluations in order to get more increase dollars.

Unfortunately, the "one-size-fits-all" approach communicates a very powerful, negative message that individual performance does not matter. That message is likely to cause both good and poor performers to become disengaged.

When looked at as a 3 to 4 percent merit increase per individual (as little as $100/month pre-tax for a $40,000/year employee), the hassle of a performance review process to determine a merit increase may not seem worth the effort. However, when aggregated for the organization, the small package of merit increase dollars represent a large investment (even before future annual compounding comes into play).

Consider an organization with 6,000 employees whose average pay is $40,000 per year. A 3.5 percent merit budget adds more than $8 million to the cost base. To that, add another 40 percent of pay for the costs associated with payroll taxes and pay-related benefits (e.g., paid time-off, 401(k) plan matches and pension accruals) and you have almost $11 million of new fixed expenses. That is a lot of money to literally give away because the performance evaluation process does not seem worth the effort.

Meeting the Challenge to make Merit Pay Matter: Various Approaches
Making merit matter is hard. Moreover, it may take several increase cycles to achieve. Nonetheless, meeting the challenge can be worthwhile. Here are several tested ideas from companies that are getting more bang for the big bucks in their small merit increase packages:

" Reposition the Organization's Mindset about Merit Increases to Consider It as Investment Spending Merit is earned through superior on-the-job performance and skill building day after day. It is not an entitlement. The merit increase budget should be viewed as a long-term investment in the talent that will drive the organization's sustainable success just like any investment. An investment in employees who have not demonstrated the performance and skill-building expected does not make sense.

A repositioning of the organization's mindset requires consistent and frequent communication with executives, managers and employees. For example, a mid-sized financial services employer talks the language of its business to its employees. This firm positions all compensation discussions in terms of an investment. Thus, employees understand that decisions with respect to individual merit increases reflect an evaluation of past individual performance and the expectation of continued further "returns on [the merit increase] investment."

" Performance Focus Employers adopting this approach promote an unambiguous organizational message that "performance counts" and that top performers will be differentiated through the merit pay system. Part of this message needs to include examples of what top performance looks like.

A $2 billion Midwest employer had been teetering on bankruptcy for several years. Despite this poor corporate performance, historically almost all the workforce had been rated a 4 (outstanding) or 5 (superior) on the 5-point performance evaluation scale used for merit increases. A new CEO stepped in. Two years later, he was widely acclaimed for "saving" the company. In the second year of his tenure the CEO communicated the following message: "To help you calibrate your performance evaluations, you should know I am a 3 (strong contributor) on the performance scale. That's what the Board has told me. In my career I have earned a higher rating only a few times." In addition to this message, the CEO instituted a process whereby the manager's manager had to sign-off on the individual's performance rating. In just one performance cycle, performance ratings fell into an almost perfect bell curve. Vibrancy was restored to merit increases.

" Aggregation of Merit Budgets An employer could aggregate small department merit increase budgets up to the next level or create a merit budget that covers at least 30 employees under three or more managers. In this way, an organization can address the concern that small departments cannot really differentiate pay when they have only a few employees.

Organizations derive an additional benefit from the aggregation approach. Specifically, their managers learn to talk about pay and performance and through the discussions establish a clearer standard that differentiates top performance from expected performance. Further, in Sibson's experience, groups of managers, when held accountable for allocating a limited merit pool find a way to equitably differentiate performance.

" Cross-Unit Calibration Calibrate performance ratings and merit increases among managers. One complaint frequently heard with respect to the merit increase process is: "The system isn't fair because my manager rates tougher than your manager." A solution that some organizations have found successful is to calibrate performance ratings and merit increases across peer managers prior to finalization. Managers bring to this peer review calibration meeting a set of preliminary ratings and merit recommendations. Like the Aggregation-of-Merit-Budget approach discussed above, these calibration meetings help to unambiguously define what performance at the highest ratings look like. Managers learn to become quite articulate about performance, are more diligent in documenting the performance of their subordinates, and seek out corporate sponsored opportunities to learn how to manage performance better.

" Set-Asides for the Top Performers By creating a Top-Performer, Merit-Increase, Set-Aside Pool, an organization ensures that top performers are systematically identified and get more money than average performers. The set-aside pool can be carved out of the merit increase pool (e.g., for a 4 percent merit pool, 3.5 percent for merit and 0.5 percent for top performers). Companies that use the set-aside pool find that the allocation determination can in itself be a beneficial process for the organization. For instance, in order to tap into the Top Performer, Merit-Increase, Set-Aside Pool one multimillion-dollar service provider requires managers to "nominate" their top performers. Using a simple form with very specific criteria, managers provide "evidence" of superior performance. The nomination forms are signed by both the manager and the nominee to acknowledge the nomination. The divisional senior management team then reviews the nominations and the Top-Performer, Merit-Increase, Set-Aside Pool is allocated among the most meritorious nominees.

Originally, this approach was introduced because the company wanted to return to a pure merit pay process. However, four years, later the company still uses the approach because of the unexpected benefits of the process:

o The truly top performers hold their manager accountable for performance discussions and the nomination process. Employees know they are eligible for nothing more than the across-the-board increase, unless the manager gives evidence of their superior performance and skill-building through a Top-Performer nomination.

o The design of the nomination forms helps to frame what top performance "looks like." After the first year (when there was a flood of nominations) there is a better understanding of "what performance it takes" to compete for a merit increase from the Top Performer, Merit-Increase, Set-Aside Pool.

o Allocation of the pool requires "silo-breaking" cross organization calibration and thoughtful senior management discussions about performance expectations.

o The performance conversations at the senior management team level have provided valuable insights about the organization's depth and quality of talent and now inform the company's evolving human capital planning process.

Selecting the "Right" Approach to Making Merit Matter
The common thread to each of the making-merit-matter approaches discussed above is the emphasis on improving how an organization thinks and talks about performance. Although each of these approaches have been used successfully, before they are adopted by an organization, the organization should evaluate the "fit" of the approach to the current and desired performance culture and pay prominence, as well as leadership's capability to execute the approach.

Making merit matter is more than just the salary increase and performance evaluation process. An organization that chooses to make merit matter says to employees, "YOUR performance matters at this company." Sibson urges employers to use effectively the big bucks and powerful messages wrapped up in their small merit increase packages rather than succumbing to the ease of a "one-size-fits-all" strategy.