Many businesses are going through the annual ritual of preparing employee performance reviews, determining individual merit pay increases and, perhaps, allocating performance-based bonus payments.
I've written previously about the need for business leaders to be honest in performance evaluations. It is equally important to be thoughtful and honest about the allocation of merit pay increases and bonuses.
In most companies, merit pay increases are budgeted at the company and departmental levels as an average percentage of the prior year's wages and salaries, excluding any overtime. This creates a merit increase "pool" in each department to be allocated to its employees.
So, for example, a company budget and its department budgets might reflect a year-over-year increase of 2.5 percent.
That is the easy part. The tricky part is determining the percentages for each individual co-worker. That is where it is critically important for leaders and managers to be thoughtful and honest and willing to make some tough decisions. It also requires that they have a feel for the performance of people who work for their direct reports.
I've seen many department managers divide up a 2.5 percent average increase by giving every co-worker in the department increases in a narrow range such as 2.3 percent to 2.7 percent. They fiddle endlessly with their salary spreadsheets, shuffling tenths of a percent around trying to make the total increase come out to exactly the 2.5 percent in the departmental pool.
This fiddling misses the point, which is to reward merit with higher pay. In a department where the average worker is paid $40,000, the difference between a 2.3 percent raise and a 2.7 percent raise is about $3 per week. That is hardly what I would call rewarding above-average performance.
These managers avoid rewarding stars because they know they have to take that money from the poorer performers, and they don't want to deal with that. They fiddle to give the stars a little something without making anyone else in the department too unhappy.
Another way of side-stepping responsibility is simply giving everyone in a department the same percentage increase. If the budget is 2.5 percent, that is what everybody gets. The manager avoids hurting anyone's feelings. As a bonus, he or she avoids spending valuable time thinking. Filling in the spreadsheet is a breeze. Just enter 2.5 percent in the top row, click and drag to the bottom.
Leaders must set the tone for putting the merit back in merit increases, first by being honest in giving merit increases to their direct reports and, second, by insisting on reviewing the allocations within the next level in their direct reports' departments. It must be clear that managers are expected to reward high performers and to have the difficult discussions with those whose performance is not so stellar.
Leaders also have to step in and look at the big picture across departmental lines. Increases are usually budgeted with an implicit assumption that the increases in every department should total to the same average percentage. That may not be the optimum.
Imagine a situation where one department manager, John, has a team of mostly solid-but-average performers and a couple that are below average. Mary, another manager, has solid-but-average performers and a couple of stars.
John has the 2.5 percent to spend, so he gives his average people more than that and his below-average people less. Mary tries to reward her stars, but then must give below average increases to her solid-but-average people to hit the departmental budget. So John's average people get bigger increases than Mary's because she has a couple of stars.
If you think this doesn't happen, think again. A business owner just described it to me. The only solution to this problem is the involvement of the overall leader.
When a company needs to reward merit and worry about retaining star employees in one department, it may need to transfer funds from other departments' pools to make it work. It makes no sense that the amount Mary can give her stars is limited by the size and makeup of her department, but that is often what happens when the leader doesn't get involved.
In the scenario I've described, John will not give any of his merit increase pool to Mary's group unless the leader forces the issue. The leader needs to review both of their plans and be savvy enough to discover what is going on in John's department and to insist that increases be allocated in the best interest of the entire company, not just in the interest of individual department managers.
Similar situations arise with the allocation of bonus pools. The leader is the only one who can ensure that allocations are made in the best interest of the total business and must get involved in these processes.