What's The Best Way To Implement Merit Pay or Pay For Performance?
First, there is no "best" way to link pay or salary to employee performance, and no best way to implement merit pay. There is only a "best" way in your situation or company, and what works in one place may not be best in another. So, you need to decide based on what you want to create, your circumstances, and the culture of your company. However, here's an approach.
Acknowledge that no pay for performance system is perfect. Nor is there a perfect way of accurately assessing the value of employee contributions. So, is there a "best way"?
If you want to tie pay to performance, here's how to do it. You make it a part of the performance planning process. You establish the criteria for a pay increase when you set objectives and standards. So, at the beginning of the year, each employee should know what he or she needs to achieve in order to receive teh pay increase or bonus. You don't tie pay to ratings or rankings. you make sure the critera are as objective and measurable as possible to reduce arguments. And, finally, no surprises at the end of the year.
Also, take the position that it is your job (as the manager) to help each employee hit that target, make that extra money, or get the bonus. Make it clear that you'll do what's necessary to help every employee succeed.
In this way, you and the employee work together on the same team.