What Is Merit Pay (Or Pay For Performance)?

Merit pay refers to the process of determining employee compensation (base salary or bonuses), in part, on the basis of how well each employee performs at work. The principle is simple, at least in theory. It makes sense to reward more productive employees for their increased contributions to the organization, in the interests in fairness, but also with an eye to trying to retain the best employees in a company.

Merit pay (or pay for performance) can take several basic forms. First, annual salary increases can be based on some sort of assessment of the employee's productivity (however that might be measured). Those judged as "better" will receive greater salary increases which maintain over the years. The second method of rewarding "superior" employees is to use a bonus program or system, where a very productive employee will receive some sort of bonus payment, which is a one time, non-recurring event.

The third approach involves direct compensation for quantified production. In a factory setting, for example, an employee may receive a "piecework" rate -- being paid x dollars for the production of each ten items. In essence, that's supposed to reward those that work faster. Or, there's a commission structure, such that you'd find in real estate industries. The more you sell, the more you get paid, and the "pay for performance" is actually built into the entire system. In the direct compensation for quantified production, one nice thing is that the link between objectively determined production and pay or compensation is clearer, better defined and requires less judgment.