What is the difference between performance bonuses and merit pay?

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How does merit pay differ from a bonus? This is an important question that all employers should ask themselves and be educated on. Although both terms are often used interchangeably when discussing employee recognition, there are significant differences between the two that must be made clear. 

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Merit pay and a bonus are generally awarded under specific circumstances and have major influence on factors such as employee satisfaction, engagement and retention. 

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Both are a type of reward system used to acknowledge high-performance and encourage employees to strive for their highest professional potential. They must be understood independently so you can make the most informed decision about implementing either one. 

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So how do these types of employee rewards differ? This article will not only answer this question, but will provide the benefits of each and the potential disadvantages too.  

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What is Merit Pay? 

Merit pay can be simply understood as an increase in salary that’s dependent on an individual’s performance in a fixed review period. These increases are usually extended as a small percentage added to the employee’s salary and depend on each person’s level of accomplishment. 

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Top performing employees are awarded a higher rate of merit pay than the team member’s that met average expectations, and those with subpar performance do not receive an increase.

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Merit pay is perfect for annually rewarding your highest performing team members as they will receive a wage increase that carries from year to year. This creates a new incentive opportunity, that’s not connected to tenure or promotional circumstances, but allows the employee to work towards reaching new heights within the company. 

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To summarize the concept of merit pay, it’s a reward system that’s based solely on employee performance and is extended per individual instead of on a team basis. 

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There are commonly fixed periods of time, established by the company, for the employee to earn the incentive. They can then be appraised against those benchmarks at the end of the fixed period and then rewarded for their individual performance. 

Potential Advantages Of Merit Pay

• Increases productivity and efficiency: Individual incentives help motivate employees to improve their performance and also create a physical standard that must be followed.
• Attracts highly skilled workers: Qualified, high-performing and ambitious employees are often eager to tie their salaries to their performance and increase their income through their individual efforts.
• Assists with employee retention: A consistent rewards system can help retain high-performing employees and push them to meet regular goals. 
• Identify employee strengths: Merit evaluation can help you understand your employees, their individual strengths and their areas of weakness. 
• Inspire competition: Individual salary growth opportunities that are attached to performance can inspire employees to push each other and participate in friendly competition to see who can produce the best results. 
• Monitor individual performance: Merit pay allows the company to consistently monitor employee performance and progress, making feedback a more accessible tool to give back to your team.

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Related: What’s The Difference Between Merit Pay Vs Incentive Pay?

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Possible Disadvantages To Watch Out For

• May cause conflict in employee relationships: Individual performance incentives may promote feelings of jealousy, resentment or add pressure to the team to outperform each other. 
• Undesirable competition: The reality of performance-based rewards is that not everyone receives the same pay which can cause division within the team and discourage cooperation.
• Favoritism: Without clear communication and understanding, the employee may not agree with the rewards process and this can risk backlash towards the company if the team feels like others are receiving more positive attention.
• Time Consuming: Merit pay requires a hefty time investment when trying to make performance measurable. Along with the careful communication required to get employees to understand the process, the time consumption can outweigh the possible benefits for this reward system.

What is Bonus Pay? 

A bonus differs from merit pay mainly in that it’s not only individual based and can be extended to entire teams, and it does not have to be linked to the employee’s annual salary (bonus reward plans can be extended daily, annually, or on a project-to-project basis). Simply put, a bonus is a one-time incentive to motivate employees on a specific project or goal. 

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Once employees are deemed eligible for a bonus, they can receive a detailed agreement that outlines the goals and targets that must be met to qualify for the reward. Unlike merit pay, this type of incentive can be offered to individuals or it can be geared towards entire teams that collaborate regularly. 

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A great example of a bonus would be giving your team a one-time monetary reward for exceeding their quarterly sales target.

Potential Advantages To Benefit From

• Less expensive: Lump-sum payments cost the company considerably less long-term than merit payments. Opting for bonuses instead of merit pay relieves employers from the economical pressure to increase salaries. 
• Sets clear expectations: Bonuses help define the company’s expectations about employee performance and contributions. 
• Obvious performance outcomes: Bonus requirements allow for direct reflection of employee performance. 
• Increase productivity and efficiency: Fuel employee motivation with bonus opportunities and encourage them to regularly improve their performance.
• Create collaboration within your team: Set team bonuses to promote collaboration between employees and positively impact productivity with concrete goal setting. 

Possible Disadvantages To Watch Out For

• Low impact: A bonus-based incentive can be dependent on the employee’s attitude and if they’re not up for the challenge, it can be easily dismissed. 
• Low motivation to achieve results: One-time rewards like bonuses only benefit the employee if they can close deals and meet goals. Lack of motivation becomes a risk if the team member is unable to meet expectations. 
• Not as enticing as an incentive: High-performing employees often seek continuous growth opportunities and want to build success through increased salaries, so a potential one-time bonus may not be high on their priority list. 

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In Conclusion

Now that you’re familiar with merit pay and bonuses and can differentiate between the two, we hope it becomes an easier process for you to select the incentive program that works best for your company. 

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At the end of the day, a successful employee reward system recognizes team members for their continuous efforts and is an excellent way to drive engagement and increase retention in the workplace. Your people will appreciate the added attention you put in to extend recognition to them!

If you are struggling to understand the difference between merit pay vs incentive pay, let us break it down for you.

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The terms ‘merit’ and ‘incentive’ pay are often used interchangeably because of their similarities. Just like incentive pay, merit pay motivates employees to be more productive as they are compensated based on their performance. However, there are key differences that can distinguish them.

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Let’s look at what makes merit pay different from incentive pay so that you know which one you should implement to reward your employees.

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Merit Pay Vs Incentive Pay: The Key Differences

Merit Pay

One of the main aspects that differentiates merit pay from incentive pay is that merit pay is a permanent increase in your employees' salary or wage. Incentive pay is generally a one-time reward.

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Since merit pay is a permanent increase in employees’ pay, it serves as a strong motivator. Employees work to improve their performance so they receive a raise.

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Merit pay is generally controlled by management because it can be subjective.

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If a manager notices that an employee is performing better than another, that employee may receive higher compensation through merit pay. Supervisors can recommend an employee for a merit award but the final decision usually comes from the HR department.

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Merit pay does not include other forms of compensation because it is, by definition, a monetary reward based on specific criteria that are accurate, detailed, and measurable. These criteria are reviewed regularly during meetings and performance reviews.

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All employees should have an equal opportunity to earn merit pay. When a company is performing well, merit pay can be offered more often. It can also be scaled back when there is an economic downturn and profits decrease to preserve cash flow.

Related: How Does Merit Pay Differ From A Bonus?

Incentive Pay 

Whereas merit pay is an individual employee reward, incentive pay can reward individuals, teams, or even the company itself.

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Incentive pay can also be monetary or non-monetary. Non-monetary incentive pay includes paid holidays or memberships. 

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When employees need a quick push to meet their goals or enhance performance, you can use incentive pay to motivate them as it is only a temporary reward.

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In some organizations, it’s common practice to use incentive pay to reward employees when their efforts help reduce costs. The temporary nature of the incentive plan and the decrease in company costs can result in a high return-on-investment over the long run. Furthermore, the resulting increase in productivity due to incentive pay can help boost sales and overall employee engagement.

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The size and function of the business determine the implementation of incentive pay. In a production-based company, incentive pay depends on the amount of production. 

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Incentive pay is effective for retaining employees and signing employees to be part of your company. Merit pay, however, is only given to an employee once they have met set criteria to earn the reward. 

Related: Is Incentive Pay A Bonus (Guide For HR)

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Conclusion

Merit pay and incentive pay appear to be similar on the surface, which is why people have used them interchangeably before. However, they have key differences that are important to understand.

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Merit pay is an individual reward, whereas incentives can be awarded to individuals and teams. 

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Merit pay involves a long term commitment but incentive pay is typically only a one-off increase in compensation and does not have long-term implications. With all these points in mind, we can confidently solve the merit pay vs incentive pay debate.