The Tyranny of the Merit Matrix

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When you think about the biggest lies in the world of HR, there’s one that comes to mind at the end of the year when most companies are considering the annual review and the pay increase that’s tied to the yearly performance ritual.

The lie? “We believe in pay for performance.”

Maybe “lie” is too strong a word. Everyone loves seeing a high performer get a 10 percent raise just for being a star. It doesn’t happen enough, and the reason is pretty simple. In this Darwinian world we call global business, cost pressure is everywhere.

As a result, we’ve got to budget for annual salary increases, and then live by the budget to make sure razor-thin margins stay intact.

Enter the merit matrix, which has a strange way of making no one happy. 

True stars in your company have options. They can give themselves a big raise by taking another job.

The merit matrix is a feature of mature compensation theory. It’s designed to take the budgeted number for salary increases companywide and create a grid telling your managers what raise is recommended for every employee based on performance and relative position in that worker’s salary band (often referred to as “compa-ratio”).

The morality play resulting from the merit matrix happens everywhere. We need average performers to make the business formula work. We’d rather give the star a flat raise than tell the average performers they’re getting little or nothing, which is what it takes to put pure pay for performance in place in a company with an aggressive, unyielding merit matrix. Sound familiar? Of course it does.

But if you’re sick of that process, you can break out of the merit matrix blues by understanding some consistent realities in corporate America. 

The first way to unshackle yourself is to understand that there are different rules for stars. It’s hard to get an exception made to the merit matrix at the end of the year.

That’s why smart managers don’t wait until the end of the year to take care of their stars. They take care of them long before the annual review/merit process kicks off.

True stars in your company have options. They can give themselves a big raise by taking another job. They know it. You know it. The people who run your company know it.

If your goal is to get a nice raise for the top talent on your team, the time to do it is in May, not in December or January. Simply raise retention of stars as a true risk and make a skip-level recommendation on an equity increase to lower the odds they’ll jump ship.

The funds are there via unfilled positions that take longer to fill than expected. Making this request with turnover risk as your rationale is the best way to take care of the star. Do it long before the merit matrix raises its ugly head.

That takes care of the stars, which are a limited group. To understand how to get pay for performance out of the standard merit matrix for the masses, you’ve got to stop treating everyone equally.

Start by acknowledging that former General Electric CEO Jack Welch was right about forced ranking; he just went too far.

Welch’s theory that you should identify the lowest performers on your team and treat them differently than your stars was technically correct. The concept of forced ranking goes south when you start firing average employees.

But the theory of forced ranking works well for merit increases, especially when you combine it with some analytical work regarding when employees are most likely to leave your company. Study voluntary turnover and you’ll find something interesting related to tenure. Average employees are much more likely to leave you between the one- to three-year marks of tenure.

The reasons for that are pretty simple. In the first year, employees still have that new “afterglow,” with the world (and your company) full of promise. Once employees hit the three-year mark at your company, they’re less likely to churn based on real and perceived benefits of tenure. 

The tyranny of the merit matrix is that you have limited resources and many mouths to feed. You believe in pay for performance, but you can’t get true separation via the merit budget you have. Mixing Welch’s philosophy and turnover trends are the best hope you have. Your path to a better blend of pay for performance that rewards top performers is to rapidly decelerate increases for average performers with more than three years of tenure, regardless of compa-ratio. 

There’s no such thing as a free lunch. Somebody has to pay in order for you have something approaching pay for performance for the masses.

Take care of your stars early, and be more strategic about how you distribute merit increases for the rest. It’s your only shot at pay for performance in today’s corporate world.