VIEWPOINTS : Scrap Merit Pay, Focus on Team Performance

Merit pay is back in favor. Bank of America, General Motors, Ford, and a host of other large corporations are either installing new merit pay plans or trying to revive their old ones.

They seem to have forgotten or ignored that merit pay has been tried and found wanting time and time again.

They also seem to be oblivious to the research which shows that there are better alternatives.

In many ways, merit pay seems to be the proverbial cat with nine lives.

It is tried, found lacking, and forgotten--only to be reborn at a later date. In many respects, this is not surprising.

The idea of paying individuals for their performance is basically attractive and is consistent with American values which argue that individuals should be rewarded according to their contributions.

Because of its expected impact on employee motivation, merit pay also seems to promise better organizational performance.

Thus, it appears particularly alluring today when most large corporations are under pressure to improve their performance.

There are several different kinds of problems with giving merit pay increases to individuals.

First, in a low-inflation environment, it is difficult to create very substantial pay differences between good performers and poor performers.

When the budget for pay increases is only 5% or 6%, how much differentiation is possible?

In addition, since merit increases become part of base pay, most of an individual’s pay ends up reflecting historical, rather than current, performance.

For this reason, study after study by myself and others has found little relationship between current pay and current performance.

Overall, merit salary increases simply are not a good delivery vehicle for money that is intended to reward performance.

Much more effective are individual bonuses given each year based on current performance.

With these, it is possible to deliver significantly different amounts of money to individuals based on their performance.

However, there are other major problems with merit pay that giving bonuses cannot eliminate.

They depend on a subjective appraisal of who is an effective performer.

There are a few corporations, such as IBM, who do an effective job of training managers to appraise individual performance.

Extremely Poor Job

Most, however, do an extremely poor job. As a result, at best, pay increases and bonuses are based upon hastily done assessments of performance and, at worst, are based upon biased, ill-informed judgments by untrained supervisors.

Because of their structure, merit pay plans can create destructive competition within organizations.

A given amount of money is typically allocated for meritorious performance and this is divided up among the employees.

Individuals know that in order to get the top bonus or raise, they have to outperform their co-workers.

A competitive spirit is not necessarily negative, especially in circumstances where individual performance is what counts, such as sales situations.

However, it can be tremendously destructive in organizational situations that require cooperation and teamwork--a condition that is increasingly common.

There is an effective alternative to individual merit pay. It requires corporations to abandon the idea of focusing on the performance of individuals.

This is hard for many organizations to give up because of the strong value system in the United States regarding individual performance.

Nevertheless, the ineffectiveness of individual plans and the movement in our society toward more complex and team-based organizations strongly argue for group and organization-wide rewards.

There are already a number of good examples of what can be done with bonuses based on group effort.

Motorola, Dana Corp., TRW and a host of other organizations have successfully used team-based rewards to create organizations that are effective in highly competitive global markets.

Perhaps the most interesting example of team- and organization-based rewards is People Express Airlines.

Every employee is an owner of the organization, participates substantially in a profit-sharing plan, and is also a member of a bonus plan that pays for group performance.

In short, the individual employee has three kinds of pay for performance, but none of them are based upon individual performance.

This is a model which should be much more widely applied by American businesses.

It is not for every organization, but for those that want to pay for performance and operate in a cooperative interdependent way, it should prove to be much more effective than individual pay for performance approaches.