What Is the Difference Between Merit Pay Incentives & Pay for Performance?

Organizational leaders use a variety of strategies in an effort to improve performance. Merit pay incentives and pay for performance are two common strategies that are easily confused. In fact, these two terms may sometimes be used interchangeably. Organizational leaders must understand the exact definition and components of each type of plan to avoid confusion. It also is essential to understand the similarities and differences between merit pay incentives and pay for performance to ensure organizational success.

Organizations typically award merit pay incentives to individual workers based on individual performance. Companies generally designate funds for use as merit pay incentives and set parameters for workers to meet to earn those incentives. Merit pay incentives are common offered organization wide and to all employees. Organizations usually offer employees an equal opportunity to work to earn these rewards. Merit pay incentives may be used as part of a larger pay for performance program.

In a pay for performance plan, a worker’s salary may be linked to his individual performance or the organization or business unit’s overall performance. Pay for performance often consists of the basing of annual salary increases on performance. For example, the employer may choose to set aside a specific percentage of overall sales for organization-wide salary increases. The employer may then base the individual’s share of that salary pool on individual performance. The organization might also choose to award stock options to individual high performers. This is an example of a merit pay incentive used as part of a pay for performance system.

Merit pay incentives and pay for performance both allow the organization to differentiate and award individual performance as opposed to organizational performance. However, merit pay incentives may only be used to reward individual performance, while pay for performance often includes both individual and organizational rewards. Both strategies may backfire if not properly implemented. In both cases, pay may be subject to the biases of the person charged with rating performance.

One of the major differences between merit pay incentives and pay for performance is that merit pay incentives are based on individual performance while pay for performance may be based on individual, team or even organizational performance. Pay for performance programs may sometimes, but not always, include merit pay incentives in some form. Merit pay incentives may be offered as a one-time reward, while pay for performance is typically approached as an ongoing, long-term, program. For example, pay for performance often consists of long-term base salary plans while merit pay incentives may include bonuses or other incentives, including non-monetary incentives. Non-monetary incentives include such rewards as a company-paid trip to Disney World for a team that meets a certain sales goal.