What Is a Merit Increase?

A merit increase is a pay raise given to an employee based on their performance. It's often used to reward the top-performing employees.

By Linda Pophal

3M Read

What is a merit increase?

A merit increase is a pay raise given to an employee based on their performance.

Employees at all levels are always interested in seeing an increase in their compensation, so knowing what factors contribute to those increases is crucial in predicting compensation in the future. Some companies have set pay bands based on seniority or tenure, but these don’t necessarily reflect all of the benefits an employee might provide to a company. It has also become less common for pay to be based on tenure, and more common for organizations to use market rates to establish pay.

Seniority and tenure increases

Seniority and tenure are both terms that reflect the length of time an employee has been with an organization. There are some subtle differences in the terms, however. Tenure refers specifically to the length of time an employee has been with a company. Seniority is a reflection of that length of time relative to other employees. So, for instance an employee with five years of tenure may have more or less seniority within a company depending on the length of service of other employees.

A long-established company may have employees with 10, 15, 20 or more years of service, meaning an employee with five years of service would have low seniority. An employee with the same amount of tenure at a newer organization, though, could have high seniority.

Seniority is sometimes reflected through titles that indicate an employee’s level within the organizational hierarchy. For instance: associate-ABC; senior-ABC; associate manager; manager; senior manager; associate director; director; senior director; associate vice president; vice president; senior vice president; executive vice president; chief XYZ officer. Employees typically expect, and companies typically provide, pay increases as staff move from one seniority level to the next.

Merit increases

A merit increase may be related to seniority and—perhaps less closely—to tenure. However, this is an entirely different type of pay increase. A merit increase is based on an employee’s performance. Two senior managers may start working with a company at the same time. However, while one senior manager’s performance may be continually rated as “needs improvement,” the other might consistently be recognized by colleagues for exceptional work. Companies often determine that employees exhibiting exemplary performance are deserving of an increase in pay.

Alternatives and limitations

Some companies might wish to keep compensation relatively consistent for staff at the same seniority and tenure levels. The most obvious alternative to a merit increase in such an organization would be to promote a high-performer to a higher seniority level. However, there are not always new positions available in an organizational hierarchy, and excelling at one position does not always ensure competency for a higher-level position.

Another alternative to merit increases are bonuses for exceptional performance. Bonuses provide a benefit to employees and recognition of their efforts without incurring a long-term liability for the employer as a pay increase would.