What is a Merit Matrix?

A merit matrix, also known as a merit increase matrix or salary increase matrix, is a mathematical grid that compensation professionals provide to help company managers accurately and efficiently administer salary increases to an organization’s employees.

If calculated fairly and communicated effectively, a merit matrix will generate ongoing conversations and feedback that give employees a compass in their career progression and instill a sense of pay equity. As a result of employees having more clear direction, a merit matrix can help boost employee engagement and retention.

In this article, the following questions will be answered:

What is a merit matrix?
How do you create a merit matrix?
How do you calculate a merit percentage increase?
What’s the difference between a standard merit matrix and a two-variable merit matrix?

Merit Matrix Approaches

There are two common approaches when it comes to designing a merit increase grid:

Standard merit matrix – based on performance rating alone
Two-variable merit matrix – based on performance rating and an employee’s position within their pay range

What Are Merit Raises Based On?

A merit increase – or merit raise – is commonly received upon meeting criteria defined within a pay-for-performance plan. These criteria help you determine how an employee’s performance should be rated, and a merit matrix calculates payouts based on those evaluations.

Depending on your organization’s compensation philosophy, you may choose a standard merit matrix or a two-variable merit matrix to determine how to administer payouts.

Standard Merit Matrix Example: Performance

In the first merit matrix example below, the highest percentage increase an employee can receive is 5% (far exceeds expectations), while other employees receive 1% to 4%, depending on their rating.

Consider your total payroll budget is $1,000,000, and you do not want to exceed $33,000 within your merit increase pool. That gives you 3.3% to play with. If you multiply “Raise for Performance” by “Percent of Employees” you will get the total percent of budget for that performance level. In this example, across all five performance categories, the sum total to payout employees is 3.07% of total payroll (i.e., $1,000,000 x 3.07% = $30,700). We are within budget!

Employee Performance and Raise Amount Based on Budget, Example 1

Standard Merit Matrix Example II: Performance with Higher Payouts

HR professionals know that the merit matrix offers flexibility. Salary increase percentages can be adjusted by performance categories and employee distributions to meet budgetary restrictions. Ideally, your organization is able to grant a significantly higher payout to its top performers. Under this philosophy, the merit matrix would involve steeper increases per performance level, maxing out closer to 10%. For instance, individuals with an “Employee Performance” rating of “5” might get paid out at 9%, whereas your “4” employees are at 6%, “3” employees are at 3%, “2” employees are at 1%, and “1” employees are at 0.5%. This more staggered merit increase scale will help you distribute salary increases to reward strong employees, and send a strong message to lesser performing employees, in an impactful way.

In the example below, the sum total to payout employees is 3.255% of total payroll (i.e., $1,000,000 x 3.255% = $32,550). We are still within budget!

Employee Performance and Raise Amount Based on Budget, Example 2

Two-Variable Merit Matrix Example: Performance & Range Position

Using a more complex merit matrix, you can take into account performance, as well as where employees fall within their pay range. This can be an effective compensation strategy to fully optimize your merit matrix budget. This approach ensures you are not perpetuating salary range outliers, i.e., employees well above or below the 50th percentile that could result in an inequitable salary structure. This can be problematic when increases are distributed based on performance alone.

In this example, employees are divided into four quartiles, from the bottom fourth of their salary range (Q1) to the top fourth of their salary range (Q4.). You can calculate where an employee falls in their salary range by using the compa-ratio or range penetration formulas.

compa-ratio: (base salary / midpoint of salary range)

range penetration: ([base salary – range minimum] / [range maximum – range minimum])

Within the same performance category, employees in Q1 will receive a higher payout than employees in Q4. This rewards employees for their level of performance, while more rapidly moving Q1 employees toward the middle of their pay range, and slowing the speed Q4 employees’ move beyond their pay range.

Employee Performance and Raise Amount Based on Budget, Example 3

Before leveraging a merit matrix, you should ensure a performance evaluation system is in place to fairly and accurately determine performance rankings for each pay period.