This post was originally published on July 21, 2015 and has been updated.Most companies today are actively working to develop a pay-for-performance culture. As an HR professional, how can you position yourself as a strategic partner to your executive team and help them achieve this goal? One way is through use of a merit matrix.A merit matrix is a two-factored table created by HR departments to help managers equitably allocate raises across their employee population. It provides a framework for managers and guides them through the merit increase decision-making process. To develop one, follow the five steps below.[clickToTweet tweet="Trying to develop a pay-for-performance culture? A merit matrix can help. " quote="Trying to develop a pay-for-performance culture? A merit matrix can help. "]
Step 1: Anticipate the Distribution of Employees Across the Matrix
The two factors most commonly used in a merit matrix are performance and position-in-range. Performance rating options are plotted along the vertical side of the matrix and the position-in-range options along the horizontal side.Examine the potential performance ratings (in our example, we’ll use ratings 1 through 5) and estimate the percentage of employees you believe will receive each type of rating. What should guide your estimation? Consider evaluating previous years’ distributions to see if there is a pattern/trend that you can lean on to make your best guess. You could also get the estimate directly from managers, based on how they think their employees are going to perform in the coming year. Alternatively, you could wait until you’ve received all the performance evaluation scores from your managers, as that will tell you the actual distribution.
Once you’ve determined your performance distribution, enter the percentage of employees alongside each rating category. Next, look at the current distribution of employees across your pay ranges. You can do this either in thirds (bottom third, middle third, top third) or in quartiles (first quartile, second quartile, third quartile, fourth quartile). Whichever way you choose, once you have the range distribution, enter the percentage of employees that fall into each position-in-range category. Double check your math — add up the percentages across the top and down the side to ensure they equal 100%!
Position-in-rangeRatingsBottom Third (20%)Middle Third (65%)Top Third (15%)5 (15%)4 (40%)3 (35%)2 (10%)1 (0%) Step 2: Determine the Mean Performance RatingTo calculate the mean performance rating, multiply each rating by the percentage of employees you anticipate are going to receive that rating. In the example above, we are anticipating that 15 percent of employees with receive a rating of 5. The calculation would be .15 x 5 = .75. Repeat that calculation for all categories and then add the results together. This will give you the mean performance rating, which in our example is 3.60.
Position-in-rangeRatingsBottom Third (20%)Middle Third (65%)Top Third (15%)5 x .15 = .754 x .40 = 1.603 x .35 = 1.052 x .10 = .201 x .00 = .00TOTAL: 3.60
Step 3: Build the Matrix
The vertical column includes your performance rating categories along with your assumptions about what type of rating employees are likely to receive. The horizontal row includes where employees are falling in their range. Now, consider your budget and the mean performance rating.Budget = 3.0%Mean Rating = 3.60Use your mean rating as a guide and find the cell that aligns with the rating and the most employees in that area of the range. In our example, 65 percent of employees are in the middle third of their range, so we are going to choose a cell in the column. The mean rating, however, is not quite as cut and dry — the rating is more than three and a little less than four, so which cell should we use?This is the art piece of compensation — use your best judgment considering where most employees fall relative to their range and where most employees fall regarding performance. Enter your budget (3.0%) in the cell you choose — in our case, we selected cell 4/Middle Third.
Position-in-rangeRatingsBottom Third (20%)Middle Third (65%)Top Third (15%)5 (15%)4 (40%)3.03 (35%)2 (10%)1 (0%)Once you’ve determined where to place your starting budget, add percentage to every cell in the matrix. How do you decide what amount to allocate in each cell? Again, this is the creative side of compensation. Consider how aggressively your company wishes to reward performance – you may decide to put higher increases in cells lining up to ratings 4 and 5, focusing less on the position in range for those performance ratings. Work your way out from you first cell (both vertically and horizontally). In this case, we chose not to allocate increases to any employee who receives a 1 (unsatisfactory) rating or to an employee who needs improvement and is in the top third of their range. Position-in-rangeRatingsBottom Third (20%)Middle Third (65%)Top Third (15%)5 (15%)6.05.03.54 (40%)4.03.02.53 (35%)3.52.52.02 (10%)2.01.50.01 (0%)0.00.00.0
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Step 4: What’s the Cost?
About this time you’re probably thinking, how do I know if I’m staying on track with my budget if I’m “arbitrarily” choosing percentages for each cell? In this next step you will need to calculate the cell contribution payout to determine if the percentages you selected — the art part — are affordable per the budget.To calculate the cell contribution payout, multiply the percentage of employees estimated to receive the performance rating by the percentage of employees in each position-in-range and by the projected increase amount. The formula should look something like this: Percentage in each Rating x Percentage in each Position-in-Range x Projected Increase.
So, for cell 4/Bottom Third, the calculation would be .40 x .20 x 4.0 = .32Position-in-rangeRatingsBottom Third (20%)Middle Third (65%)Top Third (15%)5 (15%)6.05.03.54 (40%)4.0 (.32)3.02.53 (35%)3.52.52.02 (10%)2.01.50.01 (0%)0.00.00.0 Repeat this calculation for all cells in the matrix. Once finished, add together the cells in each row, then add all five rows together. Your results should look like this:Position-in-rangeRatingsBottom Third (20%)Middle Third (65%)Top Third (15%)5 (15%)6.0 (.18)5.0 (.49)3.5 (.08).754 (40%)4.0 (.32)3.0 (.78)2.5 (.15)1.253 (35%)3.5 (.25)2.5 (.57)2.0 (.11).922 (10%)2.0 (.04)1.5 (.10)0.0 (0).141 (0%)0.0 (0)0.0 (0)0.0 (0).003.05% Step 5: Revise (If Necessary)The matrix, as it is currently built, is going to give us a merit budget of 3.05%. Depending on
