Picture two colleagues working in the same role. When compensation review season comes around, both receive a top performance rating — so their employer decides to give them both an increase of 5%. Sounds fair, right?
But here’s the thing: one of those employees is currently being paid above the midpoint of their salary range, while the other is right at the bottom. This may be due to historical unfair pay decisions or simply because one teammate negotiated better during the hiring process.
Wherever the reason, giving both employees the same percentage raise no longer looks very fair — and it could even reinforce existing pay gaps and inequities. Using a merit matrix to determine pay increases is a fairer solution that considers both an employee’s performance and their current compensation.
What is a merit matrix?
A merit matrix is a structured framework used to both reward performance and keep compensation internally fair and consistent. They help employees determine pay increases based on two key variables:
- The employee’s performance rating
- Their position within their salary band
With a merit matrix, employees who are currently positioned towards the bottom of their salary band will receive larger percentage increases than those who are already at the top, helping to close pay gaps and standardise pay across the organisation.
The benefits of using a merit matrix for compensation reviews
Here are a few of the benefits that using a merit matrix can bring to an organisation.
Aligns pay and performance
A merit matrix is designed to incentivise hard work by giving larger increases to top performers. This makes it a type of pay-for-performance model — which offers many advantages. Tying pay to performance can boost motivation and engagement, enhance productivity, and ultimately improve your company's bottom line. It can also help companies attract highly motivated talent and foster a culture of growth and learning.
Supports internal and external equity
Using a merit matrix ensures pay increases are coherent with your salary bands — which should be based on up-to-date and accurate market data. That means merit matrices help ensure your salaries remain aligned with the market, even in fast-changing industries.
A merit matrix can also help correct any historical inequities or pay gaps by giving a bigger raise to employees who are currently positioned below the midpoint of their salary band. This means merit matrices can help you ensure your salary bands are both externally competitive and internally equitable and fair.
Helps with budget planning
Using a merit matrix can help you get the most out of your salary increase budget. It allows you to distribute your funds more strategically, using them to both reward performance and improve equity and fairness. You can also use your merit matrix to forecast various scenarios, and adjust it to ensure increases fit within your budget.
Enables compliance
The EU Pay Transparency Directive will be in effect across Europe by June 2026 at the latest, and will introduce various new obligations for employers and rights for employees. Above all, employers will need to be ready to justify every pay decision they make. Incorporating a merit matrix into compensation reviews can help employers comply with the new requirements by showing that their pay criteria are objective, gender-neutral, consistent and fair.
Potential downsides of the merit matrix
While merit matrices are a powerful tool, they’re not the right solution for every organisation. Here are a few disadvantages to keep in mind if you’re considering using a merit matrix for the first time.
- Time-consuming and difficult to manage: Creating a merit matrix is a lot of work — and one misplaced figure could lead to disaster. Employers can save time (and eliminate the potential for human error) by using a tool like Figures to create their merit matrix instead of doing it manually.
- Can be seen as unfair: When you use a merit matrix, you’ll end up giving employees different percentage increases for the same performance rating. While this leads to more consistent and equitable pay overall, some employees and managers may see it as unfair.
- Represents a permanent cost: Increasing an employee’s pay is an effective way of rewarding performance — but it also means committing to an ongoing cost. For this reason, some employers prefer to use raises only for market adjustments and reward performance with one-off bonuses instead.
- Lacks flexibility: Some managers may feel unduly limited by merit matrices, which assign a set percentage increase to each employee based on their performance rating and salary band positioning. Some employers grant managers a certain amount of discretion to account for more nuanced or complex cases.
How to build your merit matrix: step-by-step guide
Considering using a merit matrix to inform your next compensation review? Here are the steps to follow to put it together.
1. Define performance criteria and rating scales
The first step is to identify clear performance criteria and distil them into a standardised rating system that will apply across the organisation. For example, some employers use a five-point scale that assigns each employee one of the following labels:
- Unsatisfactory
- Needs improvement
- Meets expectations
- Exceeds expectations
- Outstanding
It’s important to provide clear guidelines for managers on how these ratings should be applied, including examples of key behaviours and outputs for each one. Holding calibration sessions to finalise ratings can also help to keep things consistent.
2. Create or refine salary bands
If you don’t yet have a salary band structure in place, now is the time to create one (don’t worry: we have plenty of guidance to help you on this blog!). But even if your salary bands are already set up, you’ll need to ensure they're up-to-date and aligned with your compensation philosophy and your desired market positioning. Incorporating salary benchmarking data from a tool like Figures is crucial here.
3. Calculate compa-ratio or salary range penetration
Next, you’ll need to determine where each employee is currently positioned within their salary band. The simplest option is to calculate their compa-ratio, a simple figure that shows their position in relation to the midpoint of the range. For example, an employee with a compa ratio of 0.80 is paid at 20% below the median, while 1.20 is 20% above.
Alternatively, you could choose to work out each employee’s salary range penetration instead. This is different from compa-ratio in that it compares a salary to the entire range instead of just the midpoint.
4.Put it all together
Finally, develop your merit matrix by positioning each performance rating and compa ratio/salary range penetration on a grid and assigning a percentage increase amount to each combination. Here’s an example of a simple merit matrix using compa-ratio and a 4-point performance rating scale:
The traditional way to create a merit matrix is with an Excel spreadsheet or Google Sheet. However, tools like Figures make the process faster and easier, as well as limiting the possibility of human error.
Alternatives to the merit matrix
A merit matrix is just one way of determining pay increases during the compensation review process. Here are a few alternatives to consider:
- Market-based adjustments: Some companies don’t take performance into account at all when determining pay increases. Instead, they simply use raises to align salaries with market rates, guided by salary benchmarking tools like Figures. They may also reward performance with bonuses or other one-time incentives.
- Company-wide increases: Other employers simply apply performance-based raises uniformly across the organisation based on pre-defined criteria. For example, they may decide that everyone with a top performance rating gets a 5% raise. While this is a simpler option than a merit matrix, it could worsen existing pay gaps and inequities.
- Manager-defined salary increases: This approach involves giving managers a budget and broad guidelines, and leaving raises largely to their discretion. This enables more tailored rewards for unique situations. However, there’s a big risk of issues like unconscious bias, inconsistency and favouritism leading to unfair pay distribution.
- 9-box grid: A 9-box grid is essentially an extension of the merit matrix. It takes into account not just performance, but also each employee’s ‘potential’. While this can add an extra dimension to employee assessments, there’s an argument that rewarding potential is unfair and open to bias.
Should you use a merit matrix in your organisation?
A merit matrix is a powerful tool for ensuring fair, transparent compensation decisions — but it’s not the right approach for every organisation. When considering a new compensation structure or process, employers should go back to their compensation philosophy and consider whether the new approach is aligned with their core values and objectives.
Want to learn more about different approaches to compensation, and how Figures can help you put them into action? Start with these articles from our archive:
