Everything You Want To Know About Merit Cycles (But Were Afraid to Ask)

Compensation 101
February 9, 2022
min read
Pave Team

Pave has had the opportunity to assist people leaders in hundreds of merit cycles.

It’s one of the most important workflows to get right as a company, and we continue to learn more each week on how to optimize that process. 

As our customer base (and internal team) expands, we’re often asked questions about all things merit cycle related. We understand compensation is an inherently technical, often ambiguous subject. But it’s a serious issue that involves your team’s livelihoods, and since certain people at your organization might hesitate to raise their hands to ask about this process, we’ve got you covered. 

Below is a collection of the most frequent questions about merit cycles, along with our responses and related resources. Just a few caveats before we begin:

- Merit cycles are different for every company. Variables like time, budget, people involved, and communication practices will differ depending on the type of organization. There is no standard, one-size-fits-all merit cycle, but there are patterns we can point to that represent industry norms that we’ve observed with our research and customer work.

- Certain items on this list might be more of a review, especially for veteran people ops professionals. We present this as a foundational guide, with jumping off points if you’d like to dive deeper down the merit cycle rabbit hole.

With that, here’s everything you want to know about merit cycles, but were afraid to ask.

What is a merit cycle?

Merit pay is a compensation system whereby individual performance determines base pay increases. Managers are provided with an opportunity to award their employees with compensation changes if that individual’s performance meets certain criteria. The merit cycle is only the merit adjustment process. Many companies even separate performance and the merit cycle by multiple months in order to not conflate performance reviews, feedback and career development with compensation.

Are merit cycles always based on performance?

No, there are often market adjustments to get employees within compensation bands or to do a cost of living (COLA) adjustment. This can be done in parallel with merit adjustments or as a pre-adjustment to the subjective part. Also, not all companies will determine pay based on performance ratings.

Where does market data come from?

Traditionally, the data to run merit cycles has come from either public records, benchmarking, or a combination of both. Prior to the launch of comptech tools like Pave, most human resources professionals used compensation surveys to get the data. This process includes capturing data manually, often housed in different systems that aren’t integrated. The challenge is, traditional compensation surveys are only aggregated twice a year. The data becomes outdated quickly. For growing companies with lean human resources teams, we recommend using benchmarking tools with real time api integrations with all of your systems. One that will constantly refresh data with every new employee. 

When do merit cycles happen?

Most companies have some kind of annual merit cycle, sometimes based on the calendar year, or sometimes based on the company’s fiscal year. The merit cycle usually starts with employee performance reviews that will ultimately inform a small compensation increase, and maybe even a bonus or an additional equity grant. Most employees assume the best (or only) time to get a raise or promotion is during that short period at the end of the merit cycle. It’s not uncommon for companies to run a mid-year (lighter) cycle to give folks a chance to be promoted more than once per year.

When do companies start running merit cycles?

Based on our research and client conversations, we typically see about one hundred and fifty employees as a common milestone for formal cycles. This number will vary greatly depending on a number of factors, so there’s no black or white answer. But if your company gets to about a hundred and fifty people, a merit cycle might be a compensation strategy worth considering. If you want to learn more about Dunbar’s number as it applies to growing organizations, check out our culture deep dive, The Do’s & Don’ts of Rapid Scaling for Tech Companies.

Are any other terms used interchangeably with merit cycle?

When companies talk about merit pay or merit cycles, you might also hear several other terms in that conversation. These might include but aren’t limited to annual compensation cycle, focal cycle, merit cycle planning, and more. Certain regions and industries may vary within their compensation lexicon. Regardless of what language is employed, merit pay is ultimately an effective motivator that can link your team’s ambition with a reward. Running an organized and equitable merit cycle drives retention and engagement, and of course, profitability. 

What types of comp are reviewed during these cycles?

The vast majority of merit cycles relate to base pay. If your organization offers variable pay, i.e., sales commission, that may also come into play. Other types of comp to consider are your target bonuses and equity grants.

What do promotions mean for compensation adjustments?

This puts an employee into a new compensation band, which is the range in which the company is willing to pay a certain role. Say you work as an entry level employee, hypothetically earning $50k-$60k per year. If you’re performing well, congrats! Your promotion takes you up to the next level, a comp range of $57k-$67k. Keep in mind, many of the comp bands do overlap, so as to take into account tenure and performance, allowing companies to pay for experience for certain roles. Lastly, if you get a promotion, it may not only mean earning new compensation, but also more equity!

Are equity refreshers included in merit cycles?

Sometimes. This feature depends on the structure of the refresher program. Assuming you want to keep your people around for more than four years, you may want to heavily consider offering additional equity grants. Read our previous post, The Evolution of Stock Options and Why Equity Refreshes are a No Brainer to dig into the hard numbers.

Who actually runs the merit cycle itself?

Ensuring pay parity and competitive compensation takes a village, although depending on the size of the company, the division of labor will vary. Sometimes compensation will be only one person’s responsibility, and that’s a heavy workload to carry. For companies that aren’t large enough to staff a compensation manager role or a head of compensation, overseeing the merit cycle will require collaboration from a few groups of stakeholders. This extended team might include finance, people ops, human resources and other company leaders.

How do companies determine merit cycles?

Although merit cycles are not a one-size-fits-all, we recommend organizations flesh out the guiding principles that inform their financial decision making, also known as the Compensation Philosophy. This document allows you to be intentional and thoughtful about compensation practices, be proactive instead of reactive, and establish a single source of truth for comp decisions. Companies who frictionlessly administer bonuses and equity refreshers during merit cycles are effectively turning their compensation philosophy into reality. We’ve written extensively on this topic, so check out our ebook, or see our series on companies whose comp philosophies we love. This is an essential part of your compensation strategy you can’t afford to skip or rush through.

How should companies measure the success of merit cycles?

Total rewards leaders should, at the very least, track 3 merit cycle KPIs—budget adherence, timeliness of cycle, and adherence of compensation philosophy—to have a wholistic view of how their cycle went. A retrospective for merit cycles can be used to celebrate the hard work of your compensation team, but more importantly help you deliver exceptional and more efficient merit cycles. Download our Merit Cycle Scorecard Template.

What are the most common types of merit cycles?

There are numerous approaches to compensating employees, but our experience and research shows three main ways companies typically structure merit recommendations. The Flat Recommendation, where every employee gets the same recommendation percentage, regardless of performance; The Standard Merit Matrix, where the increases are directly correlated to an employee’s performance; and The Multivariable Merit Matrix, where the increases are based on multiple variables. We explained each of these in detail in our previous post: How should merit recommendations be structured?

How long do merit cycles typically take to execute?

That all depends on systems and processes. If your company lives in spreadsheet land, don’t hold your breath. Many organizations spend an inordinate amount of time auditing compensation data through external tools, performing manual data entry tasks and fixing clerical errors across various systems and sources. Their merit cycles take many weeks and even months. When this inefficiency happens, companies will often extend their deadlines, much to the chagrin of the leaders and employees. It’s critical for people ops teams to partner with the right compensation platform to create a consolidated view of their comp to efficiently and effectively communicate merit cycle outcomes. This should reduce merit cycle time exponentially.

Why are merit cycles difficult and often dreaded for HR teams?

Merit cycles have historically been an extremely manual process. There’s a prolific amount of work that goes into the administrative phase. Teams cobble together their compensation reports and have spreadsheets for every manager, all of which have to be approved, submitted and resubmitted. If you have a thousand person organization, human resources likely has eight hundred spreadsheets to send out and eventually merge, calculate and so on. To make merit cycles more difficult, in recent years, lean people operations teams are often taking on many other responsibilities, such as compensation planning, total awards, explaining equity, and of course, merit cycles. Combine those variables, and it’s easy to see how merit cycles are difficult and dreaded.

How should you communicate conversation during merit cycles?

Compensation is an emotional topic—it underscores the value an organization places on an employee’s work. Preparing managers well ahead of time with the clarity they need is crucial to delivering conversations that build trust and credibility. Additionally, educating your broader employee base before the process starts and throughout the entire cycle can help bring everyone on the same page and manage any possible assumptions or disappointment. See our full guide on how to communicate about compensation here.

Who benefits most from the merit cycle?

While managers and leaders run the actual merit cycle, everyone in the employment process is connected to the process. Your employees appreciate them because merit cycles make them feel valued and offer a livable wage. Your managers appreciate them because their teams get recognized for their great work, stay engaged at work, and are more likely to continue at the company long term. Finally, your company itself appreciates merit cycles because they reinforce fiscal responsibility and establish a sense of compensation predictability.

What does the merit cycle of the future look like?

As a company that's had the opportunity to assist people leaders in hundreds of merit cycles, Pave has many ideas on what merit cycles will look like in the future. We believe it’s only a matter of time before the days of pulling down archaic spreadsheets for every single merit cycle are gone. The CompTech Revolution has proven that there are solutions that dramatically enhance the merit cycle experience for people operations and managers. 

What should you do once the merit cycle is over?

Besides getting a two hour hot stone massage? Well, executing your company’s merit cycle accurately and efficiently is no easy task, and the final mile is critical from your talent brand and employee experience perspective. We recommend people ops teams send out visually stunning reward letters. These documents will be required in some jurisdictions, but generally it’s what the vast majority of companies do. We foresee in the not too distant future that merit cycles will no longer end in a mail merge and an impersonal form letter pdf, rather, a celebration of human potential, performance and compensation. Here’s a sample of the reward letters sent out through Pave.

We hope this like of frequently asked questions about merit cycles helps paint a clearer picture of the annual compensation process. 

Getting this important workflow right isn’t easy for any company, and we understand your team might be hesitant to ask questions about something as complicated, ambiguous and serious as how much they get paid.

If you’d like to learn how Pave centralizes compensation data in real time to manage merit cycles in one unified place (without spreadsheets), book a demo with us today!

Learn more about Pave’s end-to-end compensation platform
Pave Team
Pave Team
Pave is a world class team committed to reinventing the world of compensation and help build a more transparent future of work.

Become a compensation expert with the latest insights powered by Pave.

(function (h, o, t, j, a, r) { h.hj = h.hj || function () { (h.hj.q = h.hj.q || []).push(arguments) }; h._hjSettings = { hjid: 2412860, hjsv: 6 }; a = o.getElementsByTagName('head')[0]; r = o.createElement('script'); r.async = 1; r.src = t + h._hjSettings.hjid + j + h._hjSettings.hjsv; a.appendChild(r); })(window, document, 'https://static.hotjar.com/c/hotjar-', '.js?sv='); !function () { var analytics = window.analytics = window.analytics || []; if (!analytics.initialize) if (analytics.invoked) window.console && console.error && console.error("Segment snippet included twice."); else { analytics.invoked = !0; analytics.methods = ["trackSubmit", "trackClick", "trackLink", "trackForm", "pageview", "identify", "reset", "group", "track", "ready", "alias", "debug", "page", "once", "off", "on", "addSourceMiddleware", "addIntegrationMiddleware", "setAnonymousId", "addDestinationMiddleware"]; analytics.factory = function (e) { return function () { var t = Array.prototype.slice.call(arguments); t.unshift(e); analytics.push(t); return analytics } }; for (var e = 0; e < analytics.methods.length; e++) { var key = analytics.methods[e]; analytics[key] = analytics.factory(key) } analytics.load = function (key, e) { var t = document.createElement("script"); t.type = "text/javascript"; t.async = !0; t.src = "https://cdn.segment.com/analytics.js/v1/" + key + "/analytics.min.js"; var n = document.getElementsByTagName("script")[0]; n.parentNode.insertBefore(t, n); analytics._loadOptions = e }; analytics.SNIPPET_VERSION = "4.13.1"; analytics.load("0KGQyN5tZ344emH53H3kxq9XcOO1bKKw"); analytics.page(); } }(); $(document).ready(function () { $('[data-analytics]').on('click', function (e) { var properties var event = $(this).attr('data-analytics') $.each(this.attributes, function (_, attribute) { if (attribute.name.startsWith('data-property-')) { if (!properties) properties = {} var property = attribute.name.split('data-property-')[1] properties[property] = attribute.value } }) analytics.track(event, properties) }) }); var isMobile = /iPhone|iPad|iPod|Android/i.test(navigator.userAgent); if (isMobile) { var dropdown = document.querySelectorAll('.navbar__dropdown'); for (var i = 0; i < dropdown.length; i++) { dropdown[i].addEventListener('click', function(e) { e.stopPropagation(); this.classList.toggle('w--open'); }); } }