Incentive Pay Vs Merit Pay: Different Ways To Reward Employees

Incentive Pay Vs Merit Pay
by Signe Hegart
August 21, 2023

In today’s competitive job market, it’s more important than ever for companies to find effective ways to motivate and reward their employees. Two popular approaches for granting employee awards and recognizing their contributions are incentive pay and merit pay. While both options aim to encourage and recognize employee performance, they differentiate in their structure and goals. In this article, we’ll explore incentive pay vs merit pay, provide an assessment of their pros and cons, and help guide how companies can choose the right approach for their organization.

What is Incentive pay?

Incentive pay, also known as variable pay or performance-based pay, is a compensation strategy that rewards employees for meeting or exceeding specific goals or targets. It is designed to motivate employees to work harder and achieve better results. Incentive pay can be in the form of bonuses, gift cards, commissions, profit-sharing plans, or stock options.

In various sectors, incentive pay plays a significant role in motivating and rewarding employees for exceptional performance. Consider sales and marketing, where incentive pay, often in the form of bonuses and commissions, spurs sales representatives and marketers to surpass targets and generate revenue. In retail, this strategy encourages staff to enhance sales figures through performance-linked bonuses.

Similarly, manufacturing industries implement incentive pay systems to drive efficiency and quality. Factory workers are rewarded for reaching production quotas and maintaining high standards. In the hospitality sector, service staff, such as servers, bartenders, and hotel personnel, benefit from incentives through gratuities and tips, motivating exceptional customer service.

Types of incentive pay

There are several types of incentive pay that companies can offer to their employees:

1. Individual Incentives

These rewards are based on individual employee performance. They can be tied to specific metrics, such as sales targets, customer satisfaction ratings, or productivity levels. Organizations may also provide flexible work arrangements, such as remote work options or flexible hours, to cater to employees’ work-life balance preferences. Professional development opportunities, including training, workshops, and conferences, are tailored incentives for those seeking to enhance their skills and knowledge. Special projects or assignments, assigned based on individual excellence, provide a sense of accomplishment and motivation.

2. Team Incentives

These rewards are based on the collective performance of a team or department. They encourage collaboration and teamwork, and are often used in environments where employees rely on each other to achieve success.

Team-based bonuses tied to overall performance metrics serve as powerful motivators. When teams collectively meet or surpass predefined performance criteria, these bonuses reinforce a collective sense of responsibility for outcomes and encourage a heightened focus on achieving exceptional results.

Recognizing and celebrating team accomplishments in a public and meaningful manner also contribute to the effectiveness of team incentives. Public acknowledgment through ceremonies, events, or announcements can significantly boost team morale, reinforce a sense of belonging, and strengthen team cohesion.

In addition, team challenges and competitions introduce an element of friendly rivalry that can ignite healthy competition and camaraderie among team members. Such challenges, when paired with tangible rewards for the winning team, drive motivation and instill a shared sense of accomplishment.

3. Company-wide Incentives

These rewards are based on the overall performance of the company. They can be tied to financial metrics, such as revenue growth or profitability, and are often used to align employee efforts with organizational goals. Employee appreciation events, such as gatherings, outings, or celebrations, provide a platform for acknowledging the collective efforts of employees. These occasions strengthen interpersonal relationships, enhance team cohesion, and contribute to a positive work environment.

Flexible work arrangements introduced at the company-wide level showcase a dedication to accommodating employees’ individual needs. By offering options such as remote work or flexible hours, organizations emphasize trust and autonomy.

Professional development opportunities, accessible to all employees, underscore the organization’s investment in its workforce. These initiatives enable skill enhancement, career growth, and contribute to a more skilled and motivated workforce

Pro and cons of incentive pay

Pros of incentive pay

  1. Motivation and Engagement: Incentive pay can significantly boost employees’ motivation and engagement by directly linking their efforts to tangible rewards. Knowing that their hard work will be recognized and rewarded can drive employees to perform at their best.
  2. Performance Focus: Incentive pay encourages employees to focus on key performance indicators (KPIs) and organizational goals. This helps align individual and team efforts with the company’s overall objectives.
  3. Flexibility: Incentive pay allows organizations to tailor compensation to specific roles, tasks, or goals, providing a more flexible and customized approach to rewarding employees.
  4. Attracting and Retaining Talent: Competitive incentive pay packages can attract high-performing candidates and retain top talent within the organization, contributing to a more skilled and motivated workforce.
  5. Pay-for-Performance Culture: Incentive pay can foster a culture of meritocracy, where rewards are based on actual contributions and results, promoting fairness and accountability.

Cons of incentive pay

  1. Short-Term Focus: Employees may prioritize short-term gains over long-term goals, potentially neglecting activities or strategies that yield benefits in the long run but may not offer immediate rewards.
  2. Competition and Conflict: Incentive pay can foster unhealthy competition among employees, potentially undermining collaboration and teamwork. Additionally, employees might engage in unethical behaviors to achieve higher rewards.
  3. Subjectivity and Bias: Designing and implementing effective incentive pay programs can be complex. Subjective evaluation criteria or biased decisions can lead to perceptions of unfairness and demotivation among employees.
  4. Neglect of Non-Monetary Factors: Incentive pay may overshadow other important factors contributing to employee satisfaction, such as a positive work environment, opportunities for growth, and work-life balance.

Related: One Simple Rule About incentive programs for employees

incentive pay two cards

What is merit pay?

Merit pay, also known as pay for performance or pay for results, is a compensation strategy that rewards employees based on their individual performance and contribution to the organization. It is typically determined through performance evaluations and can be in the form of salary increases, bonuses, gift cards, or other monetary rewards.

In education, educators and teachers experience merit-based increases that directly reflect their influence on student outcomes and their dedication to continuous improvement. Similarly, across various corporate sectors such as finance, human resources, and operations, professionals are eligible for merit-based salary enhancements that closely align with their achievements and responsibilities, contributing to the company’s overall advancement.

Nonprofit organizations also utilize the concept of merit pay to inspire exceptional dedication in areas like fundraising, program success, and community involvement. In the realm of research and development, individuals involved in groundbreaking scientific endeavors and innovative projects can enjoy the benefits of merit-based acknowledgment, intricately linked to their noteworthy accomplishments and contributions to their respective fields.

Merit pay system

A merit pay system typically involves the following steps:

1. Performance evaluation: Employees are assessed based on their performance against predetermined criteria or goals.

2. Determination of merit increase: Based on the evaluation, employees are assigned a merit rating, which determines the amount of pay increase they are eligible for.

3. Implementation: The pay increase is then applied to the employee’s salary or provided as a separate bonus.

Pro and cons of merit pay

Pros of merit pay

  1. Motivation and Performance: Merit pay provides a clear incentive for employees to perform at their best and exceed expectations, as it directly links compensation to individual performance and contributions.
  2. Higher Productivity: The prospect of higher pay can lead to increased productivity, as employees are motivated to achieve and exceed their goals to earn greater rewards.
  3. Fairness and Accountability: Merit pay rewards employees based on their actual contributions, fostering a sense of fairness and encouraging accountability for one’s work.
  4. Talent Retention: Merit pay can help retain high-performing employees by acknowledging and rewarding their efforts, reducing the risk of turnover.
  5. Customization: Merit pay allows for differentiation in compensation based on the unique skills, responsibilities, and achievements of each employee, contributing to a more customized rewards structure.

Cons of merit pay

  1. Subjectivity: Performance evaluations can sometimes be subjective and open to biases, leading to dissatisfaction and disputes.
  2. Lack of collaboration: Merit pay can sometimes encourage competition among employees, discouraging collaboration and teamwork.
  3. Cost: Implementing a merit pay system can be costly, requiring resources for performance evaluations and increased pay for high performers.
  4. Unintended Behaviors: Employees might focus solely on tasks that are directly tied to incentives, potentially neglecting other important responsibilities that aren’t rewarded.

Choosing the right approach: incentive pay vs merit pay

When deciding between incentive pay vs merit pay, there are several factors to consider. Firstly, the goals of the organization should be taken into account. If the focus is on short-term targets and individual performance, incentive pay may be more suitable. However, if the organization values long-term goals, collaboration, and fairness, merit pay may be a better option. Additionally, the nature of the work and the type of employees should also be considered. Incentive pay may be more effective for jobs that are directly tied to quantitative goals, such as sales or production roles. On the other hand, merit pay may be more appropriate for jobs that require collaboration, creativity, and a broader set of skills.

In some cases, it is not about choosing one over the other and putting the incentive pay vs merit pay against each other, but a question of combining both incentive pay and merit pay approaches. This can be done by incorporating a merit-based component within an incentive pay system, or by providing a separate bonus based on individual performance. This hybrid approach allows for a balance between rewarding individual achievements and promoting teamwork and collaboration.

In conclusion, both incentive pay and merit pay can be effective ways to motivate employees and drive performance. The choice between incentive pay vs merit pay depends on the goals and values of the organization, as well as the nature of the work and the type of employees. By carefully considering these factors and potentially combining the two approaches, companies can create a rewards system that fosters motivation, fairness, and collaboration across departments.

Real-world examples

Many companies have successfully implemented incentive pay and merit pay systems. An example is Amazon´s incentive pay approach for employees which is designed to recognize, motivate, and reward exceptional performance while fostering a culture of continuous improvement and customer-centricity.


In conclusion, choosing between incentive pay vs merit pay requires careful consideration of the organization’s goals, industry, and specific roles. Both approaches have their pros and cons, and a combination of the two may be the most effective solution in certain cases. By implementing the right plan, companies can motivate and reward their employees while driving performance and achieving organizational objectives. In today’s competitive business world, companies are constantly looking for ways to motivate and reward their employees.

Rune Eirby Poulsen
morten sebastian simonsen

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A company should consider giving employees incentive pay or merit pay in various situations where it aims to achieve specific performance-driven outcomes and motivate employees to excel. Here are some scenarios when offering incentive pay could be beneficial:

  • Achievement of Key Performance Goals
  • promoting innovation
  • Driving sales and revenue
  • Encouraging Efficiency and Cost Saving
  • Enhancing Customer Satisfaction
  • Retention of High Performers

A raise and merit pay are both forms of compensation increases for employees, but they differ in their underlying principles and how they are administered:

A raise refers to an increase in an employee’s base salary. It is a broader term that encompasses any adjustment to an employee’s regular pay rate, whether it’s due to factors like inflation, cost of living adjustments, or changes in market conditions.

Merit pay, on the other hand, is a compensation approach that rewards employees based on their individual performance and contributions to the company. It’s often given as a salary increase, similar to a raise, but the key distinction is that merit pay is tied to performance evaluations and individual accomplishments.

Incentive pay is a powerful tool to motivate and reward employees for achieving specific goals or exceptional performance. Here are some common types of rewards that can be offered as incentive pay:

  • Gift Cards or Vouchers
  • Bonuses
  • Commissions
  • Time off
  • Flexible Work Arrangements
  • Training and Development Opportunities

When choosing the appropriate incentive rewards, consider the preferences and motivations of your employees, as well as the specific goals you want to achieve. A well-designed incentive program should be fair, transparent, and closely aligned with both the organization’s objectives and the employees’ contributions.