A merit cycle can be a powerful way to reward employees, boost engagement, and build loyalty. After a round of layoffs, merit awards can be even more valuable, helping to reduce the turnover, resignations, and low engagement that often follow. 

However, a merit cycle (also known as a compensation cycle) isn’t just about pleasing employees and boosting morale. As a key element of a company’s overall pay strategy, it must align with its compensation philosophy, goals, and budget.

“When leveraged in the right way, the merit cycle can be an incredibly important tool within an organization’s compensation toolbox,” said Calvin Croskey, director of Sequoia’s Compensation Advisory. “It’s powerful because it’s the one point in time when leaders across the company, from HR and Finance to managers and senior executives, come together to recognize and reward employees by providing a monetary ‘thank you.’” 

While merit cycles can be complex programs to execute, and can vary by company, we’ll guide you through common best practices to help you build a program that supports both employees and your business. Let’s start by defining exactly what we mean when we talk about merit cycles. 

What is a Merit Cycle? 

A merit cycle is the process a company uses to evaluate and reward employees based on their performance against goals, usually over the previous year. Merit awards can come in different forms, including a small salary adjustment, a one-time cash bonus, an equity refresh grant, or a promotion with a larger salary increase. They can coincide with other salary adjustments, like cost-of-living increases, aligning pay with market rates, or closing internal pay gaps.

Merit cycles usually take place annually with awards distributed during the first quarter of a fiscal year. However, it’s becoming more common, particularly within high-growth tech companies, to run them twice a year. This approach allows employers to recognize and reward high performers more frequently. Companies who run merit cycles more than once a year typically have the in-house expertise, budget, and resources to handle the administration.

The Benefits and Risks of a Merit Cycle 

When done right, a merit cycle can drive employees to perform at their best and grow their skills and careers at a company. And because individual goals are typically tied to overall company goals, they can help drive business growth and success.  

When handled poorly, a merit cycle can come across as unfair or biased, and inconsistent awards can strain finances. So how do you keep it fair, affordable, and rewarding for employees? It’s a careful balance between planning, execution, and communication.  

When Merit Award Budgets Are Set 

The budget for merit awards is set during annual planning, which typically takes place near the end of a company’s fiscal year. For example, companies that run on a calendar year begin their process in late September or October.  

During this stage, companies set financial and headcount goals, benchmark compensation against their target market, and review pay ranges and their compensation philosophy.

Planning the Merit Cycle 

There’s a reason both HR and Finance dread the merit cycle. It can be a cumbersome, overwhelming, and extremely complicated with many stakeholders and stages. For a smooth and successful process, careful planning is a must. Let’s break down the key steps to planning a successful merit cycle.

Make sure everyone knows their role  

A merit cycle usually involves the collaboration of many stakeholders including: 

  • Finance or compensation leaders: They oversee the budget, timeline, strategy, eligibility, and overall rules for how performance ratings align with awards.  
  • HR leaders: They handle the people aspects of the cycle, including preparing and guiding employees and managers.  
  • Executives: They approve department budgets, strategies, final performance ratings, and salary adjustments. 
  • Frontline managers: They conduct performance reviews and communicate merit awards to their direct reports. In some organizations, they also help determine merit awards amounts for individuals.
  • Payroll partners: They manage the processing of final awards and ensure they’re delivered correctly and on time.

Everyone involved must know their role, specific tasks, and deadlines, and have access to the information and tools they’ll need to do their part. A dedicated system, instead of a tangle of multiple tools and excel spreadsheets, can help streamline the process and support better collaboration. 

Executing the Merit Cycle 

Usually, from an employee’s point of view, the merit cycle begins with their performance review, when their manager evaluates their progress toward their goals, provides feedback, and gives them a performance rating.  

Performance reviews directly affect decisions related to merit awards. To ensure fairness, they’re sometimes combined with calibration sessions, when managers and HR leaders meet to confirm they’re using consistent ratings criteria and standards.

Merit Cycle Communication  

Just as it’s important to prepare the merit cycle team, it’s essential to prepare employees and managers. A clear communication plan can go a long way in preventing misunderstandings. 

Have a training and education plan 

Educate employees on the merit cycle process, including how decisions will be made, when performance reviews will happen, and when merit awards will be distributed or become effective. 

Encourage questions and open dialogue. And keep in mind that when employees have questions, they usually go to their managers first. To help managers prepare for these conversations, give them FAQs and talking points, and train them on compensation essentials, such as your company’s comp philosophy, job levels, and pay ranges. 

Have a plan for merit letters and signatures 

Receiving a merit letter is an exciting time for employees and another way to show them appreciation.

To make the process smooth for both employees and administrators, design letters to be clear and easy to understand, especially when detailing award types and amounts. Also, consider using electronic signatures to streamline the process. 

Remember, the merit cycle is more than just a yearly administrative task. It’s an opportunity to recognize and reward top performers, boost morale, and align individual goals with business goals. By understanding the fundamentals, involving key stakeholders, and executing with precision, companies can design a motivating and satisfying process for employees.  

Elevate Your Merit Cycle 

Merit planning can be complicated, even for the most experienced teams. But you don’t have to manage it all on your own. Sequoia’s compensation advisory and powerful platform can offer expert guidance, tailored insights and data, and tools for the end-to-end merit journey. To learn more, connect with our team.