1. Introduction

Comp leaders often grapple with the daunting task of piecing together a budget for their compensation cycle, and the stakes are high. With ever-evolving market benchmarks, fluctuating business needs, and increasing demands for fairness and transparency, building a robust merit cycle budget can seem like an uphill battle.

Yet, having a clear, data-backed strategy becomes a beacon amidst the chaos.

As the saying goes, "what gets measured, gets managed." It’s time to transition from reacting to meticulously crafting a comp cycle budget that aligns with both organizational objectives and employee aspirations.

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Download our Merit Budgeting Tool to use while reading along

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2. Ways of Building a Merit Budget

Approach #1: Merit Matrix by % Increase

This approach anchors on the principle that pay raises should be tied to an employee's performance and their position within a salary range. Here’s how it works:

• Establish Performance Tiers: Begin by identifying various performance levels – for instance, 'below expectations,' 'meets expectations,' and 'exceeds expectations.'
• Assign % Increase: For each tier, designate a specific percentage increase. As an example, those who 'exceed expectations' might receive a 4% pay bump, while those merely meeting them might see 2%.

The beauty of this method lies in its simplicity and direct link between performance and compensation. However, it doesn’t always account for market shifts or existing salary disparities.

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Approach #2: Merit Matrix by Target Compa-Ratio

While the first method is all about percentage increases, this one aligns with the idea of a 'Compa-Ratio' – a tool comparing an employee’s current salary to the midpoint of a salary range for their position. Here’s a quick guide:

• Calculate the Compa-Ratio: For any employee, this ratio is calculated by dividing their current salary by the midpoint salary for their role.
• Develop the Matrix: Create a matrix that shows merit increases based on both performance ratings and the Compa-Ratio. This ensures employees who are paid below the market rate (and perform well) get a higher increase, pushing them closer to the market median.

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This method accounts for market rates and internal equity but may seem complex to those unfamiliar with Compa-Ratios.

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Approach #3: Top-down budgeting

The first two methods take a “bottoms-up” approach to budgeting, with calculations starting at the employee level. Another method takes the opposite approach, starting with an aggregated budget and cascading that down to managers. In this method, HR might partner with Finance to: 

• Define the Budget: Set a total budget amount based on business planning or a percentage of total headcount spend
• Cascade the Budget: Determine which business units or manager levers should receive a budget for the cycle. Some organizations might choose to only allocate budgets to the CEO direct reports. Other organizations might cascade proportional allocations of the budget to the line-level manager. 

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3. Rolling Out Merit Budgets

When the time comes to roll out these well-crafted budgets, two decisions await: 

• Question 1: Do you assign specific budgets to each manager or allow them the flexibility to request without a predetermined limit?
• Question 2: What type of guidance do you give each manager for guiding their employee-level recommendations? 

Question 1: Imposing Budgets on Managers

• Assigning a Direct Budget: This strategy provides managers with clear boundaries, reducing the risk of overspending and ensuring alignment with the organization's overarching strategy. However, it might stifle managers' ability to address unique departmental needs or exceptional employee performances.
• Flexibility without Direct Budget: On the flip side, not having a stringent budget may empower managers to reward talent effectively and address disparities in real-time. But, with great power comes the potential for misuse or inconsistency across the organization.

Question 2: Guiding Manager Recommendations

• Employee-Level Guidance: This strategy involves providing employee-level guidance based on your merit matrix or % increase approach. Companies that provide the guidance to managers might still allow deviations - but with a robust explanation from the manager. 
• No Employee-Level Guidance: Conversely, another strategy involves giving managers a blank slate for making recommendations. While the manager might still be guided by their overall budget, this may result in disparities across employees with similar ratings and tenures, leading to pay inequities.

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The key is striking a balance. By experimenting or blending strategies, organizations can maintain oversight while still offering managerial autonomy. 

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Overall, the merit cycle budget is not merely about numbers – it’s a strategic tool ensuring fairness, competitiveness, and acknowledgment of talent. Whether you choose the % Increase or Compa-Ratio approach, or a mix of budget rollout strategies, always remember the ultimate goal: to reward, retain, and recognize those who make the organization thrive.

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If you want to learn about how Assemble enables you to run a Comp Cycle at scale through best-in-class software workflows, request a demo here!