Annual merit pay programs provide the means to recognize individual contributions. Individual goals allow managers to set specific target performance for their subordinates.

The annual appraisal process provides a performance rating. The rating system is point based or uses rating categories such as a five-level rating system (e.g., meets objectives, exceeds objectives, etc.). Some companies require forced distribution of performance for payout purposes.

The final summary rating provides the input to the payout schedule for determining annual/periodic pay adjustments.

There are two ways to deliver an annual/periodic base salary pay change:

• Merit Increase. The most common method is the merit increase. Management establishes a merit target amount depending on changes in market rates and the company's preferred competitive position. An individual's treatment depends on current position in the salary range or distance to the control point and individual rating.
• Merit Awards. Another method to reward individual merit performance is to split the annual/periodic adjustment into two elements: 1) a base pay adjustment tied to the movement of labor market rates and position in the salary range, and 2) a lump sum merit award tied to the accomplishment of individual goals.

Merit increase and award schedules tend to be the same for all job categories, unless unusual market conditions exist for a select job group.