Merit Pay vs Incentive Pay: What’s the Right Fit for Your Team?

Introduction

You’ve likely faced this dilemma: your sales team is hitting targets and earning bonuses, while your engineering team, despite working tirelessly behind the scenes, feels overlooked. 

This isn’t just a small frustration; it’s a serious business risk. Gallup’s research shows that employees who receive high-quality recognition are 45% less likely to leave within two years and 65% less likely to be actively job-hunting.

It’s like running a relay race where the sprinters keep getting rewarded for each lap, while the long-distance runners who make the win possible go unnoticed. The result? Disengagement, frustration, and eventually, attrition.

The real question is: how do you recognize and motivate both groups effectively without creating imbalance? Should you rely on merit pay, which rewards sustained effort, or incentive pay, which drives immediate results? 

In this blog, we’ll break down the pros and cons of both models to help you make a data-driven decision that boosts retention and long-term success.

Merit Pay vs Incentive Pay: What’s the Difference?

When it comes to rewarding employees, merit pay and incentive pay are two of the most commonly used models. While both serve to motivate and recognize employee performance, they work in very different ways.

What is Merit pay?

Merit Pay is a permanent salary increase based on an employee’s past performance, typically assessed during annual or semi-annual performance reviews. It’s about recognizing consistent, high-quality performance by an individual employee over time.

Merit pay is structured around the idea of reinforcing consistent, high-quality work over time. For example, a university might increase a professor’s base salary by 5% after a stellar teaching and research performance over the academic year. These increases become part of the employee’s salary moving forward, creating a lasting reward for long-term contribution.

In most organizations, merit increases typically fall in the 2–5% range, though top performers may receive higher adjustments in exceptional cases. The exact percentage often ties back to a performance rating scale. For instance, a 1–5 system where “meets expectations” might earn a 2–3% increase, while “exceeds expectations” could result in a 4–5% boost. This structured approach helps align compensation with clearly defined performance outcomes.

In sectors like education, civil services, or engineering, where output is harder to measure in real time, merit pay is often the preferred model.

What is Incentive pay?

Incentive Pay, on the other hand, is a one-time reward given for achieving specific goals or outcomes. Think of bonuses, commissions, profit sharing, or rewards for hitting a milestone. This kind of pay is tied directly to performance and is often short-term, making it ideal for roles with clear, measurable targets.

Incentive pay is designed for short-term goals and is often tied to specific outcomes. It's typically outside of an employee's base salary and paid for hitting measurable targets, such as closing a sales deal, hitting customer service KPIs, or completing a project on time. 

For example, Amazon delivery drivers often earn bonuses for hitting same-day delivery goals, just like sales teams that earn incentives for meeting sales targets. In sales-heavy or operational roles, this direct link between action and reward can drive focus and productivity.

Key Differences Between Merit Pay and Incentive Pay 

Pros and Cons of Merit Pay vs Incentive Pay

When it comes to designing an employee compensation strategy, both merit pay and incentive pay have their place, but they work in very different ways. In this section, we’ll dive into the real-world pros and cons of both approaches, helping you make a more informed decision about how to reward your employees.

Pros and Cons of Merit Pay

Pros:

1. Reinforces Long-Term Performance: Merit pay rewards consistent, high-quality work by permanently increasing base salary. It motivates employees to maintain strong job performance and reinforces a sense of long-term accountability, aligning their goals with the sustained success of the organization.
   
   
2. Supports Career Progression: Merit increases often accompany promotions, helping employees see a direct link between performance and career growth. This encourages ongoing development and boosts motivation by rewarding long-term commitment with tangible, upward movement within the company.
   
   
3. Provides Perceived Stability: Unlike one-time bonuses, merit pay offers predictable income growth. Employees feel financially secure knowing their contributions lead to stable, lasting rewards, especially valuable in uncertain economic environments or roles where consistency is key.
   
   
4. Ideal for Non-KPI Roles: For roles without clear metrics like research or engineering, merit pay recognizes effort that drives long-term value. It rewards consistent performance that might not show up in short-term outputs but is vital to organizational success.
   
   
5. Boosts Loyalty and Retention: Merit pay builds trust and encourages employees to stay by recognizing contributions over time. When people feel fairly rewarded and see growth opportunities, they’re more likely to remain engaged and committed to the company.

Cons:

• Subjectivity risks: Merit pay heavily relies on manager evaluations, which can be influenced by biases—conscious or not. A McKinsey report on performance management highlights this as a common organisational challenge.
  
  
• Delayed gratification: If recognition only comes once a year, it can feel disconnected from day-to-day motivation.
  
  
• Raises increase fixed costs: Unlike bonuses, raises stick. This creates long-term financial commitments for the company.
  
  
• Hard to adjust: Once someone gets a raise, it’s culturally and ethically difficult to reduce their salary, even if their individual performance declines.

Pros and Cons of Incentive Pay

Pros:

1. Performance Visibility: Incentive pay offers clear goals and immediate feedback. When employees know exactly how to earn rewards, it boosts motivation, accountability, and engagement, making it easier for teams to focus and perform against well-defined targets.
   
   
2. Cost-Effective: Incentive pay links payouts to actual results, helping businesses control fixed costs. If goals aren’t met, bonuses aren’t paid. This performance-based model keeps budgets flexible and ensures you're only spending on outcomes that move the needle.
   
   
3. Fuels Urgency: Incentives create urgency by rewarding short-term wins. This is especially effective in roles like sales or support, where employees are pushed to meet goals quickly, make decisions faster, and stay focused on delivering tangible outcomes.
   
   
4. Scalable and Measurable: Incentive programs are designed to grow with the organization. They can be applied consistently across teams, departments, and even geographies. Built-in structures like standardized goals and performance metrics ensure fairness and comparability at scale. Modern tools, such as Everstage, make this even easier by automating tracking, reducing administrative workload, and providing leaders with real-time visibility into performance across the organization..
   
   
5. Drives Specific Results: Incentive pay targets precise outcomes—like hitting quotas or completing projects on time. It aligns employee effort with business goals and ensures teams focus on the KPIs that truly impact company success.

Cons:

• Collaboration risk: Competitive individual bonuses may boost individual effort, but at the cost of teamwork. Research from the Journal of Exonomixs and Management Strategy indicates that such schemes can reduce peer cooperation and even lead to sabotage or reluctance to help colleagues.
  
  
• Short-termism: Employees may prioritize quick wins over meaningful work—like patching a bug fast instead of solving the root issue.
  
  
• Income volatility: Not everyone is comfortable with variable pay. This can lead to financial anxiety, especially in uncertain markets.
  
  
• Admin-intensive: Incentive programs require robust tracking systems. Without them, disputes can arise over missed or miscalculated payouts.

Checklist to Choose Between Merit Pay and Incentive Pay

If you’re still on the fence, this checklist can help clarify which model suits your team:

• Are you trying to encourage long-term consistency and growth? → Go with Merit Pay
  
  
• Is your goal to drive urgency and performance on specific tasks? → Choose Incentive Pay
  
  
• Do your roles involve clear, measurable KPIs tracked frequently? → Incentive Pay works better
  
  
• Do your performance reviews follow a structured and unbiased process? → That’s a green light for Merit Pay
  
  
• Do you need to keep fixed costs in check? → Incentive Pay offers flexibility
  
  
• Are your roles in sales, delivery, or support, where output is quantifiable? → Incentive Pay is ideal
  
  
• Do your employees value stability and long-term growth? → Merit Pay may resonate more
  
  
• Can your managers objectively evaluate performance? → If yes, Merit Pay is viable; if not, lean into clear incentive metrics

• Do you want a flexible incentive plan that ties payouts directly to performance? → Choose incentive pay.

Conclusion

The answer? It depends. There’s no silver bullet, only context-driven choices.

Merit pay works beautifully in structured environments where performance isn’t easy to quantify. It supports long-term career development and organizational stability. Incentive pay, on the other hand, is powerful in fast-moving, metric-driven teams that need quick wins and flexible cost structures.

Many companies today are moving toward hybrid models, combining both strategies. For instance, offering quarterly sales bonuses alongside an annual merit raise ensures both sprint and marathon performance get recognized.

Here’s our advice: Don’t commit to a model without testing it first. Start with pilot programs. Gather feedback. Analyze impact.

Want help designing a flexible, outcome-aligned compensation strategy? Book a demo to see how Everstage can streamline performance tracking, automate payouts, and support smarter decision-making.

Let’s build a rewards system your team actually loves.