The Merit System Culture in the Post WWII Era

If you are employed today, chances are you're working in a merit system.  The merit system is a compensation philosophy that essentially rewards an employee for doing their job well.  To just about everyone, being rewarded for doing a good job is about as American as apple pie and just good common sense.  To be sure, the merit system has served American industry and the employee well.  Much of our success as an industrialized nation can be attributed to the manner in which employers in the U.S. compensated their employees through this system.

Dresden, Germany

Particularly after the end of the second World War, the merit system seemed to make the most sense for both business management and employees.  People worked hard, businesses produced and grew.  The growth of American business was fueled by world demand in the wake of the destruction of the manufacturing infrastructure in Europe and Asia.  The U.S. economy grew, businesses flourished and the incomes of average workers increased as the world's demand for goods were supplied by the United States economy.

The demand for American goods was so strong, businesses concentrated on production.  The focus on production and growth went on, nearly unabated, for a generation in the years after World War II.  But around 1970, an unmistakable trend had begun to take hold.  Our former enemies, Germany and Japan, had rebuilt much of their industrial capacity and were challenging American dominance in manufacturing.  It first gained public notice in the automotive industry as Japanese car manufacturers began shipping economical, well engineered, durable vehicles to the U.S., which were superior in craftsmanship to their American competitors.  Consumers liked the vehicles and happily bought them.  

Japanese Auto ImportsJapanese Auto Imports


Unable or unwilling to respond to the importation of superior vehicles, the American automotive industry began a rapid decline.  The generation long spurt of growth was over.  Growth, which had been assumed in the post war generation, now faced an unprecedented challenge and American businesses were clearly unprepared.  But it was also this uninterrupted growth that helped entrench the merit system ethic throughout the corporate culture in America.  And it was that entrenched ethic that would prove to be a burden as American businesses fought their way back.

Management in a Slow or No Growth Environment

Businesses, like people, have a life cycle.  The early years of a business are typically marked by exponential growth.  Eventually over time, the pace of growth slows.  A number of factors can be attributed to the slow down, external to the business itself as has been described earlier.  Economic conditions and the maturity of an industry are two external factors.  Internally, it may simply be the law of big numbers that slows the pace of growth.  For example, a company with with $100,000 dollars in sales in year 1 and $2 million dollars in year 2, will reflect a 2,000% increase in sales.  But if the company continued to increase sales by 2,000% every year, by year 5, the company would have sales of $16 billion dollars.  This never happens because of many factors, but one is simply, the law of big numbers.  Even assuming the market was large enough to accommodate that kind of growth in sales, as a practical matter, it wouldn't be possible because of the massive marshaling of resources needed to drive billions of dollars in sales.

In the real world, the exponential growth early in the life of a business slows and plateaus.

When the sales growth curve peaks and then flattens, whether it's due to competition or weak market demand, businesses must make up the deficit elsewhere to maintain or improve their competitive standing.  No business can ignore this.  The competition won't remain idle and no business can survive for long if it's doesn't take action to outdo their rivals.

It's at this phase of the business life cycle when the merit system, if left intact, could prove to be counterproductive.  And this phase coincides with the experience of American businesses when Japanese and German competitors secured a foothold in the U.S. auto market.

How the Merit System Hurts Businesses

The merit system creates an expectation in the employee that their wage level increase is solely based on how well they do their job.  Employees are conditioned to be concerned with their own performance alone.  For the most part, from the individual employee's point of view, how well their department does, their division or even the company, is irrelevant.  As far as they are concerned, the deal was:  they get a raise for doing their job well.

In every merit system, there is a process of annual review and evaluation, upon which wage increases are based.  Many corporate management teams will compel their line managers to force a set distribution of performance ratings on employees as a method of controlling wage increases.  

For example, a manager with four departments and 30 or forty people reporting to him, might be told he can only give 10% of the people the most favorable performance rating; he must give 10% of the people the least favorable performance rating; and the remaining 80%, he can distribute in the other ratings classifications as he sees fit.  Since wage increases are based on these ratings, increases are limited by the forced distribution.  

The problem with forced distributions, of course, is the fact they are forced and are not aligned with actual performances.  This has an effect on the morale of the members of the work team who are given poor ratings, but whose performance shortcomings in the opinion of the judging manager, don't appear justified or reasonable.  A sense of unfairness can emerge, resulting in a less productive employee and the problem spirals.  The merit system in such cases is actually counterproductive.

At this point, it would be useful to further explain why such moves are needed.  Remember, in the no growth or slow growth environment, the merit system pushes salary and related costs higher and higher.  Compensation grows into a larger and larger component of the cost of doing business until it is no longer affordable at those employment levels and layoffs become necessary.  After a layoff, the remaining employees will be expected to do more with no promise of increases, just to avoid further layoffs.  In other words, the expectation of an annual and permanent percentage increase in salary embedded in the merit system actually causes unemployment.

The Performance Bonus and the Permanent Increase

As business leaders began to recognize these shortcomings in the merit system, they redesigned compensation programs, while leaving the merit system itself largely intact.  Averse to radical change, businesses modified their incentive structure for salaried and hourly waged employees.  The performance bonus was created.  

The performance bonus is a one time payment based on two factors:  

  1. the financial performance of the company
  2. the work performance of the employee.  

Performance bonuses can be calibrated to be more generous in successful years and less generous or absent in bad years.  It was useful in that it shifted the employee focus away from solely his or her own job performance and more toward the business generally.  It gave the employee a greater sense of having a stake in the business.  While other wage increases (permanent wage increase) didn't disappear, they could be reduced as the corporation shifted more and more of the burden to the annual performance bonus.  The key to the performance bonus was that it was a one time, annual payment and did not permanently increase base wages.  It was a form of profit sharing.


What Next?

Most corporations are so wedded to the principles contained within the merit system, many find it blasphemous to ever argue against its use.  But the simple fact of the matter is, the merit system is not conducive to good business practice in every situation, in every company.  The merit system has its place, but in today's globally competitive environment, we owe it to our shareholders, employees, co-workers, customers and countrymen to be more discerning and flexible in our thinking about the way people are compensated.  

Compensation systems should be designed wholistically, meeting the needs of the business primarily, but addressing the needs of the employees, too.  Such an arrangement will require a shift in the corporate culture and a reprioritization of values each business promotes.  There is no "one size fits all" approach.  Yet, that is precisely how the merit system is most commonly used.

Employees should be rewarded for doing their jobs well.  But every employee must be inculcated with the understanding that the pace of the wage increases given to employees cannot outpace the growth in profitability.

6 Ways to Modify the Merit System

The proper modification of our compensation and evaluation systems away from the traditional merit based systems, should focus on making the following changes:

  1. Maintain the merit based approach for individuals, but in the context of a work team.
  2. Where possible, have teammates evaluate the contribution of peer teammates, including themselves, expressed as a contribution percentage.
  3. Weight the performance rating and eligibility for wage and salary increases on a combination of management's rating of the overall team performance, the peer ratings of the team, also using the businesses overall financial performance to allocate bonuses or increases as to what is appropriate and affordable.
  4. Give every employee on every team a sense of being a stakeholder in the overall success of the business.  Rewards, whether bonuses or permanent increases, should be based on the contribution to that success.
  5. Allow teams interfacing each other to evaluate their own performance.
  6. Management must factor peer to peer and team to team appraisals, but they should have discretion over how much they can factor it into or out of their final appraisal for bonuses or permanent increases.

Modification of the Merit System along these lines will have the effect of promoting greater productivity through teaming.  Furthermore, it will give employees a clearer sense of their stake in seeing to it that the company meets its financial goals.  This is the path for a more productive and stable workplace for Americans in the 21st century.