In an ideal world, every high-performing employee would receive a substantial merit increase as a clear recognition of their contributions. However, when merit budgets are restricted—such as this year’s 3.5-3.7% average increase—organizations must make critical decisions about how to differentiate effectively between high and low performers. WorldatWork: 2026 Salary Increase Budgets Project U.S., Global Caution | WorldatWork Failing to do so can lead to disengagement, turnover among top talent, and a culture that doesn’t reward excellence.
Here’s how to approach performance differentiation when merit budgets are tight:
- Anchor the Process in Data, Not Perception
Objective performance management is the foundation for effective differentiation. When budgets are constrained, every decision must be justifiable.
- Use metrics-based evaluations tied to business outcomes, KPIs, and goals. Metrics-based Approach |
- Evaluate both what was achieved (results) and how it was achieved (behaviors aligned with company values).
- Calibrate performance ratings across departments to ensure consistency and fairness.
- Segment the Workforce by Contribution
A simple but effective framework involves classifying employees into three broad tiers:
- Top Performers (10–20%): Consistently exceed expectations, contribute to innovation, and help others perform better.
- Solid Contributors (60–70%): Dependable, consistent, and aligned with role expectations.
- Low Performers (10–20%): Require support or intervention to meet minimum performance expectations.
With a 3.5% merit budget, the average increase might look like this:
- Top Performers: 5.0%–6.0%
- Solid Contributors: 2.5%–3.0%
- Low Performers: 0%–1.0% (or no increase)
This tiered approach clearly rewards exceptional performance and sends a strong message about the value of excellence.
- Go Beyond the Numbers: Consider Impact and Influence
Quantitative results are critical, but qualitative impact matters too.
- Does the employee mentor others, improve team dynamics, or drive change?
- Are they critical to key initiatives or known for solving high-value problems?
- Have they elevated standards for their peers or improved processes?
Top performers often create a multiplier effect—rewarding that impact, even with a small budget, helps retain that value.
- Communicate the Why Clearly
One of the biggest mistakes companies make is failing to explain how merit decisions were made. How to Communicate a Raise to an Employee
- For top performers, reinforce why they received a differentiated increase.
- For solid contributors, affirm their value and what’s needed to reach the next level.
- For low performers, provide candid feedback and a plan for improvement.
When people understand the rationale, they are more likely to trust the process—even if the raise itself isn’t significant.
- Supplement with Non-Monetary Recognition
When merit dollars are tight, compensate with meaningful non-financial rewards:
- Career development opportunities
- Leadership visibility
- Special projects or stretch assignments
- Public recognition or awards
- Increased autonomy
These signals reinforce that high performance is valued, even beyond compensation. 21 Perfect Non-Monetary Incentives To Reward Your Employees
- Build Manager Capability
The success of differentiation relies heavily on managers. They must:
- Set clear goals at the beginning of the cycle
- Provide regular feedback, not just once a year
- Accurately document and advocate for employee performance
- Handle difficult conversations with empathy and clarity
Investing in manager training ensures performance ratings and merit allocations are fair, calibrated, and defensible.
Conclusion
With only 3.5% to distribute, it’s not possible to give everyone a meaningful raise. But that’s exactly why differentiation is essential. By using data-driven evaluations, segmenting by contribution, communicating transparently, and reinforcing with non-monetary rewards, organizations can create a merit process that is fair, motivating, and strategically aligned—despite tight budgets. In doing so, you not only retain your top talent—you strengthen your performance culture as a whole.