Here at Sales Cookie, we help customers automate their sales commission program. Our recommendation is always to simplify sales commission plans. The simpler your incentive program, the easier it will be to communicate it to everyone. As a result, the more likely you sales force will be to understand incentives and focus on goals.
Now, there are some situations where introducing some additional complexity makes sense. For example, it could be recoverable draws, because you need to help new reps ramp up. Or it could be commission splits, because deals are won in a collective manner. Or it could be claw backs, because you need to protect the company from cancellations.
When Do Claw Backs Make Sense?
Claw backs (sometimes also called “reversals”) gives reps the benefit of the doubt and allow them to be paid earlier. Typically, claw backs are used when you want to pre-pay commissions as soon as a deal has a high probability of closing. For example, you could decide to pay commissions immediately when a contract is signed (versus waiting for payment to be received from the customer).
In short, you haven’t received payment yet, but expect to do so, and want to reward reps immediately so that they can focus on other deals in the pipeline. By paying commissions before payment is received, you reduce the time window between a/ closing a deal and b/ receiving corresponding commissions. Making your reps wait for payment to be received could lead them to feel that commissions are “disconnected” from deals (due to multi-month delays receiving payment).
Now, you can’t afford to pay commissions for deals where customers cancel or fail to pay. You also want to make sure reps can’t game the system by prematurely declaring deals as “won”, when they know that payment may be a problem down the road. In short, you need some type of defensive counter-measure to handle failure to pay. Enter claw backs.
How Not To Implement Claw Backs
A common mistake it to try to apply claw backs retroactively. For example, let’s say that we’re in June. You just learned that a customer went out of business after signing a contract signed in January. You’ve already paid commissions for this deal and now want to “reverse” commissions. One possible approach is to try to make a negative adjustment to already paid January commissions. This seems quite reasonable since, after all, corresponding commissions were paid in January.
However, there are many problems associated with retroactive claw backs:
- Reps will end up with fragmented and confusing commission statements. Their June commission statements will have a June component, but also various “reversals” for previous periods (ex: Jan, Feb, March). Also note that some reversals may cause reps to fall to a lower January attainment tier, causing a significant drop in commissions – and so a large negative adjustment which may be hard to understand or explain.
- From an operational perspective, you will need to constantly re-calculate commissions for all previous periods. Consider our same example of a June commission statement, with a single canceled January deal. To attribute the cancellation to January and adjust the January commission, you would need to:
- Identify the deal’s original booking date (January)
- Calculate a new (lower) January total revenue for the rep
- Lookup January quota & tiers for the rep
- Calculate a new (lower) January total commission
- Take into account all previous January reversals for this rep
- Calculate a negative January commission delta (adjustment)
- Work with payroll to execute this negative adjustment
- Explained the negative adjustment in commission statements
- Finally, you are increasing your overall liability. In some US states, it is illegal to take back commissions which have been declared as “earned” or have already been paid. Unless you have a large legal department able to keep up with various legislation, you are seriously increasing risk.
How To Implement Claw Backs Correctly
The correct approach is to stop trying to handle cancellations in a retroactive manner. Instead, simply track cancellations as new events with a negative amount, and apply them to the period during which the cancellation was confirmed.
Consider our same example of a June commission statement, with a canceled January deal. You would record the cancellation as a negative deal with a June (not January) effective date. Note that you are still penalizing reps for the cancellation. The only difference is that you are doing it non-retroactively.
As a result:
- You now have clear commission statements your reps can understand
- You no longer need to constantly re-calculate commissions for all prior periods
- You are treating a cancellation the same way as a return which eliminates legal risk
Claw backs allow your reps to be paid earlier while protecting the company. They make sense if receiving actual payment from customers can take a while. Claw backs help your reps feel that your incentive program is “responsive” – when they close a deal, they receive corresponding commissions shortly afterwards.
However, claw backs make it easy to get trapped in unmanageable complexity. One key mistake it to try to attribute claw backs retroactively. Retroactive approaches cause operational, transparency, and legal issues. By treating cancellations the same way as simple returns (refunds), you can implement a successful claw back component.
Don’t get scratched by a defective claw back implementation, and visit us online to learn more about how you can automate your sales incentive program!