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 some deals require teamwork. Or it could be clawbacks, because you need to protect the company from returns / cancellations / refunds.
This blog posts explains how to implement clawbacks correctly.
When Do Clawbacks Make Sense?
Clawbacks (sometimes also called reversals) gives reps the benefit of the doubt and allow them to be paid earlier. Typically, clawbacks 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 – this could take months) or when an opportunity closes.
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 delays required to receive actual payment from customers).
Now, you also 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 clawbacks.
How Not To Implement Clawbacks
A common mistake it to try to apply clawbacks 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 in January. You’ve already paid commissions for this deal (several months ago!), 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 clawbacks:
- Most of the time, there isn’t a specific commission amount associated with the January transaction. Why? Because any plan with payout tiers precludes per-transaction commission amounts. Indeed, any plan with tiers pays commissions for results in aggregate. Learn more here.
- Reps will end up with fragmented and confusing commission statements. Their June commission statement will have a June component, but also various “reversals” for previous periods (ex: Jan, Feb, March).
- 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 legal department able to keep up with various US state legislation, you are significantly increasing risk.
- From an operational perspective, you will need to re-calculate commissions for affected previous periods. Perhaps you paid an extra bonus in January which should not have been paid given later cancellations.
Let’s elaborate on the last point. Consider our same example of a June commission statement, with a single canceled January deal. To calculate the correct reversal amount, you would need to:
- Identify the deal’s original booking date (January) and rep
- Calculate the new (lower) January total revenue for the rep
- Lookup your January quota & tiers for this rep
- Calculate a revised (lower) January total commission
- Calculate a negative January commission delta (adjustment)
- Work with payroll to execute this negative January adjustment
- Explain the negative January adjustment in June commission statements
Now suppose that in June you had a cancellation not just for a January deal, but also more deals in February, March, etc. Clearly this approach is pure madness!
How To Implement Clawbacks 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 the 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’ve eliminated some horrendous operational complexity (see above)
- You are treating a cancellation the same way as a return, eliminating legal risk
- Your overall commission spend remains the same (reps remain penalized)
Another Viable Clawback Option
In some cases, cancellations cannot be tracked as new sales events. Indeed, some sales systems don’t create new rows / records when a refund occurs. Instead, the original sales data is updated.
For example, suppose that you had the following sales in January:
Later in June, a refund was issued for a January sale. Unfortunately, the system you’re using isn’t creating a new row for June (with a negative amount). Instead, it’s updating January rows with revised totals!
A good way to handle this scenario is to use deductions to calculate commissions. Using deductions, you always take into account all sales starting from a reference date (ex: year start).
For example, to calculate January commissions, use January sales. To calculate February commissions, use January AND February sales – but deduct already paid January commissions. To calculate March commissions, use January AND February AND March sales – but deduct already paid January AND February commissions. Etc.
Essentially, each month, you’re re-evaluating total commissions due from year start. Because you’re deducting what you previously paid earlier during the year, you’re paying the correct amount. This approach allows you to handle situations where past sale data is constantly being revised.
Clawbacks make it possible for your reps to be paid earlier while still protecting the company from returns. They make sense if receiving actual payment from customers can take a while. Clawbacks also help your reps feel that your incentive program is “responsive”. When they close a deal, they don’t need to wait for months to receive their commissions.
However, an incorrect clawback implementation will leave you trapped in a web of unmanageable complexity. One key mistake it to try to attribute clawbacks retroactively. A retroactive approach can cause serious operational, transparency, and legal issues. By treating cancellations the same way as forward-looking refunds, you can implement a successful clawback component. If your system cannot record cancellations as new events, you can always use deductions.
Don’t get scratched by a defective clawback implementation, and visit us online to learn more about how you can automate your sales incentive program!