This article is relevant if you are using NetSuite and you are considering how to use the platform to generate commissions or royalty processing.

Background

Commissions in NetSuite is a challenging topic. Commission calculations, in general, are challenging. Recently, we helped a client move from their Excel spreadsheet system to a NetSuite calculated commission program. I guided one of our young and bright consultants throughout the process. In his first review of our client’s requirements, he thought we could get there pretty quickly. I warned him never to underestimate the complexity that you will face to drive commissions processing from the database.

We succeeded in delivering NetSuite driven commissions based on gross profit/margin and payable on cash receipt in an organization that has complex project-driven requirements. The journey revealed to the client that one of their commission plans was just too costly to measure and administer — the client ultimately unified to a single policy across its salesforce and is happy with the results we produced.

This discussion is not to go through that specific client journey — but to go through the thought process, I believe, that is needed to correctly solve for database driven commissions and its big brother, royalties.

Fundamentals to Commission and Royalty Processing

To talk about commissions and royalties, it is essential to break the challenge into its fundamental elements so that you can build the solution. This article will focus on commissions, which are generally about payouts to employees for specific performance. However, royalties are similar patterns which typically involve payout out to third parties, usually in licensing arrangements, for specific company-wide performance. Note, royalties often have other considerations, which I won’t cover, but include ensuring that the company does not break the rules for how to use intellectual property subject to agreed upon contract parameters.

The major commission topics to cover follows:

1. Criteria: What transactions elements qualify for commission processing?
2. Price/Rate: When a transaction (element) qualifies, what is the rate that is due?
3. Measurement: When and how do we measure and calculate the commission?
4. Obligation: Under accrual methods, what is our duty to pay a commission?
5. Payout: What events are used to trigger the payout of the obligation?

These topics should be studied carefully to ensure you account for each element in your solution design.

Commission Criteria

Commission criteria are used to outline what precisely are the situations that we want to measure to determine our commission. A simple rule looks like “a salesperson is paid a straight commission rate on sales.” The real questions are more like this:

1. Who: who is qualified to receive a commission? Might a team rather than an individual be involved?
2. What: what specifically qualifies for commission? The qualification often is expressed in terms of specifically named products and services. It usually is expressed in terms of sales (easier), but often can be on margin (more difficult). Sometimes, it can be for certain classes of customers. Sometimes it is for “spiffs” that are over an effective time horizon.

The details behind this often demand supporting tables to hold information that can be looked up to see if a transaction (or a set of transactions) qualify.

Commission Price/Rate

Once a transaction, or a set of transactions, qualify, we need to determine the rate. The rate can become interesting because management often likes to invent tiered structures to drive enhanced behavior for more difficult-to-achieve endeavors. Many times, the price can not be determined immediately once a transaction occurs — instead, some things must be measured first and then the rate is assessed. The shape of this affects the ultimate algorithm required to solve the challenge. In team situations, there may be splits or other matters that shape the price.

Commission Measurement

The measurement of the commission criteria with price/rate needs to come together at a prescribed time to accurately calculate the obligation. Many times, Management may want to be able to show salespeople their performance in near real-time. However, this may not be easy to achieve given the nature of the commission program.

For example, consider the case when we want to measure the gross margin of a sale. Why can’t this be easy to see? I have spoken before about the challenge of measuring gross margin in NetSuite. See my article Learn how to Reliably Measure NetSuite Gross Profit and Margin. First, we have to ask ourselves, “are we properly measuring margin?” That often opens up a larger conversation which reveals that the current methods for accounting processing are not correct. Try not to underestimate the challenge to measure margin right especially in commission situations.

To continue, once we think we can get gross margin accurately calculated, we may then need to aggregate information in some manner so that we ultimately look up the commission price/rate. For example, the rate may be 10% on the first $100k of margin, but 12.5% on the next $100k. Over what period are we looking up this information? The general wisdom is to think in terms of accounting periods, which commonly is monthly, but perhaps we measure margin over rolling quarters?

Commission Obligation

Once we finally have determined measurement, we need to record that we have an obligation (liability). In accrual terms, we want to measure this for the period in question. Okay, you say, why not calculate it immediately and sum it up at the end of the month? Well, is information stable under this method?

What’s interesting about the obligation is that sometimes, to get to the current obligation, we need to enhance our measurement by reviewing what the grand-total commission should now be because we have better information and then determine what we previously measured to learn the difference which will represent the current obligation. We see this common pattern in project-driven organizations where the fulfillment narrative spans multiple accounting periods. The key to this is to keep looking back and recalculating but accounting for what was previously measured.

It’s in the concern for commission obligation that allows us to speak about commission draws. Often, draw programs can help bring funds to salespeople in anticipation of sought-after performance. Thus, draws represent prepaid assets and are used to offset our commission obligation. How do we measure draws? Do we look at them transactionally or in the aggregate? Indeed, more tables are coming forth to hold this together.

Commission Payouts

We finally get to the payouts. Under the accrual accounting method, we understand our obligations from the previous efforts. However, we may not have to pay these out until some other event. The most common one is when a customer pays for the goods and services. It is not unusual because management wants to address credit risk and seek the help of the salesperson to follow up with the customer to get paid. Sure enough, the pattern for which a customer pays (or not) introduces concepts of partials. Thus, if the sale is $500, but the customer pays $300, then you could say that 60% of obligation is due. However, what if management says that cash payments must first cover costs and the funds received over costs trigger the payout? Then 60% in our example does not work. More logic is needed.

Thus, the payout questions drive another set of processing requirements to review something that happens well after we have shipped the goods.

A Word About Commission Reporting

Another consideration is how well you can get to the information behind the commission program. In my mind, the idea behind commissions is to produce incentive. Fundamentally, an incentive will be only useful if the parties involved can be trusted. Thus, the ability to calculate a commission and show how the values were derived demonstrates trustworthiness. Therefore, how we construct the solution to allow for the “story to be told” via reports brings the program to a conclusion.

Why Not Use NetSuite Incentive Compensation?

At this point, I will say a few things about the NetSuite Incentive Compensation offering. I like to say that “I so much want to love it.” If the software can meet your requirements, then by all means — use it. Yet, I am careful because, as a NetSuite Systems Integrator, our real value is the capacity to think about challenges and turn them into solutions. Solutions are feasible relative to environment / technical constraints. The primary challenge I have with NetSuite’s Incentive Compensation is that we can’t access many of the essential data elements via saved search and the API is relatively limited — this has always been strange to me because commissions are one place you need maximum freedom to invent. Hence, I am upfront to share with clients that the software qualification journey can be risky — yet if it works, it can be very well worth it.

See related articles:

1. NetSuite Transaction Line References Between Invoices and Commissions
2. NetSuite Driven Commissions – Your Way

Why Do Clients ask for Our Help With Commissions?

I see two primary situations when clients come to us about commissions: First, they often have an Excel/Spreadsheet model and it takes much time to produce the information, is error-prone, and is hard to distribute. However, is it no wonder that accountants had to build something in Excel to handle the complexities outlined above? Second, due to the challenges in NetSuite’s offering, we get a fair number of inquiries from folks; especially true once you add gross margin into the mix.

I think the more significant consideration is “would management have invented such a commission program if they understood the real administrative and measurement costs?”  Thus, to produce a commission program that is database driven demands respect for the subject domain as it connects many concepts: Accounting, software technology, and orientation for detail and nuance. If you feel that it is time to get in front of your commission or royalty challenge, let’s have a conversation.

Marty Zigman

Holding all three official certifications, Marty is regarded as the top NetSuite expert and leads a team of senior professionals at Prolecto Resources, Inc. He is a former Deloitte & Touche CPA and has held CTO roles. For over 30 years, Marty has produced leadership in ERP, CRM and eCommerce business systems. Contact Marty to set up a conversation.

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