As a software-as-a-service (SaaS) organization, you’re likely familiar with terms like total contract value (TCV) and annual contract value (ACV). For ease though, let’s define them.
Sometimes referred to as contract value, total contact value (TCV) measures the total revenue of a contract, including both recurring revenue, as well as other fees such as onboarding, professional services, training, over-use charges, implementation fees, etc. Simply put, TCV shows the amount of money a customer brings to your company throughout the duration of their contract.
ACV, on the other hand, refers to the revenue generated from a single contract over a year’s time. It includes charges that the customer incurred over that time span such as recurring, one-off, usage-based, etc.
Let’s go on a journey of the financial metrics commonly used by SaaS businesses, their meaning, differences, when to use them, calculations, and examples. We also will explore how these metrics help shape business decisions.
TCV vs. ACV: What They Represent and When to Use
While TCV and ACV may appear similar there are some significant differences. For example, ACV typically doesn’t include initial charges, one-time setup, or implementation fees. To further illustrate, let’s look at a few examples.
TCV Sales Example
Wondering how to calculate TCV? Say Customer A signs a two-year contract for a cloud-based billing software plan at a cost of $2,000 per month. They also purchased a series of training modules and professional services at $1,500 and $1,000 respectively. Customer A’s total contract value is $50,500.
- TCV = $2,000 x 24 months + $1,500 + 1,000
TCV reflects actual bookings, demonstrating a company’s growth, as well as provides a more accurate revenue estimate than other metrics. It’s important, however, to keep in mind that any changes to the length of the contract or pricing will affect the TCV.
TCV helps SaaS organizations understand and compare the amount of revenue their business generates from each contract and estimate how much each new contract will provide, helping them to better predict growth.
Sounds a bit like customer lifetime value (CLV)… doesn’t it? While there are similarities, there are also key differences. As previously mentioned, TCV is the total amount of revenue and one-time fees that a customer will pay over the course of their contract, i.e., revenue projection is based on the actual figures within the contract.
In contrast, CLV is a projection of potential profitability a business can expect throughout the duration of the customer’s relationship with the business. CLV aids organizations in determining the profitability of each customer compared to the total amount invested in acquiring the customer.
ACV Example
So what does ACV mean in business? Let’s revisit our first example – Customer B signs a two-year contract for a cloud-based billing software plan at a cost of $2,000 per month. They also purchased a series of training modules and professional services at $1,500 and $1,000 respectively. Customer B’s annual contract value is $24,000.
- ACV = $2,000 x 12 months
ACV calculations exclude the training and professional services and reflect just a one-year period.
Often interpreted differently by companies, there’s an element of confusion surrounding ACV. While ACV may appear similar to annual recurring revenue (ARR), there are differences that shouldn’t be overlooked. Here are a few of the key differences between ACV and ARR.
- ACV measures a single account, while ARR measures the revenue value of all subscription-based contracts.
- ACV’s formula can vary, for example when one-time fees are included. The ARR formula is standardized.
- ACV is best viewed in combination with other metrics. ARR is a standalone metric that shows revenue growth or loss.
- ACV measures the total amount of revenue generated for each customer, whereas ARR is a metric that tracks company expansion.
When to Use ACV vs. TCV?
As determined above TCV and ACV have their own particular uses. Let’s look at situations where you should use one versus the other.
TCV is best suited for:
- Forecasting revenues and growth based on sales.
- Developing growth strategies as it provides a macroscopic view of revenue performance.
- Analyzing your customer base. High TCV’s help companies identify revenue leaders within the customer base, providing the insight needed to focus more marketing efforts on specific customer segments.
- Acquiring a more accurate measurement of CLV, and how much the company can spend to acquire new customers.
- Evaluating the effectiveness of the sales pipeline to optimize the sales process and identify bottlenecks.
- Establishing sales quotas and ensuring the sales team is focused on acquiring customers that provide the most value to the business.
- Designing effective commission plans and ensuring the sales team is incentivized.
- Informing investors and stakeholders of financial results for the entire contract term.
ACV is best suited for:
- Assessing year-on-year growth of the contract value for revenue forecasting and planning.
- Optimizing pricing strategies to maximize profitability.
- Analyzing the performance of sales and marketing efforts to understand the immediate impact of contracts on revenue.
- Identifying which customer accounts hold the greatest revenue potential.
- Determining how sales reps are performing with respect to large deals and in upselling and cross-selling.
- Dedicating the right resources to the deals that provide the company with the most value.
- Planning marketing and sales strategies to target specific industries or customer segments.
- New sales or marketing rollouts, such as adjusting pricing, selling new bundles, offering promotions, etc.
TCV and ACV are powerful metrics, each with their own unique insights into contracts. TCV provides a broader overview of the total contract value over time, whereas ACV provides a more nuanced view of individual contracts with a focus on annual revenue.
Let’s look at where ACV can be used to help increase sales. In this example, the SaaS organization segmented customers with the highest ACV. They then looked at the strategies used in acquiring these high-value customers. By knowing the strategies used, the company can develop effective retention and re-engagement processes to help retain more customers. Additionally, it can be used to boost the performance of the sales team through training sessions that focus on the proven strategies that will improve sales reps proposal and customer acquisition skills.
Other Key SaaS Metrics
Since no metric should be considered an island, here’s key metrics that when used in combination will provide a clearer and more concise view of your company’s financial health.
- Annual contract value (ACV): The revenue generated from a contract on an annual basis.
- Annual recurring revenue (ARR): The recurring revenue your company can expect for a given year.
- Average revenue per user (ARPU): The average revenue generated per user or account.
- Churn rate: Measure of the number (percentage) of customers the company loses during a predetermined time and its impact on revenue.
- Customer acquisition cost (CAC): A metric that estimates how much the company spends to acquire a new customer.
- Customer lifetime value (CLV): Total revenue expected from a customer throughout their relationship with the company.
- Monthly recurring revenue (MRR): A normalized measure of a business’ predictable revenue that it expects to earn each month.
- Revenue run rate: A metric used to determine how much revenue the company can generate based on previously earned revenue.
- Total contract value (TCV): Represents the total revenue expected from a contract over its entire duration.
The above is not an exhaustive list and your SaaS company may be tracking other metrics like conversion rates, user engagement metrics, sales pipeline velocity, and others.
How BillingPlatform Can Help
By effectively using TCV and ACV, SaaS organizations gain the ability to navigate a crowded playing field and set themselves apart from the competition. With the insights provided by TCV and ACV they are able to make more informed decisions regarding resource allocation, pricing, and long-term growth strategies. However, tracking these metrics can be time consuming and error-prone when done manually.
BillingPlatform provides a comprehensive revenue management solution. It enables you to streamline management of your entire revenue lifecycle – from order capture and customer service to billing, revenue recognition, and payment collection – all on a single platform. Additionally, we provide robust integration capabilities and our artificial intelligence (AI)-powered tool delivers the data insights you need when you need them.
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