What Is Annual Contract Value (ACV) And How Should You Use It?

Business Academy

Modern businesses have access to so many metrics. This is especially true with SaaS, where the entire customer experience happens online. 

With the proper setup and tracking tools, the amount of available analytics data and KPIs is more than most can put to good use without guidance. Imagine comparing insights from a data analytics tool like Baremetrics with something from the first ERP tools back in the 1990s.

Enormous upfront costs ensured only the largest corporations could implement these powerful tools back then. Now internet access allows nearly all businesses access to powerful ERP and analytics tools to make better business decisions.

The alphabet soup of modern SaaS metrics (AAR, LTV, TCV, ARPU, ACV, etc.) provides loads of information about what’s going on in your company, but it’s easy to overlook or skip ‌KPIs you’ve not yet used. 

Take annual contract value — ACV for short. Indeed, you can piece the concept together, even if you haven’t heard of it.

But how can you use the ACV metric to add value to your business?

 

What is Annual Contract Value (ACV)?

Annual contract value refers to the average annualized revenue per customer contract. Although ACV is not a standardized metric (meaning there’s no generally accepted calculation method), companies typically exclude one-time fees for setup or onboarding.

 

For example:

  • Imagine you run a small B2B SaaS business that’s just signed two-year contracts for two customers with quarterly payments of $1,250. Your annual contract for each of these customers is worth $5,000. 
  • Or, imagine you’re VP of sales for a larger enterprise, and you’ve landed a new client on a 3-year contract with a total contract value of $180k. The ACV calculation of this deal would show $60,000.
  • Finally, a B2C business selling access to a fitness app has achieved 250 paying customers at $50 per month. Each of these customers has an ACV of $600.

 

Why is ACV a Meaningful Metric?

On its own, ACV doesn’t provide much information because the average contract size in any individual business depends on the business concept and target audience. 

SaaS companies focusing on B2B will have higher annual contract values than businesses focused on B2C, as ordinary consumers won’t pay thousands per month for services. But because of the value they can generate with those tools, companies have little issue paying thousands per year to companies like Salesforce or Microsoft. 

Attracting millions of users allows B2C businesses like Netflix and Spotify to build massive companies on an ACV of less than $200.

High or low, ACV has little impact on your business, except that it’s harder to build a massive company when your products command smaller (sub-$500) annual contracts.

ACV is a key metric that is an is an excellent indicator of marketing efficiency and profitability when linked to other metrics like customer acquisition cost (CAC) and customer lifetime value (LTV). These add essential information to your startup as they show you how much revenue you generate per year per customer contract.

 

How to Calculate ACV

There are a few ways to calculate Annual Contract Value and determine the average contract’s annual value. For example, by market or customer segments when your analytics tools allow it.

You can also use ACV for benchmarking against other similar companies. However, make sure you’re using the same calculation method to compare apples to apples. 

Most SaaS businesses only use contract revenue in their ACV calculation, although it’s not a standard metric like annual recurring revenue (ARR) or monthly recurring revenue (MRR). For comparable information, be sure to exclude:

  • Setup costs
  • Installation services
  • Initiation fees
  • Onboarding charges

 

Method #1 for long-term contracts: divide total contract value (TCV) by the number of years in the contract. A three-year contract with $9,000 TCV plus a $250 setup fee is $3,000 per year. 

 

By dividing the total segment TCV by the total contract periods, you can calculate the average for an entire segment or larger group of customers. 

 

Method #2 for short-term contracts: annualize the total revenue from the subscription contract. For example, a six-month contract for $4,000 has an ACV of $8,000, assuming the contract automatically renews and you can keep the customer from churning. 

 

How SaaS Businesses Should Use ACV as a Metric

As previously indicated, the ACV metric isn’t beneficial on its own. But when combined with or compared against other metrics, it can provide valuable insight to help you make data-driven sales and marketing decisions. 

Again, a large or small ACV doesn’t make much difference. SaaS success depends on your business model and how much you’re spending to generate that revenue. 

 

The best metrics to combine with ACV are:

 

What insights can we gain from combining ACV and these metrics?

 

What can CAC and ACV tell us?

Comparing your customer acquisition cost with your annual contract value lets you know how quickly you “make back” the cost of winning a new customer.

Imagine signing five new customers with an ACV of $5,000. However, the average CAC of these contracts is $8,000, making your CAC to ACV ratio 1.6. In other words, it takes close to two years (1.6 years, or over 19 months) to recover the cost of winning a new customer. 

 

Further, there’s a reasonable likelihood you won’t recover that. Although B2B contracts often span several years, there’s a risk the customer will cancel before reaching your payback. 

 

This comparison indicates what you can afford to spend to attract new customers. Of course, the business decisions behind this depend on your startup’s long-term strategy. But a CAC so much higher than ACV points to a need to reduce your acquisition costs, increase pricing, or limit customer churn.

In another example, assume you’ve got an average annual contract value of $2,000 but an acquisition cost of less than $1,000. Recovering your CAC in six months is a pretty good return and an indicator of profitability. 

 

If you’re in a growth phase, with this level of profitability, you might consider spending more to grow faster. However, the catch is to keep the new customers around and avoid attracting poor-fit customers.

 

TCV and ACV

These two metrics are closely related. ACV is the yearly value, while TCV is the total contract value. In other words, a three-year $15,000 TCV contract (excluding one-time fees) has an ACV of $5,000.

The ACV calculation permits a more straightforward comparison between customers because you’ve normalized the contract terms. 

Also, look at the average ACV and TCV across your portfolio. If the numbers are close, most of your customers are hitting the road after only one year. Maybe it’s time to address your churn?

 

Annual Recurring Revenue (ARR) vs. ACV

These two KPIs are also closely related and sometimes confused. Both are annual, revenue-related metrics, but each has a significantly different meaning.

The difference is that ACV is the average revenue of one subscription account, while ARR is used to gauge company size. 

ACV can, of course, be averaged across multiple accounts or drilled down to see contract values for different segments. But it’s primarily used to measure sales and marketing performance. 

On the other hand, ARR is a snapshot measuring the total value of recurring revenue, assuming nothing changes in your customer base or pricing over the whole year. It’s also used to measure growth and momentum and validate your pricing strategy and business model. 

 

Use Baremetrics to Calculate ACV

Although ACV isn’t a metric that Baremetrics calculates directly, users can gather customer contract data from Baremetrics and create the metric in Flightpath. Based on your new customer MRR and the number of new customers you can quickly calculate ACV and assess your SaaS company’s marketing efficiency.

 

In the Flightpath dashboard:

  • Create a new worksheet and call it “Annual Contract Value”

  • Add references for “New Customer MRR” and “New Customers”

  • Add a custom metric with a formula: =({new_customer_mrr}*12)/{new_customers}

And there’s your formula for calculating and forecasting ACV!

 

In the dashboard, you can add further comparisons, like keeping track of your ACV vs. customer acquisition cost. You’ll see in our example company above that although ACV is forecasted to decrease measurably, CAC does the same, indicating our marketing efforts are becoming more efficient.

How could you use better analytics to improve your SaaS company’s sales and marketing strategy? Get started with a free trial of Baremetrics today.

FAQ's

  • What is the annual contract value?
    Annual Contract Value (ACV) is a measure used to understand the average revenue generated per year from a subscription account. It is usually used to measure sales and marketing performance, and can provide insights on whether you're spending too much on customers that aren't bringing in enough value.
  • What is the formula for ACV?

    There are two methods for calculating ACV. For long-term contracts, the Total Contract Value (TCV) is divided by the number of years in the contract. An example of the formula would be: 9000 TVC / 3 year contract = 3000 ACV.  For example, a three-year contract with a TCV of $9,000 has an ACV of $3,000 per year. For short-term contracts, the total revenue from the subscription contract is annualized. For example, a six-month contract for $4,000 has an ACV of $8,000.

     

     

  • How do you calculate ACV from revenue?
    If you're looking at a SaaS (Software as a Service) business model where you have monthly subscriptions, you can calculate the ACV by taking the Monthly Recurring Revenue (MRR) per customer and multiplying it by 12. You'll also need to remember that the ACV only accounts for recurring revenue from the contracts and does not include one-time fees or costs.
  • What is the difference between ACV and TCV?
    Annual Contract Value (ACV) is the average yearly revenue from a contract. It's useful for comparing customers or contracts of different lengths on an annual basis. Total Contract Value (TCV) is the total revenue a contract will generate over its entire duration, including all charges. It provides a measure of a customer's total value over the contract's life.
  • How do you calculate ACV distribution?
    There are a few steps to calculate your Annual Contract Value (ACV) distribution. To start, you’ll need to gather a list of all your contracts and their corresponding ACV. You’ll then want to group those contracts into different bands based on their ACV. For example, you might have one band for contracts with an ACV of $1,000-$5,000, another for $5,001-$10,000, etc.
    Once you've done that, you’ll count how many contracts fall into each band. Finally, to get a sense of how things are distributed, you’ll figure out the percentage of contracts in each band by dividing the number of contracts in each band by the total number of contracts and then multiplying that by 100. It's kind of like putting together a puzzle - once you've got the whole picture, you can use it to help plan your sales and marketing strategies.

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