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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 use without guidance. Imagine comparing insights from a data analytics tool like Baremetrics with something from the first ERP tools 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 to access 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?
ACV doesn’t provide much information on its own 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 excellent indicator of marketing efficiency and profitability when linked to other metrics like customer acquisition cost (CAC) and customer lifetime value (LTV). These metrics 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, such as by market or customer segments when your analytics tools allow it.
You can also use ACV to benchmark against other similar companies. However, make sure you use 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 annually.
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.
$9,000 TCV = $9,250 total contracted revenue - $250 setup fees
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.
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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 spend to generate revenue.
The best metrics to combine with ACV are:
- Customer Acquisition Cost (CAC)
- Annual Recurring Revenue (ARR)
- Total Contract Value (TCV)
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 will help you determine 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.
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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.
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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 year. It also measures growth and momentum and validates 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 tracking your ACV vs. customer acquisition cost. In our example company above, although ACV is forecasted to decrease measurably, CAC does the same, indicating that 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.
