SaaS companies utilize a variety of insightful revenue metrics to understand financial performance, create accurate predictions, and make informed decisions.
The list of possible metrics to use is expansive and includes a number of highly similar terms that often get confused, conflated, and misunderstood.
For example, TCV (Total Contract Value), ACV (Annual Contract Value), and LTV (Customer Lifetime Value) all appear to provide very similar insights into the value of an average customer deal. Of the three, TCV is one of the least understood and, therefore, often underused.
WHAT IS TOTAL CONTRACT VALUE (TCV)
Total contract value is the overall value of an agreement with a customer, including aggregate revenue expected over the life of the contract, such as up-front payments, subscription payments, implementation charges, ongoing services fees, and one-time charges. TCV is an important metric for finance and accounting leaders — especially in SaaS — because it provides insight into total revenue, not just subscription income.
How to Calculate Total Contract Value
Total Contract Value includes all of the revenue you’ll receive from a given customer over the duration of their contract.
To calculate TCV, you need the following information:
Monthly recurring revenue (MRR) for the contract
Length of the contract
Any one-time fees included
The formula for TCV is as follows:
TCV = MRR x contract term length + one-time fees
The Differences Between Total Contract Value, Lifetime Value, and Annual Contract Value
There are many different ways to look at and think about the revenue generated by your contract terms, three of which are TCV, annual contract value (ACV), and customer lifetime value (LTV).
As mentioned above, TCV is the most holistic way to think about your contract terms, combining all fees and recurring revenue over the length of the agreement. ACV is a similar metric but takes a more narrow view of the customer contract.
Unlike TCV, ACV calculations don’t take one-time fees into consideration. Rather, it’s a way to annualize the recurring revenue from a customer contract. So, consider a two-year contract for $48,000 and a $5,000 upfront implementation fee. The TCV would be $53,000. But your ACV would be $24,000 ($48,000 divided by the two-year contract term, not including the service charge). In a SaaS business, ACV is a far more commonly-tracked metric than TCV because of the major focus on subscription revenue.
Comparing TCV to LTV is a bit more nuanced. Some non-SaaS businesses might talk about the two interchangeably because, technically, TCV is the value of a deal over its lifetime. But in a recurring revenue, subscription-based business, renewals are everything. That’s why your LTV calculations incorporate churn rate as you try to determine how far beyond the initial contract a customer will stay with you.
Whereas TCV only considers the life of a single contract, LTV accounts for the revenue you expect to generate over the entire span of a relationship with a customer. That may include multiple contract renewals. So, in the example above, imagine you renewed the two-year, $48,000 contract for two more years with a 10% increase to $52,800. If the customer churned after those two years, you’d find the LTV by combining the total value of both agreements — $105,800 in total.
Each of these metrics brings unique value to your business.
- Total contract value shows you the actual, committed revenue you’ll generate from a deal.
- Annual contract value shows you the average ARR you expect from new customers, which can help you build assumptions for revenue forecasting.
- Lifetime value shows you what you can expect to earn from a customer across (potentially) multiple contracts, which helps you calibrate your customer acquisition cost (CAC).
Why SaaS Companies Should (or Shouldn’t) Track Total Contract Value
The truth is that total contract value is not a standard metric for the purest of SaaS businesses. However, not every SaaS business is well-suited to focus specifically on ACV, where recurring revenue is the entire focus.
If you have a complex business model — or at least have a significant services arm or even hardware component — TCV becomes a more important way to understand cash inflows and improve the precision of cash flow forecasting.
Palantir is a good example of the use of TCV in a SaaS business. Since Palantir’s IPO in 2020, market analysts have debated the company’s business model. As a tech company with recurring revenue, Palantir was often valued as a SaaS business (which it is). But the company pulls a significant amount of revenue from its services business. As such, you’ll see TCV reported as a metric in Palantir’s SEC filings. Without it, they’d be under-reporting new bookings generated by nearly $1 billion per quarter.
Think about your own business model. If one-time fees or recurring service costs are a major part of your contracts, consider making TCV a standard part of your financial reporting. If you’re mainly a subscription/recurring revenue business with some services here and there, focus on ACV instead.
How to Improve TCV for Your Business
- Contract length. If your specific goal is to increase TCV, the easiest way might be to increase the length of your contracts. Instead of selling annual deals, consider making multi-year contracts the standard. If it aligns with the value you provide customers, you’ll see TCV trend upward.
- Pricing. The other variable is pricing, whether that’s on the recurring revenue side or the one-time fee side. Maybe you increase the cost of your implementation services. Or, maybe you raise the rate of your subscription fees. Either way, higher prices means higher TCVs.
FAQs
What is the difference between TCV and ACV?
Total contract value is the total amount of revenue you’ll earn over the length of a contract, including any service fees or one-time costs in addition to the monthly subscription. ACV, on the other hand, is an annualized view of contract value that only includes recurring revenue, not one-time fees.
What is the difference between TCV and revenue?
TCV is one component of revenue, indicating the income you’ll generate from an individual customer contract. However, revenue is a much broader term that would incorporate contract values from all customers, and you’d only recognize it as you earned it.
What is the formula for TCV?
The formula for TCV is (monthly recurring revenue x contract term length) + one-time fees.
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