Annual Contract Value (ACV) is the average annual revenue generated from each customer contract, excluding fees. If a customer signs a 5-year contract for $50,000, averaging this value per year will give you an annual contract value of $10,000.
What is ACV ?
Annual contract value (ACV) breaks down the total value of a customer’s contract into an average value per year. For example, a $10 million, 10-year contract has an ACV of $1 million per year.Annual contract value (ACV) is a revenue metric you can use to analyze your data and get a deeper understanding of the impact of sales and marketing initiatives so you can highlight strategic insights for your business.
How to Calculate Annual Contract Value
There are multiple ways you can calculate the ACV for your customer base. But at the highest level, the ACV formula is total contract value divided by the total years in that contract (focusing solely on recurring revenue).
ACV Formula
Let’s see how the formula works in an example. Say a new customer signs a 3-year contract with you for $30,000 per year of service, and you give them a 30% discount on the first year.
Their annual payments would look like this:
Year 1 = $20,000
Year 2 = $30,000
Year 3 = $30,000
For a total contract value of $80,000 over 3 years. To calculate the ACV for this customer, you would take the total contract value and divide it by the number of years in the contract.
ACV = $80,000 / 3 = ~$26,667
By calculating the average amount you receive each year, you can easily visualize how your SaaS pricing strategy affects your annual income from this customer.
There are several ways you can look at ACV in your business, including:
- Individual ACV per customer (like the example)
- Total ACV of all customers
- Average ACV of all customers
- Total ACV for a time period
- Average ACV for a time period
How to use ACV ?
Because ACV normalizes your contract amounts, you can use it to:
- Compare customers whose contracts differ in type or duration
- Discover which accounts provide the greatest revenue value
- Better service individual clients, especially those with the greatest long-term potential
Why ACV Is Important
Leveraging ACV as a strategic finance tool helps you get a better understanding of your SaaS business in two ways:
- It can help you understand the true value of each customer when you have variable pricing.
- It informs which type of SaaS products you offer so you can tailor your growth strategies accordingly.
Helps Shape Your Pricing Strategy- SaaS companies are increasingly shifting toward consumption-based pricing, which means they offer pricing tiers that depend on usage variables. This pricing strategy puts annual income from individual customers in flux, impacting your ACV calculations.
There are several reasons why the actual income you earn from a contract varies each year, including:
- Discounted pricing
- Onboarding costs and other one-time fees
- Service and feature add-ons
- Product usage variables such as user licenses, features, queries, and number of integrations
ACV gives you a clear picture of the monetary value of each company by normalizing the total income over contract length. This way, when you look at historical data, you can see the effect your pricing strategy has on the value of a customer or various customer cohorts.
Informs Business Strategy & Decision-Making- SaaS companies come in a wide variety of shapes and sizes. But from an annual contract value perspective, you can split the SaaS industry into two broad categories: high ACV and low ACV.
- High ACV companies rely on bringing in fewer contracts with higher ACV. They’re more common for B2B companies that serve enterprise-level organizations.
- Low ACV companies focus on attracting a large number of low ACV contracts. This is more common in the B2C industry, especially with paid mobile apps.
SaaS companies with products that can be used by individuals and organizations of all sizes might have a high ACV product tier and a low ACV one. You see this from companies like HubSpot and Salesforce, which have free tiers that are meant to drive up customer acquisition for later expansion and increases in ACV.
Understanding which ACV strategy applies to your business can help you focus on the right activities and avoid getting caught up in industry trends that don’t work for your business model.
ACV vs. Annual Recurring Revenue (ARR)
Annual recurring revenue (ARR) is a subscription metric that also measures annual revenue. It tells you how much income you generate each year from all of your subscription accounts (including new bookings, upgrades, and renewals).
ARR also accounts for customer churn, which is the total revenue lost from customers who stop using your service
SaaS companies and startups use ARR to measure growth over time and predict future revenue. Compared to ACV, ARR is the more fundamental financial metric that companies and investors use to benchmark growth.
ACV vs. Total Contract Value (TCV)
Total contract value represents the total income you receive from a fixed-term contract, and it’s used in the ACV formula. When you calculate ACV, you divide TCV by the number of years in the contract.
TCV is based on customers you’ve already won, and it’s useful for providing an accurate report of the income generated by multi-year contracts with a clear end date. With TCV, you can look at which customer segments bring in the most income and use it to help focus your customer acquisition efforts.
Automating Annual Contract Value
Financial metrics are necessary when evaluating your growth and pitching to investors, but they’re also valuable strategic tools that can help you put your limited resources to better use.
Using ACV to understand the annual value of your existing contracts can help you improve your marketing strategies, identify the best upsell opportunities, and optimize your sales strategy.
FAQs
What is the difference between ACV and ARR?
Annual contract value (ACV) is the value of a customer’s contract when averaged for every year of the contract. On the other hand, annual recurring revenue (ARR) measures the annual value from all contracts and considers things like upgrades
What is included in ACV?
Annual contract value solely looks at the total contract value of your customers and divides it by the number of years in the contract to give you the average value of the contract per year. Similar metrics, like ARR or MRR, also take expansion and contraction revenue into account.
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