What Is Annual Contract Value (ACV)?
Annual contract value (ACV) measures the average annualised revenue per subscription contract minus one-time fees.
This differs from the total contract value (TCV) as a customer may sign a multiyear contract with a SaaS provider, and TCV will indicate the entire revenue generated by that contract, including the one-time fees. Also, ACV correlates more with recurring revenue due to its annualised calculation and normalisation (deduction of one-time fees).
How Annual Contract Value Benefits SaaS Companies
While annual contract value offers an overview of the revenue landscape, it does not delve into the specifics of financial well-being. Of course, SaaS companies can use this metric to make informed decisions regarding sales and marketing. But to thoroughly understand the revenue potential, using ACV with other financial indicators is most effective. Below are the key metrics that complement ACV:
- Total contract value (TCV)
- Annual recurring revenue (ARR, more on this later)
- Customer acquisition cost (CAC)
ACV can also be utilised for various purposes, including:
- Growth planning: Monitors revenue and helps plan resource allocation and expansion
- Performance tracking: Consistently measures a company’s performance and growth in terms of recurring revenue
- Pricing review: ACV insights can guide pricing decisions and adjustments to optimise revenue generation.
- Financial health evaluation: A critical metric for businesses and investors, this helps evaluate a SaaS company’s financial health and growth potential.
How To Calculate Annual Contract Value
The formula to calculate annual contract value:
Total contract value – (one-time fees) ÷ Years of contract
Let us understand this with an example. A SaaS company signs a new customer for three years. The total contract value is $90K, with a one-time setup fee of $5K. Therefore, the ACV for this customer will be: ($90K – $5K) / 3 = $28.33K
This means the SaaS company can expect to receive an average of around $28K per year from this customer over the course of the three-year contract.
ACV Vs ARR: Which Metric Matters Most For SaaS Startups And Why
Both metrics – annual contract value and annual recurring revenue – measure revenue. However, ACV measures the annualised revenue generated by a single subscription account, while ARR captures the total revenue from all subscriptions, plus the recurring revenue from upgrades and add-ons. In both cases, the numbers are normalised annually, which means one-time fees are deducted from respective amounts.
“ARR is the North Star metric that must be tracked on a company level to keep growing,” says Dhruvil Sanghvi, founder and CEO of the logistics SaaS startup LogiNext. It is because ARR calculates the revenue a company generates from customers on a recurring basis, thus emerging as the key indicator of the company’s growth. “Therefore, a company’s valuation will largely depend on its ARR,” adds Sanghvi.
He further explains when a company experiences a rise in ACV, while its ARR remains constant, it indicates customer churn. On the other hand, if the ARR demonstrates an upward trajectory while the ACV remains steady, that is acceptable as it signifies the acquisition of customers with the same ACV.
“It is not necessary to increase your ACV all the time. You can increase the number of customers to boost your ARR,” says Sanghvi.
How To Drive Annual Contract Value (ACV)
SaaS companies often witness an organic rise in annual contract value as their products mature and sales capabilities improve. This happens even when they continue to target the same customer segment as before. However, some companies are keen to focus more on customer acquisition instead of pursuing a higher ACV through increased pricing.
Another way to boost the annual contract value is to target high-growth industries and businesses. However, many SaaS providers choose to work with slow-paced industry segments/companies, typically registering YoY revenue growth of 10% or so, just because their payments add up to build a consistent revenue stream.
Expanding to global markets with high purchasing power can also push annual contract value. That is why many homegrown SaaS companies have evolved and scaled up their products/services to enter more affluent markets such as Southeast Asia, the Middle East, the EU and North America.
