Advanced businesses have access to numerous metrics. This is specifically true in the case of SaaS, where the whole user experience happens virtually. If you have proper setup and tracking tools, the available analytical data and KPIs are more than enough for good use.
Back in the 1990s, only the largest corporations could implement these powerful tools. The key reason behind this was the enormous upfront costs needed to be more reasonable for all corporations. However, nowadays, the trend has changed. The Internet allows all businesses to access powerful ERP and analytics tools to make better business decisions.
The alphabet soup of modern SaaS metrics, such as AAR, TCV, LTV, ARPU, and ACV, can provide you with loads of information about different happenings in your company or organization. However, you can easily overlook the KPIs you haven’t used yet.
Take annual contract value, abbreviated as ACV. You can piece the concept together even if you don’t have any idea about it. However, the main thing is how to use ACV metrics to add value to your business.
What is Annual Contract Value (ACV)?
The annual contract value is the mean revenue generated from each customer contract. All the fees are excluded from it. However, ACV is not a standardized method, i.e., it’s not generally accepted, just like other calculation methods.
Examples
Example 1: You are running a small B2B SaaS business that’s just signed contracts for two years with two customers. Each customer has to pay a quarterly payment of $1250. So your ACV for each of these two customers will be $500.
Example 2: Imagine you are the vice president of sales of an enormous enterprise. You have just signed a 3-year contract with a new customer valued at $180K. So the ACV for this customer will be $60K.
Example 3: Now, imagine you have a B2C business selling access to a fitness app. You have achieved 250 paying customers at $50 per month.
Why is ACV a Meaningful Metric?
As the average contract value of any individual is based on the business size, notion, and Audience, it provides little data.
SaaS B2B companies usually have higher ACV as compared to B2C ones. The reason is simple; ordinary clients cannot pay thousands every month. Because of the values companies can generate using those tools, they almost have no issue in paying thousands per month to companies like Microsoft and Salesforce.
Some B2C businesses can build massive companies on an ACV of less than $200. Netflix and Spotify are prime examples of such companies, as they can attract millions of users.
ACV has minimal impact on your business. But it takes work to build enormous companies when your product gets annual contracts of less than $500.
However, linking AVC with other metrics, such as customer acquisition cost (CAC) and lifetime value (LTV), can help you add valuable information to your startups. It shows you how much annual revenue you can generate per customer contract. In short, it’s an excellent indicator of marketing efficiency and profitability.
How to Calculate Annual Contract Value?
There are a few ways to estimate the ACV and determine the average contract’s annual value. For example, you can do so by market and customer element when your analytics permits.
You can benchmark your business against other similar companies using the ACV. However, make sure you use the same calculation method for this comparison.
Most SaaS businesses only use contract value in ACV calculation. To get comparable information, you must exclude the following values.
- Setup costs
- Installation services
- Initiation fees
- Onboarding charges
Method #1: This method is used to calculate ACV for long-term contracts. In this method, you have to divide the total contract value by the number of years present in the contract. For example, TCV for a 3-year contract is $9000 plus a $250 set up fee, then ACV for this contract is $3000.
By dividing the total segment TCV by the total contract period, you can get the mean for a whole segment or a relatively larger group of customers.
Method#2: This method is used for short-term contracts. In this method, you must annualize short-term contracts or subscriptions to get ACV. For example, if your business receives a six-month contract valuing $400, its ACV will be $8000. You have to assume that the agreement will renew after six months and that your customers will stay calm.
How Should SaaS Businesses Use ACV as a Metric?
It has already been indicated that ACV is not beneficial on its own. But when it combines or is compared with other metrics, it can give you helpful data insight. You can use it to make data-driven decisions for marketing and sales.
ACV doesn’t decide the success of your business. SaaS success is based on the business model, strategies, and your investment to generate revenues. The following are the best metrics you can combine with ACV.
- Customer Acquisition Cost (CAC)
- Annual Recurring Revenue (ARR)
- Total Contract Value (TCV)
However, the main thing is what insights or information we can get by combining these metrics.
What Can CAC and ACV Tell Us?
When you compare your annual customer value with customer acquisition cost, you can find out how long it will take you to make back the expense of winning a new contract or customer.
For example, you signed 5 new contracts at $5000 ACV. However, the average customer acquisition cost is around $8000. So the ACV to CAC ratio will be 1.6. In simple words, you can say that it will take you 1.6 years or around 19 months (near about 2 years) to make back the cost of winning a new customer or contract.
Furthermore, there’s a plausible likelihood that you won’t recover. Most B2B contracts span several years. So, there are risks that your customers may cancel the contract before you reach the payback.
This comparison helps you figure out what you can afford to spend to entice new consumers. Of course, your long-term business strategy will be behind your every decision. However, a very high CAC value than ACV indicates that you need to reduce acquisition cost or limit customer swirl. You can opt for increasing pricing as well.
Now imagine you signed a new contract of ACV of $2000 and CAC of $1000. So the ratio will be 0.5. It means you can earn back your CAC in 6 months which is a pretty good time, especially for the status and indicates the profitability and growth of your business.
However, if you are in the growth phase, then you must consider spending more to grow quicker. The catch is you must always keep new customers around and avoid attracting customers who don’t fit properly.
TCV and ACV
Both these metrics are closely related to each other. TCV is the total value of the contract, and ACV is the one annual part of it. In other words, for a contract of $15000 for 3 years (all fees are excluded), then the ACV will be $5000.
ACV calculation helps you normalize the contract, which permits a straightforward comparison between customers.
If the average ACV and TCV numbers are close to each other, it means that most of your clients hit the road just after a year. Maybe it’s time to grapple with your churn.
Annual Recurring Revenue (ARR) vs. ACV
These two KPIs are also closely linked and sometimes confused with each other as well. The main reason behind the confusion is that both these metrics are annual and revenue related. However, they have significantly distinct meanings.
The key difference is that ACV is the average annual revenue of one subscription or contract, while ARR gauges your company’s size.
ACV can be averaged across more than 1 account or can be drilled down to see the contract values for specific segments. However, the primary use of ACV is the measurement of the performance of the sales and marketing department.
On the other hand, ARR is a snapshot that calculates the total value of recurring revenue. During the calculation, it is assumed that nothing has changed in your customer base or pricing for the whole year. It is also used to measure the growth and acceleration of your company which indicates the validity of your pricing strategy and business model.
Use Baremetrics to Calculate ACV
Baremetrics is not used to directly calculate the ACV metric. You can get the information or customer contract data from Baremetrics and then create the metric in Flightpath. Knowing the number of new customers and each one’s monthly recurring revenue, you can quickly calculate the ACV and assess the marketing efficiency of your SaaS company or organization.
You have to follow the following path in the Flightpath dashboard to calculate ACV.
- Firstly create a new worksheet and name it “Annual Contract Value.”
- Now add references for “New Customers MRR” and “New Customers.”
- Add a custom metric with a formula: =({new_customer_mrr}*12)/{new_customers}
And here’s the formula to estimate and forecast ACV.
In the dashboard, you can add further comparisons as well, such as ACV vs. customer acquisition cost(CAC).
How could you use satisfactory analytics to make better your SaaS company’s sales and marketing strategies? Get started with a free trial of Baremetrics today.
