For startups in the SaaS space, the metrics can often be overwhelming. You’re told you should be measuring average revenue, lead momentum, conversion rate, lead velocity rate … the list goes on.
But how can you cut through the numbers to actually learn about where your company stands? Luckily, ACV might be just the metric you need.
What is Annual Contract Value (ACV)?
Annual contract value refers to the total sales revenue of a particular customer contract across the span of a one-year period. ACV is particularly relevant for SaaS companies since it is can be applied to subscription-based business models.
But there’s already a ton of sales metrics for SaaS businesses, such as customer lifetime value (LTV) and customer acquisition cost (CAC). Why should we be paying any notice to the ACV?
By itself, the annual contract value isn’t a completely helpful metric. But when combined with the other sales KPIs, ACV can be integral for informing your sales, marketing, and pricing strategies.
For example, low-cost consumer subscriptions like Netflix or Hulu have a lower annual contract value but then they don’t have to work hard on acquiring new customers. Instead, B2B companies may spend more on customer acquisition, but retain higher ACV per client.
ACV vs ARR
It’s easy to confuse annual contract value (ACV) with annual recurring revenue (ARR). Of course, both ACV and ARR metrics are alternative 12-month versions of monthly recurring revenue (MRR). There is no standard calculation for ACV but there is an industry standard for ARR, which often results in a gap between values of ARR and ACV.
For starters, the ACV metric looks at the total revenue from one multi-year contract and condenses this into an annual value. However, ARR would average out the total value of each year’s contract across a 12-month period.
Secondly, analysts can choose to include expansion revenue (from upsells and cross-sells) and one-off training or set-up fees in its ACV. Instead, using the billing structure to measure ARR is irrelevant – the total revenue is calculated between two specific dates.
How to Calculate ACV
Each SaaS business may choose to calculate ACV in various ways, which is why it’s hard to compare between businesses in the same industry. Some will include one-time set-up fees, expansion revenue, and churn rate, while others will not while calculating ACV.
The general formula for calculating ACV from your short or long term contracts is as follows:
Total Contract Value (TCV) / Total Years of Contract
Let’s take a look at an example. Your company onboards a new client for a contract worth a total contract value of $30,000 revenue across 5 years.
$30,000 / 5 = $6,000 Annual Contract Value
It’s worth noting that the general formula to calculate ACV includes one-off fees and expansion revenue. At this point in time, you add a $100 set-up and training fee. In the first year, your annual contract value (ACV) increases to $6,100; but in the second to fifth years, it remains at $6,000. Calculating Annual Recurring Revenue (ARR) would result in a different result since it averages the $100 fee over the whole five years.
Annual Contract Value and SaaS Metrics
As mentioned, ACV truly thrives when in the context of other SaaS metrics like CAC, LTV, and churn rate.
Customer Acquisition Cost (CAC)
In relation to Customer Acquisition Cost (CAC), you can use annual contract value (ACV) to find out how many new clients are required to cover the cost of acquiring them. This is incredibly useful since it informs your pricing and marketing strategies over the long term. Plus, ACV in relation to CAC can let you know how sustainable the growth of your business is likely to be, referring to the Rule of 40.
For example, if your ACV is $125 and your CAC is $62.50, you know that for every two customers you spend money acquiring, you’ll make a profit margin of one customer’s revenue.
Customer Lifetime Value (LTV)
Customer Lifetime Value (LTV) is a useful metric to able to help you determine the net profit per customer over the predicted course of their subscription. This integrates with annual contract value (ACV) since the value of the contract, alongside the lifespan, is used in order to calculate LTV.
Where the two metrics differ is that the ACV looks at a particular customer, while LTV takes an average of all of your clients.
Churn Rate
Lastly, ACV is skewed towards accounting for churn rate. Knowing exactly when the churn occurs during the sales process is incredibly important in order to improve and overcome it. The churn rate highlights the value of recurring revenue.
Thus, ACV might be better suited to those who are looking to explore the holes in their customer retention mechanisms. For example, let’s say churn consistently occurs during year 4, leading to a lower ACV than predicted during the penultimate and ultimate years of the contract. Clearly, an incentive is required at the later stage of the contract in order to reduce the churn rate and have the ACV remain at its standard, rather than having the customer downgrade or even drop to zero.
SaaS Industry Standards
In the SaaS industry, there is a lot of data circling. It shows that if your SaaS startup can hit certain benchmarks time and time again, it has more chance of succeeding and becoming a multi-million-dollar (or even billion) company.
What are the benchmarks in the SaaS industry?
In terms of Annual Contract Value, there is a large discrepancy between those focused on B2B and B2C. While the average ACV in a B2B company is $1080, the B2C equivalent sits at just $100. While this might not come as a shock, it means that startups trying to penetrate the B2C sector will require a larger working capital fund from the get-go to overcome their low ACV.
Furthermore, the CAC for small B2B SaaS businesses averages at $727. Including this with the ACV data means that a 6-month contract is likely to be unsustainable for the majority of SaaS businesses.
While it’s easy to get confused with all of the numbers flying around, these metrics are here to help you succeed. We hope you found this article useful and will share your own insights as you crack the billion-dollar market!
