A Comprehensive Guide on Calculating Annual Contract Value (ACV)
In today's modern era, advanced businesses are using several metrics. This is precisely true when it comes to SaaS, where the whole user experience is virtual. With proper setup and tracking tools, you can get enough KPIs and analytics data for good use.
If you look back a few decades back, in the 1990s, only some gigantic firms could afford access to these powerful tools. The main reason behind this was the upfront costs that are not affordable by all corporations or firms. However, today, everyone has access to the Internet. It allows all businesses and organizations to access powerful analytical tools that help in taking the right decisions.
There is an alphabet soup of advanced SaaS metrics such as AAR, TCV, LTV, ARPU, and ACV. You can use them to get lots of information related to several things in your corporation. However, you can easily ignore the KPIs you have not used yet.
In the case of annual contract value, or simply ACV, you can piece the concepts together even without having any knowledge about it. However, the main thing is the usage of ACV metrics for the betterment of your business.
What is Annual Contract Value (ACV)?
The average annual revenue your company or organization generated from each customer is called ACV.Set up fees, acquisition fees and all other charges are excluded from it.
Examples
Example 1: As a vice president of the sales department of the sales department of a large corporation, you signed a contract of $150K with a user for 3 years. So the annual customer value will be $50K.
Example 2: You are running a small SaaS corporation. You get 50 new subscribers for a price plan of $10per month. So the ACV per customer will be $120.
Example 3: You signed a 4-year contract with 2 customers. Each of them has to pay you $1000 after every 3 months. So the ACV per customer will be $4000.
Why is ACV a Meaningful Metric?
ACV metrics don’t provide much information as it is based on several factors such as business size, strategy, audience, etc.
When we talk about SaaS corporations or companies, B2B companies usually have considerably higher ACVs than B2C corporations. The reason is straightforward. In the case of B2C, you have to deal with regular customers or subscribers who are unable to pay very large amounts. While in the case of B2B, your main customers are corporations and companies that can afford big prices.
Some b2C businesses can also develop massive ACVs every year by getting a lot of customers. Netflix and Spotify are the main examples of such companies as they have millions of subscribers who help them generate huge ACVs.
In general, ACV doesn’t have a deep impact on your business. However, businesses with an ACV of less than $500 per customer are less likely to become massive companies unless they have millions of users.
You can add value to your company by linking ACV with some other metrics such as customer acquisition cost (CAC) and customer lifetime value (LTV). It will give you information about the average revenue you are generating per customer. If you want to estimate the efficiency and profitability of your marketing and selling department, then these metrics are very helpful.
How to Calculate Annual Contract Value?
There are more than 1 method for calculating ACV, so it's not a big deal to do so. You can estimate it by market and customer element, in case your analytic permits it.
You can also compare your company with other similar companies based on ACV. However, make sure to use the same calculation methods for comparison to keep it fair.
Excluding the following charges is mandatory to get comparable ACVs.
- Setup costs
- Installation services
- Initiation fees
- Onboarding charges
There are the following methods to calculate ACV.
Method 1: It is used for long-term contracts or customers. Let's say you get a contract of $60K and the duration is 3 years. To find ACV, you have to divide the total customer value by the number of years present in the contract. So the ACV for a customer with an LTV of $60K for 3 years will be $20ak.
Method 2: It is for short-term contracts only. You simply have to annualize the short contracts. For example, a contract valuing $200 for a month means the ACV will be $ 2400. You have to assume the customer will not churn and the contract or subscription will be renewed every month.
How SaaS Businesses Should Use ACV as a Metric?
As mentioned earlier, ACV is of almost nonuse without linking it with other metrics. Furthermore, a higher ACV is not a guarantee of the success of your business. Success depends upon your business model, strategies, and other similar factors.
The best metrics to link with ACV are:
- Customer Acquisition Cost (CAC)
- Annual Recurring Revenue (ARR)
- Total Contract Value (TCV)
What Can CAC and ACV Tell Us?
Linking customer acquisition cost with ACV helps you find out how much time it will take to earn back the amount to get a new customer.
For example, if you have signed 5 contracts each with an ACV of $5000, but the acquisition cost is $8000, then ACV to CAC value will be 1.6. It means it will take you 19 months to make back the amount to get new customers or contracts.
However, it's not guaranteed that you always make back the amount of winning a new customer. Several contracts may span several years. So, there are chances that your customer leaves or stops paying before you reach the payback. It often happens in B2B businesses.
It gives you an idea of how much you can spend on bringing in a new subscriber or user. However, you cannot decide everything based on this comparison. Obviously, you will make decisions that are backed by your long-term business strategies. CAC Vs. ACV indicates that you must keep the acquisition cost low. You can do so by minimizing the customers' swirl or increasing pricing.
For example, imagine you get a new customer with an ACV of $4000. However, the acquisition cost is $2000. So the ACV to CAC ratio is 0.5. It means you can get payback to win new customers in 6 months which is a very good period.
If your business is in the growing phase, you must spend a considerable amount to speed up the process. The catch is you must always have new customers around and avoid signing the contracts that don’t fit properly.
TCV and ACV
Both these metrics are closely related as TCV is the total value of a customer or contract ACV is an annual part of it. For example, if you signed a 5-year contract at an LTV of $50K, then the ACV will be $10K.
LTV must be considerably higher than the ACV. If yourLTV and ACV are almost similar, it means most of your customers are hitting the road just after a year. Don’t you think it's time to govern your churn rate?
Annual Recurring Revenue (ARR) vs. ACV
Both these metrics are based on per-annum revenues, so they are linked with each other. However, they are often confused with others as well due to the same reason. In actuality, they have distinct meanings.
ARR gauges your company’s size as it is the annual recurring revenue. On the other hand, ACV is just the average revenue per customer per anum.
ACV can be drilled down or averaged across several accounts. The purpose behind this is to catch a glimpse of the contract values for different segments. However, the primary function of ACV is to estimate how successful and beneficiary the marketing is.
Contrary to ACV, ARR is the snapshot that calculates the whole recurring revenue. When calculating ARR, you need to assume that nothing has changed for the whole year. Pricing or customer base is assumed constant for the whole year. It is also used to measure the growth rate of your SaaS corporation which further indicates the success rate of your business model and strategies.
Use Baremetrics to Calculate ACV
Baremetrics cannot help you directly calculate the ACV metric. You can get information about the customer contract and the prices from Baremetrics and then create a metric in Flightpath using this analytics data. Knowing the details about customer contracts helps you find out the ACV rapidly.
The steps you have to follow on Flightpath dashboard to estimate ACV are:
- Creating a new worksheet and naming it “Annual Contract Value” or simply “ACV”.
- Adding references for New customers and their MRR.
- Adding customer metric with the formula =({new_customer_mrr}*12)/{new_customers}.
That's the formula to estimate and forecast ACV. You can add different comparisons in the dashboard as well such as ACV vs CAC.
How can you make better sales and marketing strategies for your SaaS company or corporation using satisfactory data analytics? Get registered on Baremetrics and start with its free trials.