Like annual recurring revenue (ARR), annual contract value (ACV) is used by SaaS business owners to get a better grasp of their organization’s health, though some disagree on how exactly to calculate annual contract value.
Let’s clear things up by examining what is annual contract value, why it’s important, and how to calculate and use it for your business.
What is annual contract value (ACV)?
Annual contract value (ACV) is the average annual revenue generated from every customer contract, not including fees.
Here’s an annual contract value example: if a customer signs a four-year contract for $40,000, averaging this value per year gives an annual contract value of $10,000.
How to calculate annual contract value
You might come across several ways to calculate annual contract value. The equation we prefer is:
(Total revenue from contracts – total fees from contracts) / total number of customers
Or, more simply put:
Annual contract value = (Contract revenue – contract fees) / number of customers
To measure your company’s annual contract value in this way, you’ll need data on the following items:
- Total revenue from contracts: this is the total amount of money your customers have paid you for contracts signed in a given period.
- Total fees from contracts: this number includes one-time fees associated with a contract (such as installation or setup fees), as well as any monthly fees that are not recurring revenue.
- Total number of customers: this is the number of customers who have signed a contract in a given period.
How to use annual contract value as a metric
After calculating your annual contract value, how can you use the metric to help your business?
1. Measure customer lifetime value (CLV)
Customer lifetime value (CLV) is the total revenue a customer generates for your company throughout their entire relationship with your business. While there are a few different ways to measure customer lifetime value, annual contract value is often a key part of the calculation.
2. Measure customer churn
Customer churn is one of the biggest threats to any business. Annual contract value is helpful when measuring churn as it provides a snapshot of how much revenue each customer contributes on average.
3. ACV as a benchmark for sales proposals
When you’re pitching new deals, it’s helpful to have a benchmark to compare against. Annual contract value can help you gauge whether a potential deal is worth pursuing.
Ways to use the annual contract value metric
Now that we’ve covered the basics of annual contract value, let’s look at some practical examples of how you can use this metric in your business.
- Measuring customer churn: Use annual contract value as a benchmark to measure your success in retaining customers. You can compare your current annual contract value to past measurements to spot fluctuations in customer loyalty.
- Comparing product offerings: Use annual contract value to determine what products are more or less popular with customers. This information can help you make strategic decisions about future product development.
- Tracking sales progress: Use annual contract value as a proxy for overall sales growth. Tracking changes in annual contract value gives you a better idea of your sales team’s performance.
For these reasons and others, annual contract value is a SaaS metric worth tracking and understanding.
What is a typical annual contract value for SaaS?
When it comes to SaaS companies, there is no “one size fits all” answer for what a typical annual contract value looks like.
This is because many different factors can impact annual contract value, including company size, industry, and pricing model.
That said, some estimates place the average annual contract value for a SaaS company between $5,000 and $30,000. Keep in mind that this is just a range: your company’s annual contract value could be higher or lower depending on the aforementioned factors.