Tracking sales metrics is essential for both startups and established SaaS companies, as it provides valuable insights into company performance and areas for improvement. One such key metric that companies track is ACV or Annual Contract Value. ACV is considered a highly valuable sales metric.
ACV can be a useful tool for evaluating the effectiveness of your sales strategy, especially if you are operating with a subscription-based business model. This metric provides a holistic view of your sales strategy. One can identify areas of friction and assess what is functioning well in the process.
This article provides a comprehensive overview of ACV, including its definition, significance in sales strategy, and methods for calculating it.
What does Annual Contract Value (ACV) mean in sales?
ACV refers to the average annual contract value of a customer's subscription.
ACV calculates a client's value for a single fiscal year by considering various factors.
Monthly contracts
Annual subscriptions
Consulting services
It represents the revenue generated from a customer's contract on an annual basis.
ACV - Annual Contract Value is a crucial metric for SaaS businesses that offer services with annual or multi-year contracts. It records the total annual revenue generated from each customer's subscription.
Analyzing the average customer value is an important sales metric as it allows you to determine the value each customer contributes, taking into account the customer acquisition cost. Understanding the value of each customer to your business will impact your customer satisfaction and retention strategy by helping you prioritize effectively.
Companies analyze sales metrics by comparing ACV to other SaaS metrics, such as annual recurring revenue (ARR), customer acquisition cost (CAC), and customer lifetime value (LTV), to gauge their importance.
Now that we understand the meaning of ACV, let's explore why it is important.
Why ACV is important?
At this point, you may wonder about the significance of understanding the value of a single contract. Although sales calculations may not be as effective for large-scale budget planning, ACV serves two essential purposes in sales:
Helps shape your pricing strategy
SaaS companies are adopting consumption-based pricing models, where pricing plans are based on usage variables. This pricing strategy can affect annual income from individual customers, which may impact your ACV calculations.
The actual income earned from a contract can vary each year due to several reasons.
Reduced prices
Expenses related to set up costs and other one-time fees
Service and feature enhancements
Product usage variables include factors such as user licenses, features, queries, and the number of integrations.
ACV provides a standardized method to assess the financial worth of each company by adjusting total revenue based on contract duration. By analyzing historical data, you can observe how your pricing strategy impacts your revenue over time.
Informs business strategy & decision-making
SaaS companies vary in size and type. From an annual contract value perspective, the SaaS industry can be divided into two main categories: High ACV and Low ACV.
High ACV companies prioritize securing a smaller number of contracts with higher ACV. They are commonly used by B2B companies that cater to enterprise-level organizations.
Small ACV companies prioritize acquiring a high volume of low ACV contracts. This is a common occurrence in the B2C industry, particularly with paid mobile apps.
SaaS companies offering products for both individual and organizational use may have varying product tiers with different ACV levels. Companies like HubSpot and Salesforce offer free tiers to attract customers and drive customer acquisition, leading to potential expansion and increased ACV.
Knowing which ACV strategy is suitable for your business can guide you toward effective activities and shield you from irrelevant industry trends.
Now that we understand the importance of ACV for your company let's explore how to calculate this metric.
Annual Contract Value (ACV) calculation
There are various methods available for calculating the ACV of your customer base. But at the highest level, the ACV is calculated by dividing the Total Contract Value (TCV) by the Total Years in that contract (focusing solely on recurring revenue). Let's break this down with the help of an example.
ACV example for sales
Let's say Client A signs a five-year contract worth $10,000. Here's how we calculate the ACV:
Total Contract Value: $10000
Duration of contract= 5 years
ACV: $10,000 / 5 = $2000 per year
Now Client B has signed a contract for a monthly subscription plan priced at $100 per month:
Monthly subscription revenue: $100
ACV=Annual subscription revenue: $100 * 12 months = $1200
By calculating ACV manually, companies can obtain an approximate value of the revenue they can expect from a single source over a year.
What's the average ACV in sales?
The average ACV in sales is influenced by the size of the company. There is no universal answer to this question.
Let's review multiple studies on SaaS businesses and their ACVs to determine an average.
According to a report by Vendr, the ACV for enterprise-level tech companies such as Salesforce and Microsoft falls within the range of $250,000 to $1,000,000.
The ACV for high-value products such as Zoom, Zendesk, and Asana falls between $50,000 and $250,000, while medium-value products like Hubspot, Figma, and 1Password have an ACV ranging from $20,000 to $49,999.
Different factors affecting ACV value in sales
After discussing the calculation of Annual Contract Value (ACV) in sales, we will now explore the different factors that can affect its value. Understanding these factors is crucial for businesses to enhance their sales performance:
Number of customers
The quantity of customers is directly linked to the sales from Average Contract Value (ACV). Understanding the total number of customers—whether through securing several large-value deals or numerous smaller transactions—is crucial for projecting total revenue.
Number of contracts
It is important to track both the number of customers and the number of contracts in the pipeline. Remember that the customer contracts you're tracking should be active. The active contract values will contribute to reaching your yearly revenue targets.
Understanding the number of active contracts in the pipeline can help determine the additional contracts needed to reach the annual revenue goal.
Overall subscription cost per year
Calculating the overall subscription cost is crucial in determining the ACV of a SaaS company. The subscription cost is determined by the customer's chosen subscription plan, the specific period, and any additional upgrades, downgrades, or canceled subscriptions in the ongoing customer contract.
Recurring revenue earned from upgrades
Recurring revenue is calculated as the sum of revenue generated from customer subscriptions and any additional features or upgrades chosen on a consistent monthly or yearly basis.
This factor plays a significant role in increasing the annual contract value (ACV). By analyzing this important factor, you can determine the amount of annual recurring sales revenue generated by the company, as well as the portion of this revenue attributed to upgrades.
Revenue lost from cancellations or downgrades
When customers cancel their subscriptions, the SaaS company incurs a loss in recurring revenue due to churn.
Focusing on cancellations or downgrades is essential for your company, as subtracting this amount from the revenue earned is necessary to calculate the ACV. This step is crucial for ensuring the financial stability of your SaaS business.
Subscription renewal rate
Are the customers currently renewing this subscription? If customers do not renew their subscription, it will have an impact on your ACV. It is recommended to prioritize the contract renewal rate over the length of the contract.
For instance, if there are 100 active accounts up for renewal and 12 of them cancel their subscription, you would be left with 88 active customers. The subscription renewal rate (Customer Retention Rate) is projected to be 88.0%.
The subscription renewal rate is influenced by the number of downgrades or customer churn. To increase ACV in sales, the focus should be on reducing subscription cancellations.
How to increase the sales ACV?
Here are four ways you can increase the sales ACV:
Segment your repeat customers to further engage with them through emails and in-app messaging, as they are more prone to upgrade to higher pricing tiers in the future.
Utilize interactive guides and tooltips to inform users about recently released product features. By learning how to utilize these features effectively, businesses can enhance their overall customer experience.
Consider revising the structure of your pricing plans. Following that, inform users about the upcoming increase in subscription prices and the updated pricing plan details through personalized in-app messages.
Utilize cross-selling techniques to offer complementary products to customers, potentially increasing the overall contract value.
How to leverage ACV to make better decisions
Let's delve into how businesses can leverage ACV to make better decisions and drive sustainable growth:
Benchmark new contracts
Pricing discounts are a commonly used sales tactic that can be effective in securing large clients.
Determining the appropriate discount for your sales team to offer is important.
Analyzing the average ACV per customer from previous years can provide a reference point for developing new customer contracts. ACV can illustrate the impact of first-year discounts on the total income generated from a new single client.
While it's not necessary to strictly adhere to it, sales leaders find this rule a helpful tool in conducting cost-benefit analysis.
Evaluate upsell opportunities
According to Key Bank Capital's SaaS Metrics Report, the majority of SaaS companies generate 36% of their net revenue from existing clients. As businesses expand, upselling becomes increasingly crucial as a source of revenue.
Analyzing per customer ACV data can provide valuable insights into potential upsell opportunities. For instance, if a customer is actively involved but has a lower-than-average ACV, the account management and sales teams can collaborate with customer success to provide an upgrade offer to increase the ACV, which will lead to a growth in revenue.
Assess sales rep performance
High-performing sales professionals can close deals without depending on discounts. If sales representatives rely too heavily on pricing to acquire customers, it can impact the revenue metric.
Analyzing average ACV provides insights into the performance of sales representatives. One can analyze performance to determine which representatives consistently identify opportunities for contract extensions and upselling to the existing customer base.
For companies with multiple product lines, allocating sales representatives to prospects of varying sizes can be a helpful strategy.
Allocate sales and marketing resources
There is no specific recommended ACV to strive for. ACV can help analyze the revenue impact of strategic initiatives.
Over time, investing in tactics that achieve the most growth at the lowest cost can be beneficial.
ACV can be used by sales teams to prioritize accounts that may require more attention than others. For instance, it is not ideal for sales representatives to dedicate excessive time pursuing a low ACV prospect, whereas more effort can be allocated to a high ACV account.
ACV can be utilized in marketing to gain insight into top-of-funnel objectives. A low ACV strategy and lower conversion rates require a high volume of leads at the top of the funnel.
Enterprise marketing funnels with high ACV prospects require a targeted account-based approach that emphasizes lead qualification and sales funnel metrics over lead volume.
Comparing ACV to other SaaS metrics
The world of Software as a Service (SaaS) is full of metrics. Here is a comparison of ACV to other commonly used metrics by Investors and sales leaders:
ACV vs. Annual Recurring Revenue (ARR)
Annual Recurring Revenue (ARR) is a key subscription metric that calculates annual revenue. The income generated from all subscription accounts, including new bookings, subscription upgrades, and renewals, is calculated annually.
ARR also considers customer churn, which refers to the revenue lost from customers who discontinue using your service.
ARR is commonly used by SaaS companies and startups to track growth and anticipate future revenue. When comparing ACV and ARR, ARR is often considered the more fundamental financial metric used by companies and investors to measure revenue growth.
ACV vs. Total Contract Value (TCV)
The total contract value is the total income received from a fixed-term contract, and it is an essential component in the ACV formula. To calculate ACV, divide TCV by the number of years in the contract.
TCV is calculated based on existing customers and is beneficial for accurately tracking the revenue generated from long-term contracts with clear end dates. Using TCV, you can analyze which customer segments generate the highest income and utilize this information to target your marketing strategies effectively.
ACV vs. Customer Lifetime Value (LTV)
Customer lifetime value (LTV) is a metric used in SaaS to calculate the average revenue a customer contributes before discontinuing their service, whereas Average Contract Value (ACV) assesses the average value of a customer contract, excluding any one-time charges.
Conclusion
In conclusion, the Annual Contract Value (ACV) is a crucial metric for startups and established SaaS companies. This metric provides insights into your financial health, customer value, and pricing strategies simultaneously. By utilizing ACV and understanding its significance in your sales strategy, you can optimize your pricing, identify upsell opportunities, and efficiently manage your resources for consistent growth. When combining ACVs with other essential SaaS metrics, you are equipping yourself with a valuable set of tools to make strategic decisions and effectively navigate the competitive landscape. Consider it a tool to navigate the world of SaaS, helping you build better customer relationships and increase profits.
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