What is Annual Contract Value - ACV
Annual contract value (ACV) is one of the most important SaaS metrics that every SaaS business should track and optimize. But before we get into the specifics of this metric, let’s first define a contract value.
Simply put, contract value is what a customer contract is worth.
Contract values can be expressed quarterly, semi-annually, or annually. This is essentially where annual contract value emanates from. By definition, annual contract value is the average revenue per customer contract, normalized across a year. ACV excludes any one-time fees, which may make the first year’s ACV in a multi-year contract higher than the following years. Individual SaaS businesses have different methods of calculating their annual contract value.
For example, if you have a customer who signed a 5-year contract for $50,000, your annual contract value is $10,000. If you have 50 subscribers on a monthly plan at $2,000, your annual contract value is $480. This metric comes in handy when compared to other metrics such as customer acquisition cost. SaaS businesses can use annual contract value to adjust the amount spent on customer acquisition.
Annual contract value tends to be confused with annual recurring revenue (ARR) as they seem like one, but they are different metrics. ARR is the value of the recurring revenue of a business’s subscriptions normalized for a single calendar year. ACV might also be confused with ACV bookings, which is entirely a different metric. ACV bookings are the total value of contracts for one year.
You do not necessarily have to have a large annualised contract value to run a successful SaaS business. You only need to implement the right annualised contract value strategy. There are many successful SaaS businesses that have soared great heights based on small annualised contract values. If your annualised contract value is small, then you’ll have a low customer acquisition cost. This means you’ll gain a competitive edge in the market as you don’t have to spend a lot of money and time on securing contracts. On the other hand, a high annualised contract value correlates to a higher customer acquisition cost because a business will have to spend more on finding leads and turning them into contracts. Understanding and tracking ACV helps businesses to make informed decisions.
WHY IS ANNUAL CONTRACT VALUE IMPORTANT FOR SAAS COMPANIES?
Annual contract value allows SaaS businesses to make accurate revenue projections. It also enables marketing teams to gauge the effectiveness of the marketing strategies in place and determine if they are pursuing the right clients.
Generally, annual contract value is one of those metrics that do not have a uniform formula for calculation. No matter how your business decides to calculate ACV, it’s important to have uniformity for purposes of consistency and accuracy in evaluating revenue and growth. Annual contract value is essential for making decisions on sales strategy, marketing, and development.