Annual Contract Value (ACV)

What is the Annual Contract Value?

The annual contract value (ACV) can be used as a revenue indicator to examine the results of your sales and marketing efforts and highlight key takeaways for your SaaS business.

Why is it Important in SaaS? 

Utilising ACV annual contract value as a strategic financial tool enhances your understanding of your SaaS company in two ways:

With variable pricing, it can help you realise the genuine value of each customer. It reveals the type of SaaS products you provide, allowing you to formulate growth strategies accordingly.

Annual contract value SaaS and variable pricing

SaaS businesses are increasingly using consumption-based pricing, which entails offering tiers of pricing based on usage characteristics. This pricing method puts annual customer income in flux, influencing your ACV annual contract value estimates.

The real money you make from a contract varies from year to year for numerous reasons, including:

Discounted costs

Initiation costs and other one-time charges

Product utilisation variables include user licences, features, queries, and the number of integrations.

ACV provides a clear picture of the monetary value of each company by normalising total income over the duration of the contract. Thus, while analysing historical data, you can determine the impact of your pricing strategy on the customer or customer cohort value.

ACV and strategy

There is a vast range of sizes and shapes among SaaS organisations. However, from the perspective of the annual contract value, the SaaS sector can be divided into two major categories: high ACV and low ACV.

  • Companies with a high ACV concentrate on acquiring fewer contracts with a higher ACV. They are particularly prevalent among B2B companies that serve large enterprises.
  • Low ACV businesses concentrate on acquiring a large number of low ACV contracts. This is more prevalent in the B2C sector, particularly with paid mobile applications.

SaaS companies with products that individuals and businesses of various sizes can utilise may have a product tier with a high ACV and one with a low ACV. Such is the case with HubSpot and Salesforce, whose free tiers are designed to encourage client acquisition for future expansion and ACV growth.

Understanding which ACV strategy corresponds to your organisation will assist you in focusing on the proper activities and avoiding industry trends incompatible with your business model.

How to Calculate Annual Contract Value?

Multiple methods exist for calculating the annual contract value formula of a client base. At the highest level, however, the ACV calculation is the total contract value divided by the total contract years.

ACV = Total Contract Value / Total Years in Contract

Let's see how the formula operates with an example. Consider the following scenario: a new client enters a three-year contract with you for $30,000 per year of service, and you provide a 30% discount on the first year.

Their annual compensation would be as follows:

Year 1 = $20,000

Year 2 = $30,000

Year 3 = $30,000

For a total contract value of $80,000 over the course of three years. To determine the ACV for this customer, you would divide the total contract value by the number of contract years. 

ACV = $80,000 / 3 = ~$26,667

By determining the annual average amount received, it is simple to illustrate how your SaaS pricing plan influences your annual revenue from this customer.

There are a number of business perspectives on ACV, including:

  • Individual ACV per customer (like the example) 
  • Total ACV of all customers
  • Average ACV of all customers
  • Total ACV for a time period
  • Average ACV for a time period