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.
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.
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:
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.
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.
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.
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: