What TCV means and why you should calculate it

Owning a business is an excellent idea because the modern business landscape makes it relatively easy to run a business. But here's the catch: so many businesses like yours are jostling for a limited number of clients, so you need to have the edge over them.

To do that, you'd need to develop effective marketing strategies, find ways to optimize your sales and be able to predict your revenue over time.

Enter your TCV

In case you haven't heard, your TCV (Total Contract Value) is arguably the most important metric that you need to keep your business thriving. And guess what?

The rest of this article will describe what TCV means, how to go about TCV calculations, and how vital TCV is to your business. We will always find the time to explain other important metrics you need to know about.

Make sure you read this article to the very end.

Total Contract Value Definition

Total contract value (TCV) is a SaaS metric that deals with the total revenue generated from one contract, which in this case could be a customer. Revenue refers to the money you generate from offering products or services. It is calculated as the average sales price multiplied by the number/quantity of products or services provided. 

When we say total revenue, we mean everything from onboarding fees, professional service fees, cancellation fees, and just about any form of revenue(recurring and one-time) that comes in from a single contract for as long as it is valid.

That way, you can tell how much value such a contract brings to your business. Some of the factors that can affect a contract's full value include:

  • The nature of the service or product that the contract is built on
  • The size of your company
  • The industry that you operate in

The total contract value of a contract is tied to its length or nature, whether it is a subscription or a license kind of contract. That said, a total contract value has nothing to do with the aggregate invoice amount that is billed in the course of the subscription. No, it simply deals with the customer's financial commitment and helps with revenue predictions.

What is TCV in SaaS?

Like with most businesses, the total contract value tcv is a key performance indicator. It is a SaaS metric that allows SaaS businesses to ascertain the total revenue generated from customer contracts. Now here's the thing.

SaaS businesses are built on a business model that looks to increase recurring revenue. That explains why many SaaS companies favor multi-year contracts. Longer contracts allow them to lock in their customers and reduce the risk of individual customer churning or loss of significant revenue.

Benefits of total contract value

Here are a few ways that the knowledge of total contract value can benefit SaaS businesses:

You Are Afforded The Luxury of Accurate Calculations 

You will be much more accurate when calculating total contract value because it is tied to contract length and not based on assumptions that clients who subscribe will make financial commitments next year. So with calculating total contract value, there is no question of inflating or manipulating figures because the calculations are based on actual numbers that let you ascertain your revenue in real-time.

You Have An Increased Understanding of The Configuration of Your Client Base

When it comes to getting a grasp of your client base, your total contract value is one of the most useful SaaS metrics for viewing your existing client base and understanding them better.

How?

With total contract value (tcv), you get to use the demographics of your customers to create authentic customer personas. It also allows you to identify your most important and profitable customer segments with the highest TCV and tailor your marketing activities towards them.

You Optimize Your Marketing Budgets and Channels

One of the reasons why TCV is such an important metric is that it allows you to make the most of your marketing budget while eliminating needless expenses.

Thanks to the level of accuracy that it provides, you can easily tell when your marketing activities do not match your meet-up to your projected business success. It also lets you know how efficient your marketing channels are and which channels work best for your various customer personas. 

Your Marketing Becomes More Effective

With total contract value (tcv), you are better equipped to identify the best contract lengths for different customer segments. If you properly leverage the information from your TCV bookings, you'd be able to tell if one customer group prefers monthly subscriptions to annual ones.

Armed with such information, you can prioritize your sales rep outreach and other sales and marketing activities. And ultimately, when you target your marketing activities at your most valuable customers(based on their behavior), you are more likely to generate more profitable leads and reduce your customer acquisition cost.

You Get To Make Better Revenue-Centric Decisions

Thanks to TCV, you get to make data-backed decisions for revenue growth that are based on tcv bookings and not mere projections. Let's say, for instance, that you are looking to scale your company. You can deploy TCV to ascertain your projected revenue for a given period during which you intend to make the investments that will help you make that big jump.

How Do You Calculate Total Contract Value

The good news is that calculating your company's TCV is a straightforward process, all thanks to this pretty straightforward TCV formula:

Total Contract Value= Monthly Recurring Revenue(MRR) + Contract Term Length(in months) + One-Time Payments

Any changes in the monthly recurring revenue or the length of the contract term will reflect in your TCV, and these are some of the most important factors that influence the pricing strategies of companies like yours.

Now several scenarios could play out when working with a TCV calculator but let's look at a few.

So let's say that you have a software firm that charges $1000 as a monthly subscription fee. Along the line, you get a customer who signs up for 4 months before they cancel their contract(let's say you charge $100 as a cancellation fee).

In this case, your TCV = (1000x4)+100=4,100

Now let's say that you decide to do things differently by offering a lower monthly subscription(say $750). This would significantly increase your chances of landing clients who opt for longer-term contracts.

So let's say you land a client that subscribes for a year(12 months).Barring any one-time payment, your TCV= (750 x 12)=9000

TCV calculations are necessary as TCV is one of two metrics that can help you gauge your company's growth, especially if your business does a lot of prepaid deals.

The Downsides Associated With Estimated TCV

As great as TCV is, there are some issues associated with estimated TCV revenue. For starters, when you close a subscription deal with the average customer for long-term contracts, you have your mind set on high returns, right?

But what's to stop that customer from canceling their contract sometime in the middle of the contract period? Yes, you might have cancellation fees and penalty clauses, but the cancellation fees will not be as high as the revenue generated if the contract goes as planned. Then again, enforcing the penalty clauses could be tasking, and you even risk serious PR issues for all your efforts.

Other SaaS Metrics

Now that you know about TCV and how to calculate it let's look at other metrics that can help minimize company loss and drive business success. 

Annual Contract Value(ACV)

This SaaS metric refers to the average annual revenue per contract minus one-time payments. It is a baseline metric that can be used to compare other metrics. Thankfully, you don't need to have a huge annual contract value ACV to experience business success. All you need to do is to have the right annual contract value(ACV) strategy. There are loads of successful companies with low annual contract values that rank high on other metrics.

So what's the difference between TCV and ACV?

Well, TCV refers to the total revenue that is generated by a contract. It shows the total value of a new customer booking across the stated contract period. On the flip side, ACV refers to the annualized revenue amount from a contract and captures only a year's worth of the total contract.

Annual Recurring Revenue

Annual recurring revenue is another prevalent SaaS metric. Annual recurring revenue represents the revenue that your company will generate within one year in the course of a contract. Annual recurring revenue only includes fixed contract costs but can be normalized to a single year.

Monthly Recurring Revenue

Monthly recurring revenue shows you the state of your revenue stream across the various subscriptions and contracts that you offer. It is a popular metric because it can tip you on the growth of your business. It gives you some level of predictability and facilitates accurate financial projections that help you make decisions that can grow your company.

Total Revenue 

This is an excellent indicator of your ability to sell a product or service. It is often confused with customer lifetime value which deals with how much value a customer offers a business for the specified term length of a single contract. It does not cover expenses or costs, so you might not want to use it to gauge business success. That said, it is a great way to ascertain your cash flow.

Deferred Revenue

Refers to the situation where clients pay upfront for future products and services. In such circumstances, the payment becomes valid once the stipulated terms of the contract have been met.

Contract Price

Contract price refers to the total amount that the parties involved in a contract settlement. The project owner (principal) pays the contractor when the contract terms have been met.

Takeaway 

As an owner of a service-based business, you must understand what TCV means and how you can calculate it

Why?

Because it is a key indicator of business growth and should be managed and leveraged as efficiently as possible.

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