Whether you are a startup or an old Saas company, tracking sales metrics is necessary because it will give you an insight into your company's performance, how far you have gone and what you can do better.
ACV, annual contract value, is a crucial sales metric that can help you evaluate the effectiveness of your sales strategy, especially if your company has a subscription-based business model.
With a firm understanding of ACV's impact on sales, you can gain momentum to encourage your sales team. You can also raise your packages to meet your annual growth target and identify high-value clients that will sustain your business.
In this article, we will take you through everything you should know about ACV; its extensive meaning, its importance in your sales strategy, and how to calculate acv, including hypothetical scenarios. We will also distinguish ACV from some other prominent sales metrics like ARR.
What is ACV?
ACV means annual contract value. ACV is the average annual contract value of a customer's subscription. It is the total revenue generated from a customer's contract within a year.
ACV is an essential metric for your Saas business if your service involves annual or multi-year contracts. It captures the total revenue generated from each customer's subscription within a year. It is a breakdown of the Total Contract Value ( TVC) annually.
ACV per customer is a valuable sales metric because the calculations help you understand how much each customer is bringing to the table, considering your customer acquisition cost. The result will influence your customer satisfaction and retention strategy because you know what each customer is worth to your business and whom to prioritize.
To maximize the importance of sales metrics, companies often compare ACV to other Saas metrics like annual recurring revenue (ARR), customer acquisition cost (CAC), and customer lifetime value (LTV).
Now that we've grasped ACV's meaning let's learn how to calculate it.
How to calculate ACV
Before we delve into ACV sales calculations, it is essential to note that there is no standard formula for calculating annual contract value because it's not an industry standard metric. Its calculation may vary from business to business.
Some businesses may choose to take into account all other one-time fees like training costs, registration fees, and set-up costs. Conversely, some companies might exclude these additional fees unless they are recurring revenue. You need to have a standard formula for calculating ACV and stick to it to compare metrics accurately.
To calculate the ACV of your customer's contract, you can use this formula:
ACV = Total Contract value ÷ Total number of years in the contract.
However, suppose your company has a yearly subscription calculated monthly. In that case, you can calculate your monthly recurring revenue (MRR) by dividing the total contract value by the number of months in the contract. Since ACV is an annualized measure, ACV will now be MRR multiplied by 12 months.
To put this formula into practice, we will use two hypothetical companies. Company A does not consider one-off fees, while Company B does.
The star salesperson in company A just closed a 5-year contract worth $50,000 with a new client. The client also made one-off payments, including a $ 2000 one-off fee and a $5000 training fee.
After all the celebration, it's time to get real with numbers. Based on the calculation standard of company A, the ACV of the contract will be $50,000 ÷ 5, which is $10,000.
They also signed up a client worth $120,000 spread across 24 months. The MRR will be $5000, while the ACV will be $5000 multiplied by 12, $6000.
Company B also closed a five years subscription deal worth $150,000. The client was charged a $5,000 administrative fee and $8000 for materials.
The ACV of the contract was calculated thus; $150,000÷ 5= $30,000. However, $13,000 one-off fees paid were added to year one ACV making it $43,000. Year one ACV will be $43,000, while the value of each of the remaining four years is still $30,000.
ACV vs. ARR
Are you also wondering if ACV is the same as annual recurring value (ARR)? Both may appear similar at a glance, but they are different metrics on a closer look.
ACV and ARR both act as key metrics to analyze the value of your customer contracts throughout the year. However, the difference lies in the goal of your business analytics. ACV sales calculation focuses on one contract and its revenue stream over time. Annual recurring revenue evaluates the total revenue of customer contracts within one year.
Unlike AVC, a company's ARR metric can be calculated and used independently. The ACV sales metric is used most often when paired with other sales metrics, measuring the success of sales representatives and customer success teams. The AVC could influence marketing and advertising efforts to sustain or increase contract volume.
In most cases, ACV is only applicable to subscription-based software companies. ARR can be calculated by the service provider and can be as high as the lifetime value of customer contracts in other sectors, such as e-commerce.
You should also note that ARR is an industry standard for calculating the annual revenue expected by a Saas company. On the other hand, ACV is not an industry standard of calculation; each company may have its way of arriving at the average annual value of each customer's contract.
The ARR can help a sales team calculate the growth rate they need to sustain or gain to continue providing services. If yearly contracts, such as subscription models, are the bulk of your business, your ARR could propel your business forward to meet quarterly goals.
How to calculate ARR
Since ARR is a calculation of revenue from all your customer contracts and not just from one customer, its calculation may be a bit extensive. But it is a great way to track revenue growth.
To calculate the ARR of your company contracts, follow this formula:
ARR = The summation of total revenue from all customer contracts + Total amount gained from revenue expansion - total amount lost due to cancellation of subscriptions (churn)
The formula reflects your revenue growth from new customer subscriptions and account upgrades. It also includes the dollars you might have lost due to some customers downgrading their accounts or canceling their subscriptions.
ACV vs. ACV bookings
ACV bookings is another term often confused with ACV; some people even use them interchangeably. ACV bookings are the total value of accepted term contracts.
The calculation of ACV is usually averaged, while ACV bookings are only added together. ACV bookings are one-year calculations, while ACV calculations are for multiple years.
Benefits of ACV to your SaaS business
Sales team performance analysis
Often, most companies measure their sales representatives' performance by analyzing their customer accounts' ACVs. By calculating the ACV of each customer account and matching them to the sales reps in charge, the recurring revenue can show the total revenue a salesperson has generated for the company within a year.
As such, you can use ACV and other metrics to determine your employees' accomplishments and know the ROI of their hiring costs. It can also help determine the effectiveness of their training and how to improve them.
Analysis and prioritization of customer account
Aside from analyzing sales efforts, ACV calculation helps you analyze the value of your customers' contracts and measure what each client brings to the table.
With this knowledge, your sales team will be able to recognize high-value clients and devise means of retaining them when they are approaching the expiration of their contracts.
You can also use the ACV sales metric to analyze and review your service delivery. Suppose your Saas company is unsatisfied with the recurring revenue from a customer contract. In that case, you may consider it wise to raise the total value of your service to generate more income.
Maximization of resources
If your company is focused on maximizing its limited time and resources, ACV is an important metric that can give you a sense of direction.
Resources and time required to manage customer relationships are inevitably limited. Your customer service team has to manage multiple accounts every day, and some clients may not even get their full attention despite using customer relationship systems.
By analyzing each client's recurring value, you can decide alongside other executives which high-value clients are benefiting the most from your services and which are costing more time and energy to keep on annual contracts. You can reallocate your resources towards satisfying clients and bringing in more value.
Business expansion and restructuring
Using ACV calculation is an excellent sales strategy when looking to expand or restructure your goods and services. You will find that your average ACV sales are largely based on the previous year's value of customer contracts.
As you calculate your ACV, you will acquire the knowledge needed to move forward with your services. Whether that be raising rates, reallocating resources, or even time, your priorities will shift to meet your business's lucrative needs.
Typical ACV for Saas companies
There is no typical ACV for Saas companies; it depends on each company's pricing strategies. There is no good or bad subscription model. Your business can be successful with either a low or high ACV strategy, depending on what your sales team deems profitable.
Businesses with lower ACV strategies focus on gaining more customers with cheap subscription costs. For instance, Netflix is a subscription-based company with subscription costs as low as $12.99 a month with $155.88 ACV per customer. This low rate attracts several subscribers to Netflix.
Despite the lower rate, they could still record increasing annual revenue, as high as $26.7 billion in 2021. The company continues making more profit because it prioritizes acquiring many low-value customers over a few high-value ones.
Conversely, businesses with high ACV invest more into acquiring a few high-value customers. B2B Saas companies like Hubspot utilize the high ACV model.
Hubspot recorded $412.4 million in subscription revenue in Q2 2022, which was a 37% increase compared to Q2 2021. Although the company may not have many customers, it still makes a good profit from high subscriptions paid by its fewer customers.
Getting the most from ACV
Companies on a grander scale, with soaring ACVs and ARRs, such as Google and Facebook companies on a greater scale, have disrupted the global advertising market. Online ad spending was forecasted to reach peak sales.
As these monstrous companies continue to raise their ad spending, they can easily justify outsourcing to SAAS metrics providers, such as Zendesk, and Brainshark, that offer an ad-serving system that generates monumental revenue per visitor.
For smaller-scale Saas businesses, the ACV key metric in collaboration with other Saas systems allows you to congratulate your highest earners, improve upon customer feedback, and prioritize the clients that invest in your services.
What is sales automation in ACV sales?
The buying process can sometimes be gruesome as clients don't want to be told what they need to buy but want to be shown it.
Various Saas businesses rely on subscriptions and recurring revenue to sustainably raise their company's current ACV. You must show clients how their needs will soon change to incorporate the additional aspects you can provide.
This form of sales automation continues to pull in customers looking for a decent and reliable service with all of the bells and whistles that make their job as a customer easier.
Managing ACV can be one of the most valuable things you can learn when determining the best pricing strategy for your business. In collaboration with the ARR, you will be equipped with the knowledge you need to accurately judge your monthly and yearly earnings while preparing to make changes if these numbers are not sustainable in the long term.
After learning about AVCs, you can consistently evaluate which clients deserve your time, effort, and adoration.