What is SaaS annual contract value? How do you calculate it?

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Apr 17, 2024

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6 min read

Suppose you are a B2B SaaS owner who converted two leads into buying customers. Let’s call them Customer A and B.

Customer A signed a 3-year contract for $4,000, while Customer B invested $400 only for a quarter. Based on revenue, customer A will seem to be more valuable, right?

However, it is equally important to consider the duration of the contract. How would you know which customer will bring you more profit in less time?

The answer is Annual Contract Value (ACV). This blog will explain ACV in SAAS, compare SAAS metric ACV with other SaaS metrics, and explain how to calculate ACV in SaaS.

What is ACV in SaaS?

The annual contract value in Software as a Service (SaaS) metrics is used to show the income linked to a certain customer. It is important for SaaS firms that deal with contracts that span years or longer.

It is worth noting that different SaaS businesses often diverge in their interpretations of ACV SaaS. Nevertheless, almost all businesses agree it should only include recurring revenue, excluding one-time setup, onboarding, or software installation charges.

Why is Average Contract Value (ACV) important?

Calculating ACV holds significant importance for SaaS businesses, offering valuable insights into recurring revenue estimates, aiding in strategic planning, and facilitating performance management within the SaaS marketing mix.

It Helps You Compare Your Customers With Each Other

Customers exhibit varying ACVs due to contract duration or payment frequency. This analysis helps identify high-value customers and tailor strategies accordingly.

It Helps You Compare Your Business With Competitors

Comparing ACVs with competitors provides a benchmark for performance evaluation. Understanding competitor ACVs offers insights into industry trends and strategies that help businesses repurpose their approaches.

It Helps You Measure Your Profitability

ACV assists in measuring profitability when considered alongside Customer Acquisition Cost (CAC). While ACV reveals revenue per customer, CAC accounts for the expenses incurred in acquiring them.

By comparing the two, businesses can assess the efficiency of their acquisition strategies and determine the time required to recoup costs. Ideally, a lower CAC-to-ACV ratio signifies quicker profitability and sustainable growth.

How To Calculate ACV?

To calculate the Annual Contract Value (ACV), you divide the Total Contract Value (TCV) by the number of years in the contract.

ACV = total contract value/ # of years the contract is active

For example, If Customer A signs a three-year contract worth $3,000, the ACV would be calculated as follows: $3,000 divided by three years equals $1,000 per year.

However, for customers with contracts shorter than a year or those using a SaaS product without signing a contract, the same method applies, focusing on annualization. Now, say Customer B, whose $400 contract lasts for a quarter, which is 0.25 of a year. The ACV for this contract would be calculated as $400 divided by 0.25 year equals $1,200 per year.

Consider Customer C, who doesn’t commit to a contract but consistently purchases your SaaS product monthly for $120. In such cases, it’s simpler to annualize the monthly revenue by multiplying it by 12: $120 multiplied by 12 months equals $1,440 per year.

ACV VS ARR

After discussing the ACV definition SaaS, let’s contrast it with another significant financial metric: annual recurring revenue (ARR).

It’s common to compare ACV with ARR, as they are both important key performance indicators (KPIs) that measure annual revenue.

However, the main difference is how they measure revenue. ARR calculates all recurring revenue across all customers, whereas ACV focuses solely on individual contracts or customers.

You can say that ARR represents the total ACV across all customers.

ACV VS ARPU

While Annual Recurring Revenue (ARR) is practically the total Annual Contract Value (ACV) of all your customers, it is not the same as your annual Average Revenue Per User (ARPU).

However, these SaaS marketing metrics are closely linked.

ARPU represents the average revenue generated per customer or user. It is calculated by dividing the total ARR by the number of customers or users.

ARPU essentially reflects the average recurring revenue earned per customer, considering all customers collectively unless segmented separately.

In contrast, ACV represents the specific recurring revenue obtained from each individual customer, indicating variations among customers.

Thus, one could look at annual ARPU as the average ACV across all customers.

What is a Standard SaaS ACV?

Once you grasp the importance of Contract Value (ACV), in SaaS companies you may wonder about the ACV value and how it fits into your SaaS marketing customer journey. However establishing an accepted ACV benchmark poses a challenge due to the characteristics of each business.

Several studies have tried to shed light on ACV patterns in the SaaS sector. For example a survey by Pacific Crest examined 400 private SaaS firms. Found an ACV of $21,000. The survey showed that 26% of respondents had an ACV below $5,000 while 13% reported values exceeding $100,000.

It’s interesting to point out that this study didn’t categorize the participants so there could be a range of responses. The different ACV amounts, varying from $5,000 to, over $100,000 show the nature of the industry.

Another research conducted by RJMetrics sheds light on the ACV figures, for both B2B and B2C SaaS businesses. B2B SaaS companies had an ACV of $1,080 while their B2C counterparts reported a lower average ACV of $100.

These are an average figures and may not reflect the specific circumstances of individual businesses. Tracking your ACV over time is crucial for gauging business performance. A growing ACV suggests effective strategies, whereas a declining ACV signals potential issues that require attention.

This information is invaluable for refining your SAAS marketing strategy and winning saas marketing team.

How To Improve Your Annual Contract Value?

Improving your Annual Contract Value (ACV) is crucial for business growth, signalling an annual revenue expansion per contract. Here are some strategies to enhance your ACV:

Adopt a Value-Based Pricing Strategy:

Pricing your SaaS product appropriately is necessary. You need to figure out the balance between profitability and customer satisfaction. Set your production or service pricing based on after checking perceived value of your products to customers. There are many ways to check whether customer is interested in purchasing your product, such as surveys, interviews, and focus groups.

Improving SaaS Upselling Efforts:

SaaS upselling is a key aspect of SAAS marketing strategy b2b. It involves persuading customers to upgrade to higher-priced subscription tiers. Set upsell triggers based on usage patterns or milestones, such as reaching a certain number of users or tenure. When triggers are activated, offer customers upgrades that align with their needs and usage, aiming to enhance their experience and scale.

Target Larger Markets

Moving upmarket involves shifting focus towards larger, more established enterprises. While initially targeting end-users and small to medium-sized businesses is common, transitioning to bigger enterprises can increase ACV. However, this shift requires thorough research into the needs and preferences of larger companies. Develop new ideal customer profiles (ICPs) and buyer personas, and keep in mind the distinct requirements and risk aversion commonly found in larger organizations while managing your SAAS marketing budget.

Conclusion

Now, we are well aware that ACV is one of the most essential metrics a SaaS company should consider tracking. It not only helps you measure how much profit a particular customer will bring in, but it can also be beneficial in evaluating the profitability of the contract. ACV alone is effective, but it is advised to use it with different metrics such as ARR, ARPU, and CAC.

Learn how Saffron Edge, a SaaS marketing agency, will help you utilize these metrics to make the best decisions for your business.