When we talk about modern SaaS companies, a lot of metrics are involved there as the whole customer experience is virtual.
If you have proper data tracking and analytics tools, you can get more than enough useful data that you can put to good use. Compare the data analytics from a tool like Baremetrics with that of the ERP tools used in the 1990s. Definitely, Baremetrics will give you more valuable data.
In the past, companies have had to bear large upfront costs to use data analytics tools. Therefore, only large corporations had access to them. Today, the use of the internet allows almost every business to access modern and advanced ERP tools to track data and make better decisions.
A variety of SaaS metrics such as AAR, LTV, TCV, ARPU, ACV, etc. provide loads of information about different happenings in your company or firm.
Let’s consider Annual Contract Value or simply ACV. Even if you don’t know about this term, you can piece the concepts together to get an idea about it.
But the main point is how you can use it to add value to your business.
Annual Contract Value (ACV)
It is simply the average annualized revenue you generate from each customer contract. It is not considered as a standardized metric as there is no generally accepted estimation method for it. SaaS companies usually exclude one-time fees for onboarding.
Examples
Example 1: Let’s say you own a small B2B SaaS company. You signed a 3-year contract with 2 customers with biannual payments of $5000 each. So the ACV for each customer will be $10000.
Example 2: Now have a look at B2C business as well. Imagine you launch a new streaming app and manage to achieve 500 customers at $100 per month. So, the ACV for each of them will be $1200.
Is ACV a Noteworthy Metric?
The answer can be yes or no. If you talk about its individual value, it may not be a meaningful metric because average revenue mainly depends upon the business size and nature.
B2B SaaS companies tend to have a higher ACV as compared to B2C companies. The reason is simple. Ordinary customers cannot pay huge amounts for products or subscriptions. Companies can generate a lot of useful information using different tools. Therefore, it doesn’t hurt them to pay the companies like Salesforce or Microsoft.
Some bB2C companies can also grow big by attracting a large number of customers. Netflix is the prime example of such a company which has developed into a very large business with an ACB of less than $200.
The ACV can be Noteworthy if you link it with other SaaS metrics such as CAC, and LTV. ACV is a very valuable addition as it tells you how much revenue you can generate from each customer in a year or even less duration. It gives you a better idea of marketing and profitability.
Methods to Calculate ACV
You can opt for a couple of methods to calculate ACV for your business. You can use ACV as a benchmark to compare with other SaaS companies. However, make sure that you are comparing apples with apples, i.e. use the same formula and compare with companies having ACV almost similar to you.
Numerous SaaS companies often count contract values when estimating ACV. ACV is not a standard metric like ARR or MRR. You can exclude the following things when trying to calculate more comparable ACV.
- Setup costs
- Installation services
- Initiation fees
- Onboarding charges
Method #1
This method is usually applicable for long-term contracts. When using this method, you have to divide the total contract value by the number of years in that contract.
Example: You signed a 3-year contract with $9000 CTV. $250 is a setup fee and is charged separately. The ACV will be:
9000 ÷ 3 = $3000.
Method #2
This method is widely used to calculate ACV for short-term contracts. In this case, you have to annualize the contract value assuming that the contract will be renewed once the first term is over.
Example: You signed a 3-month contract with $2000. The ACV will be $8000, assuming that the contract is going to be renewed after every 3 months.
Leveraging ACV as a Crucial Metric for SaaS Businesses
As mentioned earlier, ACV is not beneficial on its own. It can be helpful only when combined with other metrics. Doing so enables you to get useful information and make data-driven decisions.
I will mention again that ACV, low or high, cannot predict the success and growth of your business. It purely depends upon your business model and strategies. The following are some top metrics you can pair with ACV.
- Customer Acquisition Cost (CAC)
- Annual Recurring Revenue (ARR)
- Total Contract Value (TCV)
What will you get by pairing up these metrics with ACV? Let’s find out.
CAC and ACV
By pairing or comparing these two metrics, you can easily figure out the time you will take to earn back the amount to get a new customer.
For example, you signed 5 new customers with ACV of $5000 and CAC of $8000. The CAC to ACV ratio i.e. 8000/5000, is 1.6. It means it will take you 1.6 years or simply 19 months to earn back the amount of signing a new customer.
There are equal chances that you may not be able to earn back this amount. The reason behind this is the duration of B2B contracts. Your customer may churn before you reach the payback amount.
This comparison simply described what you can afford to acquire a new customer. There is no need to mention that your long-term business strategies will be backing your final decision. However, a CAC much higher than ACV doesn’t seem good for your business. To maintain it, you can do 3 things: reduce churn, increase pricing, and decrease CAC.
TCV and ACV
These two SaaS metrics are linked closely with each other. TCV is the total value of the contract you signed and ACV is simply its annualized version. For example, the TCV for a 3-year contract is $150,000 (setup fees and other charges are excluded). The ACV for this contract will be $50,000.
Estimating ACV can give you a better comparison between two customers as compared to TCv because it normalizes the contract terms.
Now compare ACV and TCV. If you observe the two metrics have almost similar values, it means your customers are hitting the road just after one year of the contract. It’s time to focus on your churn rate.
ARR Vs ACV
These two KPIs have a close relationship. They are often confused with each other as well because both are related to annual revenues. However, they are significantly different from each other.
The main difference is that ACV is for a single contract only while ARR is for the whole company. It gauges the size of any SaaS company.
ACV can also be averaged across multiple contracts or accounts and can be drilled down to give insights into the contract values for different segments. But its primary function is to estimate sales and marketing performance.
On the other hand, ARR deals with the annual recurring revenue of the whole company. It assumes that nothing changes in your company in a year. It gives information about pricing strategies and business models.
Using Baremetrics to Calculate ACV
Using a SaaS data analytics tool such as Baremetrics can help you calculate the comparable ACV. By using this tool, you can quickly calculate ACV based on new customer MRR and the number of new users or customers.
Follow the following steps after getting into the dashboard:
- Create a new worksheet with the title “ACV”.
- Add references in this sheet for new customers and the MRR of these customers.
- Now add a custom metric having the formula= ({new_customer_mrr}*12)/{new_customers})
And it’s the formula for forecasting ACV.
In the dashboard, you can add comparisons such as ACV Vs CAC or ACV Vs TCV to keep track.
How can you use data analytics to improve the sales and marketing of your SaaS company? Register for the free trial of Baremetrics today and figure this out.
Photo Credit: Infoset
