Annualized Contract Value: What Is It, How To Calculate It & How To Increase ACV in SaaS
Did you know that Annualized Contract Value (ACV) is one of the most critical yet underlooked SaaS metrics?
SaaS companies try to monitor a lot of metrics. However, it also makes it easy to overlook important metrics while focusing on vanity metrics.
So let’s see what Average Contract Value is and how you can increase ACV and leverage this critical metric to achieve a successful business.
What is annualized contract value (ACV)?
In SaaS, the annualized contract value is a metric that breaks down the total contract value of a customer into an average annual contract value.
ACV basically gives you the average revenue you earn from a user’s subscription every year. Although the metric seems to resemble the annual recurring revenue (ARR), there’s a distinct difference between the two.
Annual Contract Value (ACV) vs. Annual Recurring Revenue (ARR)
ACV and ARR are both annual measures of revenue. However, one critical difference between the two is that while ARR measures revenue for all customer accounts at the same time, ACV measures revenue for a single user account.
Moreover, ARR is a standardized metric that a SaaS business measures at a particular point in time. But ACV is the revenue metric that spans several years but is normalized to show the average value per year.
Let’s see the example below.
Suppose that your business has 3 customers – A, B, and C with an ARR of $1,000, $750, and $500, respectively. In year 1, the ARR will be the summation of these 3 values, whereas the ACV will be the average of these 3 numbers.
In year 2, if customer A doesn’t renew their 1-year agreement, the new ACV will be equal to the average ARR of the remaining customers.
Annual Contract Value (ACV) vs Total Contract Value (TCV)
On the other hand, total contract value (TCV) differs from ACV with respect to time. TCV measures revenue across the lifespan of a given contract.
For example, if you have acquired a new user on a 2-year contract with a TCV of $160,000, the ACV for this deal would be $80,000.
Why is annual contract value a key metric in SaaS?
Tracking ACV is critical for understanding your customer acquisition efforts and go-to-market strategy.
Although it’s one of the most valuable SaaS metrics, the annual contract value tends to get overshadowed by more popular metrics such as the customer lifetime value and monthly recurring revenue.
ACV is very useful when it comes to comparing users whose contracts vary in duration or type. It also helps you identify users who are paying you consistently.
With ACV, you can identify accounts that bring in the greatest revenue. The metric allows you to better serve your customers, especially those with the highest potential for long-term retention.
How to calculate annual contract value?
There are a few different ways you can calculate annual contract value. The calculations may or may not consider the following:
- ACV for all accounts and adding them
- ACV for all accounts and calculating the average
- Customer churn rate
- Expansion revenue from upsells or cross-sells
- One-time fees such as set-up and training costs. Note that for a multi-year contract, these costs can make ACV in the first year higher than that of the following ones.
Annual contract value formula #1
The formula below is for long-term contracts. Here, ACV is found by subtracting one-time fees from the total contract value and dividing the result by the contract term length.
Annual contract value formula #2
This formula is for short-term customers, where you can calculate ACV simply by dividing the total contract value by the total number of years in the contract.
What is a typical ACV for a SaaS company?
There is no one typical ACV for SaaS companies. Instead, the right annualized contract value varies from business to business.
It’s important to realize that your subscription model can demand a low ACV. Rather than assessing your ACV on its own as simply good or bad, you should evaluate the context of all other financial metrics that define the success of your business as a whole.
A survey of 400 private SaaS companies found that the median for ACV was around $21,000. Note that the sample size is not large enough to represent the SaaS industry as a whole.
You can also find distinct differences in ACV between B2B and B2C companies. An RJMetrics study revealed that the average B2B user has an ACV of $1,080, which is more than 10 times that of a B2C customer – $100.
How to combine ACV with other SaaS metrics to get more insights?
ACV may not be very helpful on its own because the average contract size varies from company to company based on the business model and target market. But you should always use it along with other metrics for better results.
Analyzing ACV along with metrics like ARR and CAC can give you actionable insights for developing well-informed business strategies.
Customer Acquisition Cost (CAC)
A low customer acquisition cost means that it’s alright for your annualized contract value to be low as well. You will be good to go as long as the ACV is higher than the CAC.
This comparison with CAC can help you know how fast you can take back the cost of acquiring a new client. If your ACV can’t offset the cost of acquiring a new user, it could be due to friction in the sales process, which delays the time taken to close deals.
Annual Recurring Revenue (ARR)
ACV is more useful in measuring marketing and sales performance. You can use this metric to create customer targeting and segmentation strategies.
Because ARR can be used to know the year-on-year revenue growth, it’s great for validating your business model and pricing strategy as well as pitching to existing and potential investors.
6 Actionable strategies for SaaS companies to increase annual contract value (ACV)
Now that you know how to make the best use of ACV, let’s see how you can improve it for your business.
Provide personalized in-app flows to create a positive customer experience
Personalization is a perfect means of showing customers that you put them first. You can personalize onboarding in different ways depending on the user behavior, user role, user state, and milestones.
Personalized interactive walkthroughs provide new users with actionable tips that would help them reach value faster.
Therefore, personalization leads to happy customers who drive user engagement and retention. They are more likely to upgrade or subscribe to higher-priced plans in the future.
To personalize onboarding, you first need to track in-app engagement and collect data. You can do this by using Userpilot’s feature tagging or tracking in-app interactions such as clicks, hovers, and text inputs to collect more insights.
Then you can use the data you collected to build and trigger personalized in-app flows.
Here, the image shows how Userpilot enables you to trigger a promo code.
Segment customers to focus efforts on power users
Create a separate segment for your best users – the power users. They are happy, stable, and long-term customers who keep making repeat purchases and bring up your ACV.
By focusing on users who are already using some of the most advanced features of your product, you can convert them into loyal brand advocates. They are also more likely to subscribe to even more advanced tiers.
To identify your power users, you first have to track their in-app interactions, as discussed above. Then create a power users segment based on the data collected.
Collect feedback from them to know what improvements you can make to your product and increase engagement among other segments as well.
Focusing on this segment is crucial for increasing the ACV as their recommendations can attract new leads and users, which will lower your customer acquisition cost.
Use tooltips to prompt customers to upgrade their accounts contextually
Tooltips are great for showcasing specific product features, and encouraging customers to upgrade. And it’s done completely contextually.
Here is how you can use tooltips.
When a user interacts with a particular feature on a high level and approaches the limit, trigger the tooltip to pop up to let them know what premium feature they are missing out on.
Use cross-selling techniques to sell add-ons and boost total contract value (TCV)
Cross-selling is a means of account expansion. It involves selling complementary products, which work well as standalone products but can be used for the same persona.
For example, Atlassian offers multiple products for project and product management teams. Now suppose a customer with a particular persona uses the Jira software. If the user needs another solution that makes it easier to collaborate with team members, they can sign up for Trello as well.
Make sure that the purpose of each product is clearly defined so that customers can easily take their picks and gain additional value.
Adjust the pricing plans and announce the change in a more personalized way
Price changes have varying degrees of impact on different customers. This is because customers are at different stages of the user journey with unique needs. Therefore, you need to customize your messages to address specific concerns directly.
Price increase announcements can be tricky since they might cause churn. Here, you should follow a different approach for each customer segment based on their current pricing plan and needs.
Userpilot lets you do so by segmenting users based on their frequency of user or subscription accounts and sending contextual in-app messages.
Here’s an example by Ahrefs. Take a look at how they have implemented in-app messaging to notify customers about pricing changes.
Use exit surveys to understand why customers are leaving and fight churn
Exit or churn surveys are a great way of knowing why customers leave your product.
The feedback can help you understand the critical issues that cause friction so you can improve your product or user experience accordingly. This helps to reduce churn among the remaining customers.
Furthermore, you can use exit surveys to show alternatives to deleting accounts, such as pausing accounts temporarily or downgrading. This might sway churning users to change their decision and thus prevent churn.
Conclusion
If you haven’t already started tracking ACV, it’s time to begin. Evaluate other financial metrics that determine the success of your business to find the right ACV. Further, combine ACV with your ARR and CAC to maintain stable revenue growth.
Want to track in-app interactions and other invaluable customer data to increase your annualized contract value? Book a Userpilot demo and see how easily you can do it.
