The world of SaaS is awash with cryptic acronyms. If your business model relies on annual subscriptions, ACV will be a term that’s constantly on your mind as your company grows.So, what is ACV in sales and what is a typical SaaS ACV? We explain all that and more, below.
What is ACV in Sales?
ACV (annual contract value) is a metric that typically represents the average annual contract value of a customer subscription. It is used by SaaS businesses that have a primary focus on annual or multi-year subscription plans. The term ACV is often used interchangeably with “ACV bookings” (the total value of accepted term contracts), which, depending on your particular calculations, might be the same thing as ACV – or completely different.
How to calculate ACV
Let’s imagine your star salesperson signs up a new customer for a 36-month contract for a total of $180,000. Once you’ve popped the champagne and given everyone vigorous high-fives, it’s time to punch those numbers. A $180,000 contract spread across 36 months will give you a monthly recurring revenue (MRR) of $5,000. As ACV is an annualized measurement spanning a 12-month period, you’ll need to multiply your MRR by 12. This contract will, therefore, be valued at $60,000 in terms of its ACV. In essence, it seems identical to annual recurring revenue (ARR), but we’ll get to that shortly. Individual businesses all have different methods of calculating their internal ACV. This may or may not take into account:
- One-time fees (e.g. training, set-up costs) which will make the first year’s ACV in a multi-year contract higher than the following years
- Expansion revenue from upsells/cross-sells
- Customer churn rate
- Calculating ACV for all contracts and adding them together
- Calculating ACV for all contracts and finding the average value
If you take the above example of the 36-month contract with its $60,000 ACV, you might decide that you prefer to include the initial set-up and training costs as part of your calculations.
Let’s say there’s a training fee of $8,000, plus an implementation fee of $2,500 as part of the total contract. This would change the ACV for the first year to $70,500 in order to incorporate the one-time fees, but the remaining two years will still have the original ACV of $60,000.You can see how ACV can be a confusing metric for startups to get to grips with. Plus, it’s almost impossible to gauge comparisons with other similar companies who might well be calculating things in an altogether different way than you are.
ACV versus ARR
At a glance, these metrics might seem like one and the same – the total value of all completed contracts per annum. If you’re adding the values of your ACVs instead of averaging them, you will most likely reach the same figure as your ARR, just in a more roundabout way. Zuora defines ARR as follows:
“The value of the recurring revenue of a business’s term subscriptions normalized for a single calendar year.”
Unlike ACV, it’s a metric that is agreed upon across the industry and shows the amount of revenue a SaaS company expects to repeat year upon year.
ARR takes stock of basic accounting principles in its calculations, primarily that:
- One-time charges are not included
- Only contracts of 12 months or greater in duration are included
- Billing cycle structure is not important – as long as the subscription is longer than 12 months, the cycle timing is irrelevant
- It can be calculated to the exact day
What is a typical SaaS ACV?
There appears to be little in the way of solid data to guide SaaS companies on what a typical ACV should be for their particular business. Owing to a wide variety in subscription models, pricing, business-to-customer versus business-to-business sales, and company-specific calculations, most of the information available on what makes “good” or “bad” ACV is tentative at best.
A Pacific Crest survey of 400 private SaaS companies showed that there was a median of around $21,000 when it came to calculating ACV.In this survey, 26 percent of respondents came in below $5,000 and 13 percent came in above $100,000 for the value of their annual contracts. This survey sample is small, however, and does not contain a wide enough sample of SaaS companies to represent the industry as a whole.Additionally, these numbers should be taken with a grain of salt as they do not take into consideration the vast differences from one SaaS company to the next. A typical SaaS ACV should not necessarily be evaluated on its own as just good or bad, but rather within the context of all the other financial metrics measuring the success of the company as a whole.
According to an RJMetrics study, there is also a marked difference between business to customer (B2C) and business to business (B2B) calculations. Their study showed the average B2C customer has an ACV of $100, while the average B2B customer has an ACV of $1,080 – over 10 times higher.
How useful is ACV as a standalone metric?
ACV is one of the core metrics for SaaS companies, but it’s best looked at in conjunction with other metrics such as customer acquisition cost (CAC), total contract value (TCV), and annual recurring revenue (ARR) as opposed to analyzing a standalone metric.
A high ACV often correlates to a higher CAC, as more effort will be spent finding leads and turning them into big-ticket contracts. If your ACV calculations look woefully low against that of other companies, it might be that your sales process has lower friction. In reality, you might be better off than your competitors as you don’t have to spend so much money and time on securing contracts.
There is no visible correlation between high versus low ACV value and company growth. Some of the fastest-growing startups (e.g. Slack) fall under the low ACV umbrella, yet they have still been able to succeed and scale at lightning speed.
In conclusion, ACV is one of those murky metrics which is hard to get a firm grip on across the wider SaaS industry. No matter how you decide to define and calculate ACV for your own business, it’s important to ensure your entire team is on board with your exact method of calculation. This will help ensure consistency and accuracy when it comes to evaluating your revenue and growth.
This blog was contributed by Lighter Capital, this article originally appeared on The Startup Finance Blog.
