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What is annual contract value?

Annual Contract Value (ACV) sounds self-explanatory: The total revenue per client per year. The alleged easiness of the term lends to its lack of popularity among marketing and sales teams, in contrast to many other metrics used to measure the profitability of B2B businesses. Many financial experts claim that ACV doesn’t say much on its own, despite being very important for IT B2B lead generation. A company can have a low ACV and be successful. But ACV can reveal the true effectiveness of a chosen sales strategy and product development choices, when compared with other crucial metrics. For example, ACV helps appointment generators figure out whether they should spend more time cultivating qualified leads longer, how many leads they need to convert to achieve their sales goals, and how large an average deal is. Let’s look closer at this concept and see how to increase your annual contract value

Annual contract value definition

Basically, annual contract value measures the average value of signed contracts per year divided by the number of clients. The latter is an essential detail because there are many cases when the contract length (one year or more) influences the metric calculation. However, the definition of annual contract value somewhat differs - usually, the business model and the industry are taken into consideration.

ACV is used by SDRs to measure the total revenue a contract generates in a year. If a contract is less than a year, it cannot be included in its annual value. In SaaS businesses, ACV is valid for annual rather than monthly subscription-based solutions.  

B2B and B2C will have very different ACVs. B2Cs normally have a significantly lower ACV because it is a normal practice for them to have low-paying contracts but more customers. Contrastingly, B2B companies have fewer clients but higher-paying accounts and hence a bigger ACV. According to statistics, the average difference between ACV for B2C and B2B companies is ten-fold ($100 and over $1000, respectively).

Looks too simple?

Ok, it is more or less clear what an Annual Contract Value is. But what is Total Contract Value (TCV) and Annual Recurring Revenue (ARR) then? Their definitions sound very similar. Are they synonymous with Annual Contract Value? Not really.

TCV refers to revenue across the entire contract term. Financial teams need this metric to understand which of their customers are most valuable through years of cooperation.

ARR measures the annual revenue made from a single subscription rather than a company’s subscription per year. This metric is not SaaS-specific and is used across industries.

All these pieces of information should be compared and contrasted against each other. Many businesses use annual contract value calculation to compare it to ARR or CAC (customer acquisition cost) and see how well each contract is doing. 

Annual contract value calculation

It is up to companies to include additional charges into their ACVs. Some companies calculate ACV using the bare total revenue from contracts, while others may add, for example, training charges. 

Let’s take a closer look at how to calculate ACV for solutions of different length. A year-long contract needs no ACV calculation: e.g., if Lanos makes a 12-month contract worth $2000, ACV is $2000.

When a contract is longer than a year, its worth should be normalized accordingly.

For instance, if DAEWOO makes a 3-year contract worth $10,000 in total, its ACV is $10,000 / (36/12) = $3,333.

Thus, you calculate ACV for each customer, and then you find your average ACV. Using the examples above, your average ACV might look like this:

$2,000 + $3,333 = 5,333 / 2 = $2,666.

How to increase your annual contract value?

After ACV is measured, the next question is how to boost it to increase your revenue. Normally, increasing ACV has nothing to do with the product or service. ACV is not that easy to affect because the success of a company’s financial policies has many factors. Some suggest doing a lot of groundwork, fixing USP and ICP. Others recommend sales reps to qualify leads better and learn how not to waste time on lukewarm prospects. Among the most effective tactics of ACV increase are:  

Upselling and cross-selling. Famously, it is easier to sell a more expensive product to a loyal customer rather than nurture a B2B lead into closing a deal. However, proceed delicately and don’t focus on generating fast revenue - concentrate on customer health instead. Indeed, customer experience matters, so avoid giving an impression that you are pressing a client to buy more. Keep the customer’s interest as a priority. 

Raising prices. The process is not as straightforward as one might want. When raising prices, it is essential to move with caution and do it all elegantly: Notify customers beforehand, give them time to adjust to new prices, don’t rush them into signing deals, etc. Then your actions will be more successful.     

Overall

ACV is a reflection of many factors such as product architecture, marketing support, sales reps’ qualification, etc. Many businesses choose to track and analyze their financial metrics on their own, not allowing third parties to see their revenue. However, there is always an option to outsource ACV optimization to specialists. 

 

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