“What is ACV in sales?”, we hear you ask.
Well, are you a SaaS company or an organization that deals with yearly or multiyear subscriptions and/or contracts?
If so, it’s a key metric you might be missing out on.
In this article, we’ll teach you all you need to know about ACV.
Key takeaways
- ACV stands for “annual contract value.” It’s a metric that tells you about the yearly revenue generated by individual contracts.
- Calculating ACV can deliver many benefits, from increased customer retention to better forecasting.
- ACV is different from ARR. The former tracks revenue from individual customers, whereas ARR looks at total revenue.
- ACV and ARR are essential KPIs for tracking the success of subscription-based companies.
What does ACV stand for in sales
The meaning of ACV in sales is “annual contract value” and is a metric that tells you the revenue generated by a contract over a year.
It goes hand-in-hand with total contract value (TCV).
This is the total revenue you gain from a customer for a specific contract throughout their relationship with your organization.
However, ACV does differ from average contract value, which is the average amount of money you get from one contract.
ACV can be used for a variety of different contracts. These might include monthly or yearly subscriptions or plans with different pricing tiers.
By calculating it, you can evaluate the real value of your TCVs on a yearly basis.
The importance of knowing ACV in sales
ACV is an important metric for a variety of reasons. We’ve explored some of these below.
- It shows which customers are the most lucrative. Which customers are investing the most in your organization? Once you know this, you can nurture these relationships to drive more revenue.
- It helps when targeting new customers. An analysis of the demographics of these high-value customers helps you target prospects. Prioritizing campaigns that are likely to attract high-value clients can also boost revenue.
- It helps you plan. Your current ACVs can help you predict future sales. You might spot a clear trend in subscriptions either increasing or decreasing.
- It alerts you to a drop in customer retention. Is a customer beginning to invest less in your contracts? If so, you can take steps to reengage them.
How to use ACV, and who needs to use it
ACV helps companies identify the profitability of individual clients.
It’s a sales metric that’s used in a variety of organizations. These range from SaaS companies to magazine publications.
Essentially, if you have a subscription-based model, ACV is for you. Within these companies, this metric can be used by employees across various roles.
Let’s look at some examples of how different individuals might utilize ACV.
- Sales or marketing managers. Keeping an eye on your ACVs helps managers improve team performance. They can find ways to boost customer uptake and increase subscription rates.
- Sales reps. This metric can also inform which customers reps should target. They can use their time and resources more efficiently by focusing on customers with the highest value.
- C-suite executives can use this metric to inform the creation of future products. ACV can indicate which packages are working/popular and if a fresh approach is needed.
What is ARR?
ARR stands for “annual recurring revenue.”
This metric shows how much you generate from your recurring subscription accounts each year.
It’s a handy metric that can be deployed anytime to measure your revenue.
For subscription-based companies, ARR is a key indicator of success. As your company grows, so should this figure.
Calculating ARR is straightforward, but it’s important to note that it relates only to recurring revenue; it doesn’t include any one-off revenue items.
How to use ARR
ARR is a guide to the overall health of a company’s revenue. As with ACV, it’s a metric that can provide various insights.
These include:
- Monitoring the success of new subscription services
- Comparing growth between subscriptions of different lengths
- Helping forecast future sales cycles
- Providing insights into the performance of sales team members
ARR example
Calculating ARR should be relatively straightforward.
You simply need to add the annual value of each of your subscriptions or contracts.
This can be done by dividing the total revenue from each subscription by the number of years it covers. To make this clearer, let’s look at an example.
Imagine a company with 10 subscription customers. Five of these have one-year subscriptions at $500, whilst the other five have three-year subscriptions at $1,200.
The annual revenue from the one-year subscriptions would be 5 x $500, totaling $2,500.
The annual revenue from the three-year subscriptions would be 5 x $1,200/3, which gives a total of $2,000.
Adding these together gives a total ARR of $4,500.
To provide better analysis and support forecasting, overall ARR is often broken down into the following components:
ARR added from:
- New customers
- Renewals by existing customers
- Upgrades by existing customers
ARR lost from:
- Downgrades by existing customers
- Non-renewals
ACV vs ARR sales: What’s the difference?
Both are essential metrics—but what’s the difference between ACV and ARR?
Let’s take a look.
- Sales ACV tracks revenue for individual customers, while ARR looks at total revenue.
- ACV helps to measure the total amount of revenue generated for each client, identifying profitable customers. ARR is a metric that tracks company expansion.
- Some guides suggest that ACV should include all revenue earned within a year. ARR, on the other hand, only focuses on recurring payments. This is not, however, a general practice—both models usually take account of recurring costs only.
How to calculate ACV easily
Let’s look now at how ACV is calculated. Calculating ACV follows a similar process to ARR, except it looks at individual clients.
As with the latter, it divides the total recurring revenue by the contract length.
Calculation:
Examples of calculating ACV
Example #1: Magazine subscription
If we go back to our earlier example, we imagined five clients with a three-year subscription and five clients with a one-year subscription.
Instead of looking at the total annual revenue, the ACV calculates the annual recurring revenue from each client.
In this example, each of the three-year subscriptions was $1,200 over three years, generating $400 per year per client.
The five customers on one-year contracts each paid $500 per year.
This shows that one-year subscriptions are more profitable than three-year contracts.
Any analysis of this, however, would need to recognize the uncertainty of renewal after a one-year term.
Example #2: Internet security specialist
Let’s now imagine that the example we described above relates to an Internet security provider.
This company offers various services, such as firewalls, virus scanning, VPNs, and password generation, for a range of subscription prices.
In this scenario, let’s say that, in addition to basic services, two of our customers on three-year contracts have selected additional VPN services, which cost an extra $600 over three years.
In this case, those customers would have an ACV of:
$1,200 + $600 = $1,800
$1,800/3 years = $600
This shows us that not all customers have the same value to the company.
Although five customers have three-year subscriptions, the ACV of the two with additional VPN services is $200 higher than those who selected the more basic package.
Calculating ACV can highlight higher-value customers and so help refine your sales strategy.
High vs low ACV
It’s important to note that a low ACV isn’t necessarily a bad thing.
Many successful companies operate with a low annual contract value.
The catch is that most of these companies offer less expensive subscriptions with the expectation that sales volumes will increase.
Some subscription-based companies therefore need to sell more or fewer subscriptions than others.
A CRM SaaS product, for example, is generally more expensive than cloud storage, so a CRM provider will expect a higher ACV.
To generate the same income, the cloud storage business must aim for a higher sales volume.
Of course, there are companies that exist within the same industry but have different ACV goals.
Two SaaS companies might offer marketing automation products, but one may offer extensive features while another provides a more bare-bones solution.
These companies would likely have different pricing structures and ACV goals.
This is similar to luxury vs low-end brands. A high-end car company needs to sell fewer cars than a low-end brand to be successful.
So, a low ACV might not be a cause for concern for your organization. It is important to understand the ACV that your business model requires, though.
How to leverage ACV to make better decisions
ACV can be a powerful metric, helping inform strategies and boost subscriptions.
For example, you should look at customers with the highest ACV and ask yourself what strategies helped to win them over.
How can these strategies be used to bring in other clients and generate more high-value subscriptions?
As mentioned, ACV can also help you retain your most valuable customers.
Once you’ve identified them, you can develop effective retention and re-engagement strategies.
Another important upside of tracking ACV is it helps to boost the performance of your sales teams.
Keep an eye on the rates attributed to each employee.
Those with lower ACVs might benefit from undergoing additional training (you might, for example, send a team member on a course to improve their sales proposal skills).
Those with the highest rates, on the other hand, might be prime candidates for promotion.
Comparing ACV to other SaaS metrics
Alone, ACV can only provide limited insights. It’s most effective when combined with other useful SaaS metrics.
We’ve already talked about ARR, so now let’s look at some other examples.
Like ACV, these KPIs can have multiple purposes and will help with compiling your sales reports.
1. Monthly recurring revenue (MRR)
This reveals your subscription-based revenue each month. Essentially, it’s a more granular version of ARR.
You can spot patterns as they develop and track the success of subscription tiers throughout the year.
Your business may use both ARR and MRR. The nature of your contracts should guide you in evaluating which of the two is most useful.
If you tend toward longer-term contracts, ARR might be best.
If your subscription commitments are short-term, however, MRR may be especially helpful.
Here’s how to calculate MRR:
Average monthly revenue x the total number of subscribers in a month
2. Customer lifetime value (LTV)
This provides insights into the value of individual customers to your company.
LTV doesn’t just look at current data but projects the value of various customers throughout their relationship with your business.
It’s an essential metric that can inform your marketing and retention efforts and much more.
Here’s how to calculate LTV:
Customer value x the average customer lifespan
3. Average order value (AOV)
In this particular instance, this metric can be used to identify the average value of subscriptions.
AOV should be checked regularly to monitor the growth of your organization.
Here’s how to calculate AOV:
Total revenue / the total number of orders
Automating annual contract value: Making the most of ACV insights
If you’re only dealing with a small number of subscribers, manually calculating your ACV will be time-consuming but likely doable.
But as your subscriber list grows, you’ll find the task becomes much more difficult.
Instead of focusing on more valuable work, you’ll constantly be bogged down with admin.
And remember, you won’t just be calculating ACV but ARR and a host of other metrics.
Not only this but when dealing with so many calculations, you can easily make mistakes and produce the wrong information.
Luckily, automation offers a solution to this issue.
Specialist software can handle these calculations for you in a matter of seconds.
Moreover, as long as the data is right, there’s no risk of error—you’ll always get accurate information.
To put it in a nutshell, if you’re a company that deals with hundreds of subscribers per year, automation is the answer you’ve been searching for.
Optimize agreement workflows and maximize revenue with PandaDoc software
Calculating ACV is essential if you’re dealing with subscriptions.
Alongside other metrics, like AAR, MMR, and LTV, it’s an important KPI for tracking the growth of your company.
Used correctly, ACV can inform many aspects of your business.
You can refine your marketing and retention strategies, improve team performance, and more.
In short, ACV is key to maximizing revenue in your organization.
Of course, increasing revenue is vital to all businesses, so you’ll want to find tools to help you achieve this.
Frequently asked questions
-
ACV is the value of a customer’s contract averaged over a year. It’s calculated by dividing the total contract value by its length.
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SaaS bookings are the total sum of signed contracts with customers. This is before any money has been exchanged.
ACV, on the other hand, focuses on revenue for contracts over a year.
Both are essential factors to consider when dealing with contracts.
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