What Is ACV In SaaS & What Is A Good
ACV For SaaS Companies?
Imagine you’re running a B2B SaaS business and you just landed two new customers.
Let’s say Customer A signs a three-year contract worth $3,000. While Customer B’s contract will last for only a quarter and is worth $300.
Now, if you just looked at the revenue figures, it would seem like the first customer is much more valuable.
But what if you didn’t consider the length of the contract? How would you know which customer brings you more revenue in a shorter amount of time?
This is where the annual contract value (ACV) comes in.
What is ACV in SaaS?
The annual contract value is the annualized revenue you receive for a specific customer. It is an important SaaS financial metric, especially for SaaS businesses that have multi-year or longer-term contracts.
The thing about the SaaS ACV is that not all SaaS businesses look at it the same way.
However, almost all of them agree that it should only include recurring revenue. That excludes one-time fees for setup, onboarding, or software installation.
How To Calculate ACV
To calculate your annual contract value, simply take the total contract value (TCV) and divide it by the number of years in the contract.
Let’s take our earlier example, Customer A signs a three-year contract worth $3,000. That means your ACV calculation would look something like this:
$3,000 / 3 years = $1,000 per year.
But how about customers whose contracts last for less than a year? How about those who didn’t sign any contract and just use your SaaS product month to month?
The ACV calculation method we mentioned above still applies.
The key word here is “annualized.”
So let’s take Customer B from our earlier example. Their $400 contract lasts for only a quarter, so that’s 0.25 of a year.
Calculating ACV for that customer contract would look something like this:
$300 / 0.25 year = $1,200 per year
For another example, let’s add a Customer C who doesn’t have a contract, but consistently subscribes to your SaaS product every month for $120.
The formula we discussed earlier would still apply. But in a case like this, annualizing your monthly revenue would be easier if you just multiply it by 12.
To annualize their revenue, we’ll just multiply the monthly recurring revenue (MRR) from that customer by 12:
$120 x 12 months = $1,440 per year.
ACV VS ARR
Now that we’ve gone over what is ACV in SaaS, let’s compare it to other important financial metrics like annual recurring revenue (ARR).
It can be easy to confuse ACV with ARR since they are both key performance indicators (KPIs) that measure your annual revenue.
But the main difference is that ARR accounts for your recurring revenue for all of your customers, while ACV only deals with one contract or customer.
So you could look at your ARR as the total ACV among all of your customers.
ACV VS ARPU
If ARR is practically the total ACV of all your customers, does that mean it’s the same as your annual ARPU?
No. But they are also closely related.
The average revenue per user (ARPU) is the average amount of revenue you generate per customer or user.
In calculating your ARPU, you take your total ARR and divide it by the number of customers or users you have.
As suggested by the metric’s name, ARPU is the average recurring revenue you’re getting for each customer.
There is only one ARPU for all of your customers. Unless you’re tracking it per segment, in which case, there is only one ARPU for each customer segment.
On the other hand, ACV is the actual recurring revenue you’re getting from a specific customer. It varies from customer to customer.
So you could also look at your annual ARPU as the average ACV among all of your customers.
Why Is Calculating ACV Important?
But what makes ACV so important?
There are a few reasons.
It Helps You Compare Your Customers With Each Other
As you can see from our examples above, different customers can have different ACVs.
Some may sign longer contracts. Others may sign shorter ones. And some may not sign any contract at all and just pay month to month.
So by calculating the ACV for each customer, you can get a better idea of which ones are bringing in more revenue to your business.
It Helps You Compare Your Business With Competitors
In any industry, it’s important to keep an eye on what your competitors are doing. And that includes tracking their financial metrics.
By knowing what their ACV is, you can get a better idea of how much recurring revenue they’re generating per customer.
This, in turn, can give you some insights into how well they’re doing compared to your business. If they generally have a higher ACV than you, you might want to find out how they are doing it.
You might learn a thing or two to help you keep up or even overtake them.
It Helps You Measure Your Profitability
On its own, ACV doesn’t really tell you how profitable your business is.
Sure, it tells you how much revenue you’re getting from a specific customer. But it doesn’t really take into account the costs of acquiring and retaining that customer.
That’s why you also need to compare your ACV with your CAC.
Your CAC is the average amount of sales and marketing costs you’ve spent to acquire a single new customer. That includes things like your ad spend, salaries, commissions, and license fees for SaaS solutions that you use for those operations.
Now, dividing your CAC with your ACV can tell you how long it will take you to recoup your customer acquisition costs.
For example, let’s say your CAC is $1,000 and your ACV is $2,000.
$1,000 / $2,000 per year = 0.5 year
That means it will take you half a year (or six months) to make back your customer acquisition cost.
Ideally, you want this number to be as low as possible. That way, you’re breaking even and making a profit sooner.
What Is A Good ACV For SaaS Businesses?
Now that we’ve discussed what ACV is and why it matters, you might be wondering what’s considered a good ACV for a SaaS business.
Unfortunately, there’s no one-size-fits-all answer to this question. Every business is different, and what works for one might not work for another.
So let’s look at a few studies made on SaaS businesses and their ACVs.
According to a survey by Pacific Crest, the median ACV for 400 private SaaS companies was $21,000. Twenty-six percent of respondents say that their ACV falls below $5,000, and 13% say it’s above $100,000.
However, this study doesn’t categorize all 400 respondents in any way. That’s probably why they got a lot of different answers that are so far apart from each other.
After all, $5,000 to more than $100,000 in ACV is indeed a pretty wide range, don’t you think?
Now, a separate study by RJMetrics managed to establish an average both for business-to-business (B2B) and business-to-consumer (B2C) SaaS businesses.
B2B SaaS businesses have an average ACV of around $1080, while B2C ones make an average of $100.
Of course, these are just averages. Your business might have a lower or higher ACV, and that’s perfectly fine.
The important thing is to track your ACV over time and see if it’s growing or shrinking.
If it’s growing, that means you’re doing something right. If it’s shrinking, that’s a red flag that you need to address.
How To Improve Your Annual Contract Value
Increasing your ACV is so much easier said than done. What’s more, it’s not really the end goal.
But an improved ACV is a good sign of growth.
If you’re generating more revenue per contract per year, it’s a good indicator that your business is expanding.
So how do you do that? Here are a few tips:
- Make sure you have a value-based pricing strategy
- Boost your SaaS upselling efforts
- Move upmarket (start selling to enterprise markets)
Let’s talk about them one by one.
1) Make Sure You Have A Value-Based Pricing Strategy
Knowing how to price your SaaS product is one of the most important aspects of running a successful business, especially for SaaS startups.
After all, if you price your product too low, you might not be able to make a profit. Price it too high, and fewer people will be willing to buy it.
The key is to find that sweet spot where your pricing is just right.
But how do you do that?
One way is to base your prices on your product’s perceived value.
In other words, ask yourself, what are the benefits that your customer gets from using your product? How does it make their life easier or solve their problems?
But the most important question is “How much are your customers willing to pay for those benefits?”
You can answer that question by conducting customer surveys, interviews, and focus groups.
Based on their answers, you can come up with a price range that maximizes your revenue while making sure that your customers are still happy with the pricing.
2) Boost Your SaaS Upselling Efforts
SaaS upselling is the process of getting your customers to upgrade to more expensive subscription tiers of your product.
For example, if you offer a basic and premium version of your software, you can upsell your customers from the basic to the premium version.
One of the most effective ways of doing this is setting upsell triggers and monitoring your customers’ usage of your product.
Upsell triggers can be any action or event that indicates that the customer is ready for an upgrade. For example, if they’ve reached a certain number of users or if they’ve been using your product for a certain amount of time.
When you see that one of your customers has hit an upsell trigger, you can reach out to them and offer them an upgrade before they can renew their contracts.
This way, the upsell is not just about you making more money. It’s also about helping them scale and benefit more from your product.
3) Move Upmarket
Moving upmarket is the process of selling to bigger and more established companies.
If you’re selling a B2B SaaS product, you may have started by targeting end-users and small to medium-sized businesses (SMBs).
But as your product matures, you can start targeting bigger enterprises. They usually have more money to spend and are more willing to pay for a high-quality product.
Still, expanding your SaaS product and target market is no joke.
Remember that it’s a whole new market you’re selling to. You have to do your homework and research what these bigger companies want and need. You’re going to need new ideal customer profiles (ICPs) and buyer personas.
What’s more, bigger companies usually have different requirements and expectations. They’re also more risk-averse, so they’ll be more careful about what products they invest in.
This is why it’s important to have a solid go-to-market (GTM) strategy in place before you start selling to enterprises.
Final Thoughts About The Annual Contract Value
The ACV is one of the most important metrics that a SaaS company should track.
Not only does it enable you to assess how much revenue you are bringing in through a specific customer. It can also help you evaluate how profitable that contract is.
Still, ACV on its own doesn’t tell much of a story. It’s best used in conjunction with other metrics like ARR, ARPU, and CAC.
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