Total Contract Value: Why It’s Important and How To Calculate It
Jun 12 2019
Total contract value (TCV) is one of the most useful core SaaS metrics, but it's also one of the most poorly understood. And that's a shame. Understanding your TCV can help make your sales more efficient, lower your marketing costs, and improve your revenue predictions.
Fortunately, calculating your TCV isn't difficult. Let's walk through a quick definition of TCV, how to calculate your TCV, and why the metric should matter to your SaaS business.
Total contract value measures how much value a contract is worth once executed. It includes any recurring revenue from the contract, as well as all one-time charges like professional service fees, onboarding fees, and any other charges incurred throughout the contract term.
How to calculate your TCV
To help you understand how you can calculate total contract value, let's first go over the TCV formula, then we'll walk through an example showing how to calculate TCV for SaaS companies.
The TCV formula itself is fairly straightforward:
Total Contract Value = (Monthly Recurring Revenue * Contract Term Length) + Contract Fees
Changing themonthly recurring revenueor offering longer or shorter contract terms can have a dramatic effect on TCV. Remember to account for any variations when comparing TCV bookings if you happen to update yourpricing strategyor contract length.
Also, TCV differs from customerlifetime value(LTV) in that it's based on actual contract commitments instead of projections. This means you can't calculate TCV for month-to-month or evergreen subscriptions since there's no way of knowing the contract term length in advance. And the TCV for one-time payments is simply the total amount paid by the customer since there's no recurring component.
Calculating TCV: an example
Marketing platformHubSpotoffers a range of different prices and plans for theirMarketing Hub, depending on what their customers need. Let's look at the TCV of two different hypothetical HubSpot customers:
Customer A:Signs up for the Starter plan at the base price of $50/mo for a one-year contract.
Customer B:Signs up for the Enterprise plan at the base price of $3,200/mo for a two-year contract, plus a one-time onboarding fee of $6,000.
For Customer A, the TCV is calculated like so:
( $50 MRR * 12 months ) + $0 fees = $600
The TCV for Customer B is calculated the same way:
( $3200 MRR * 24 months ) + $6000 fees = $82800
TCV is a powerful but overlooked metric for SaaS businesses
Understanding total contract value is particularly useful for SaaS and other subscription companies, but the metric is often overlooked in favor of flashier numbers. Predictive metrics such as customer lifetime value (LTV) impress investors and validate growth—but they're often unrealistically positive, especially in the early days of a company.
Since total contract value reflects true bookings instead of predictions, it shows how a company is growing and predicts revenue more accurately, helping you optimize your sales and marketing efforts.
Predict your revenue more accurately
Basing your calculations on TCV instead of LTV gives a more accurate prediction ofrevenue growth. This accuracy can protect you from increasing staffing spend too quickly or limiting your marketing budget unnecessarily. Accurate revenue numbers also make for happy investors.
Identify your most profitable customers
Like we saw in the HubSpot example, SaaS businesses can have a large or small TCV and still be successful. No matter the contract length and value of a customer, though, breaking down TCV bookings by customer segment can help your sales teams better understand your customers. Your TCV allows you to see which customer groups are spending the most, helping you concentrate your sales resources on the most profitable leads and simultaneously increasing revenue and lowering costs.
Discover which package lengths work for which cohorts
Different contract lengths also tend to work better or worse across different customer segments. You might find, for example, that a certain demographic only buys subscriptions one month at a time, while others are more likely to pay upfront for a year or longer. By knowing which package lengths work best for which cohorts, you can optimize your sales for longer contracts, increasing your average TCV.
Optimize your sales and marketing spend
Marketing is a game of efficiency—the money you're investing in growth needs to return more than what you're investing. Dividing TCV bookings by yourcustomer acquisition costmeasures the efficiency of your marketing efforts. This lets you understand which marketing channels you should double down on and which channels might be hindering your growth.
TCV vs. ACV (annual contract value)
While TCV includes all the payments across the length of the contract,annual contract value (ACV)normalizes bookings across a single year. Many companies also choose to exclude one-time fees and customerchurnfrom their ACV calculations.
Let's jump back to Customer B in our earlier HubSpot example. While the TCV is $82,800, excluding the onboarding fee and dividing by the two-year contract length means the ACV is only $38,400.
Just like TCV, there's no correlation between company success and high versus low ACV. Take webinar companyZoom, for example—their ACV isat the lower endof their cohort, but their growth rate, profitability, and marketing efficiency are all among the highest in the business.
ACV comes in handy over TCV for comparing different cohorts and for analyzing growth. Annualizing contract value eliminates the differences arising from varying contract lengths, making it much easier to see whether new bookings are growing over time and whether those bookings are truly more valuable versus just being longer.
No matter how you choose to calculate ACV, though, everyone in your company, along with any investors and stakeholders, must calculate it the same way. Keeping your metrics consistent helps avoid confusion and ensures everyone has a shared direction when making decisions.
TCV impacts more than just profits
Understanding how to calculate your TCV helps you improve your revenue estimates, increase your marketing return, and optimize your sales revenue. Remember, though, that having a higher TCV doesn't mean your company is more successful—it just gives you another tool in your belt to help you grow faster.
By Patrick Campbell
Founder & CEO of ProfitWell, the software for helping subscription companies with their monetization and retention strategies, as well as providing free turnkey subscription financial metrics for over 20,000 companies. Prior to ProfitWell Patrick led Strategic Initiatives for Boston-based Gemvara and was an Economist at Google and the US Intelligence community.