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When customers enter contracts with businesses, service providers, or vendors, one of the most essential aspects of the agreement is the total contract value (TCV).
TCV is a measure of the long-term value of the contract, which can be calculated as a sum of two components: the average annual revenue generated by the agreement and the estimated lifetime value.
What is TCV (Total Contract Value)?
Total contract value is the total worth of a contract over its lifetime. It includes the estimated short-term revenue generated by the agreement and any potential long-term revenue resulting from renewals or expansions.
Subscription-based companies use TCV to quantify the worth of their contracts for better decision-making and revenue forecasting.
By calculating TCV, organizations can identify opportunities for growth and adjust prices accordingly to generate maximum
When calculating total contract value, businesses account for the expected annual contract value (ACV) and customer lifetime value.
Annual revenue is the amount a company will receive from customers in a given year, while customer lifetime value (LTV) represents the net present value of all future retained profits over the course of an agreement.
In revenue management, these figures are based on averages derived from past performance and industry data.
Unlike annual recurring revenue (ARR) and monthly recurring revenue (MRR), the total contract value includes add-ons, such as additional services and subscription renewals, that may increase the agreement’s value over time.
- Customer Lifetime Value (CLV) – The total revenue predictions of a customer throughout the duration of their agreement.
- Annual Contract Value (ACV) – The revenue generated by an agreement in any given year.
- Predictable Revenue – Revenue that can be reliably forecasted over the course of an agreement.
- Subscription Value – The total value of subscription-based services over a period of time.
Total Contract Value (TCV) vs. Annual Contract Value (ACV)
Although TCV and ACV are both essential components of any commercial contract, there are several differences between them.
The annual contract value will indicate how much a company stands to make in the present agreement term.
The total contract value, however, measures larger long-term goals such as customer lifetime value and customer retention rate. It also looks at expected revenue from any potential expansions or renewals.
When looked at retrospectively for reporting purposes, the difference between ACV and TCV can be quite visually significant.
For example, the ACV of a single-year contract is the annual revenue generated by that agreement, while TCV considers all potential renewals and expansions.
Simply put, ACV measures average profitability over a shorter contract period (one year), while TCV takes a holistic look at long-term value.
Because it doesn’t factor in one-time fees, ACV is best used to evaluate the success of current campaigns and marketing endeavors. TCV is better for evaluating the long-term success of contract strategies.
Total Contract Value (TCV) vs. Customer Lifetime Value (CLV)
ACV and CLV are closely related, but there is a critical distinction between total contract value and customer lifetime value.
TCV measures the revenue generated by a single contract over its duration. Customer lifetime value looks at the average revenue per customer over time, up to and including potential renewals or expansions.
In other words, TCV measures one agreement’s estimated profitability, while CLV provides a more expansive view of the customer’s overall value, including multiple revenue streams.
Although these terms seem similar and are sometimes used interchangeably, it is essential to note that their functions differ in revenue management.
For instance, a Software-as-a-Service (SaaS) company that wants to implement new pricing strategies or test new marketing channels should use TCV to evaluate the potential returns of each contract at each price point and marketing channel.
In this same situation, CLV can be used to identify revenue opportunities from renewals, upsells, and other inside selling techniques.
Importance of Total Contract Value (TCV)
For companies that use the subscription model, TCV offers a more accurate view of an agreement’s value than just the ACV.
Without considering renewals and potential expansions, it is impossible to accurately predict long-term revenue or make informed decisions on contract terms.
Predictable revenue is a critical part of revenue management. In the subscription economy, customer retention is more important than ever, and understanding the total contract value of each agreement can unlock new opportunities to acquire and retain customers.
And although businesses can get a good idea of customer lifetime value from customer acquisition costs, predicting TCV is the best way to measure specific customer revenue streams.
When companies determine where they need to put their money, a big part of the decision-making process is understanding the total contract value of their agreements.
Companies can use TCV to better understand their budgets and decide where to invest their funds.
By determining the expected total contract value, companies have a better idea of how much they are willing to risk in order to obtain new customers or retain existing ones.
With so many marketing channels available, customer acquisition costs can quickly skyrocket while the most successful ones are often unknown.
When companies measure the total contract value from all sales and marketing efforts, they can determine which channels drive the most revenue and double down on the ones that work the best.
How to Calculate Total Contract Value (TCV)
Four things go into calculating TCV:
- Monthly Revenue Per Customer: This is the expected or actual revenue generated from each customer per month.
- Contract Lengths: You will multiply your MRR by the length of the contract in order to get an estimated total for each agreement.
- Renewal Rates: Many companies offer discounts at the time of renewal, so it is important to factor these into the calculations if this is the case.
- One-Time Fees: Any one-time fees or setup charges should be included in the calculations.
Total Contract Value Formula
The TCV formula is as follows:
Monthly Recurring Revenue × Contract Length + Renewal Rates + One-Time Fees = Total Contract Value
For example, let’s say that a company is offering an annual subscription at $500 per month. The total contract value would be:
$500 x 12 months + 0 (no renewal rates) + $99 (one-time setup fee) = $6,099 TCV.
How to Increase TCV
(one of the ways should include using technology, including CPQ and subscription management software)
Increasing total contract value is one way to ensure long-term health for any business. There are several methods to increase TCV, including:
1. Incentivize longer contract lengths
The main reason that MRR doesn’t give firms a complete picture of actual revenue over the contract’s life is that it doesn’t consider renewals.
Companies can increase their total contract value by changing future contract terms to lock in a longer contract length, and they can incentivize customers to sign longer contracts by offering discounts or exclusive benefits (e.g., testing out beta software, free add-on features, etc.).
2. Optimize pricing
Companies can also increase total contract value by optimizing their pricing models.
By understanding customer needs and budget constraints, firms can adjust their pricing to ensure they are charging the right amount while still maximizing revenue.
One way to do this is by creating pricing tiers offering different access levels or services. This allows companies to attract both high-value and low-value customers.
3. Add new revenue streams
Since TCV factors in both recurring and one-time revenue, companies can increase their total contract value by developing new products or services that will generate additional income.
Companies can also expand their existing offerings by partnering with other businesses to offer bundles of related services.
One of the best ways to do this is with the “freemium” business model, which offers a basic version of the product for free and charges more for additional features.
4. Use technology to automate the process
There are plenty of tools out there to help companies automate their sales and marketing processes and drive revenue growth.
CRM software is one of the best tools for managing customer relationships, tracking leads and sales opportunities, and analyzing customer data.
By improving the overall customer experience, these tools can help reduce the monthly churn rate, increasing the total contract value.
For businesses with complex pricing models, CPQ software can quickly generate and send quotes. This allows companies to create accurate contracts with the right pricing and terms for each customer.
People Also Ask
Why is ACV better than TCV?
ACV is better than TCV because it is more standardized.
Since it is based on mathematical averages, it provides a more consistent measure of the company’s value over time. It also eliminates one-time costs and discounts that can skew total contract values, giving a more reliable picture of actual revenue across multiple contracts.
What is the difference between contract value and contract price?
Contract value is the total amount of money a customer will pay over the contract’s life.
Contract price, on the other hand, refers to the amount of money charged for each individual service or product in the contract.
The two values are not mutually exclusive—contract prices can be used to determine total contract value by multiplying them by the number of services or products included in the contract.
How do you convert TCV to ACV?
By subtracting one-time fees and dividing the resulting amount by the contract length (in years), you can convert TCV to ACV. This will give a more accurate measure of the true value of each customer over time.