Revenue
What is Total Contract Value?
SaaS companies utilize a variety of insightful revenue metrics to understand financial performance, create accurate predictions, and make informed decisions.
The list of possible metrics to use is expansive and includes a number of highly similar terms that often get confused, conflated, and misunderstood.
For example, TCV (Total Contract Value), ACV (Annual Contract Value), and LTV (Customer Lifetime Value) all appear to provide very similar insights into the value of an average customer deal.
Of the three, TCV is one of the least understood and, therefore, often underused.
In this article, you’ll learn what total contract value is, how to calculate it, and how SaaS companies can use this helpful metric to understand marketing ROI, improve sales effectiveness, and make more informed revenue decisions.
What Is Total Contract Value?
Put plainly, Total Contract Value (TCV) is the total amount of revenue you receive from a given customer. It includes all recurring subscription revenue as well as one-time fees that may be associated with the contract, such as implementation fees.
For example, let’s say you’ve closed a deal with a new customer, and they’re paying $5000 per month on a 24-month contract.
The deal also stipulates an implementation fee of $8000 to get the customer set up on your platform, import data, and train their team members.
Your TCV would include this fee, as well as the recurring revenue ($5000 x 24 months + $8000 = $128,000).
This is a critical metric for SaaS business as it’s a direct reflection of the revenue you’ll receive over a given period of time. By understanding TCV across all customers, subscription-based startups are better able to make investment, expansion, and spending decisions.
How To Calculate Total Contract Value ?
Total Contract Value includes all of the revenue you’ll receive from a given customer over the duration of their contract.
To calculate TCV, you need the following information:
Monthly recurring revenue (MRR) for the contract
Length of the contract
Any one-time fees included
The formula for TCV is as follows:
TCV = MRR x contract term length + one-time fees
Let’s illustrate with an example.
Take HubSpot’s pricing model for its marketing software platform.
Let’s say HubSpot wants to calculate TCV for a new enterprise customer.
This customer has signed up for the Enterprise plan for 36 months, with a monthly recurring revenue value of $3200.
However, the client also needs to migrate from their existing marketing platform. This requires data migration and a customized setup and onboarding process so the HubSpot team can train key users of the product and set the system up in a way that works best for their current workflows.
This process is going to cost an additional $11,000.
Applying the Total Contract Value formula (TCV = MRR x contract term length + one time fees):
TCV = $3200 x 36 months + $11,000
Meaning HubSpot’s Total Contract Value for this specific client is $126,200.
Any change, then, in either the length of the contract or the value of MRR affects the final TCV calculation.
Why Is TCV Important?
As you’ve seen, calculating TCV isn’t particularly difficult, but what does it offer SaaS revenue leaders over other revenue metrics?
One of the major benefits the Total Contract Value metric provides is its inclusion of one-time fees. Many other revenue metrics, such as Annual Recurring Revenue (ARR), don’t include this figure.
While these metrics are valuable, they don’t paint a comprehensive picture of your revenue situation. This is particularly important for companies targeting enterprise clients, where one-time implementation and onboarding fees are more common.
The other major reason TCV should form a crucial part of your revenue monitoring is that it's a true measure of your company’s financial health.
Where metrics like Customer Lifetime Value (LTV) appear impressive to investors and can help to validate growth claims, they aren’t realistic measurements of financial health because they’re predictions.
LTV is a running estimate of the projected revenue you’ll receive from a given customer. TCV is calculated using real-life contracts that existing clients have signed.
This has important implications for making revenue decisions.
For example, let’s say you’re planning a headcount for the next financial year and need to determine how many new sales reps to hire to meet your revenue goals.
While this is partially based on your objectives, it’s also going to be crucially tied to your current cash flow (you can’t hire beyond what you can afford to pay).
Metrics like LTV can lead you astray in this scenario, as they’re not true indications of financial health.
TCV, on the other hand, tells you exactly what you can expect to receive from your current customers over a specified time period, meaning you can make more informed, accurate financial decisions such as hiring.
How Can SaaS Companies Use TCV Indicators?
TCV has a number of insightful uses. Let’s review the four most important ways that SaaS companies can leverage TCV indicators.
1. Better Understanding of Client Base Makeup
TCV is a powerful metric for understanding the structure of your existing client base from a financial perspective.
Revenue leaders can perform an analysis of their primary customer segment, determine which segments deliver the highest TCV, and prioritize those clients in marketing activities.
If you sell a CRM platform, for instance, an analysis of your TCV across each segment might reveal that small and medium sized businesses are your most lucrative clients, so marketing efforts such as content creation should be geared toward this audience to maximize revenue impact.
2. Optimize Sales Targeting
TCV can also help SaaS companies understand how to prioritize sales rep outreach.
By analyzing the data you have on your existing customers (such as buying characteristics, behaviors, and demographics), you’ll be able to pull out the key identifiers that point to high-TCV clients.
For example, a marketing automation platform may identify that across their largest TCV customers, a common factor driving the purchasing decision was the need to scale.
This information can be applied to lead scoring by prioritizing inbound leads that include the word “scale” (or specified synonyms) in their lead capture form.
3. Understand Marketing Efficiency
Metrics can be helpful in isolation, but they’re often much more valuable when analyzed together. SaaS revenue leaders can combine TCV with CAC (Customer Acquisition Cost) to understand the return on investment on marketing spend.
The simple calculation, in this case, is:
ROI = TCV / CAC
For example, if you have a Total Contract Value of $140,000 and your CAC is $4,000, your ROI on this spend is 35:1.
Breaking this down by segment helps us determine where marketing spend should be prioritized.
4. Make Stronger Revenue-Based Decisions
SaaS companies use TCV to make data-backed decisions. Where values such as LTV are useful forecasters, they are inherently predictions, meaning they can be unreliable metrics for making revenue decisions based on.
Total Contract Value, on the other hand, is grounded in actual bookings, not projections, so you can more confidently rely on this metric to make revenue decisions.
For example, a company looking to expand into new territory might use TCV to understand their expected revenue for the next 36 months, the timeframe in which they’ll be investing heavily in marketing activities in this new region.
Problems With Using TCV as an Indicator
While TCV is an important metric for revenue leaders to track, it’s not without its problems.
The main drawback of using Total Contract Value is that it’s assumptive. That is, you’re making the assumption that just because a contract is signed, that revenue is 100% guaranteed.
It may be in theory, but in practice, it is anything but.
Contract cancellations do happen, and while you may have cancellation clauses built-in, enforcing these is unlikely to recoup the totality of the revenue loss.
Plus, you need to consider whether you’re really going to enforce that clause (often, cancellation clauses are used more as a deterrent than actual punishment, like a dummy camera set up on a busy streetside).
Let’s look at an example.
You close a customer on a 36-month term, with an MRR of $3500 and one-time fees of $2000.
Your TCV looks like this:
$3500 x 36 + $2000 = $128,000.
Unfortunately, after the first year and a half, your client is acquired by another firm that uses a competitor product and wants to cancel their contract to ensure uniformity across their entire organization.
Let’s imagine, in this scenario, you have a cancellation clause that stipulates early contract cancellations pay an additional three months of their one year contract, and you decide to enforce it.
In this case, then, your TCV calculation is:
($3500 x 18) + ($3500 x 3) + $2000 = $75,500
In the end, the contract amounted to just 59% of your projected TCV. While situations like this may be the exception rather than the rule, they are an expectation at scale, meaning Total Contract Value as an indicator should be used with some caution.
Difference Between TCV and LTV
TCV and LTV are two commonly used and important SaaS metrics. However, there are some crucial differences SaaS leaders must understand.
TCV (Total Contract Value) measures the total value of revenue you receive (recurring and one-off) from a given customer. LTV (Customer Lifetime Value) is a projection of the amount of revenue you’ll earn from a given customer.
While these seem to be describing the same metric, the crucial difference is that LTV is based on your projections (that is, what you expect the average customer to look like), whereas TCV is based on actual contracts you have with real customers.
There is also less consensus on calculating LTV than there is with TCV.
The formula for TCV is pretty clear cut:
TCV = Monthly revenue x duration of contract (in months) + one-time fees
With LTV, there are a few ways that you can arrive at this figure:
Average monthly revenue per customer x Average customer lifespan
Average monthly revenue per customer / Monthly churn rate
Average order value x Number of repeat sales x Average customer retention time in months
The method you choose for calculating Customer Lifetime Value will inevitably depend on your revenue model.
If you sell a physical product, for example, you’re unlikely to have an “Average monthly revenue value,” so the last formula on the above list will be more suitable. The opposite is true for SaaS and other businesses operating on a subscription model, such as publishing companies.
Difference Between TCV and ACV
TCV (Total Contract Value) and ACV (Annual Contract Value) appear, at least on the surface, to be very similar revenue metrics.
While they are, there are two crucial points to make in the Annual Contract Value vs. Total Contract Value debate.
The first is obvious: ACV measures the value of a given contract for a single year. TCV, on the other hand, measures it across the duration of the contract.
You’d expect, then, that for a 36-month contract, TCV would be exactly three times the value of ACV. However, this calculation ignores the second distinction:
TCV also takes into account one-time fees (such as onboarding and training fees).
As such, the calculations for these metrics are as follows:
TCV = Monthly recurring revenue x Duration of contract [in months] + one-time fees
ACV = (Total Contract Value - one-time fees) / Duration of contract [in years]
Are TCV and Total Revenue the Same?
Total contract value vs. revenue: are they the same thing?
The short answer is no; these metrics are crucially different.
TCV demonstrates the total amount of revenue you gain from a single customer. Total revenue, on the other hand, is what your company earns from all customers
However, it’s not quite as simple as just adding up all of your different TCV values.
Consider Metadata, a paid advertising platform that also offers managed services to clients who need actively managed demand generation services, not just an ad platform.
In Metadata’s case, their total revenue would include the TCVs for each of their monthly subscription clients, as well as revenue from these consultancy-type arrangements.
Conclusion
Having a comprehensive understanding of the myriad revenue metrics (and how to apply them) is crucial for those in charge of revenue growth at subscription enterprises.
Total Contract Value is an important indicator of growth (if TCV is moving upwards, your efforts to target higher-value clients are paying off), but it shouldn’t be viewed in isolation.
To learn more about revenue metrics, check out our article discussing Bookings vs. Total Contract Value vs. Revenue.
