by Sam Franklin | August 09, 2022 | 10 min read
SaaS metrics 101 – Total contract valueGet funded
Last updated: September 03, 2022
SaaS companies need insight from consistent data to achieve revenue growth and efficiency. Total Contract Value (TCV) is a key performance indicator and one of the most useful SaaS metrics that can help you create profitable strategies for long-term business success.
TCV calculations can provide more accurate estimates of your company’s growth, revenue, and financial health than other SaaS metrics. However, it’s often overlooked and underutilised by many SaaS companies.
In this guide, you’ll learn what TCV is, how to calculate it, and why it’s a vital metric for SaaS businesses looking for sustainable success.
Table of contents
- What is the total contract value?
- How to calculate total contract value
- Why is total contract value important?
- Total contract value FAQ
What is the total contract value?
The TCV SaaS metric measures how much revenue a contract is worth. It’s an important metric showing you the total value an individual customer brings to your business over the entire contract period.
The total contract value involves a contractual agreement for a licence or subscription rather than an arbitrary projection. It can help you estimate how much profit you can generate from a single contract by taking into account the following:
One-time fees like cancellation fees, the onboarding fee, or professional service fees
What does the total contract value indicate?
The total contract value (TCV) indicates the entire revenue of a new customer across the agreed contract term length. You can generally think of the TCV as the customer lifetime value of a contract from the time the customer signs until cancellation or churn.
It indicates actual bookings instead of relying on revenue predictions like other SaaS metrics. TCV calculations use prepaid amounts over the specified term length of the contract instead of defining your income by monthly recurring revenue (MRR) or annual contract value (ACV).
Why do companies use total contract value?
Companies use total contract value to gain more accurate revenue estimates and insight into the company’s growth. You can easily steer your business in the right direction when you know the total value of the contract the customer signs with your company.
TCV can help convince investors that your business is attractive. It’s preferred because it doesn’t leave room for cancellation surprises. The total contract value is backed by real figures, accounting for customer churns and providing data-led insight into your company’s future earnings and the average return on investment (ROI).
TCV insights help subscription and SaaS companies discover and focus on efforts that lead to revenue growth and profitable leads.
When is total contract value useful for a SaaS business?
TCV can help SaaS companies set prices for their products or services. The TCV is a function of the term length of the contract, and term lengths are indirectly critical considerations in pricing.
When companies calculate and track TCV correctly, they can set appropriate pricing strategies that increase the profits and total revenue brought in by the average customer.
For example, you can offer more favourable pricing to customers in longer-term contracts because you’ll have the customer locked in. With longer contracts, company losses from customers churning are also significantly reduced.
TCV is useful when you need to understand what you’re doing right in your business to drive revenue and customers and what is not working. Such insight can help you eliminate unnecessary spending so you can budget accordingly.
How to calculate total contract value
To figure out your company’s TCV, multiply the monthly recurring revenue (MRR) with the term length of the contract and add any one-time fees included in the contract. Many SaaS companies don’t know about TCV or how to calculate it.
However, you can calculate TCV through a very straightforward TCV formula.
Total contract value formula
TCV = (Monthly Recurring Revenue x Contract Term Length) + One-time Fees
The total contract value (TCV) will change based on adjustments made to the monthly recurring revenue or contract lengths. Offering shorter or longer contract terms or changing the MRR can dramatically affect the TCV.
When evaluating TCV trends, remember to account for any contract length or pricing strategy updates that can impact the analysis. Unlike the customer lifetime value (LTV) SaaS metric, TCV is based on real contractual commitments instead of projections.
As a result, you can’t calculate TCV for evergreen subscriptions or those made month to month because there’s no way of having advanced knowledge of the contract term length. The TCV for one-time payments would simply be the total amount the customer pays since there’s no recurring component.
Total contract value example calculation
Let’s assume two different SaaS companies, A and B, offer four-year contract agreements to their customers for a licence or subscription.
Company A has a four-year plan with monthly payments of £200 and a one-time cancellation fee of £400. Let’s assume in this scenario that the customer breaches the contract halfway and doesn’t complete the original term, which triggers the cancellation fee and makes it a two-year contract.
Monthly recurring revenue (Subscription fee) = £200
Contract Term Length = 2 years (24 months)
One-time cancellation fee = £400
Company B also has a four-year plan, but instead of monthly payments, it features a £1500 fee you pay upfront at the start of each year, translating to £125 every month. The contract states there’s no cancellation fee if the customer ends the contract early, an incentive that makes the annual payment plan more attractive.
Let’s assume in this scenario that the customer does business with company B for the entire four-year period.
Monthly recurring revenue = £125
Contract term length = 4 years (48 months)
One-time cancellation fee = 0
TCV = (Monthly Recurring Revenue x Contract Term Length) + One-time Fees
Company A TCV = (£200 x 24) + £400 = £5,200
Company B TCV = (£125 x 48) + 0 = £6,000
Although company A’s annual contract value (ACV) is higher, company B’s TCV is higher than company A’s by £800.
This means the lower monthly recurring revenue or subscription fee was beneficial in the long term. It also likely brought the company positive benefits like access to capital from investors who prefer consistent operating performance and recurring revenue.
Why is total contract value important?
Instead of projections, TCV uses confirmed bookings, making it a more accurate method of predicting growth and revenue. It can help you determine which direction your business needs to take. While other metrics like LTV can validate growth, they’re often unrealistic.
The benefits of TCV for SaaS
Various benefits make TCV a better gauge for SaaS businesses than other metrics. These include:
More accurate calculations
TCV allows you to make more accurate calculations to create realistic estimates of your company’s growth and revenue. It ultimately helps you tailor your budgeting, marketing and sales efforts accordingly while avoiding costly mistakes from unrealistic predictions.
TCV accuracy can help you avoid budgeting for unnecessary resources, onboarding new staff or investing too little in marketing campaigns. Investors also prefer accurate predictions which are not inflated or manipulated, and TCV can help convince them to give you the funding you need.
Optimising budgets and channels
The total contract value can help you budget accordingly and eliminate unnecessary spending. You can optimise your marketing and sales budget by understanding which methods efficiently bring in new customers.
Efficiency is necessary for marketing to ensure the money you invest in growing your business brings in more returns. You can divide the customer acquisition cost by TCV bookings to measure the efficiency of your marketing efforts.
It helps you determine which marketing channels are helping you grow based on how much value they bring in and which are hindering or stagnating your growth so you can know where to focus.
Identifying your customers
You can identify the most valuable customers for your SaaS business by calculating the TCV of various customer demographics. Breaking down TCV bookings by dividing customers into different segments helps you understand them better.
It shows you the customer segments that are high spenders regardless of the length or size of the contract. Such data allows you to focus your sales and marketing efforts on the most profitable leads that bring in more revenue and decrease expenses on the unprofitable ones.
Determine appropriate contract lengths
TCV allows you to determine which contract lengths work best for particular customer segments. You may find that a specific demographic is likely to pay upfront for a year or longer while others only buy subscriptions a month at a time.
By knowing which package lengths work best for each segment, you can optimise your sales efforts for short-term or long-term contracts to improve your average TCV.
Problems associated with TCV
While TCV is one of the most useful SaaS metrics, it bears some pitfalls you should be aware of.
One of the significant issues with TCV involves the revenue recognition principle, where you count your income when it’s received rather than what you expect. For example, if a two-year contract has a total contract value of £1,000 annually, you may assume that you’ve got a £2,000 customer in your books.
However, the £2,000 is deferred revenue because the customer can cancel the subscription halfway through and refuse to pay in the next billing cycle, resulting in drastic changes to your revenue predictions.
Another problem is that you may have penalty clauses in your contracts, but are you going to enforce all of them? All customers may comply with all contract terms, eliminating fees from penalties and changing data predictions.
In such cases, you may consider only working with prepaid deals as you use TCV for financial forecasting or projections. A prepaid deal features fixed income, giving you a more reliable and valid rate of revenue.
Total contract value FAQ
What’s the difference between TCV and CLV?
The customer lifetime value ( CLV) is the net profit a business can generate from a single customer for the duration of the business relationship. Although it may seem like the TCV and LTV are measuring the same thing, they’re not entirely similar.
TCV differs from CLV because it uses existing contract commitments, while CLV uses projections.
What is the difference between total contract value and annual contract value?
While both TCV and annual contract value (ACV) serve the same purpose of measuring how much a contract is worth, there are a few differences.
ACV only captures one year’s worth of total bookings, while the TCV captures the entire value across the stated contract term length. TCV gives you the revenue of the entire contract, while ACV gives you the average yearly income from the agreement.
TCV considers all fees and revenues paid throughout the contract period, including one-time and recurring fees. ACV only represents the yearly recurring revenue and excludes any one-time fees.
How does the monthly recurring revenue affect the total contract value?
Your company’s TCV will change if any changes occur to the monthly recurring revenue (MRR). The MRR involves the monthly cash flow or the income you expect to receive in monthly payments.
If you make a mistake, like including semi-annual or annual figures at once when calculating MRR without normalisation, you can throw off the TCV calculation. You must account for variations and divide the figures by the intended subscription length.
The total contract value provides you with well-rounded and accurate insight into your business’s overall revenue and how it’s likely to grow. Combining TCV with other SaaS metrics can give you a clear picture of your company’s financial health and what you can do to improve. With TCV accuracy, you can easily convince investors that your business is sustainable and get the funding you need.
Sam founded his first startup back in 2010 and has since been building startups in the Content Marketing, SEO, eCommerce and SaaS verticals. Sam is a generalist with deep knowledge of lead generation and scaling acquisition and sales.