What is Total Contract Value (TCV)?
The Total Contract Value (TCV) represents the full value of a customer’s contract across an agreed-upon term, inclusive of all recurring revenue and one-time fees.
How to Calculate Total Contract Value (TCV)?
TCV, an abbreviation for the “total contract value,” is a key performance indicator (KPI) that helps SaaS companies determine the total revenue associated with their customer contracts.
Total contract value (TCV) is the total customer commitment stated in a contract, factoring in all recurring revenue and one-time payments.
The total contract value represents a contractual commitment by the customer rather than just an arbitrary projection.
The TCV metric factors in the following:
- Recurring Revenue Sources
- One-Time Fees (e.g. New Customer On-Boarding, Cancellation Fees)
The TCV is primarily a function of the term length of the contract, which can be an agreement for a subscription or license.
The specified term length on the contract is indirectly one of the most important considerations when setting pricing for SaaS companies, i.e. the longer the term, the more favorable the pricing offered to customers.
However, SaaS companies – particularly B2B enterprise software companies – have business models oriented around maximizing recurring revenue, which can be achieved through multi-year customer contracts (i.e. customer is “locked in”).
The risk of customers churning and a company’s revenue being wiped out is substantially reduced from multi-year contracts, especially if substantial cancellation fees are included.
Total Contract Value Formula (TCV)
Formulaically, the total contract value (TCV) is calculated by multiplying the monthly recurring revenue (MRR) by the term length of the contract, and adding any one-time fees from the contract.
Unlike ACV, the TCV considers all recurring revenues plus one-time fees paid throughout the contract term, making it more inclusive.
The relationship between TCV and ACV is that ACV is equal to TCV divided by the number of years in the contract. However, TCV must then be normalized and exclude all one-time fees.
What is the Difference Between TCV vs. ACV?
To reiterate from earlier, the total contract value (TCV) is indicative of the entire value of a new customer booking across the stated contract term length.
In contrast, as implied by the name, the annual contract values (ACV) capture only one year’s worth of the total booking.
Not only does the ACV metric represent just one year, but it also excludes any one-time fees, i.e. ACV is meant to represent only the yearly recurring revenue.
Thus, the difference between TCV and ACV is that the latter measures the annualized revenue amount from a contract, whereas the TCV is the entire revenue attributable to a contract.
But if the contract length is structured as an annual contract, the TCV would be equal to the annual contract value (ACV).
As a generalization, the TCV can be thought of as the “lifetime value” of a customer contract, i.e. from initial customer acquisition until churn or cancellation.
If the TCV is calculated and tracked correctly, companies can set their pricing strategies appropriately to maximize the total revenue and profits brought in by the average customer, even at the expense of lower monthly revenue (i.e. a trade-off worth it over the long run).
SaaS and subscription-based companies will often strive to maximize their recurring revenue by paying most of their attention to ACV rather than TCV.
But as most SaaS companies are aware, practically all customers will someday churn.
Thus, the value of multi-year contracts cannot be neglected; i.e. multi-year deals can counter-balance the inevitable churn of customers (and lost revenue).
Total Contract Value Calculator (TCV)
We’ll now move to a modeling exercise, which you can access by filling out the form below.
1. SaaS Operating Assumptions
Suppose there are two competing SaaS companies offering four-year contracts to their customers.
The first company (“A”) offers a four-year plan with monthly subscription payments of $200 and a one-time cancellation fee of $400.
For our hypothetical scenario, we’ll assume the customer does, in fact, breach the contract early halfway through the original term (i.e. 2 years), triggering the cancellation fee clause.
- Contract Term Length = 24 Months
- Monthly Subscription Fee = $200
- One-Time Cancellation Fee = $400
The second company (“B”) also offers a four-year plan but with an upfront annual payment of $1,500 received at the start of each year, which comes out to $125 per month.
To further incentive customers to agree to their annual payment plan, the company’s contract states there is no cancellation fee if the customer seeks to end the contract before the four years are up.
Unlike the previous example, the customer continues to do business with the provider for the entire four-year duration.
- Contract Term Length = 48 Months
- Monthly Subscription Fee = $125
- One-Time Cancellation Fee = $0
2. Total Contract Value Calculation (TCV)
In the next part of our exercise, the total contract value (TCV) equals the monthly subscription fee – i.e. the monthly recurring revenue – multiplied by the contract term length, which is added to any one-time fees.
- Company A = ($200 × 24 Months) + $400 = $5,200
- Company B = ($125 × 48 Months) + $0 = $6,000
Despite Company A’s annual contract value (ACV) being higher, the total contract value (TCV) of Company B is higher by $800. Therefore, the lower monthly subscription fee paid off over the long run and most likely brought positive benefits to the company, such as more access to raising outside capital from early-stage investors that place substantial weight on recurring revenue and consistency in operating performance.