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Total contract value (TCV) in SaaS: What it is and how to calculate it

Total Contract Value (TCV) helps SaaS companies determine the total value of their multi-year contracts. This article will show you how to calculate it.

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SaaS finance leaders, in particular, use numerous metrics to analyze and predict business performance, track cash flow, and ensure informed decision-making. These SaaS metrics, unless clarified and internalized, can appear to be confusing for their colleagues and peers. Total contract value (TCV) is one of them. 

Total Contract Value, also known as contract value, is a key performance indicator (KPI) that helps SaaS companies determine the total value generated by multi-year contracts. It refers to the total revenue that a company expects to receive from a customer contract over its entire duration including one-time fees (e.g. implementation fees) and all recurring subscription revenue.

While other key SaaS revenue metrics—for example, annual recurring revenue (ARR), , annual contract value (ACV), RPO and customer lifetime value (LTV)—very often provide similar insights into the value of a customer deal and business performance, in this article we will explore the importance of TCV for SaaS businesses. 

Table of Contents
How to calculate total contract value (an example)
ACV vs TCV
How does TCV relate to other SaaS revenue metrics?
Why should you track your TCV?
FAQs

How to calculate total contract value (an example)

TCV is an important metric for SaaS companies, especially those for which services constitute a significant component of the revenue. TCV provides the total value an individual customer brings to the business over the entire contract period. 

Let’s look at the table below, which shows an example of how a multi-year SaaS contract is commonly structured. 

Table showing an example of how a multi-year SaaS contract is commonly structured. This example shows a three-year contract with increasing revenue each year. The table shows two types of revenue, subscription revenue and services revenue. The first year subscription fee, which is typically prepaid, is 100,000 dollars, the second and third year subscription fees are 120,000 dollars and 130,000 dollars respectively. There are two types of service fees, a one-time implementation fee of 10,000 dollars and an annually recurring fee of 10,000 dollars for support services.
Example structure of a multi-year SaaS contract.

As you can see in the revenue column, the calculation of TCV includes two primary types of revenue, subscription revenue and services revenue, which correspond to revenue line items in your profit and loss (P&L) statement.  

It’s important to note that in SaaS, services revenue also often has two components, too, which are recurring services and non-recurring or one-time services. We have included both in our example. 

But wait a minute! Wouldn’t the revenue from the recurring support services be considered subscription revenue? That’s a good question. 

By definition, that revenue probably should be included in the subscriptions. After all, it’s money earned by the company on a recurring basis via the subscription model. Whether recurring services should be considered subscription revenue or services revenue remains an ongoing debate in the SaaS industry. 

Ultimately, whether you report revenue from recurring services as subscription revenue or services revenue in your P&L really doesn’t matter as long as you specify which category you’re using and use it consistently. And it doesn’t matter for the TCV calculation, either.    

To calculate the TCV, you have to add up the annual contract value (ACV) for all three years of the contract, adding the one-time implementation services fee to year 1, and the fees for the recurring support services to each of the three years.   

The ACV for year 1 equals 120,000 dollars, which is the subscription fee of 100,000 dollars plus the 10,000-dollar fee for the first year of support services plus the one-time implementation fee of 10,000 dollars. The ACV for year 2 equals 130,000 dollars, which is the subscription fee of 120,000 dollars plus the 10,000-dollar fee for the second  year of support services. The ACV for year 3 equals 140,000 dollars, which is the subscription fee of 130,000 dollars plus the 10,000-dollar fee for the third year of support services. Adding the ACVs for all years, 120,000 dollars, 130,000 dollars, and 140,000 dollars results in a TCV of 390,000 dollars.
TCV calculation for our example multi-year SaaS contract.
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ACV vs TCV

ACV tells you the average annual revenue generated from each customer contract. In contrast, TCV tells you the total value of a given contract, factoring in all revenues and fees to be paid throughout the entire contract period, including recurring and one-time payments. 

The ACV calculation for a given contract is pretty straightforward. It’s simply the TCV divided by the number of years in the contract. However, as you can see from our example above, the actual ACV can vary from year to year based on how the contract is structured, so it may not be the same as your average ACV. 

One benefit of ACV is that if your company has contracts of varying lengths, it can help you better understand your revenue growth from new bookings. This is because ACV annualizes the revenue for each contract (whether calculated as an actual value or an average). 

Thus, the ACV can tell you whether the revenue growth you’re seeing is the result of 1) a higher value booking (the customer is paying more each year), or 2) a function of the contract term (the customer is paying the same amount each year but the contract is longer). 

This is an insight that using TCV alone can obscure.   

How does TCV relate to other SaaS revenue metrics?

TCV is one of several metrics SaaS companies can use to understand different aspects of their revenue. It’s important to remember, though, that different metrics tell different stories and some, by nature of how they’re calculated, don’t tell the full story or can obscure important insights. 

To use metrics effectively, you need to understand how they relate to each other so you can determine which one is the best metric to use based on what you need to know.  

Now that you know how TCV relates to ACV, let’s take a look at how it relates to some of the other more common revenue metrics SaaS companies typically track.

Annual recurring revenue (ARR)

ARR is the recurring revenue from subscriptions, normalized over a period of one year. Based on this definition, ARR captures revenue only from subscriptions. Unlike TCV, it does not include one-time fees and often also excludes variable fees and consumption-based fees.  

So, you might be wondering at this point whether TCV is a more accurate representation of revenue than ARR. After all, it accounts for more of the revenue actually being generated, right?

The answer to this question is that ARR and TCV differ in purpose. Both are useful because each gives you a different piece of the revenue puzzle.   

Recall that TCV is a metric that helps you understand total revenue when you’re dealing with multi-year contracts, which can be very useful in planning. In contrast, ARR is used to understand recurring revenue regardless of whether you have monthly or yearly plans and/or multi-year contracts, which offers a different perspective. 

ARR is probably the most widely used metric in SaaS today and with good reason. ARR not only gives you a quick way to track gross sales, it also offers a lot of valuable insights into different aspects of your business that can impact revenue, including sales, customer success and satisfaction, and a customer’s lifetime value (LTV).   

Subscription Revenue

Subscription revenue is the money a company earns when a customer enters into an agreement to pay a recurring fee in exchange for its product or service for a specified period of time. 

When calculated as an annual number, subscription revenue is really just another way of referring to ARR. Likewise, calculating your subscription revenue as a monthly number will tell you your monthly recurring revenue (MMR)

Subscription revenue is calculated based on the pricing model you use in your SaaS business, such as flat-rate pricing, tiered pricing, usage-based pricing, or hybrid pricing, which combines two or more pricing models.  

The main difference between TCV and subscription revenue is that the latter does not include one-time fees. Subscription revenue can, however, include consumption-based fees and variable pricing as part of a hybrid pricing model, as long as they are recurring in nature as part of a subscription. 

Customer Lifetime Value (LTV)

TCV and LTV are different ways of looking at revenue. TCV measures the total value of an existing contract (or all contracts if you’re calculating an aggregate TCV). Whereas, LTV is the average recurring revenue (adjusted for churn and gross margin) that your customers generate over their entire relationship with your business. 

The main difference between TCV and LTV is that the former represents revenue from actual existing contracts with your customers while LTV is based on projections.

In comparison to TCV, calculating LTV is more complicated with different LTV formulas you can use depending on whether you’re interested in the unit economics at the customer level or for every dollar of ARR the customer will generate. Your pricing model can also influence how you calculate LTV. While the definition of LTV suggests that it considers only recurring revenue, it may make sense for you to include one-time service fees if they make up a significant portion of your revenue.    

Remaining Performance Obligation (RPO)

Remaining Performance Obligation (RPO) is an indicator of the revenue a company expects based on executed contracts that have not yet been fulfilled as of the end of a reporting period. It is the sum of deferred revenue (advance payments for services not yet delivered) plus backlog (the amount of money contracted but not invoiced) within a defined period of time. 

Due to its relative simplicity, TCV doesn’t capture this nuance. Calculating TCV across all your contracts simply measures their total value, which doesn’t take into account how much revenue is remaining to be billed for them. Thus, RPO is a more granular metric than TCV. So, is it a better metric? That depends on the question you’re asking. 

RPO is very important for accounting in SaaS because SaaS products often involve complex pricing and renewal options not typical of other industries. It’s also useful for giving prospective investors quick insight into a company’s future revenues. However, RPO has little utility in the planning context. For this, TCV and other revenue metrics are generally more useful. 

Why should you track your TCV?

The main benefit of the TCV metric is that it provides “real” revenue numbers from customers that have signed contracts. In contrast to other revenue metrics, it also includes one-time fees. Thus, it gives you a more comprehensive view of your revenue.

Knowing the amount of revenue you can expect to receive over a given time can be quite useful in planning. When you know how much money you’ll have to work with, you can be more confident in your spending decisions.  

Of course, we all know that churn happens, and TCV doesn’t account for that. However, that doesn’t make TCV any less reliable for planning. If you know your churn rate, you can factor it in. You simply multiply the TCV from all your contracts by your churn rate and subtract the result from your total revenue to get a more accurate number for planning.  

Another good reason for tracking your TCV is that it can offer useful insights. For example, analyzing TCV for different types of customers (e.g. SMB vs enterprise customers) you can identify which type generates higher-value contracts – an insight you can use to prioritize your sales and marketing activities.

FAQs

Are TCV and Total Revenue the same metric?

TCV is the total amount of revenue earned from a single customer for the duration of that contract. Total revenue, on the other hand, is the total revenue gained from all customers. It includes all sources of income, including product sales, subscriptions, consulting revenues, and other services. 

What is the difference between TCV and LTV?

At the outset, both TCV and customer LTV seem to be describing the same metric—except for one crucial difference. Customer LTV is a projection of the amount of revenue that will be earned from a given customer, which is determined based on when that customer is likely to churn. Hence, depending on a business’ revenue model, there are different methods for calculating the customer LTV. On the other hand, TCV is focused on actual contracts with actual customers. 

What is the difference between TCV and ACV?

ACV tells you the average annual revenue generated from each customer contract. In contrast, TCV tells you the total value of a given contract, factoring in all revenues and fees to be paid throughout the entire contract period, including recurring and one-time payments. 

Is TCV the same as ARR?

For SaaS companies, ARR is the recurring revenue from subscriptions, normalized over a period of one year. Given its “recurring” context, a SaaS company’s ARR captures revenue only from subscriptions. Unlike TCV, ARR excludes any one-time fees or charges.

ARR will include only committed and fixed subscription or recurring fees. ARR always excludes one-time fees and usually excludes any subscription consumption or variable fees.

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