What is Annual Contract Value (ACV)?
Annual contract value (ACV) is an average annual contract value of subscription revenue from each contracted customer. It excludes any one-time fees. For Ex: A customer has signed a 4-year deal with you for $40,000, normalizing this to a single year ACV will be $10,000.
Annual Contract Value (ACV) Formula:
ACV = Total Contract Value (excluding one-time payment) / Total years in contract.
Difference between ACV and ARR?
Here is an example to clear the confusion between ACV and ARR:
Customer A: Customer A agrees to a 3-year agreement, worth $60,000 and plans to pay on a yearly basis.
ACV = $60,000/3 = $20,000
ARR = $60,000/3 = $20,000
Customer B: Customer B agrees to a 6-month agreement, worth $5,000 and plans to pay on a monthly basis.
ACV = $5,000/1 = $5,000 (normalised to annual value: must be minimum 1 year)
ARR = $10,000/1 = $10,000 (assuming Customer B renew subscription after 6 months)
Combining ACV for both customers:
Calculating ARR = $20,000 (from Customer A) + $10,000 (from Customer B)
Calculating ACV (year 1):
[$20,000 (from Customer A) + $5,000 (from Customer B)] / 2 (no. of customers)
Calculating ACV (year 2 & 3):
[$20,000 (from Customer A) + $0 (from Customer B)] / 1 (no. of customers)
Importance of ACV?
By itself, the annual contract value isn’t a super-useful metric. But, by understanding your strategy for ACV, and by comparing it to other SaaS metrics, you can pull out some valuable insights to help guide your business decisions.