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Amol Ghemud Published: December 30, 2022
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Introduction to Total Contract Value (TCV)
We are aware that contracts help businesses and companies grow their potential and generate revenue. And some of the most notable and significant metrics to understand how much revenue can be captured by a contract are Annual Recurring Revenue (ARR), Customer Acquisition Cost (CAC), Lifetime Value (LTV), Total Contract Value (TCV), and more. Through the help of these metrics, businesses get a big and clear picture of how impactful their sales strategy is, pinpoint their places of friction, and change their game plan whenever required.
In order to consistently improve business efficiency and revenue growth, businesses come across in need of a constant data stream. This, in turn, lets businesses make use of a variety of SaaS metrics, one of which is known as Total Contract Value (TCV). Though Total Contract Value (TCV) has never been prevalent, it is still one of the most suitable SaaS metrics that businesses can look forward to.
What is Total Contract Value (TCV)?
Total Contract Value or TCV can be referred to as the total amount of revenue generated by a business from an individual contract or client (this includes one-time charges such as an onboarding fee, cancellation fee). TCV calculates the prepaid amount of the contract over the lifetime and hence is used to accurately predict long-term financials when compared to the other measures.
With TCV, businesses can quickly gain a clear picture of the amount of revenue that they can expect from a particular client once they’ve signed the contract. Knowing this, businesses can accordingly design a profitable strategy that will benefit their company in the long run.
How can Total Contract Value (TCV) be calculated?
Total Contract Value (TCV) is a figure representing the amount a client pays to the company during their contract period.
The formula to calculate TCV is quite simple, as stated below:
TCV = (Monthly Recurring Value x Contract Term Length) + one-time fees
This states that the Monthly Recurring Value acquired by the client must be multiplied by the number of months that a contract lasts for. TCV will also include the one-time fees or any additional fees that the customer or the client pays.
TCV is an essential metric of businesses as it is a projection made on concrete numbers that customers tend to pay for the service over the course of their subscription contract.
Calculating Total Contract Value (TCV) With An Example
Let us consider an example of companies named company A and company B, where both offer a four-year contract to their customers.
Company A offers a four-year subscription plan with a monthly subscription payment of $200 and a one-time cancellation fee of $400.
Let’s consider that a customer breaches the contract term in two years. This will, then, in turn, trigger the cancellation fee clause since the contract was supposed to last for four years.
So here,
The Contract Term Length = 24 Months (i.e. 2 Years)
Monthly Subscription Fee = $200
One-time Cancellation Fee = $400
Company B also offers a four-year plan but asks for an annual payment of $1,500 at the start of every year; this comes to $125 monthly. Here, the company clearly states that there is no cancellation fee if the customer ends the contract before four years are up.
Let’s consider that a customer sticks with company B for four long years.
Here,
The Contract Term Length = 48 Months (i.e. 4 Years)
Monthly Subscription Fee = $125
One-time Cancellation Fee = $0
The Total Contract Value (TCV) formula is given as follows:
TCV = (Monthly Recurring Value x Contract Term Length) + One-time Fees
For Company A:
TCV = ($200 x 24 Months) + $400 = $5,200
Whereas,
For Company B:
TCV = ($125 x 48 Months) + $0 = $6,000
The above example clearly defines that the TCV of company B is higher than company A’s by $800. The fact is lower monthly subscription fee paid over a long time is likely to bring positive results and be profitable for the company.
Why is Total Contract Value (TCV) considered an essential metric?
With subscription contracts, there comes a lot of data, and TCV is a crucial metric that helps the company measure all of this data, along with helping businesses make important decisions based on this data.
Below are a few reasons why tracking contacts is vital for businesses.
TCV is a highly crucial metric when it comes to businesses accessing the effectiveness of their marketing strategies. This includes various marketing aspects like brand awareness, the packages that a company offers to its customers, and more.
TCV helps businesses identify their most valuable customers and then offer them the best deals and packages to retain them for a longer period.
Through TCV, businesses can more accurately predict what revenue and growth look like in the long run.
Another critical aspect that TCV takes care of is highlighting riskier contracts, so businesses understand the contract value and de-risk the contracts whenever necessary.
Businesses can quickly evaluate their customer portfolio through contract value in order to strengthen business strategy and allocate resources to every customer wisely. TCV enables businesses to understand which customer segments are high so that the sales resources are more inclined toward the most viable leads.
To analyze how efficient businesses are in getting new customers, one can simple divide TCV by customer acquisition cost (CAC).
Final words on Total Contract Value (TCV)
The prime objective behind using Total Contract Value (TCV) is that it helps businesses identify and understand the most profitable customer segments and focus their sales and marketing on these to enable more revenue and potentially grow businesses. The cherry on top is that TCVs help companies to figure out which contract length works best for which demographics. With the help of TCV, a business can focus on its budget spent and eliminate unnecessary spending wherever required.
FAQs
1.What are TCV and ACV?
Total Contract Value (TCV) measures all the fees and revenue paid throughout the contract period, including the one-time payments and the recurring costs. Whereas, Annual Contract Value (ACV) measures the recurring payments made throughout the year. Both TCV and ACV serve the same purpose, that is, measuring the worth of a contract.
2. What is the total contract amount?
Total Contract Value (TCV) summarizes the total contract amount generated by a customer over the duration of their contract. TCV can be easily calculated for both short-term and long-term contracts.
Amol has helped catalyse business growth with his strategic & data-driven methodologies. With a decade of experience in the field of marketing, he has donned multiple hats, from channel optimization, data analytics and creative brand positioning to growth engineering and sales.
Don’t let the media or society define what success looks like for you. You know what you’re capable of, you the effort you’re putting in. You’ve got this 🙂 👍🏼
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