Total Contract Value: Your Comprehensive Guide

SaaS businesses spend countless hours on reporting and data collection, but how much of that information turns into impactful growth is questionable. 

‍McKinsey found that aggregating information from various databases, spreadsheets and software systems> consolidating data into single reports> checking data quality for inconsistent or inaccurate data makes reporting a challenging process. 

The SaaS metric you choose is often the differentiator between success and failure. 

However, certain metrics are universally valuable. They often keep sales, marketing, and finance teams together. 

One of those metrics is Total Contract Value. 

Total Contract Value calculates the lifetime value of a contract, which can help you accurately predict your revenue for your SaaS businesses. It provides “real” value on how much a business will make from a contract. 

Many SaaS businesses struggle to calculate and understand Total Contract Value, and many confuse it with Average Contract Value. 

This article will remove all your confusion regarding how to calculate, use cases, challenges, and how Total Contract Value is different from Average Contract Value. 

What is Total Contract Value? 

Total Contract Value (TCV) is a metric that measures the total value that a company can earn from a customer contract over its entire duration. It is a metric that measures how much a contract is worth by taking into account both recurring revenue and one-time fees.

This figure is then used to calculate revenue, how much money each customer brings into your company and to project growth in the future. 

Total Contract Value can also be used to calculate Average Contract Value. Although both terms are often interchangeably used to determine contract value, they are quite apart. 

The Annual Contract Value measures the average annual revenue collected from a single contract. This calculation excludes any upfront costs, like installation fees. You can calculate Annual Contract Value  by adding up Total Contract Value  for a given period and dividing it by the number of contracts for the given time. 

Before we explore more differences between Total Contract Value and Annual Contract Value , let us look at how Total Contract Value is calculated and why it's important to track for your SaaS business. 

How to calculate Total Contract Value 

To calculate the Total Contract Value add up all the revenue components of a contract for the entire term. 

Here are some revenue components that need to be included:

• Recurring revenue: This includes regular, consistent payments a customer has to make across the contract tenure (for example, monthly or annual subscription fees).

• One-time fees: These are initial charges that a customer has to pay in addition to their subscription amount, such as installation, training, or migration fees. 

• Variable fees: Many businesses offer usage-based pricing in addition to the subscription fee that must be included in your Total Contract Value . 

• Renewals: Not many SaaS businesses count renewals while calculating Total Contract Value  since it introduces uncertainty and assumptions. However, if your business has set any terms regarding renewals, you can add your renewal amount to your Total Contract Value . 

• Discounts: Deduct any discount offered to your customers

The Total Contract Value formula is pretty straightforward:

‍Total contract value = (Recurring revenue/ subscription fees x contract term length) + one-time fees

Let's put this into perspective using an example:

Example 1: Simple Total Contract Value calculation 

Let us say you want to calculate the Total Contract Value  for Mailsuite, an email tracking software. Mailsuite offers two paid plans for $2.99 and $5.99 each/per user/month (billed annually). 

For instance, a customer purchases an Advanced plan for $5.99/ user/month for two years. If you see the pricing page, there were no other monetary charges besides the subscription fees. 

Total contract value = (Recurring revenue/ subscription fees x contract term length) + one-time fees

=($5.99 * 24 months) 

= $143.76

Meaning Mailsuite will receive a fixed amount of $143.76 in two years from this customer.  

Example 2: Total Contract Value calculation with variable fees

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Let us take Hubspot as our second example. Hubspot pricing is tricky. In addition to the subscription fee, it charges onboarding fees and additional fees per 3/5 seats. 

It offers two paid plans:

• Marketing Hub Professional= $800/month ( 3 additional seats at $45/month)
• Marketing Hub Enterprise=$3600/month (5 additional seats at $75/month

For instance, a customer chooses the Marketing Hub Professional plan for three years with a monthly recurring bill of $800/month. They also require help in onboarding and data migration so that they will opt for the Hubspot professional onboarding feature. Plus, they also want to opt for three additional seats to manage access to their Hubspot account. 

Total contract value = (Recurring revenue/ subscription fees x contract term length) + one-time fees

= ($800*36)+($45*36)+$3000

=$28,800+$1620+$3000= $33,420

That means Hubspot will receive an amount of $33,420 for this specific client unless there's a change in either the tenure of the contract or the value of subscription fees. 

Why is calculating Total Contract Value  important for SaaS businesses? 

Total Contract Value  is one such metric that is often overlooked. Most companies prefer to use other sales performance metrics, such as Customer Lifetime Value (CLV), Annual Recurring Revenue( ARR) growth, or churn rate, which investors find impressive. 

Even though these metrics validate growth, they're often based on assumptions and are an unrealistic indicator of your company's growth. 

Total Contract Value  differs from all these metrics since it provides "real" revenue numbers from people who have signed contracts with the company. It also includes "one-time fees" that give marketers a more comprehensive view of the company's revenue. 

Knowing the amount of money your business makes can be helpful in making future spending decisions. By determining the Total Contract Value , companies can get a better idea of how much they are willing to risk to gain new customers or retain existing ones. 

What are the use cases of Total Contract Value ? 

Total Contract Value  is not just another one of the several metrics that tell the same story as others. It provides a number of insightful use cases that SaaS companies can leverage to unravel amazing revenue opportunities and make informed decisions. 

1. Identify your best customers 

You must have heard of the Pareto Principle that 80% of outcomes are a result of 20% input. The same principle applies to your SaaS business. All your customers are not created equal; 80% of revenue comes from 20% of your clients. 

Total Contract Value  is a powerful metric to analyze your existing customers from a financial perspective. You can break down your Total Contract Value  bookings into various segments. 

For instance, sum up all revenue generated by each vertical and calculate their share of the top revenue and the number of paying customers. (Check the image for reference.)

Now. define 10% of companies that generate the most revenue as Tier 1, another 10% as Tier 2 and the remaining 80% as Tier 3. 

Another reason to analyze your top-paying customers is that they carry greater contractual risk. A contractual risk is a situation involving a potential risk of danger, harm, or loss to the company. 

While it is not possible to eliminate all contractual risks, one can mitigate them by following comprehensive review processes and establishing safeguards throughout the contractual agreement. 

2. Optimize sales and marketing initiatives 

Use your Total Contract Value to identify your best buyers from Tier 1, Tier 2 and Tier 3 segments. Now, sit with your sales and marketing team to analyze their buying process and why they chose your product. 

After the conversation, you'll be able to understand your best customer’s::

• Buying triggers: What made them best buyers buy your product over others?
• Research process: Where and how did they reach you? 
• Decision-making process: What influences their buying decisions? Who is involved in the product approval process?
• Goals, challenges and objections

As a sales professional, you can now clearly see who you are targeting, their buying habits, and why they bought your product. 

3. Helps in making stronger negotiation decisions 

B2B buyers' journeys have become longer and more complex, with more people involved in decision-making. 

Even experienced AEs and leadership teams are finding it challenging to close deals with longer sales cycles (134 days), lengthy negotiations (an extra 16 days to the sales cycle), and increased stakeholders. 

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When discussing the deals on the contract, it can be tempting to offer hefty discounts or accept the first counter offer you receive. While these are essential to getting contracts signed faster, Total Contract Value  ensures that you aren't leaving value on the table.

By reflecting on what previous clients have paid, the sales team can understand what fees are reasonable and what terms are non-negotiable. 

Difference between Total Contract Value vs Annual Contract Value  

Total Contract Value and Annual Contract Value often appear on the same surface. Both of these metrics serve the same purpose of calculating how much a contract is worth. 

However, there are a few differences:

Challenges of using Total Contract Value as an indicator 

While Total Contract Value  is one of the most useful metrics, it comes with its own set of challenges. 

One of the primary issues with calculating Total Contract Value  is that it is assumptive. It fails the revenue recognition principle, which states a business can only recognize revenue when it is earned rather than when the payment is made. 

For instance, if someone purchases a subscription of $1000/ month for 24 months, you may assume that the company will revive $24,000 after the contract is completed. It may be in theory (on your contract page), but it is often said rather than done. 

The customer can cancel their subscription at any time. While you may have a cancellation clause, most companies do not abide by this rule. The same goes for renewals or variable components. There is a risk that these assumptions may not materialize. 

Total Contract Value  also provides limited insight into profitability. It doesn't account for the cost associated with delivering a product or service. A high Total Contract Value  doesn't mean a high level of profitability. You might face losses and see a high Total Contract Value . 

Make measuring Total Contract Value a priority for your SaaS business 

Total Contract Value  is an important metric to find your best customers, predict future revenue with accuracy and measure the performance of your business. In contract negotiations, Total Contract Value  can provide you with insights that help companies make strategic decisions.

Zenskar makes it easy to track the Total Contract Value metric by integrating all your critical systems of record-CRM, EPQ, ERP and billing systems. The platform also lets you continuously monitor your customer's billing/usage throughout the billing period.

Curious to learn more? Book a demo, and we'll show you how Zenskar can automate revenue recognition. 

Frequently Asked Questions (FAQs)

1. How do you convert Total Contract Value to annual contract value?

You can easily convert Total Contract Value  to Annual Contract Value  by subtracting the one-time fee and dividing the remaining recurring revenue by the contract length. Here's the formula that you can apply to calculate Annual Contract Value : 

(Total Contract Value - one-time fees) / Duration of contract [in years]

2. What does Total Contract Value mean?

Total Contract Value is the total amount of revenue received from a customer over the life of a contract. It includes all recurring subscription amounts plus one-time fees or discounts that may be associated with the contract. 

3. What is the difference between Total Contract Value and revenue? 

Total Contract Value  is a component of revenue, indicating the total revenue generated by a customer in the contract period. However, revenue is a much broader term that will incorporate contract amounts from all customers and can only be counted when they are recognized.