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What is Total Contract Value (TCV) and How to Calculate it

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in
Krzysztof (Kris) Szyszkiewicz
Head of Delivery, Partner
January 30, 2024
SaaS
indicators

Imagine you're running a marathon, and every mile you complete represents a new phase in your SaaS company's journey. Just as you keep track of the miles to gauge your progress, understanding the Total Contract Value (TCV) is essential to measure your company's growth and success.

What is the Total Contract Value?

Total Contract Value (TCV) is a crucial financial metric in the SaaS industry, which represents the total revenue that a company expects to receive from a customer contract over its entire duration. This metric is not just about the immediate value, but it's a long-term view of the revenue. It includes recurring charges, one-time fees, and any other related service fees.

How to Calculate Total Contract Value

Calculating TCV is quite a simple job. Here's how to do it:

  1. Identify all revenue components: This includes your monthly recurring revenue (MRR), any one-time fees (like onboarding fees), and additional service charges.
  2. Consider the contract term: Whether it's a one-year contract or a two-year enterprise plan, the length of the contract is crucial.
  3. Calculate the total: Multiply the monthly subscription amount by the contract term length (in months) and add any one-time or additional fees.

TCV formula:

For example, if you have a $500 monthly subscription on a two-year contract with a $1000 onboarding fee, the TCV would be:
$500 x 24 months + $1000 = $13000

What's considered a "good" TCV varies significantly across businesses and depends on factors like the company's size, the industry standard, and growth targets. Generally, a higher TCV indicates more revenue and is a positive sign, especially if the cost of acquiring and serving the customer is well-managed.

Understanding TCV in Context

TCV is part of a suite of SaaS metrics that include Annual Contract Value (ACV), Customer Lifetime Value (CLV), and others. While TCV gives you a broad picture of the total value a customer brings, it's also vital to understand:

  • Annual Contract Value (ACV): It measures the value of the contract per year, which helps in understanding yearly revenue trends.
  • Customer Lifetime Value (CLV): It projects the total revenue a company can expect from a single customer, considering their entire relationship.

In addition, TCV affects expected revenue growth. Why? Because it affects revenue growth forecasts and can be a barometer of a company's financial health. If the indicator decreases or increases, you can make appropriate conclusions and react quickly, e.g. give subscription discounts, update the price list, add bonuses, etc.

Why is TCV an Important Metric for SaaS Companies

TCV is very important for SaaS companies for a simple reason - it provides a lot of information. And based on them, you can:

1. Forecast future revenue with accuracy

Total Contract Value offers a comprehensive view of the revenue expected from a customer contract, and thus, it encompasses recurring revenue, one-time fees, and other charges.

For instance: if a SaaS company signs a two-year contract at $1000/month, the TCV is $24,000. Thus, this precise figure allows the company to plan its resources, investments, and growth strategies with a clear understanding of future cash flows.

2. Understand customer value in your company

TCV provides a deeper insight into the value each customer brings over the contract term. This helps SaaS companies tailor their services and marketing efforts to maximize customer retention and satisfaction.

For example: if a customer’s TCV is significantly high due to a long contract length, the company might prioritize their support, offer personalized solutions, and ensure a higher return on investment.

3. Guide sales and pricing strategies

Understanding TCV helps SaaS businesses in shaping effective sales and pricing strategies. It allows them to identify which contract terms (like annual vs. monthly contracts) and pricing models (base price plus additional services) are most profitable.

For example: if annual contracts yield a higher TCV than monthly ones, your SaaS company might offer incentives for annual subscriptions and align sales efforts to secure longer-term contracts.

4. Evaluate CAC

TCV is crucial in evaluating the efficiency of customer acquisition strategies. By comparing TCV with Customer Acquisition Costs (CAC), SaaS companies can determine whether they are spending the right amount to acquire customers.

For instance: if the TCV of a customer acquired through a particular marketing campaign is high compared to the CAC, it indicates a successful strategy worth continuing or scaling up.

5. Determine company health

Finally, TCV acts as a barometer for the overall health and growth potential of a SaaS business. A consistent increase in TCV indicates a growing customer base and expanding contract values, which are signs of a healthy, growing company.

For example: a steady rise in TCV across multiple customers suggests the company is successfully scaling its operations, attracting more valuable contracts, and is on a sustainable growth trajectory.

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How to Improve Total Contract Value

And what should you do to improve this metric? We have some useful ideas.

#1 Optimize pricing strategies for higher-value contracts

To enhance the TCV in a SaaS business, you can optimize pricing strategies. This means designing pricing models that align with customer needs and perceived value, while maximizing revenue. Just see - introducing tiered pricing based on features or usage can cater to a broader range of customers, from small businesses to large enterprises, right?

Another approach in this area is implementing dynamic pricing based on contract length. Offering discounts for longer commitments can entice customers to sign extended contracts, thus increasing the TCV. A 10% discount on a two-year contract compared to a one-year term can make a significant difference in the total amount paid and, of course, can secure customer engagement.

#2 Leverage upselling and cross-selling opportunities

Assess customer usage and satisfaction to identify upselling opportunities. For example, customers frequently exceeding their plan limits might appreciate such an upgrade. This not only boosts revenue but also enhances user experience.

Also, tailor your offers to individual customer needs. Analyze customer behavior and preferences to make relevant suggestions. Personalized recommendations resonate more and are likely to be successful.

Further, train your sales teams so they can identify and act upon upselling and cross-selling opportunities. Such strategies ensure customers receive value and businesses maximize their revenue potential.

#3 Enhance customer success to boost contract renewals

Establish a strong customer success team focused on guaranteeing clients are gaining maximum value from your product. If customers understand and utilize your product fully, they are more likely to renew their contracts. Regular check-ins, personalized support, and providing valuable insights can lead to higher renewal rates.

Moreover, proactively address potential issues and offer solutions before problems escalate. Offer regular training and updates to keep customers engaged and informed about new features or improvements. For instance, a customer struggling with a feature might benefit from a tailored training session, which will lead to increased satisfaction and the likelihood of contract renewal.

#4 Implement effective contract length optimization

Analyze different customer segments to determine the most effective contract lengths. Longer contracts might be more appealing to enterprise clients seeking stability, whereas smaller businesses might prefer flexibility. Offering a variety of contract lengths can cater to these diverse needs.

Also, incentivizing longer contracts through pricing strategies or added benefits can encourage customers to commit for extended periods. Offer a discount or additional features for two-year contracts compared to one-year agreements. This not only increases the TCV but also ensures customer retention.

Of course, regularly reassess and adjust these strategies based on market trends and customer feedback to remain competitive and attractive to your target audience. Effective contract length optimization is about finding the right balance between customer needs and business objectives and can contribute to increased revenue and sustained growth.

#5 Focus on the right segments

Identify which segments generate the most revenue and focus on them. If enterprise clients contribute significantly to the annual contract value, tailor marketing and sales efforts toward them. This means understanding their specific needs and customizing the service accordingly.

Segmentation involves analyzing revenue metrics and customer behavior to determine who brings higher contract values. Once identified, concentrate resources on these segments. It might involve designing specialized annual contracts or offering unique features that appeal to them. By doing so, companies ensure they are not only attracting but also retaining customers who contribute significantly to the company's TCV.

#6 Improve product offerings to increase perceived value

Enhancing product offerings is also crucial for TCV. This involves regularly updating and adding features that provide real value to customers. For instance, introducing advanced analytics in a SaaS product can significantly boost its perceived value and encourage customers to sign or renew contracts at a higher rate.

Continuously evaluating and improving the product based on customer feedback and market trends is vital too. It ensures that the product remains competitive and meets evolving customer needs. This approach not only helps in retaining existing customers but also attracts new ones, as the product's value proposition becomes more compelling. Ultimately, a product that continually evolves and improves is more likely to command a higher contract value.

#7 Bet on strategic bundling your services and features

Strategic bundling involves combining various products or services into a single, more attractive package. Creating a software solution with complementary services like extended support or additional storage can increase the overall contract value.

This strategy works by offering customers a more comprehensive solution, often at a better price point than purchasing each component separately. It's essential to tailor these bundles to meet specific customer needs, making them feel personalized. Bundling not only makes the offer more attractive but also simplifies the customer's decision-making process. As a result, customers perceive higher value, which translates into increased TCV.

#8 Utilize data analytics

Use data analytics for targeted customer strategies. Analyze revenue metrics and customer behavior patterns to understand preferences and needs. For instance, data might show that customers with certain usage patterns are more likely to upgrade. If so, tailor your approach based on these insights.

Data-driven strategies allow for a better customer experience. Therefore, you should customize communication, offer relevant add-ons, or adjust contract terms. Accurate data analysis helps predict which customers are likely to sign higher-value contracts and enables more effective sales targeting.

#9 Build stronger customer relationships

Strengthening customer relationships is a must. Thus, focus on long-term engagement rather than short-term gains. Provide continuous value through exceptional service and regular communication. For instance, regular check-ins and personalized service can enhance customer satisfaction and loyalty.

Strong relationships lead to longer contract lengths and higher contract values. Engaged customers are more likely to renew and upgrade their contracts. Building these relationships involves understanding customer needs and consistently meeting or exceeding expectations. And satisfied customers become advocates for your business and bring in more high-value contracts through referrals.

#9 Use innovative payment and incentive models

Offer flexible payment options to accommodate different customer needs. Introduce a tiered pricing model that rewards longer commitments with lower rates. This encourages customers to sign longer-term contracts and can increase TCV.

Incentives like early payment discounts or loyalty bonuses can also motivate larger commitments. So, offer a discount on the total contract value if a customer pays annually instead of monthly. These strategies make it financially attractive for customers to commit to longer terms or higher tiers, thus enhancing the total contract value. Aligning these models with customer preferences and business goals is key to their effectiveness.

Partner with Valueships

Apart from "how much revenue" and "how many customers" metrics, SaaS companies should calculate TCV. With the right approach, TCV can be a new North Star for many.

And if you need help or advice with your pricing strategies, just contact Valueships. We'll help you every step of the way: we'll do the research, discuss possible options for improvement, and help you with choosing the right approach. Our experts are ready to serve you with their knowledge and experience, so don't hesitate to get back to us.

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Krzysztof (Kris) Szyszkiewicz
Head of Delivery, Partner

Certified expert in price, revenue and margin management in B2B companies and e-commerce. Member of the prestigious Professional Pricing Society. At Valueships, he is responsible for the implementation of consulting projects and taking care of the profitability of clients. Prior to joining Valueships, he worked at McKinsey & Company in the area of ​​pricing and strategy.

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Krzysztof (Kris) Szyszkiewicz
Head of Delivery, Partner

Certified expert in price, revenue and margin management in B2B companies and e-commerce. Member of the prestigious Professional Pricing Society. At Valueships, he is responsible for the implementation of consulting projects and taking care of the profitability of clients. Prior to joining Valueships, he worked at McKinsey & Company in the area of ​​pricing and strategy.