What is total contract value (TCV)?
SaaS companies need a constant influx of hard numbers and data to understand how effectively theyre able to generate revenue. Total contract value (TCV) is one of the most beneficial metrics to explore, although its also one of the most misunderstood. Read on to find out more about TCV, including benefits and potential issues. TCV definition  Total contract value is an important metric that measures how much a contract is worth after its been executed, including recurring revenue and fees (onboarding fees, professional service fees, etc.). Its especially useful for SaaS businesses as it provides a clear picture of how much your business can expect to earn from an individual customer once theyve put pen to paper and signed the contract. How to calculate total contract value  Before you learn how to calculate total contract value, youll need to know the formula. Fortunately, the TCV formula is relatively straightforward:  TCV = (Monthly Recurring Revenue x Contract Term Length) + Contract Fees  As you can see, changing the length of the contract or increasing/decreasing your businesss monthly recurring revenue (MRR) can have a massive impact on TCV. Lets see an example. Imagine Company A offers an information technology subscription service with a range of different prices and plans: Plan 1 (for individuals) offers a base price of 125/month for a one-year contract and Plan 2 (for enterprise) offers a base price of 1,200/month for a two-year contract, plus a 300 onboarding fee. Although total contract value and customer lifetime value (LTV) might seem, on the face of it, to be measuring the same thing, there are some relatively significant differences between the two metrics. Put simply, LTV is based on projections, whereas TCV is calculated using real contract commitments. While this means that its not possible to calculate total contract value for evergreen subscriptions, as theres no specified term length for the contract, TCV is backed by real figures, and therefore offers a more data-led insight into your businesss future earnings. Because TCV is based on true bookings, not projections, its a more accurate way to predict revenue and growth. This can help you budget accordingly and eliminate unnecessary spend. Its also important to note that total contract value can help you optimize your marketing/sales budget  divide TCV by your customer acquisition cost (CAC) to see just how efficient you are at bringing in new customers. This should help you understand which marketing channels are pulling their weight, and which channels are hindering your companys growth. Total contract value can also help you to identify which customer segments are most profitable for your business. After youve gathered the data, you can focus your sales and marketing resources on the most profitable leads and hopefully bring in more revenue. Another benefit of TCV is the added ability to work out which contract lengths work best for which demographics. For example, if you find that a certain demographic is more likely to pay upfront for a longer contract than they are to pay one month at a time, you can optimize sales for longer contracts and boost your TCV. Problems associated with total contract value  Despite the many advantages of TCV for SaaS companies, there are a few limitations that you should keep in mind. The principle of revenue recognition is an issue that frequently crops up. If the total contract value for a three-year contract comes out to 1,000 per year, you might assume that youve got a 3,000 customer on your books. This 3,000 is actually deferred revenue, because the customer could potentially cancel the contract halfway through and refuse to pay at the next billing cycle, wreaking havoc on your revenue predictions. In cases like this, you may wish to consider only dealing with prepaid deals when using TCV for financial projections. We can help  GoCardless helps you automate payment collection, cutting down on the amount of admin your team needs to deal with when chasing invoices. Find out how GoCardless can help you with ad hoc payments or recurring payments.