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What is Average Contract Value?
Average Contract Value (ACV), sometimes written as Annual Contract Value, is a tech marketing metric that measures the average value of customer contracts by averaging and normalizing them over a one-year period.
Why is Average Contract Value Important?
Your average contract value has important implications for how you will acquire new customers to grow and scale your subscription-based tech business.
Imagine two tech businesses with the same goal: scaling from $1 million to $10 million ARR. Business A currently has 2000 customers with an ACV of $500/year, while Business B has just 10 customers with an ACV of $100,000/year.
To achieve their goals while maintaining the same ACV, Business A has to gain 18,000 new customers while Business B only needs 90 additional customers to reach $10 million ARR. Compared to Business B, Business A will need to:
- Acquire thousands more customers to reach $10 million ARR,
- Maintain much lower customer acquisition costs (CAC) to ensure profitability, and
- Scale customer service and success teams to mitigate churn and maintain high service standards for a massive customer base.
Tech businesses can be successful at any ACV, from B2C companies like Netflix that reach 200M subscribers with an ACV of under $100, to tech companies like Crowdstrike, which IPOed in 2019 with 1500 customers and an ACV of more than $167,000.
But in both cases, ACV played a major role in the strategies these organizations used to acquire customers and achieve sustainable growth.
How to Calculate Average Contract Value
Calculating ACV for your tech company is typically a two-step process. First, you’ll need to individually calculate the annual contract value for each of your customers. Then, you’ll need to add those values together and divide by the total number of customers to get an average ACV for your whole business.
The formula for calculating the annualized value of a customer contract is:
Annual Contract Value =Total Value of Contract / Contract Length in Years
The formula for calculating average contract value (ACV) for your tech business is:
Average Contract Value (ACV) =Total Value of All Contracts / Total Contract Lengths in Years
A tech company signs an agreement with a new customer. The customer pays a one-time setup fee of $2,000, then $1,000/month over a 24-month contract term. The annualized value of the contract is calculated as:
Annual Contract Value = ($2,000 + (24 x $1,000)) / 2 years
= $26,000 / 2 years
= $13,000 / year
A tech company has a total of 100 customers. Eighty of those customers are paying $100/month for the service on annual contracts, while the other twenty benefitted from a special promotion and are paying a lower rate of $50/month.
To determine the ACV, we have to figure out the annualized contract value for both customer segments, then calculate the average. The annualized contract values are calculated as:
Annual Contract Value (Full Price Group) = ($10012 months) / 1 year = $1,200
Annual Contract Value (Discount Group) = ($5012 months) / 1 year = $600
The company has 80 contracts with an annualized value of $1,200 and 20 contracts with an annualized value of $600. Now we can find the tech company’s ACV by taking the weighted average of its contract values using the formula above. ACV will be calculated as:
Average Contract Value = ($1,20080 contracts) + ($600 20 contracts) / 100 customers
= ($96,000+ $12,000) / 100 customers
What is a Good ACV for Tech Businesses?
When it comes to determining a “Good” average contract value for your tech business, there’s no one-size-fits-all solution. As we’ve already mentioned, tech businesses have found success with ACVs that range from the hundreds to hundreds of thousands of dollars.
But while ACV on its own might not be the most useful metric, tech business leaders can combine it with other metrics to evaluate the overall performance of the business.
If you know your ACV, you can divide it by your annualized customer retention rate to calculate your customer lifetime value:
Customer Lifetime Value (LTV) = ACV Customer Retention Rate
Once you’ve calculated your LTV, you can compare it to your customer acquisition costs (CAC) to assess the efficiency of your digital marketing efforts using LTV:CAC ratio. At Directive, we target an LTV:CAC ratio of 3:1 to help our tech clients generate sustainable long-term growth.
Increase Your Average Contract Value with Directive
Our Customer Generation methodology is proven to positively impact tech business KPIs, including ACV, trial conversion rates, CAC, and LTV. To achieve positive results across the board, we leverage 1st-party data to define your total addressable market (TAM), zero-in on high value prospects that fit your ideal customer profile, and convert those prospects into paying customers.
Want to learn more? Let’s get on a call.