Depending on your industry or business model, there are numerous metrics by which to measure revenue and business growth. If you operate on a subscription-based sales model (commonly seen in SaaS), you are probably familiar with or at least encountered the terms ARR and ACV.
But what do they mean, and how are they relevant to your business?
In this guide, we’ll explain what ACV and ARR are and show you how to calculate each and use them to boost your sales and marketing results.
ACV—or annual contract value—defines the annual worth of an ongoing customer contract by calculating the contract’s average value over one year.
ACV helps you understand the individual value of customers who have a contract with your business and measure it against the cost of acquiring that customer (CAC).
What is ARR?
Annual recurring revenue, or ARR, is a metric used to measure the total revenue generated by all recurring customers over one year. Like with ACV, it’s based on the subscription model of sales, where customers pay a recurring fee to access your services.
It doesn’t measure the profit gained from individual customers but rather all your current customers as a whole. This measurement also accounts for revenue generated from any upgrades made by customers, as well as discounts offered.
ARR is a useful metric for understanding revenue growth over time and forecasting income fluctuations from renewals, upsells, or cancellations.
ACV vs ARR: key differences
ARR is often mentioned alongside ACV when looking at revenue metrics. While both are helpful indicators for understanding your business’s profit, there are key differences that make them helpful in different cases.
Both ACV and ARR measure the annual revenue value generated by customers in a subscription-based business model, but there are a few key differences, as illustrated below:
Definition: Annual Contract Value (ACV) measures the revenue value of a single, subscription-based contract, while Annual Recurring Revenue (ARR) measures the value of all of a company’s subscription-based contracts.
Scope: ACV may include all income generated in a year, including one-time purchases, while ARR measures revenue generated only from recurring subscriptions.
Calculation: ACV is measured as the average dollar amount generated by a customer, while ARR calculates the total dollar amount generated on an annual basis.
Formula: The formula for ACV may vary by company, while the formula for ARR is standardized and used across most companies.
Use case: ACV is an isolated metric that is most useful when used in conjunction with other metrics, while ARR is a figure that can be used on its own to track revenue growth and make better sales and marketing decisions.
The importance of monitoring ACV
When you understand your customers’ ACV, you can compare customers whose contracts differ in type or duration and discover which accounts provide the most significant revenue value to your business. Knowing this empowers you to better service individual customers, especially those with the greatest long-term potential. Here are a few benefits of using ACV as a revenue metric.
Prioritize high-value accounts
You can use ACV to measure what your customers bring to the table and prioritize those who bring the most.
When you know which contracts are most profitable to your business, you can recognize your most high-value customers and focus your efforts on retaining them as their contracts near the end of the subscription period.
Monitor sales rep performance
Knowing the ACV of individual customers and matching them to the sales rep in charge of the account lets you understand the total revenue each sales rep brings to the company.
This information allows you to determine the effectiveness of their training and how you can improve sales rep performance.
Maximize the use of company resources
Most companies have limited time and resources, so you want to ensure that you’re allocating your valuable resources to the accounts with the highest return on investment.
ACV, in this case, gives you a sense of direction. When customer support is stretched thin, for example, you can decide which customers benefit the most from your services and which require more time and energy to keep. You can then reallocate your resources towards satisfying clients who bring in more value.
Provide insight into marketing strategy
Understanding individual account revenue generated lets you know which accounts generate the most ROI. Usually, these accounts have factors in common, such as industry or company size.
Taking stock of the common denominators of high-value customers allows you to build a profile of your ideal customer. Your marketing team can use this profile to create more targeted marketing campaigns for client acquisition.
You can also focus your marketing efforts on existing high-value clients to encourage loyalty and retention, such as offering incentives in exchange for contract extensions, reviews, or testimonials.
DOWNLOAD
Want to generate more leads? (Of course you do.)
The B2B Marketer’s Toolkit collects 120+ of the best lead generation tips ever published on the Nutshell blog. Download it today!
In general, understanding ACV allows you to better understand the direction your business can take to experience the most growth and revenue.
As you calculate your ACV, you’ll acquire the knowledge needed to move forward with your services. Whether raising rates or reallocating resources, your priorities will shift to meet your business’s needs.
Who needs to use ACV and what for?
Various companies that sell their services via subscriptions can use ACV to measure revenue. This metric is not limited by industry, but the most common types of companies that use ACV are:
Software companies: SaaS companies are the primary industry that relies on subscription services to generate revenue, so the ACV metric is most useful for them to identify growth opportunities and measure progress.
Retail companies: Retail companies can use ACV to measure the revenue from customer accounts when they use subscription-based services or loyalty programs.
Financial services companies: Banks, credit unions, and wealth management companies can measure the ACV of their clients who use their accounts, cards, and other financial services.
Telecommunications companies: Telecom companies can use ACV to measure the revenue generated from purchases such as new phone plans, data plans, and add-ons.
Within these companies, ACV can also be used by employees to accomplish specific goals, for example:
Sales representatives can use ACV to identify high-value customers and strategize how to retain them during contract extension negotiations.
Sales managers may need ACV to monitor individual sales rep performance and tweak training efforts as needed.
CFOs or other C-suite executives can use ACV to improve timing and projections around annual budgets and future revenue forecasts.
How to calculate ACV
ACV is an average value you can calculate when you know the total value of a customer’s contract and the number of years it will be active.
Depending on your preference, you can add one-time purchases to the total value, although many companies leave those out and only use the income generated by recurring subscriptions.
For example, if Person A takes a SaaS annual subscription contract active for four years, and the total value of the contract is $120,000, then you can calculate the ACV like so:
ACV = Total value of all contracts/number of years
= 120,000 ÷ 4
= $30,000
If your customer takes a monthly subscription contract, you can still calculate ACV, but you first need to calculate the annual value by multiplying the monthly subscription fee by 12.
Person B, for example, takes a monthly subscription, paying $60 per month for a 3-year contract. To get the ACV of person B, first calculate the annual subscription value and then multiply it by 3 to get the total contract value.
Annual subscription value = $60 * 12 = $720
Total contract value = $720 * 3 = $2,160
With the total contract value, you can now calculate the ACV as follows:
ACV = Total value of all contracts / Number of years
= 2,160 ÷ 3
= $840
If a customer opens multiple contracts with different values and durations, you want to calculate the ACV of each contract, add the values to get the total ACV, and divide that number by the number of contracts.
ACV (multiple contracts) = Total ACV of all contracts / number of contracts
Note that the formula for ACV is not standardized, so the calculation and result may differ for different companies. For example, one company may prefer to calculate the ACV of customers purely on the subscription fee paid, while another company may want to include once-off fees, such as onboarding or installation costs.
Reporting & analytics in Nutshell
Learn more about Nutshell’s reporting and analytics features
Seeing as ARR and ACV are often connected, it’s worth knowing the standardized formula for calculating Annual Recurring Revenue as well.
ARR is the total value of income generated in a year from subscription-based contracts. It includes upgrades and downgrades. The general formula is:
ARR = Monthly Recurring Revenue (MRR) * 12
, where MRR is the monthly income generated from your subscriptions. To incorporate changes to ARR generated by contract upgrades and downgrades, for instance, a more inclusive formula would like:
ARR = ARR at the beginning of the year + ARR gained from new customers + ARR gained subscription upgrades – ARR lost to subscription downgrades – ARR lost to customer churn
Strategies to increase ACV
Now that you’ve calculated the ACV for your customers, how can you use the information to further your business goals? Here are some suggestions for making the most of your ACV results:
Benchmark new contracts: Analyzing ACV trends from previous years can provide a baseline when creating new customer contracts. They can also help you understand how first-year discounts affect your total income from a new customer.
Identify upsell opportunities: For example, if you notice a highly engaged customer with a low ACV, you can consider offering them an upgrade or addition to their contract.
Assess sales rep performance: Analyze which sales reps may be over-relying on discounts to close a deal, as well as those who excel at offering cross-sells and upsells to customers. Use this data to measure sales rep performance and adjust your training and lead assignment accordingly.
Allocate sales and marketing resources: Invest in tactics – and customers – that help you achieve the most revenue growth at the lowest possible cost.
FAQs about ACV
Still have questions about ACV that haven’t been answered in the article? Check out our list of most frequently asked questions about ACV below!
What is the difference between ACV and ARR?
Annual contract value (ACV) measures the average annual value of an individual customer’s contract(s). On the other hand, annual recurring revenue (ARR) measures the yearly value of all contracts.
Is ACV the same as SaaS bookings?
Unlike ACV, SaaS bookings take the total contract value at the time that contract is signed. ACV instead describes the average value per year of the contract.
What factors influence ACV and ARR?
Since ACV and ARR are revenue metrics, they are affected by factors such as your company’s pricing strategy, customer behavior, marketing efforts, and your business’s overall goals.
How can you increase ACV and ARR?
To increase your ACV and ARR metrics, you can focus on maximizing your revenue by focusing on pricing strategies, product marketing, customer experience, and customer retention—factors crucial to boosting your company’s revenue.
Use ACV and ARR to boost your business’s revenue
Now that you understand the importance of measuring ACV and ARR, the role these metrics play in your business, and how to calculate each, you’ll likely find many ways to leverage these numbers to meet your goals.
We have a number of resources available to help you create your ideal sales strategy and understand sales reporting and forecasting methods. Take a look and be inspired to find the best ways to improve your revenue year over year.
The important thing to remember is that revenue doesn’t come from nowhere. It comes from your clients and customers—people with whom you need to forge good business relationships.
With Nutshell CRM, you’re empowered to make the most of your customer relationships with sales automation, personalized email, advanced analytics, and more world-class features!
Try Nutshell free for 14 days – no credit card required. Or contact our team to learn more about how Nutshell can help your business achieve its revenue goals.
See Nutshell in action
Give our powerful, easy-to-use CRM a try for free for 14 days! Or join a live demo to see Nutshell at work!
