Annual Contract Value(ACV)
The calculated amount that a customer under contract will pay over a year.
How Annual Contract Value (ACV) Works
Annual contract values (ACVs) are routinely used by Software as a Service (SaaS) companies, which are companies that solely operate via the internet by selling digital content or access to digital content. For these companies, calculating ACVs for their customers can reveal many insights into their target audience and how they should do business. First, as the ACV shows the annual revenue that a company is making from providing a service to its customers, it can monitor the growth or decline of its revenue over time. Not only does this allow for the sales and marketing teams of the business to recognize what influences their contracts, or subscriptions, with customers, but it also allows them to see what works in expanding the company and what doesn’t.
Additionally, a business can use an ACV to compare its total revenue from customer subscriptions with other companies in the same field, which gives the business a method of comparing different factors to their competition. This is especially useful if the two companies have different rates they charge their customers. Generally, you can calculate the ACV for a particular customer by dividing the amount the customer is paying by the number of years the customer is paying (ACV = amount paid (by customer) / # of years). You should note that some companies charge one-time fees, and you may also factor this into the equation. Simply put, the ACV is similar to an annual rate for the customer.
There are two types of ACVs: the small ACV and the large ACV. A small ACV means that a company charges its customers with a low rate, normally in the hundreds or less, each year. In this case, the company charging a small ACV has many customers and still makes a significant profit. On the other hand, a large ACV translates to a much higher rate, generally in the thousands and tens or even hundreds of thousands, for customers, which usually means fewer customers; however, they pay more and provide the business with a notable profit.
Real-World Example of Annual Contract Value (ACV)
Netflix is known to provide online entertainment to millions of people across the world. As Netflix only offers digital content and not physical products, it is considered a SaaS company.
Netflix charges each consumer with a basic Netflix subscription around $14 per month (as of January 2021), or around $168 per year ($14 ✕ 12 months) per customer. This value, $168 per year, would be the ACV for customers with a basic subscription. Using that information, we can determine that Netflix has a small ACV: a relatively low rate for a good number of consumers.
When Netflix tries to determine the overall revenue they will make from their customers, they would also need to use the ACV for other, more expensive Netflix plans and the number of customers with each type of subscription. With this information, Netflix could find ways to better budget over the year or advertise to different demographics.