Total contract value (TCV) is a metric that represents the total revenue value of a contract over its duration. This includes one-time charges, recurring fees, and any other revenue-generating activities associated with the contract.

Below, we’ll cover what businesses should know about calculating TCV, how they can use this knowledge, and how to improve TCV.

What’s in this article?

• An overview of software-as-a-service (SaaS) metrics
  
• How is total contract value calculated?
  
• Why total contract value matters
  
• Total contract value limitations
  
• How to improve total contract value
  

An overview of software-as-a-service (SaaS) metrics

TCV is one of several important performance metrics for businesses. Below is a list of these metrics, including TCV, outlining what each metric measures and how businesses can use it to assess performance.

• Total contract value (TCV): This metric represents the total revenue that a contract is expected to generate over its lifetime. It includes all recurring revenue, one-time fees, and any other charges that are part of the contract.

• Annual recurring revenue (ARR): ARR measures the annual expected revenue from recurring payments. It’s a key performance indicator for the predictable and stable revenue that a business can expect year over year. ARR focuses solely on recurring charges and excludes one-time payments.

• Monthly recurring revenue (MRR): MRR is the recurring revenue a business can expect to receive each month, the monthly equivalent of ARR. It tracks monthly income from subscriptions and is an important marker of short-term financial performance.

• Customer lifetime value (CLTV or LTV): This metric estimates the total revenue a business can expect from a single customer throughout the customer’s relationship with the company. CLTV helps assess the long-term value of maintaining customer relationships and can guide investment in customer retention.

• Customer acquisition cost (CAC): CAC measures the total cost of acquiring a new customer, including marketing and sales expenses. Comparing CAC with LTV provides insights into a business model’s sustainability.

• Churn rate: Customer churn rate indicates the percentage of customers or revenue lost over a specific period. A high churn rate will have an impact on ARR and MRR. Churn rate is often used as a reflection of customer satisfaction and product-market fit.

These metrics provide a comprehensive view of a business’s financial health and growth potential in the SaaS sector. While TCV gives a snapshot of the contract’s total value, other metrics such as ARR, MRR, LTV, CAC, and churn rate provide deeper insights into recurring revenue, customer value, and business sustainability.

How is total contract value calculated?

To calculate total contract value, add up all the revenue components of a contract over its entire term. Here’s a detailed look at how to calculate TCV, including the different elements that might be included.

Components of TCV calculation:

• Recurring revenue: This includes all the regular payments a customer is expected to make over the duration of the contract (e.g., monthly or annual subscription fees).

• One-time fees: These are initial charges that might be applied at the start of a contract. Examples include setup fees and implementation charges.

• Variable fees: These fees include any usage-based charges or other fees that can be reasonably estimated over the contract term.

• Renewals: If a contract is likely to be renewed and the terms are known, you could add the value of the renewal term to the TCV. For instance, if a one-year contract for $1,200 is expected to renew for another year, the TCV would be $2,400. However, since this can introduce a level of uncertainty and assumption, it’s more conservative to calculate TCV without assuming renewals unless they are contractually committed.

• Discounts: Deduct any discounts from the total value.

Formula for TCV calculation:

TCV = (Recurring Revenue × Contract Duration) + One-time Fees + Estimated Variable Fees

Example 1: Simple TCV calculation

• Recurring revenue: $100 per month
  
• Contract duration: 12 months
  
• One-time setup fee: $500
  
• Variable fees: None
  

TCV = ($100 × 12) + $500 = $1,200 + $500 = $1,700

Example 2: TCV calculation with variable fees

• Recurring revenue: $200 per month
  
• Contract duration: 24 months
  
• One-time setup fee: $1,000
  
• Estimated variable fees: $50 per month
  

TCV = ($200 × 24) + $1,000 + ($50 × 24)

TCV = $4,800 + $1,000 + $1,200 = $7,000

Why total contract value matters

TCV is an important metric for businesses, particularly in sectors such as SaaS. Understanding a contract’s full financial impact can inform strategic planning and help determine a business’s financial health. Here’s a detailed breakdown of why TCV matters.

• Financial forecasting: TCV is a key component of financial forecasting, and provides a long-term view on one aspect of expected revenue.

• Financial management: TCV allows businesses to anticipate the revenue stream from existing contracts and plan accordingly for future expenses, informing budgeting and cash flow management choices.

• Investment prioritization: By evaluating the TCV of different contracts, businesses can prioritize investments and focus on the most lucrative agreements or customer segments.

• Resource allocation: TCV helps businesses allocate appropriate resources for sales, marketing, and support, prioritizing long-term revenue generation over short-term gains. Higher TCV contracts might warrant more attention or dedicated resources to ensure customer satisfaction and retention.

• Product and service optimization: Insights gained from TCV can guide a business in developing or refining products and services, with a focus on features that are likely to increase contract values.

• Sales team performance: TCV helps assess the performance of sales teams, evaluating the quality of the contracts secured by the team.

• Customer success and relationship management: TCV can influence strategies around customer success and relationship management, especially in identifying key accounts that require more focused engagement and support to ensure retention.

• Company valuation: For both startups and more established businesses, TCV can influence market valuation. Investors often look at TCV to assess the company’s growth potential and financial health.

• Fundraising and investor communication: TCV is an important metric in discussions with investors as it reflects not just the current revenue but the secured future revenue, adding depth to the company’s narrative in fundraising conversations.

• Contract stability and customer dependence: Analyzing TCV helps identify any risks associated with customer concentration or dependence on a few large contracts. Businesses can analyze TCV across their contract portfolio to strategize ways to diversify their contract base.

• Renewal risk assessment: TCV can help businesses assess the impact of contract renewals or terminations and plan accordingly, mitigating risks associated with revenue fluctuations.

• Market positioning: TCV provides a benchmark for evaluating the performance of contracts against industry standards. Knowing the TCV of contracts can provide insights into a company’s position in the market relative to competitors based on the value of the deals they are securing.

• Strategic negotiations: In contract negotiations, TCV helps businesses make informed decisions and secure terms that will help them meet their strategic and financial objectives.

Total contract value limitations

While TCV is a valuable metric for assessing the financial impact of a contract, it has several limitations that businesses should consider.

• Does not reflect cash flow timing: TCV shows the total value of a contract but doesn’t give insights into the timing of cash inflows. A large TCV does not necessarily indicate immediate liquidity.

• Potential overemphasis on long-term contracts: TCV can place too much emphasis on longer-term contracts, which might not always reflect a company’s short-term growth goals or cash needs.

• Assumptions in revenue recognition: In cases where TCV includes estimated values like expected renewals or variable components, there’s a risk that if these assumptions don’t materialize, the figure will be inaccurate, which could lead to misleading financial projections.

• Risk of misinterpretation: Without a nuanced understanding, stakeholders might misinterpret TCV as a measure of immediate revenue, and fail to recognize that it’s spread over the contract’s term. Relying solely on TCV for strategic decision-making can also be misleading. For a comprehensive analysis, TCV should be examined alongside other metrics such as CLTV, MRR, and churn rate.

• Limited insight into profitability: TCV doesn’t inherently account for the costs associated with delivering the service or product. A high TCV doesn’t necessarily translate to high profitability.

• Subject to unpredictability: Factors such as market volatility, economic downturns, and midcontract changes, downgrades, or cancellations can affect the value realized from a contract, making TCV a less reliable predictor of future revenue.

• Not helpful for comparison: Comparing TCV across different contracts or businesses can be challenging, especially if they include different terms, pricing models, or revenue recognition practices.

How to improve total contract value

Improving TCV means understanding your customers, aligning offerings with their needs, and managing relationships and pricing strategically. Use customer data to analyze usage patterns, satisfaction levels, and industry benchmarks, which will provide a solid foundation for targeted strategies that increase TCV while building stronger, more sustainable customer relationships. Here are some specific strategies for growing TCV.

• Upselling and cross-selling: Introduce higher-tier plans or additional products and services to existing customers, tailoring these offerings based on customer usage patterns and feedback.

• Value-based pricing: Build your pricing strategy based on the value perceived by your customers. Implementing a pricing model that directly reflects customer benefits can justify higher contract values.

• Longer contract terms: Encourage customers to commit to longer contract terms through incentives or discounts. Longer durations directly increase TCV and provide more stability in revenue forecasting.

• Customization and personalization: Offer customizable solutions or add-ons that cater to specific customer needs. Premium pricing tiers and other additional charges contribute to a higher TCV.

• Account management: Identify high-value customers and allocate resources to develop these relationships. Understanding their needs and business challenges can reveal opportunities to expand the scope of contracts.

• Performance-based upscaling: Introduce clauses that allow for contract expansion based on performance metrics or usage thresholds. This links your success with the customer’s and paves the way for natural contract growth.

• Renewal strategy: Develop a proactive renewal strategy that begins well before the contract ends, focused on demonstrating value and serving the customer’s evolving needs to lock in longer or more lucrative renewals.

• Customer success: Invest in a customer success program that ensures customers achieve their desired outcomes with your product or service. Satisfied customers are more likely to expand their contracts and less likely to churn.

• Market and competitive analysis: Analyze market trends and competitors to ensure your products or services remain competitive and compelling.

• Contract flexibility: Incorporate flexibility into contracts where possible, allowing customers to scale their usage up and down within the contract period. If customers know they can adapt as needed, higher tiers and additional services might seem more attractive.

• Customer incentives: Offer incentives for customers to renew their contracts early or upgrade to a higher tier, which can lock in a higher TCV earlier and extend the customer lifecycle.