Total contract value (TCV) in SaaS: What it is and how to calculate it

How to calculate total contract value (an example)?

TCV is an important metric for SaaS companies, especially those for which services constitute a significant component of the revenue. TCV provides the total value an individual customer brings to the business over the entire contract period. 

Let’s look at the table below, which shows an example of how a multi-year SaaS contract is commonly structured. 

As you can see in the revenue column, the calculation of TCV includes two primary types of revenue, subscription revenue and services revenue, which correspond to revenue line items in your profit and loss (P&L) statement.  

It’s important to note that in SaaS, services revenue also often has two components, too, which are recurring services and non-recurring or one-time services. We have included both in our example. 

But wait a minute! Wouldn’t the revenue from the recurring support services be considered subscription revenue? That’s a good question. 

By definition, that revenue probably should be included in the subscriptions. After all, it’s money earned by the company on a recurring basis via the subscription model. Whether recurring services should be considered subscription revenue or services revenue remains an ongoing debate in the SaaS industry. 

‍Ultimately, whether you report revenue from recurring services as subscription revenue or services revenue in your P&L really doesn’t matter as long as you specify which category you’re using and use it consistently. And it doesn’t matter for the TCV calculation, either.    

To calculate the TCV, you have to add up the annual contract value (ACV) for all three years of the contract, adding the one-time implementation services fee to year 1, and the fees for the recurring support services to each of the three years.

ACV vs TCV

ACV tells you the average annual revenue generated from each customer contract. In contrast, TCV tells you the total value of a given contract, factoring in all revenues and fees to be paid throughout the entire contract period, including recurring and one-time payments. 

The ACV calculation for a given contract is pretty straightforward. It’s simply the TCV divided by the number of years in the contract. However, as you can see from our example above, the actual ACV can vary from year to year based on how the contract is structured, so it may not be the same as your average ACV. 

One benefit of ACV is that if your company has contracts of varying lengths, it can help you better understand your revenue growth from new bookings. This is because ACV annualizes the revenue for each contract (whether calculated as an actual value or an average). 

Thus, the ACV can tell you whether the revenue growth you’re seeing is the result of 1) a higher value booking (the customer is paying more each year), or 2) a function of the contract term (the customer is paying the same amount each year but the contract is longer). 

This is an insight that using TCV alone can obscure.   

How does TCV relate to other SaaS revenue metrics?

TCV is one of several metrics SaaS companies can use to understand different aspects of their revenue. It’s important to remember, though, that different metrics tell different stories and some, by nature of how they’re calculated, don’t tell the full story or can obscure important insights. 

To use metrics effectively, you need to understand how they relate to each other so you can determine which one is the best metric to use based on what you need to know.  

Now that you know how TCV relates to ACV, let’s take a look at how it relates to some of the other more common revenue metrics SaaS companies typically track.

Annual recurring revenue (ARR)

ARR is the recurring revenue from subscriptions, normalized over a period of one year. Based on this definition, ARR captures revenue only from subscriptions. Unlike TCV, it does not include one-time fees and often also excludes variable fees and consumption-based fees.  

So, you might be wondering at this point whether TCV is a more accurate representation of revenue than ARR. After all, it accounts for more of the revenue actually being generated, right?

The answer to this question is that ARR and TCV differ in purpose. Both are useful because each gives you a different piece of the revenue puzzle.   

Recall that TCV is a metric that helps you understand total revenue when you’re dealing with multi-year contracts, which can be very useful in planning. In contrast, ARR is used to understand recurring revenue regardless of whether you have monthly or yearly plans and/or multi-year contracts, which offers a different perspective. 

ARR is probably the most widely used metric in SaaS today and with good reason. ARR not only gives you a quick way to track gross sales, it also offers a lot of valuable insights into different aspects of your business that can impact revenue, including sales, customer success and satisfaction, and a customer’s lifetime value (LTV).   

Subscription Revenue

Subscription revenue is the money a company earns when a customer enters into an agreement to pay a recurring fee in exchange for its product or service for a specified period of time. 

When calculated as an annual number, subscription revenue is really just another way of referring to ARR. Likewise, calculating your subscription revenue as a monthly number will tell you your monthly recurring revenue (MMR). 

Subscription revenue is calculated based on the pricing model you use in your SaaS business, such as flat-rate pricing, tiered pricing, usage-based pricing, or hybrid pricing, which combines two or more pricing models.  

The main difference between TCV and subscription revenue is that the latter does not include one-time fees. Subscription revenue can, however, include consumption-based fees and variable pricing as part of a hybrid pricing model, as long as they are recurring in nature as part of a subscription. 

Customer Lifetime Value (LTV)

TCV and LTV are different ways of looking at revenue. TCV measures the total value of an existing contract (or all contracts if you’re calculating an aggregate TCV). Whereas, LTV is the average recurring revenue (adjusted for churn and gross margin) that your customers generate over their entire relationship with your business. 

The main difference between TCV and LTV is that the former represents revenue from actual existing contracts with your customers while LTV is based on projections.

In comparison to TCV, calculating LTV is more complicated with different LTV formulas you can use depending on whether you’re interested in the unit economics at the customer level or for every dollar of ARR the customer will generate. Your pricing model can also influence how you calculate LTV. While the definition of LTV suggests that it considers only recurring revenue, it may make sense for you to include one-time service fees if they make up a significant portion of your revenue.    

Remaining Performance Obligation (RPO)

Remaining Performance Obligation (RPO) is an indicator of the revenue a company expects based on executed contracts that have not yet been fulfilled as of the end of a reporting period. It is the sum of deferred revenue (advance payments for services not yet delivered) plus backlog (the amount of money contracted but not invoiced) within a defined period of time. 

Due to its relative simplicity, TCV doesn’t capture this nuance. Calculating TCV across all your contracts simply measures their total value, which doesn’t take into account how much revenue is remaining to be billed for them. Thus, RPO is a more granular metric than TCV. So, is it a better metric? That depends on the question you’re asking. 

RPO is very important for accounting in SaaS because SaaS products often involve complex pricing and renewal options not typical of other industries. It’s also useful for giving prospective investors quick insight into a company’s future revenues. However, RPO has little utility in the planning context. For this, TCV and other revenue metrics are generally more useful.