SUBSCRIPTION FINANCE
How to Calculate Total Contract Value (TCV): Subscription-Based Business Guide
What is Total Contract Value?
Total Contract Value (TCV) measures the total revenue of a contract’s recurring revenue and contract fees. And it’s one of the must-know metrics for subscription-based businesses looking to grow.
Sound like you? Awesome. Because, in this guide, we’ll share everything you need to know about TCV, including:
- How to calculate TCV using a simple formula
- The difference between total contract value and annual contract value
- The difference between total contract value and lifetime value
- When and when not to use total contract value as a metric for making important business decisions
Want an accurate way to predict the revenue and growth of your business? Decide which expenses from your marketing and sales budget you need to cut? Know the key metrics your investors may ask about in your next meeting?
Then, you need to know the meaning of Total Contract Value (TCV).
TCV Meaning and Examples
Total Contract Value refers to the total amount of money a customer pays over the lifetime of their contract with your business. When calculating TCV, you’ll include the recurring revenue from a contract as well as any additional, one-time fees.
For clarity, let’s look at an example before moving on to show you how to calculate TCV for your business.
Let’s say you’re a business that needs a subscription for a new project management software. So, you sign up for a 3-year contract for software that costs $650 per month. When you sign up, you also have to pay an onboarding fee of $500 and decide to buy an add-on service to the software for a flat fee of $1200.
The total value of your contract with this software company would be $25,100. How did we get that number? Easy. Just follow the formula in the next section.
How to Calculate Total Contract Value
To calculate TCV, all you have to do is use this simple formula:
TCV = MRR x Number of Months the Contract Is Effective + One-Time Fees
So, going back to our example in the previous section, we can calculate $2,510 by applying the TCV formula like this:
$25,100 (TCV) = $650 (monthly fee) x 36 (months) + $500 (onboarding fee) + $1200 (add-on fee)
How TCV Is Different from ACV and LTV
You may think that Total Contract Value sounds a lot like two other important metrics, Annual Contract Value (ACV) and Lifetime Value (LTV). And, while there are some similarities, there are also some key differences to be aware of.
TCV vs. ACV
ACV is the total amount of recurring revenue that a customer will pay for your service over the course of one year.
TCV, on the other hand, is the total amount of recurring revenue and one-time fees that a customer will pay for your service over the entire course of their subscription contract.
TCV vs. LTV
LTV is the total amount that you can expect a customer to spend with your company during their customer lifespan.
Again, TCV is the total amount of recurring revenue and one-time fees that a customer will pay for your service over the course of their subscription contract.
Both metrics are useful to your business. But TCV is a projection based on concrete numbers included in your contract, while LTV is a projection of potential revenue that you can use to measure the health of your customer relationships.
When to Use TCV to Make Important Business Decisions
Now that you know what Total Contract Value means, the TCV formula to calculate it, and how it’s different from other important metrics, let’s look at how you can use it to grow your business.
Here are a few examples of key business decisions that can be informed by Total Contract Value:
Revenue forecasting: TCV is an effective method for forecasting revenues and growth based on real sales.
Revenue recognition: TCV can help you make sure that you’re accounting for all of your subscription revenue when making decisions based on projected revenue.
Marketing budget: TCV can give you a better understanding of what effect your marketing channels and campaigns have on growth, helping you decide how to best allocate your marketing budget.
Customer acquisition costs: You can use TCV to get a more accurate measurement of your customer lifetime value and how much you can spend to acquire new customers.
Customer segment comparison TCV can be used to compare customer segments to see which ones are more valuable to your business. You can then focus more of your marketing efforts on these particular customer segments to increase your chances of retaining your most valuable customers.
Subscription mix: You can use TCV to see if it would be more valuable for your business to focus on selling more of one type of subscription rather than another.
Sales pipeline analysis. You can use TCV to evaluate the effectiveness of your sales pipeline, allowing you to optimize your sales process and identify any bottlenecks.
Sales quotas: You can use TCV to help you establish sales quotas and ensure that your sales team is focused on acquiring customers that bring the most value to your business.
Commission plans: You can also use TCV to design effective commission plans for your sales team and ensure your sales team is adequately incentivized to sell the services that generate the most revenue for your business.
Key Takeaways
Total Contract Value (TCV) is a useful metric for subscription-based businesses because it can be used as a projection of revenue when planning your budget, managing the growth of your business, and speaking with investors.
Unlike the metrics ACV and LTV, TCV measures the value of a contract’s recurring charges and one-time fees.
This makes TCV a more accurate projection of your future revenue.
TCV is calculated using this simple formula:
TCV = MRR x Number of Months the Contract Is Effective + One-Time Fees
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