What is ACV? Understanding the Importance of Average Contract Value for Brands
Many companies prioritize achieving the broadest distribution possible, but placing a product on store shelves doesn’t guarantee success. Often, the key isn’t how many stores your product is in, but the quality of those stores. Success often comes from focusing on high-traffic stores rather than several low-traffic locations.
This leads to the concept of Average Contract Value (ACV), a key metric that helps businesses evaluate the true worth of their customer relationships.
Who needs to measure ACV?
ACV is a key metric used by businesses, especially in subscription-based models (like SaaS), to measure the average revenue generated from a single customer contract over a specific period.
For CPG brands, ACV is crucial when evaluating retail partnerships and how they utilize tools like retail execution software. This software can help track sales data and optimize how products are presented in stores, aligning product placement with high-ACV accounts.
- Industries that use ACV: SaaS, CPG (Consumer Packaged Goods), and more.
- Why it’s important: It helps businesses assess the profitability of their customer base and inform resource allocation and sales strategies.
- ACV calculation: Total revenue from all contracts over a given time period divided by the number of contracts.
What is a Good ACV?
Determining what constitutes a “good” ACV can vary significantly depending on the industry, business model, and target market. However, generally speaking, a higher ACV is often an indicator of a strong, high-value customer base. It reflects that the company is securing contracts with customers who are willing to spend more, often because they perceive higher value in the product or service being offered.
In industries where contracts are typically small and short-term, like certain B2C (Business to Consumer) markets, a lower ACV might be normal and acceptable. Conversely, in industries like B2B (Business to Business) SaaS, where customers often commit to long-term contracts for enterprise-level software, a higher ACV is desirable. Tools such as sales-performance-management-software can also play a key role in maximizing ACV by ensuring that sales teams are targeting high-value accounts effectively.
To determine what a “good” ACV is for your business, it’s essential to benchmark against industry standards and consider the specific characteristics of your customer base. Factors such as customer acquisition cost, lifetime value, and churn rate also play crucial roles in assessing whether your ACV is healthy for your business model.
Factors Affecting ACV:
- Industry standards
- Customer base characteristics
- Customer acquisition cost (CAC)
- Lifetime value (LTV)
- Churn rate
Measuring ACV: A Key Performance Indicator
Measuring ACV is straightforward but requires accurate data on total revenue and the number of contracts. The basic formula is:
ACV = Total Revenue from Contracts / Number of Contracts
For example, if a company has $1,000,000 in revenue from 100 contracts, its ACV would be $10,000. This metric can be measured over different periods, typically annually, to account for seasonal variations or economic cycles.
a company has $1,000,000 in revenue from 100 contracts, its ACV is $10,000.
If a company signs a contract worth $120,000 over three years, the ACV would be $40,000. This calculation assumes that the revenue is evenly distributed across the contract’s duration.
However, companies may also choose to include one-time fees or adjust for contract variations in their ACV calculations. For instance, if a contract includes a one-time setup fee, the company might decide to exclude this from the ACV to focus purely on recurring revenue. Alternatively, they might average it over the contract term to get a blended ACV that includes both recurring and one-time revenues.
It’s also important to consistently apply these calculations across all contracts to ensure the ACV metric is reliable and comparable over time. Inconsistent calculation methods can lead to skewed results and misinformed business decisions.
Advanced ACV Analysis:
- Segment by customer category: Enterprise vs. small business.
- Track ACV trends over time: Increasing ACV suggests improved contract value, while declining ACV could signal pricing issues or increased competition.
ACV vs. ARR: Key Differences
While ACV focuses on the average revenue per contract, Annual Recurring Revenue (ARR) provides a broader view of the company’s recurring revenue over a year.
- ACV: Focuses on individual contracts and sales strategies.
- ARR: Offers insight into overall revenue health and future cash flow.
- Balanced approach: Combining both ACV and ARR offers a more comprehensive view of financial health.
Brands that utilize retail execution software to manage product placement in stores can see direct impacts on both ACV and ARR, as optimizing where and how a product is displayed can lead to stronger sales outcomes. Furthermore, focusing solely on either metric can be misleading. A balanced approach that considers both ACV and ARR, along with other metrics like customer retention and lifetime value, provides a more holistic view of the business’s financial health.
Why CPG Brands Need to Know ACV
Consumer Packaged Goods (CPG) brands, traditionally more focused on sales volume and market penetration, are increasingly recognizing the value of understanding ACV. For CPG brands, ACV can provide insights into the profitability of different distribution channels, customer segments, and product lines.
By analyzing ACV, CPG brands can determine which retailers or distributors are generating the highest average revenue per contract. This can inform decisions about where to allocate resources, which partnerships to prioritize, and how to structure contracts to maximize profitability. Leveraging sales performance management software can further enhance a brand’s ability to drive up ACV by helping the sales team focus on the right accounts and strategies.
Understanding ACV can also help CPG brands refine their merchandising strategy. This insight is crucial in today’s retail environment, where shelf space is limited and competition is fierce. Focusing on high-ACV relationships can drive better financial outcomes with lower risk.
ACV is not just a metric for SaaS companies, it is a powerful tool for any business looking to understand and maximize the value of its customer relationships. By focusing on ACV, brands can make more informed decisions about their sales strategies, pricing models, and customer segmentation, ultimately driving greater profitability and growth.