As a SaaS business leader, you're probably all too aware of the importance of key performance indicators like Annual Recurring Revenue (ARR) and Average Contract Value (ACV).
ARR is undoubtedly the most common SaaS metric most companies tout when they’re thinking about their performance. It’s often the first question investors ask, and what most operators and owners themselves look at…. But it’s not the whole picture, and it may not be the top priority of the metrics you should be tracking.
While both are key performance SaaS metrics to maximize and track (obviously we want both to be as high as possible), focusing on ACV might be more beneficial than ARR depending on company's stage and situation.
Below, we'll dive into the particulars of both metrics, and the pros and cons of assessing them as the major indicator of your business performance. We'll also cover which types of SaaS businesses should zero in on average ACV as their main momentum metric.
First: Get Your Financial Reporting House in Order
Before we get into the weeds, a callout (or word of caution): Determining which financial metric to focus on presumes you have a solid way to measure them in the first place.
As we’ve covered in other blog posts, financial reporting is an absolute must for any kind of B2B SaaS business. First – for the simple reason that it provides insights into the company's financial health, cash flow, and growth potential. And second – because these metrics help guide new strategies as well as a baseline for securing investment. It's impossible to make any kind of realistic financial projections without knowing where you currently stand as a business.
If you're struggling to determine how much revenue you're getting because of inaccurate invoices, wonky plans and more, Wingback might be a good starting point.
Having accurate financial projections and metrics are the springboard for basically everything else your business does: from optimizing product development, to allocating resources effectively towards marketing efforts and customer acquisition.
So – as a caveat to the metrics themselves and which ones to prioritize and why – it bears repeating that the first step is to make sure you’ve got an accurate and reliable way to measure them in real time.
With that said, let’s dive into ARR and ACV.
ACV & ARR Pros & Cons
This may be refresher material for you, or even come as obvious, but it’s worth covering…
Annual Recurring Revenue (ARR)
ARR represents the total revenue from subscription-based products or services that a SaaS company expects to generate over a single year. This metric is typically calculated by taking the monthly recurring revenue (MRR) and multiplying it by 12, though there may be some exceptions here.
As the name implies, ARR focuses on revenue generated from recurring subscriptions, not one-time or one-off charges or fees, including unpredictable usage.
✓ Pros
- Provides a clear picture of recurring revenue streams and the growth rate of the business.
- Helps track the success of subscription-based products and services.
- Easy to calculate and understand.
✖ Cons
- May not accurately represent the true value of longer-term contracts.
- High short-term ARR with high churn might not be sustainable in the long run.
Average Contract Value (ACV)
ACV represents the average revenue generated per customer contract over a specified time period, usually a year. This metric takes into account the total value of all customer contracts and divides it by the number of contracts, giving an average revenue per contract.
As the name implies, ARR focuses on revenue generated from recurring subscriptions, not one-time or one-off charges or fees, including unpredictable usage.
NOTE: Average - not ANNUAL
ACV can also stand for Annual Contract Value, which is simply the total sum of all contracts throughout a 1-year period; similar to ARR. Here, we’re talking about Average Contract Value per customer.
NOTE: Average - not MEDIAN
This may go without saying, but keep in mind that average (mean) isn’t the same as median; typical ACV isn't the same as average ACV. So if you have a major outlier on the high or low end of the spectrum (for example, one anomalous customer on a $100k contract when most others are on a $10k one) you’ll want to keep this in mind as you make the considerations below.
✓ Pros
- Offers insights into the value of individual customer contracts and their contribution to overall revenue.
- Helps identify high-value clients and opportunities for upselling or cross-selling.
- Useful for businesses with longer contract lifetimes and low churn rates.
✖ Cons
- May not capture the full potential of businesses with shorter-term contracts and high churn rates.
- More complex to calculate than ARR, as it requires data on contract values and durations.
ACV essentially helps you understand the value of each customer and how pricing strategy, customer acquisition, and customer segments impact overall subscription revenue.
Your standard ACV calculation may look like this:
ACV = (total contract value) / (number of customers)
Why you Should Consider Assessing ARR and ACV together
ARR and ACV measure different things, so naturally they paint different pictures about the value you’re getting from customers. ARR tells you, in short, how much money you’re generating per year from your subscriptions, while ACV tells you how big your customers are. For example, let’s say your ARR is $1 million. Does that come from 5 customers? 50? 500? 5,000? That’s the much-needed context that ACV gives you when you’re looking at ARR.
Let’s look at the opposite scenario. You’ve got an ACV of $20,000. Great! But if your total ARR is only $50,000, that’s not so rosy of a situation.
The two metrics alone can be vastly different in terms of the stories they tell about your SaaS business, so choosing the right ones to focus on matters – as does looking at them in tandem for greater context and insights.
When to focus on ACV over ARR
Of course, if you’re a savvy SaaS business leader, you’re already likely looking at both metrics. But here’s why and when you might give ACV more weight than ARR:
Support for complex plans with varied pricing models
SaaS businesses that have longer contract lifetimes should focus on ACV, as it provides a more accurate representation of the revenue generated over the entire contract period. This is the case if your ideal customer might be using your product as a critical piece of their infrastructure or otherwise will be locked in for time periods significantly longer than 1 year.
If that’s the case, a low MRR with a high ACV can actually be a positive indicator, as it suggests low churn and long-term revenue potential.
Contract Activation and Usage
For some SaaS businesses, contract activation may take longer, and the more usage occurs, the more money they make. For example, maybe your product has a per-seat component, and so usage and revenue tends to grow as more users throughout the customer’s business add seats and build up their personalized dashboards.
In these cases, the contract value might increase over time, making ACV a more relevant metric to track.
High-Value, Low-Churn Customers
SaaS companies with a customer base that’s largely made up of fewer contracts but with higher value can generally outperform products with high short-term MRR and high churn. Why? For one, because customer acquisition cost is typically so high, it’s more valuable to aim for long-term loyalty over churn-and-burn quick wins. If you have a smaller number of customers but each one is a "big fish," you're probably in this boat. So keep churn rate in mind as you assess any ACV metric or ARR metrics.
In these situations, focusing on ACV can help you hone in on new opportunities for growth and retention as you learn from your most loyal, dedicated users.
Focus on the Metric That Represents Your Company's Performance
Ultimately, the decision to focus more of your attention on ARR or ACV should be based on which metric you believe best represents the performance of your SaaS business, taking into account your unique situation. Consider things like the nuances of your business model, customer base, and contract lifetimes; given this, what metric most closely aligns with success? Choose the most relevant metric to zero in on -- knowing that you'll still be tracking and looking at both.
Hint: The answer may change over time!
Just as your priorities and situations as a business change quarter to quarter, year to year, so will the main metric you’re basing your “north star” on. Today, success might be most clearly signaled by your ARR, but in 6 months and some tweaks, ACV might make more sense, and vice versa.
Summary
Knowing the differences between ARR and ACV and their respective impacts on your SaaS business is crucial for making informed decisions and driving growth.
While ARR is an excellent metric for tracking recurring revenue streams and overall growth, ACV can provide valuable insights into individual customer contracts and long-term revenue potential. If your SaaS business is currently characterized by having a “slow-burn” effect – either in terms of long-tailed activation and usage, customer value that increases over time, or low-churn, yearslong customers – you’re most likely going to benefit from prioritizing ACV over ARR.
However, this also can change over time as your strategies, target customers, and other aspects of the business also evolve, so it’s not a one-and-done decision, but rather a reminder that you need to keep a sensible finger on the pulse of your business.
At the end of the day, you’ll want to focus on the metric that best represents your company's performance so you can optimize your pricing strategy, customer acquisition efforts, and product development to ensure long-term success.
Whichever metric you feel is most important to use as your “north star” right now may (and probably will) change over time, and can also be greatly informed by looking at the other. So be sure to stay on top of financial reporting, and ensure you’ve got a reliable, accurate way to measure these metrics.
