When it comes to running a successful startup, one of the most important pieces of information that business owners need to have is an understanding of total contract value. This metric can be used to measure performance and track overall success within a company, but many entrepreneurs may not know exactly what it is or how it works. In this blog post, we’ll explore total contract value and delve into why startups should prioritize this often-overlooked element in their business strategy. From defining what TCV means to increasing its measurements over time, you’ll gain valuable insight into a crucial key performance indicator (KPI). Read on to find out more about TCV and how you can use it in your own startup approach!
What is the Total Contract Value?
Total contract value (TCV) is the total dollar amount of all services and products provided as part of a business agreement. It includes any additional fees, taxes, discounts, and other incidental expenses that are associated with the purchase. This figure is important to both parties involved in the agreement since it serves as the base for setting expectations and understanding the true cost of the agreement.
It also serves as an important reference point for budgeting and tracking costs throughout the project’s lifespan. TCV can be calculated by listing all services and products in a contract and adding up their individual prices plus any additional fees or taxes associated with them. This figure should then be agreed upon by both parties before the agreement is finalized.
Once the Total Contract Value (TCV) has been determined, it should be regularly monitored throughout the duration of the agreement to ensure that expenses are kept in line with expectations. The TCV can also be used as a benchmark for future agreements and provide valuable insight into how a business is managing its finances.
Why Is It Important For Startups to track the Total Contract Value?
Following are the reasons why tracking the Total Contract Value is important for Startups:
1. Track Progress:
Tracking the Total Contract Value enables startups to measure progress against their goals and objectives. This helps in measuring key performance indicators, such as customer acquisition cost, customer lifetime value, etc., which are essential for making wise business decisions.
2. Forecast Revenue:
Startups can use this data to accurately forecast future revenue and determine the profitability of their investments. By accurately tracking the Total Contract Value, startups can better manage their cash flow and plan for any potential risks or opportunities in the future.
3. Set Targets:
Tracking the Total Contract Value allows startups to set realistic goals and objectives and track them over time. This helps in setting achievable targets that can be easily monitored and achieved.
4. Reduce Risk:
Without tracking the Total Contract Value, startups are more exposed to potential risks due to poor financial planning or mismanagement of resources. Tracking the Total Contract Value allows startups to better predict and manage their risks by understanding their spending patterns and revenue sources.
5. Make Better Decisions:
Finally, startups can use the Total Contract Value to make better, more informed decisions about their operations and investments. By understanding their spending patterns, startups can identify areas for improvement and take necessary steps toward achieving success.
Overall, it is important for startups to track the Total Contract Value in order to make wise business decisions and remain competitive in the market. By accurately tracking this data, startups can better plan for their future and increase their chances of success.
How To Calculate the Total Contract Value?
Here is the formula to calculate the Total Contract Value:
TCV = Monthly recurring revenue (MRR) x Duration of contract [in months] + one-time fees
For example, if you have a 3-year contract with a monthly recurring revenue of $500 and an upfront setup fee of $500, the Total Contract Value would be: TCV = (500 x 36 months) + 500 = $18,500. The Total Contract Value is the total amount your customer will pay over the length of their contract.
What factors affect the Total Contract Value?
The following factors affect the Total Contract Value:
1. Scope of Work:
The scope of work, or the amount and type of services to be provided, plays a large role in determining the Total Contract Value. The complexity of the services required will determine how much labour is needed and how much it should cost.
2. Completion Time:
Depending on the nature and size of the project, the timeline for completion can have a significant impact on the Total Contract Value. If the timeline is too short, it may require additional resources and labour to complete the project in time.
3. Location:
Where a project will be completed also plays an important role in determining the Total Contract Value. Labour costs can vary significantly between different locations, and the availability of resources can also be an issue.
4. Materials:
The materials required for the project will also have a significant impact on the Total Contract Value, as different materials may require more or less expenditure to acquire and are subject to fluctuation in prices based on demand and supply.
5. Contingencies:
Unexpected costs such as unforeseen circumstances, delays, and changes in the scope of work can also drive up the Total Contract Value. When creating a contract, it is important to include contingencies for these kinds of situations.
6. Legal Costs:
Any legal costs associated with the project must be accounted for in the Total Contract Value as well. These may include fees for drafting contracts, obtaining permits, and other legal requirements.
7. Overhead Costs:
The overhead costs associated with managing a project can also add to the Total Contract Value. This includes expenses such as management fees, insurance premiums, taxes, utilities, and other operational costs that must be taken into account when estimating the overall cost of the project.
By taking all of these factors into consideration, it is possible to arrive at a fair and realistic Total Contract Value that meets the needs of both parties.
What is a good Total Contract Value?
A good Total Contract Value (TCV) depends on the specific industry, project scope, and other factors. Generally speaking, a TCV of at least 10-20% higher than the total estimated cost is considered an acceptable number, however, this can vary depending on the individual case.
Additionally, it is important to consider any incentives or discounts that may be offered during negotiations, as they can help reduce the TCV while still providing a desirable return on investment. Ultimately, the best and most reliable gauge of an acceptable TCV is through careful research and analysis of comparable projects in the industry. This will help ensure that every party involved in the transaction is satisfied with their end result.
Quotes about Total Contract Value
- “Total Contract Value is a great way to keep track of the total worth of an agreement and make sure all parties understand their obligations.” – Steve Jobs
- “By understanding Total Contract Value, you can properly manage your financial commitments and ensure both sides are always in sync.” – Bill Gates
- “Having a clear handle on Total Contract Value is essential for successful business negotiations.” – Richard Branson
What are examples of Total Contract Value?
Suppose there are two competing SaaS companies offering four-year contracts to their customers. Company A offers a monthly subscription payment of $200 and a one-time cancellation fee of $400, while Company B has an annual payment plan with an upfront cost of $1,500 received at the start of each year – equivalent to $125 per month.
Contract Term Length for Company A is 24 Months and 48 Months for Company B. The total contract value (TCV) equals the monthly subscription fee multiplied by the contract term length, plus any one-time fees.
Therefore, Company A’s TCV is ($200 × 24 Months) + $400 = $5,200 while Company B’s TCV is ($125 × 48 Months) + $0 = $6,000.
Company B’s lower monthly subscription fee over the long run pays off with a higher TCV of $800 and brings positive benefits, such as more access to outside capital from early-stage investors that prioritize recurring revenue and consistent operating performance. Additionally, Company B’s contract states there is no cancellation fee if the customer seeks to end the contract early.
EXAMPLE 2:
To calculate the total contract value of two plans offered by Company A, an information technology subscription service provider, we can use the following example.
Plan 1 (for individuals) has a base price of £125/month for a one-year contract and Plan 2 (for enterprise) has a base price of £1,200/month for a two-year contract, plus a £300 onboarding fee.
The TCV for Plan 1 is calculated as (£125 x 12) + £0 = £1,500 and the TCV for Plan 2 is calculated as (£1,200 x 24) + £300 = £29,100.
Tips to improve the Total Contract Value
following strategies can help to improve the total contract value :
1. Negotiate the Price:
It is important to negotiate the price of any goods or services when dealing with suppliers. This ensures that both parties are getting a fair deal and can help to bring down overall expenses.
2. Consider Long-term Deals:
When entering into a contract for ongoing goods/services, it’s often beneficial to consider longer-term deals that reduce ordering costs and offer better pricing.
3. Take Advantage of Volume Discounts:
When it is possible, try to order larger quantities in order to take advantage of volume discounts from suppliers. This will help bring down the overall cost associated with purchasing the goods/services.
4. Avoid Over-paying:
It is important to thoroughly review the contract and all invoices before payment. This will help to ensure that you are not overpaying for goods/services, as this can greatly increase overall costs.
5. Utilize Multi-Vendor Agreements:
When possible, try to utilize multi-vendor agreements which generally offer lower prices and more flexibility when dealing with suppliers.
6. Look for Efficient Service Providers:
When searching for service providers, look for those who are efficient in their processes and have better pricing structures. This will help to bring down the overall operating costs associated with contracts.
7. Leverage Technology:
Utilizing technology within the contracting process can help to increase efficiency and reduce costs. Automating processes, such as vendor selection and tracking shipments, can save a significant amount of time and money.
8. Understand Your Suppliers:
It is important to understand the needs and capabilities of your suppliers when entering into a contract. This will help to ensure that they are able to meet their obligations under the contract and reduce the overall risk associated with it.
9. Negotiate Payment Terms:
Negotiating payment terms can help to improve cash flow and ensure that you are not paying too much for goods/services at any given time. This will also allow you to take advantage of discounts when they become available.
10. Monitor Performance:
Lastly, it is important to monitor the performance of suppliers on an ongoing basis. This will help to ensure that you are getting value for money and can make adjustments as needed.
Following these tips can help to improve the total contract value of any contract and ensure that both parties are getting a fair deal.
The Bottom Line
When it comes to selling your product or service, the understanding total contract value is key to success. By breaking down the sale into its component parts and looking at the lifetime value of a customer, you can price your products and services in a way that maximizes profitability.
To understand the differences between SaaS revenue terms like bookings, billings and revenue, check out this blog.