Making sense of contract value is a crucial task for legal teams, yet it can sometimes be riddled with a variety of nagging challenges. From ambiguous pricing structures and fluctuating market conditions to complex amendments and inconsistent data, accurately assessing the value of a contract has proven to be more than meets the eye.
In this guide, we will delve into the fundamentals of contract value, covering everything from its definition and significance to calculation and management. By exploring these key elements, you will be equipped with the knowledge necessary to navigate the complexities of contract value with confidence.
What is Total Contract Value (TCV)?
Total Contract Value (TCV) refers to the monetary worth of a contractual agreement throughout its lifecycle. It represents the overall financial commitment or investment associated with the contract over its entire duration.
TCV takes into account all the anticipated revenue or payments that will be made during the course of the contract, including base fees, additional products or services, potential price adjustments, and any other financial considerations specified in the contract. It provides an aggregated view of the contract's value, encompassing both recurring and one-time payments.
It is important to note that TCV represents the potential value of the contract. But the actual revenue or payments realized may differ due to factors such as contract modifications, performance-based adjustments, early terminations, or other contractual provisions.
Understanding the difference between contract value and contract price
The terms "contract value" and "contract price" are often used interchangeably, but in certain contexts, they can have slightly different meanings. Here's a breakdown of their general distinctions:
Contract value refers to the overall financial commitment associated with a contract, including all anticipated revenue, fees, costs, and payments. It encompasses the total worth of the contract, including base fees and any additional services or modifications.
Contract value is like looking at the bigger picture. It considers not just the money involved but also other important things like benefits and risks. It tells you how valuable the whole agreement is.
In contrast, contract price specifically refers to the agreed-upon amount one party will pay to the other for the goods or services outlined in the contract. It represents the specific monetary value associated with the core deliverables of the contract.
How to calculate Total Contract Value (TCV)
To calculate your TCV, you’ll need the following variables:
- The contract’s Monthly Recurring Revenue (MRR)
- The contract’s duration
- Any one-time fees or additional payments incurred
Putting these together, you should get your TCV using the formula below:
TCV= (MRR x contract duration)+ one-time fees and/or additional payments
Picture yourself as a SaaS provider. Let’s say you opened a contract with a customer for your enterprise-tier subscription priced at $3,500 per month. The customer chooses an annual subscription (12-month contract).
Let’s also say your contract stipulates a one-time fee of $2000 for onboarding and team training sessions and an additional $300 for custom integrations.
To calculate the total value of your contract with the customer, you will implement the formula as follows:
Duration= 12 months
Standard one-time fees and additional payments= $2000 + $300 =$2300
TCV= ($3,500 x 12) + $2300 = $44,300
This means that the total contract value for this specific customer is $44,300. As already established, this value can change depending on modifications in variables like contract duration and add-on services.
5 Reasons to calculate Total Contract Value (TCV)
From revenue projection to risk assessment, this section explores some of the reasons why TCV has remained significant in the modern business landscape.
#1 Helps with revenue forecasting
TCV provides a comprehensive view of the revenue potential of a contract. When you analyze the TCV of multiple contracts tied to your company, you will get a well-rounded estimate of your business’s total revenue over a given period. This information is crucial for budgeting, resource allocation, and growth projections.
TCV also uncovers trends, patterns, and opportunities based on the value of contracts companies have secured over time. By comparing the TCV of current contracts to historical data, businesses can assess their revenue growth or identify potential risks and take necessary actions.
#2 Helps you win investor confidence and valuation
TCV provides valuable data on a company's contract portfolio and revenue potential, which is valuable for communicating with investors and stakeholders. It enables transparent reporting and demonstrates the financial strength and growth prospects of the business.
TCV also offers insights into a company’s overall capabilities in establishing and maintaining long-term customer relationships. Investors often value companies that can secure repeat business and retain customers over an extended period. A high TCV can demonstrate the company's ability to maintain customer loyalty and generate consistent revenue from ongoing contracts.
#3 Assists in measuring Customer Lifetime Value (CLTV)
TCV is a valuable tool for calculating Customer Lifetime Value (CLTV), which is a crucial metric for businesses.
TCV measures the total revenue a company can expect to make from a customer throughout their entire relationship. By considering the TCV of contracts, organizations can estimate the long-term value of their customer base and make data-driven decisions regarding customer acquisition and retention.
A higher TCV implies a greater potential for long-term revenue from the customer, indicating their value to the company. TCV also aids in resource allocation, helping businesses prioritize investments in customer segments with higher CLTV.
#4 Makes performance evaluation better
TCV allows businesses to evaluate the performance of their sales teams, business units, or overall company based on the total value of contracts won or closed. It provides a tangible measure to assess the effectiveness of sales efforts and the success of various business strategies.
A higher TCV indicates that the organization is successful in securing larger and more valuable contracts, which can serve as a key performance indicator. Additionally, comparing the TCV of contracts over time enables organizations to identify trends, assess the effectiveness of business strategies, and optimize sales processes.
#5 Helps with assessing risky contracts
Another crucial benefit of TCV is its ability to help you assess risky contracts. It helps with risk assessment by providing a comprehensive view of a customer's value over their lifetime.
By understanding the long-term revenue potential and customer behavior patterns, you can assess the level of risk associated with each customer relationship. TCV allows for identifying high-value customers who contribute significantly to your company's revenue and are less likely to churn.
This knowledge lets you prioritize resources and focus on retaining and satisfying these valuable customers.
Additionally, by assessing TCV, you can identify potential risks in customer segments or product lines, develop risk mitigation strategies, and make informed decisions to protect your company's revenue streams.
“It’s difficult to be part of any business and not hear about “risk.” It’s everywhere. Risk is the new black.”
~Sterling Miller, CEO and GC at Hilgers Graben PLLC.
Ten Things: Spotting, Analyzing, and Managing Risk
How can SpotDraft help manage contract value?
One of the many benefits of contract value lies in its significance to contract management.
As an all-in-one Contract Lifecycle Management (CLM) tool, SpotDraft leverages contract value to enhance contract management for legal counsel and business teams.
#1 Setting approval workflows based on contract value
“There is a stratification based on the contract value [at my organization]. We have set monetary thresholds. When the contract value exceeds that number, the contract goes through a strict review and approval process, and only certain authorized signatories can approve that contract."
~Nadia Louis Hermez, Legal Ops Manager, Next Insurance, Inc
The Counsel Corner: Building a Robust Legal Ops Function
Traditional contract negotiation is typically a long and drawn-out process, notorious for causing value leakages and lost opportunities.
However, with SpotDraft, negotiation cycles can be cut down by up to 50%. This is done by automating approvals for contracts that meet specific criteria.
For example, you can set automated approvals when a contract’s value falls below certain thresholds. These are generally low-risk contracts that don’t need to be reviewed and approved by every stakeholder, as this causes unnecessary bottlenecks in the process.
On the contrary, when the contract value exceeds the thresholds, it is considered high-value and high-risk and is run through stricter review and approval processes.
This automated approval speeds up contract closing processes, helping organizations close more contracts and scale revenue.
Also read: How to Set up an Efficient Contract Approval Workflow
#2 Automatically add or remove clauses based on contract value
Let’s say you have a library of mandatory and optional provisions you use in all your high-risk contracts. You can automate the addition and removal of these clauses based on the value of the contract in the pipeline.
When the contract value meets a certain threshold, SpotDraft can automatically include these risk mitigation clauses to proactively address any potential risks.
Such clauses include limitation of liability, indemnification, confidentiality and non-disclosure, intellectual property rights, and change control.
#3 Using filters to find contract information
SpotDraft offers a secure, robust, and searchable repository for storing contract information.
Its fully customizable dashboard comes with filtering capabilities, allowing you to locate specific documents based on certain attributes like time created, expiration, and value, among others.
Suppose you want to find all contracts with a contract value of $100,000. All you need to do is select your options through the filter menu. This will fetch and display contracts that have the specified value.
SpotDraft allows you to apply multiple filters to get more customized outputs. For instance, you can filter out contracts with values over $100,000 that are either on hold, getting redlined, in draft, or in execution.
This helps you understand the status of specific contracts, identify blockers, and manage contracts more efficiently.
Making sense of the numbers
Contract value is a crucial metric that plays a major role in business, considering its direct relationship with revenue.
To maintain a consistent influx of contracts with high TCV, businesses should learn to implement strategies that focus on building long-term customer relationships, delivering quality services, and reducing churn. The first step towards achieving this is to eliminate poor contract management practices and adopt a productive, digitized approach.
If you'd like to get a first-hand view of how a CLM can help you boost your TCV, book a free demo with SpotDraft.