As companies move to XaaS sales models with multi-year contracts, their sales incentive plan decisions must also account for choosing the best contract value calculation to incent sellers on. With transactional sales, there is no future sales value to consider. The seller is credited for the transaction’s value at the time the product or service is delivered. Contractual sales however consist of multiple calculations to account for the “present” and “future” nature of contracts that a seller can be credited for.
The 4 contract value calculations to choose from are:
Following is a summary of the pros and cons of each of the 4 contract value calculations, and common use cases of each method. Combined with your specific sales and organization’s circumstances, you’ll be able to arrive at an informed decision of which contract value calculation is best for you. You can also create derivatives of these baseline calculations to further suit the needs of your sales organization. Emblematic of other sales incentive decisions, we must balance the financial risks to the organization with the perception of fairness to and driving the desired behaviors of the seller.
TCV – The total value of the contract over the contract’s full term.
The total contract value calculation is the simplest to administer because it does not require any additional calculation. Sellers are also able to quickly understand the amount of the sale that they are to be credited for. This contract value calculation also presents the largest financial risk to the organization. Generally, multi-year contracts have no guarantee of the full contract value being recognized as revenue. The risk grows the longer the contract term is. However, this option is the most rewarding for the seller and is typically aligned with aggressive sales roles focused on acquiring new business or accelerating company growth.
ACV – The total contract value divided by the total number years the contract includes.
The average contract value calculation accounts for the length of the contract to determine the annualized value the contract is worth. This calculation is helpful when you want to prioritize consistency in the annual value of a contract and manage multi-year contract discounting. This calculation does not incentivize multi-year contracts so additional incentives will be required to drive that sales behavior.
FYCV – The value of the first 12 months of a new contract.
Crediting for only the first 12 months of a new contract usually assumes 1 of the following: most contracts are only for 1-year, there is a high rate of renewal, or there is high risk in revenue being realized beyond 12 months. This calculation is best for roles whose primary responsibility is to maintain existing relationships and retain revenue. For organizations that have moved into a mature growth rate phase, crediting on the FYCV greatly reduces the risk of crediting for revenue that will not be realized.
Recognized Revenue – The seller is credited the amount of revenue that is recognized at the time of product or service delivery.
Crediting when the revenue is recognized is most appropriate for roles whose primary responsibility is account retention and compensation plan does not have a large variable component. Because it doesn’t credit until the revenue is recognized, it is the option most misaligned to the time of the sell. This is the most conservative crediting option and only pays when revenue is recognized eliminating the risk of paying for unrealized revenue.
Analysis of historical revenue and contract data will further help assess your organization’s unique risk exposure associated with the various contract crediting options. This analysis along with the desired selling behaviors you want to prioritize, will help you choose the appropriate crediting type for your desired sales goals.
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Director of Consulting Services with SalesGlobe.
15+ years experience across Sales Operations, FP&A, and Client Strategy Support.