The more I hear about SaaS companies talking up big total contract value (TCV) figures, the more I worry about The Tightening, and the more I think we should create a new SaaS metric: TTCV = theoretical total contract value.
TTCV = PCV + NPCV
Prepaid contract value (PCV) is the prepaid portion and NPCV is the non-prepaid portion of the subscription in multi-year SaaS agreements. We could then calculate your corporate hype ratio (CHR) with TTCV/ARR, the amount by which you overstate ARR by talking about TTCV.
I make the suggestion tongue-in-cheek, but do so to make real point.
I am not against multi-year SaaS contracts. I am not against prepaid SaaS contracts. In high-consideration enterprise SaaS categories (e.g., EPM), buyers have spent months in thorough evaluations validating that the software can do the job. Thus, it can make good sense for both buyer and seller to enter into a multi-year agreement. The seller can shield contracts from annual churn risk and the buyer can get a modest discount for the contractual commitment to renew (e.g., shielding from annual prices increases) or a bigger discount for that plus a prepayment.
But it’s all about degree. A three-year prepaid contract often makes sense. But, for example, an eight-year agreement with two-years prepaid (8/2) often doesn’t. Particularly if the seller is a startup and not well established. Why?
Let’s pretend the 8/2 deal was written by an established leader like Salesforce. In that case:
- There is a very high likelihood the software will work.
- If there are problems, Salesforce has major resources to put behind making it work.
- If the customer is nevertheless unhappy, Salesforce will presumably not be a legal lightweight and enforce the payment provisions of the contract.
Now, let’s pretend that 8/2 deal was written by a wannacorn, a SaaS vendor who raised a lot of money, made big promises in so doing, and is way out over its skis in terms of commitments.
- There is a lower likelihood the software will work, particularly if working means building a custom application, as opposed to simply customizing an off-the-shelf app.
- If there are problems, the wannacorn has far fewer available resources to help drive success — particularly if they are spread thin already.
- If the customer is unhappy they are much less likely to pay because they will be far more willing to say “sue me” to a high-burn startup than to an established leader.
So while that 8/2 deal might be a reasonable piece of business for an established leader, it looks quite different from the perspective of the startup: three-fourths of its value may well end up noncollectable — and ergo theoretical. That’s why startups should neither make those deals (because they are offering something for an effectively fictitious commitment) nor talk them up (because large portions of the value may never be realized).
Yet many do. And somehow — at least before The Tightening — some investors seem to buy the hype. Remember the corporate hype ratio: TTCV / ARR.