Whenever an unexpected or discontinuous change occurs, we have to be able to step back and revisit how we analyze market data.
As I've discussed earlier, there are some significant trends in the market place regarding reduced contract durations and the resulting reduction in TCV. These trends are relatively recent and significant market changes, and they require us to revisit how we consolidate and interpret market data.
Historically, TCV (total contract value) was a key measure used by service providers to report their "signings" as well as the basis for reporting on the overall size of the market.
However, as the following hypothetical example shows, in times of changing contract durations, TCV can become a misleading value and needs to be at least supplemented by ACV (annualized contract value).
- In year 1, TCV of $50M is signed as five 10-year deals of $1M per annum each, yielding an ACV of $5M per annum.
- In year 2, TCV of $42M is signed as six 8-year deals of $1M per annum each, yielding an ACV of $6M per annum.
- In year 3, TCV of $40M is signed as eight 5-year deals of $1M per annum each with one being a renegotiation of a year 1 deal, yielding an ACV of $8M per annum. (Note that the renegotiated deal is still counted towards the ACV.)
The TCV in the above example shows a declining market from $50 to $42 to $40M. However, the ACV shows an increasing market that added $5M then $6M then $8M per annum.
If we look at actual industry data, we see a similar pattern where the TCV numbers are declining while the ACV numbers are increasing.
While it may seem obvious to start representing data using ACV in order to eliminate distortions caused by changes in contract durations, this is not without its challenges.
First and foremost, we need to re-educate all those involved in the sourcing market (clients, service providers, stockmarket analysts, journalists, sourcing advisors, legal counsel, etc) to understand and interpret not just TCV trends and the story they tell, but also the ACV trends and the story they tell.
The second element is to address the topic that was hinted at above, namely, how to take into account the effects of renegotiations--something that is also a changed trend compared to historical situations. We'll come back and revisit that another time.
The key is that TCV and ACV give a more complete picture of the sourcing market.