Calculating Customer Lifetime Value – A Detailed Guide

SaaS companies have the responsibility to keep a tab on various metrics. Among them, customer lifetime value, commonly known as LTV, is often termed the most mysterious. Many perceive it to be difficult to calculate, and they don’t really know what to do with the acquired results. If you are also in the same boat, we have got you covered. This guide contains everything about customer lifetime value; ways to calculate it & how you can use it more effectively for the betterment of your organization. Continue reading!

What Is Customer Lifetime Value (CLTV)?

CLTV is the estimated amount your customer is going to spend on your business (by buying a product or service) throughout the duration of their association with you. Calculating CLTV can help you focus on the long-term value of recurring business instead of a transaction-based approach.

A simple example of calculating CLTV could be:

A customer purchases your service worth $50 per month. In this case, their LTV will be $50 x 12 = $600.

Ways to Calculate Customer Lifetime Value

The aforementioned example works perfectly well in the case of a single customer. However, SaaS companies tend to have a larger customer base, which kind of makes it impractical. This is why calculating CLTV requires two more metrics.

These include churn rate (number of users lost in a particular time period) and average revenue per user (Total revenue/total users, quite self-explanatory).

Using these two metrics, you can calculate CLTV by multiplying the average monthly recurring revenue per user by the expected customer lifetime. Or you can divide the average monthly recurring revenue per user by user churn to calculate LTV.

Pro Tip: Having access to SaaS analytical tools, such as Baremetrics, can help know about your customer’s lifetime value quite conveniently.

Churn Variance and Sample Size

In many cases, calculating or using churn can be quite complicated. For instance, if you take into account a group of users who purchased your services in 6 months, there can be a ‘cliff’, which usually appears right after the first month of the start date (after the group subscribed). This, in simple words, is called churn variance.

In order to keep it accounted for, multiply the results obtained by a discount rate. It is basically the rate that is discounted for cash flow losses your business may face in the future.

On a similar note, taking sample size into consideration is also crucial. For example, if your business doesn’t have many subscribers or you are taking too few users for calculations, the results obtained may not be scientifically valid.

You can follow the following scientific guidelines pertaining to sample size:

• Count for 50% or more user data in the case of less than 100 users. The ideal scenario would be using 100% users.
• Count for 10% of user data in the case of 1,000 to 10,000 users.
• Count for 1% of user data in the case of over 1 million users.

Lifetime Value and Customer Acquisition Cost

One of the many reasons why calculating LTV is important for a SaaS business is that it helps to drive your spending on acquiring new customers. For example, if your customer acquisition cost is $50 and you earn $200 from the same customer, your business in minting $150 from them.

The primary reason LTV is so important for your SaaS business is that it drives what you can spend to acquire new customers. If your customer acquisition cost (CAC) is $100 and that same customer has an LTV of $500, you’re basically printing $400.

This means, your LTV has to be higher and CAC lower for your business to grow faster.

Also, you should keep track of both these costs in relation to each other. In simple words, your LTV/CAC shouldn’t be less than 3. Otherwise, you’re overspending on the acquisition, which is not a very good thing for your business.

Churn and LTV

If there’s one thing that can massively impact your LTV, it’s churn. Even if you’re offering your services at the most discounted prices, you will still encounter churn. Therefore, you need to keep an eye on both. And for this, you can rely on Baremetrics.

Ways to Increase Customer Lifetime Value

Now that you have understood the importance of knowing your customer’s lifetime value, let’s proceed ahead and know how to improve the figure you have obtained:

Select the Customers with the Highest LTV & Interview Them

First things first, if you want to improve your CLTV, start by talking to your existing customers. For this, find out the customers with the highest LTV and know more about them.

A brief overview of things you should learn about them include:

• How do they use your service/product?
• How do they get the most value for money from your service/product?
• What drew them to your business initially?
• How they found out about your business/product/service?
• For how long they have been associated with you?

A short interview with your customers with the highest CLV with help you obtain these details. You should send them an articulately curated email for this purpose and wait for their response. Also, you can offer them some discount in lieu of the interview. It’s not compulsory but can be a nice gesture for them.

Include in the email a link to schedule interview time and day so that the process becomes super convenient and seamless for them.

Keep taking notes during the interview. It will come in handy for them. Make sure you are organizing the data in a spreadsheet for enhanced clarity.

Reduce Your Churn

CLTV is a function of two things; money customers spend on your products/services and the duration they remain associated with your business.

From this information, it can be deduced that retaining customers for a longer period is important to increase CLTV. This is where churn comes into the picture. As stated above, churn indicates customers lost in a particular period. Knowing why they leave your business and after how long can help you identify factors that are leading to a higher churn rate, and therefore, come up with an actionable plan to reduce it.

And when churn will be reduced, CLTV will automatically improve.

Make Efforts to Increase Your ARPU

Churn is inevitable. No matter how hard you try, customers leave. This doesn’t mean that you should stop trying to retain them. What this means is that you should also focus on another aspect of CLTV, which is the average revenue per user (ARPU).

You can improve your ARPU by increasing prices or expanding revenue. Now the former is a rather touchy subject of money, but the fact that setting prices too low can shun your growth cannot be denied.

It is important to do a decent amount of testing prior to making any changes to your pricing model. However, if you believe business growth is facing a halt for a while, you may consider changing your price.

Talking about the second tactic (i.e. expanding revenue), it’s less scary than the former but still requires a lot of work. You can increase the revenue by upgrading existing customers to high-priced plans, offering add-ons, and cross-selling complementary services/products.

Set a CLTV Goal

Ideally, it should have been the first pointer, but better late than never, right?

According to a Harvard study, people who set goals have 10x chance of getting successful compared to those who don’t. Even if we keep this aside, setting goals (realistic ones) can prove to be highly motivational. They give you a direction to follow and create a roadmap to your destination.

And when you have a goal in place, it’s easier to come up with strategies to accomplish them. You can use tools, such as Baremetrics, to set goals and work actively towards achieving them.

Also, when you’re setting goals, do not just pose any random figure as your ultimate target. There should be a logic behind the goal you have set. The right way to go about is to take a look at your historical numbers and then make an informed decision vis-à-vis setting a goal.

Wrapping Up

To sum it up, lifetime customer value isn’t just another SaaS metric. It’s much more than. Understanding and improving it can help your business grow, expand your customer base, and improve revenue. What else does a business want?