Lifetime Customer Value (LTV) is likely the most mysterious of all the metrics you have to track as a SaaS Company. It’s difficult to calculate LTV, Customer Lifetime Value however, the struggle continues even when you have the calculations. It doesn’t matter if it’s good or bad, you don’t know what to do with it.
Hopefully, we will demystify this metric and offer some insight to help you use it for the betterment of your company.
Table of Contents
What is Customer Lifetime Value (LTV)?
Customer lifetime value is the estimated or predicted amount a customer will spend to hire your services or buy products throughout the relationship. That’s why we use the word “lifetime”.
This metric helps you focus on the long-term value of repeat business and lets you move away from transaction-based thinking.
For example, a customer gets your service or subscription for $100 per month which lasts for a year. So the LTV will be $100×12= $1200.
How to calculate customer lifetime value?
The aforementioned example shows how you can calculate the LTV for a single customer. Hopefully, you have more than 1 customer, so obviously it’s not practical for operating your enterprise. You need two additional metrics to calculate LTV.
Churn Rate
It is the rate at which you lost your customer in a given period. In simple words, it is the number of customers or subscribers who stop paying you in a given period.
For example, if you had 100 customers or subscribers in 2022 and lost 5 of them then the churn rate will be 5%.
Average Revenue Per User (ARPU)
It is simply the mean revenue of all your existing accounts. You can calculate it by dividing monthly recurring revenue by the total number of users.
For example, you have 100 accounts in total. 50 of them make you earn $50 per year and the remaining 50 make you earn $100 per year. So the average revenue per user will be $75.
Now let’s have a look at how to calculate the LTV of a customer.
Customer lifetime value formula – LTV Formula:
LTV = ARPU (average monthly recurring revenue per user) × Customer Lifetime
You can also calculate the LTV by using the churn as this number is more readily available.
LTV = ARPU / User Churn
So, there is an inverse relation between LTV and user churn. The higher the churn value, the lower will be the LTV, and vice versa. Paying attention to both these metrics is mandatory for the growth of your company.
You got lucky there as you don’t have to calculate the LTV manually. If you have Baremetrics, a SaaS analytics tool, you can keep a record of LTV and analyze its growth over time.
Churn Variance and Sample Size:
Quite often, churn can be chaotic. For example, when you think about the cohort, a group of people signed a contract or subscribed to your service at the same time (i.e. all the subscribers you got in a month), there’s often a cliff just after the first month.
To keep track of this churn variance, you can set a discount rate and multiply the results rate with it. (Discount rate is simply the discount for cash flow losses that may happen in the near future).
Let’s say you set a discount rate of 0.75. The results will be:
((ARPU x Profit Per User)/Churn rate) x .75
ex. $1200 x .75 = $900
Sample size also matters and unfortunately, the scientific method is not up to the mark in terms of businesses. It often falls by the wayside in the enterprise.
If you don’t have a lot of users or count a low number of customers in the metrics, then your data may be invalid in terms of the scientific method. The following are the scientific guidelines about sample size.
Less Than 100 Users: You must calculate the data of at least 50 percent of users. Going with 100% will be the best option.
1,000 to 10,000: 10% of user data must be counted for calculations. For example, if you have 5000 users in total, you must consider the data of 500 customers for calculations.
More Than 1 Million: In such a case, you need to consider the data of at least 1% of users. For example, if the total number of users count 3,000,000. You must include data of at least 3,000 users in the calculations.
Customer Acquisition Cost and Lifetime Value:
The primary reason behind the importance of LTV for your SaaS organization or company is that it tells you how much you can spend to acquire new customers. For example, if the acquisition cost for a customer is $100 and the LTV is $500, then you are printing $400 from that customer.
What about saying LTV is the “Money Machine”??
Now you can say higher LTV and lower CAC result in the rapid growth of your business.
Knowing the value of customers for a lifetime will help you make wise decisions when acquiring them.
A good rule of thumb is that if your LTV to CAC ratio is not greater than 3, it means you are spending a lot on acquisition.
LTV and Churn:
A Nasty Word, Churn is the main reason behind those LTVs probably being so different.
Generally speaking, the customers you have on the lowest-costing plans will also have the highest churn. It will make your LTV more dismal than any other plan.
Do you recall what we told you earlier? LTV drives what you can spend on acquisition. For example, if your ACA for a customer is $200, there is no sense in taking that customer with an LTV of $100. Knowing your LTV for each customer segment is very vital for your company or organization.
Baremetrics(SaaS analytics and insights) offers this thing right out of the proverbial box. It will be available immediately after you connect your account.
How to Increase Customer Lifetime Value
Yeah! It’s nice to know your customers’ lifetime value. However, only seeing some numbers on a graph isn’t going to help you grow your business.
It’s almost pointless unless you do something with the KPIs you are tracking to improve your business.
Therefore, now we are going to talk about the use of LYV analysis and other tactics to improve your business. Don’t worry! It’s easier than it sounds.
Hint: All the tactics I am going to show you can easily and directly be done using Baremetrics. You can get it now and sign up for free.
Interview Your Customers With the Highest Lifetime Value:
When you aim to increase the LTV of your customers, the best place to start is speaking to existing customers.
When you start interviewing them, you must always go for the users or customers with LTV higher than your average. You need to know more about them as you need to acquire similar clients to increase your customer LTV.
The key things you need to learn by interviewing them are:
- Where do they fetch the most value from your product or service?
- How is your product useful for them?
- How did they find out about you and were drawn to you initially?
- How have they grown with your products or services since they registered?
- And any other insight that helps you figure out what is keeping these customers with high LTV around?
Step one is to calculate the current average LTV that can easily be grabbed from your metrics dashboard.
Now let’s head toward your customers. You need to apply some filters here.
Active Members: The first filter you have to set is based on the activity of your users. Ideally, you would like to talk to the active customers. It gets awkward when you reach a customer who canceled the interview.
LTV: This filter is set to find out those customers that have LTV higher than your average.
Now you must have a list of all your customers with a higher lifetime value.
Once you have the list, you need to reach them and ask them for an interview to learn more about them. You can get feedback about your services or products as well. Sending emails is the best way to reach them.
You can offer them something in return to easily get them to agree to the interview. A 10% discount on the next bill can do the trick for you. It is not necessary to offer them something for exchange, however, doing so can help you get more people to opt in.
Make sure to include a link like Doodle or Calendly to schedule a time for the call. It will make it super convenient for the users to set up.
Now you just have to interview them and gather the information and feedback. You can organize it in a spreadsheet. During analysis, you need to look for trends and use them to increase the LTV of your other customers as well.
For instance, if you evaluate that most of your customers or users are coming from a single source such as Google Ads, SEA, Emails, etc. then you know what to do, and invest more in that source.
Similarly, if you figured out most of your customers with high LTV are sticking around just due to a specific feature of your product, you can advertise this feature more and improve it further as well. It will for sure attract more users with high LTV.
Compare Lifetime Value by Customer Segment:
You may start observing a trend here. Looking at your LTV as a single digit may be nice to give you a 10,000 feet view. However, to make it more actionable, you need to cut it into different smaller segments or groups as it will help you specify the trends.
You have to do so because all customers are not created equal or equal.
You need to estimate the LTV of every major customer segment. When we talk about SaaS companies, that’s generally the various price points you offer.
For example, a customer Joe subscribed to your plan for $30/month. His LTV will be a fraction of the LTV of Sally (another user) on your plan of $200/month. This is not just because $200 is greater than $30.
You can see plan-level LTV as well by using Baremetrics.
You can observe a pretty obvious trend that the lowest-priced plans usually have lower LTV as compared to other plans despite having the highest number of customers.
It often happens in SaaS companies. Customers on lower-priced plans churn more and pay less. On the other hand users on higher-priced plans don’t tend to churn often. Furthermore, they pay you more as well which helps in generating more revenues.
Based on that data, it’s clear that it’s worth spending time to figure out how to get mid-large-sized customers.
Pricing plans are not the only way to segment your customers though. In Baremetrics, you can segment your customers based on acquisition cost, location, and several other criteria.
You can slice the data in tons of different ways using Baremetrics. However, you don’t have to get nerdy there. Always focus on identifying the segments which have the highest LTV and try to get more customers like them.
Reduce Your Overall Churn:
If you recall the LTV formula, you will notice it based on two key things:
- The money customers spend with you
- The time they remain your customer
So, it’s obvious that the longer you keep your users or subscribers paying you, the better will be the chances of increasing your average customer LTV.
Therefore, now we need to look at the churn rate. How long can users last as your customers before they cancel?
Firstly, you need to check out whether or not the churn rate is high. If you have Baremetrics, you can use Benchmark to find out the churn rate and compare it with other similar companies.
Benchmarks show you how your churn metrics compare to the companies with a similar ARPU as you.
You have to take notice of all the points where you fall in both churn value and customer LTV benchmarks. If you are in a lower quartile for both, there are chances that your churn rate is the problem. You need to develop strategies to lower your churn rate.
Increase Your ARPU:
Now, let’s talk about the 2nd part of the LTV formula, average revenue per user (ARPU).
You know churn is inevitable, you cannot solely rely on reducing its percentage to increase LTV. You also need to check out the ways to increase ARPU as well. As you have seen in the aforementioned example, customers who pay less tend more toward churn and let you generate little revenue. While customers who pay more don’t churn so often and make you generate good revenue as well.
Keeping things straightforward, the two ways to increase average revenue per unit are:
- Raise Prices
- Expand Revenues
Raising pricing can be a touchy subject for some founders, especially beginners. However, you may believe it or not, pricing your product too low is not going to help you but stunt your company’s growth.
You’ll have to do proper testing before bringing any dramatic changes to your pricing. However, if your company’s growth has been at a standstill but LTV is low, then raising pricing is the best option to go with.
The second tactic isn’t scary for the founders at all. You can expand revenues through customer expansion. Apart from that you can earn revenues from existing customers as well by:
- Cross-selling some products (i.e. complimentary products)
- Upgrading them to plans with higher costs
- Offering add-ons that can improve their current subscriptions.
Set a Customer Lifetime Value Goal:
I know the Infamous Harvard Study that states that people who set goals have 10x more chances of success than those who don’t set goals. I am not going to tell you more about this study, so let’s keep this aside.
If you are a person who works passionately toward achieving something then setting goals can be very motivational for you. Goals are just like planting a seed to take action as they motivate you to develop strategies and do work to achieve them.
You can set goals in Baremetrics.
Whenever you set goals, avoid picking any arbitrary number. Your goals must have some logic behind them. The best way to do so is to look at your historical numbers.
What’s Your Customer Lifetime Value?
Customer LTV is more than just another SaaS metric. It tells you about the pricing of your product and how your customers get value from it. Only tracking it isn’t going to help you until you try to improve it.
If you don’t have an idea about your company’s LTV or don’t have any tool to calculate it, you can try Baremetrics. Sign up now for a free trial and get started.
