We all want some relationships to last a lifetime for the value they add to our lives.
SaaS businesses want that too!
SaaS Lifetime Value, or SaaS LTV, is an important metric that tracks the average value a single customer brings during their relationship with your business.
- Check out 10 fantastic tips to improve your Activation Rate and get more conversions!
- Learn the ABCs of Product Led Growth and if it’s the right strategy for your SaaS business.
- Keep tabs on additional recurring revenue by tracking Expansion MRR.
This Article Contains:
- What is SaaS Lifetime Value (LTV)?
- Why Does SaaS LTV Matter?
- How to Calculate SaaS Lifetime Value?
- SaaS LTV Benchmarks
- How to Improve SaaS LTV?
- 4 Related Metrics to Track
Let’s get started!
What Is SaaS Lifetime Value (LTV)?
Lifetime Value (LTV) is the average money individual customers spend on your product and services for the duration of their customer relationship with your business.
Tracking LTV allows you to determine how much each new customer, on average, adds to your overall revenue in order to justify your customer acquisition cost.
This means that the longer you retain your customers and the more they spend on your product, the more revenue you generate from their subscriptions.
But what type of companies is this metric applicable to?
Let’s find out.
Who Should Track LTV?
LTV is an important metric for startups and established B2C and B2B SaaS businesses.
Measuring LTV can help SaaS businesses with:
- Revenue projection: Startups can estimate their future revenue potential based on the value they can obtain from each customer over their lifetime. It can also help established SaaS businesses assess which customer segments are contributing significantly towards revenue and optimize other customer segments accordingly.
- Customer acquisition costs: Businesses, especially startups, invest heavily in customer acquisition. Comparing acquisitions costs with lifetime value can help them determine if their acquisition channels are sustainable or not.
- Ensuring customer success and reducing churn: Calculating CLV provides insights into customer behavior and usage patterns. This information can be used by established SaaS businesses to improve their customer success initiatives, address customer needs and reduce churn.
Let’s dig a little deeper into why tracking SaaS LTV is important.
Why Does SaaS LTV Matter?
Lifetime Value is one of the most important metrics to track for a growing SaaS company because it:
- Provides an overview of the company’s financial profitability: Tracking LTV allows a company to estimate the potential revenue customers will generate over time. Based on this information, they can make critical decisions on how to acquire and retain high-value customers.
- Helps in determining the effectiveness of retention strategies: Companies can track customer LTV to see how variations in retention strategies affect the lifetime value of their customers. This enables them to identify improvement areas and make strategic changes.
- Enables more effective marketing: Knowing how and where your customers like to spend enables you to customize your marketing campaigns which can significantly reduce customer acquisition costs.
Ready to track your SaaS lifetime value?
Let’s get to the calculations.
How to Calculate SaaS Lifetime Value
For LTV calculation, you need to track a few additional metrics.
These metrics are:
1. Churn Rate: The percentage of customers or subscribers that have canceled or haven’t renewed their subscriptions during a given period. You can calculate monthly churn or annual churn.
Here’s the churn rate formula:
|Churn Rate = Lost Customers / Total Customers at the Start of Time Period * 100|
2. Average Revenue Per User (ARPU): Average Revenue Per User measures how much revenue you generate per active customer. But ensure that you stay consistent with the time period.
Here’s how you can calculate ARPU:
|ARPU = MRR (Monthly Recurring Revenue) / Total Number of Active Accounts in that period|
3. Customer Acquisition Cost (CAC): Customer acquisition cost is the average amount of money spent on acquiring new customers.
Here’s how you can calculate customer acquisition cost:
|CAC = Total Sales and Marketing Expenses / Number of New Customers Acquired|
Now, let’s look at the different ways you can calculate LTV.
3 Methods for Calculating Customer Lifetime Value
There are three classic methods for calculating LTV SaaS, but the method you choose depends upon the nature of your business and the data available to you.
We’ll show you how to apply these methods one by one.
1. Simple Method
Here’s the formula for calculating customer lifetime value with the simple method:
|LTV = Average Purchase Value * Average Purchase Rate * Average Customer Lifetime|
Let’s look at what each of these components means:
- Average Purchase Value is the average dollar spent on your product or goods sold in a single transaction.
- The Average Purchase Rate or the Average Purchase Frequency Rate is the average number of transactions a user makes over a certain period (usually a month or year).
- Average Customer Lifetime or Average Customer Lifespan is the average number of months or years between customers’ first and last order dates
Let’s understand this with the help of an example.
Suppose your company’s average purchase value is $300, your customer has an average purchase frequency of 6/year, and the average customer lifespan is 9 years.
So your customer lifetime value will be $300 x 6 x 9 = $16,200.
2. Lifetime Revenue Method
In this method, you need to multiply the average revenue per customer by the average customer lifetime.
Here’s the formula to calculate LTV using the Lifetime Revenue Method:
|LTV = Average Revenue Per Customer * Average Customer Lifetime|
Let’s say a customer spends $70 per month on average on your SaaS app, and the average customer lifetime is 12 months.
The customer lifetime value will be: $70 x 12 = $840.
3. SaaS Profitable Method
This LTV calculation method measures customer lifetime value in terms of profit rather than revenue and requires metrics like:
- ARPU (Average Revenue Per User)
- Gross Margin = Gross Profit / Total Revenue * 100
- Net Revenue Churn Rate = (Monthly Churn – Expansion Revenue from Existing Customers Due to Upgrades) / Monthly Recurring Revenue at the Beginning of the month X 100
Here’s the formula to calculate LTV with the SaaS Profitable method:
|LTV = (Average Revenue Per Customer * Gross Margin %) / Revenue Churn Rate|
Let’s see how you can calculate LTV using SaaS profitable method:
For example, say your average revenue per customer is $200, the gross margin is 70%, and the revenue churn rate is 8%, the customer lifetime value will be: ($200 x 70%)/8% = $1750.
This method focuses on expansions or contractions within your SaaS subscriptions (e.g., upgrades and downgrades). By taking into account the revenue churn rate, you can achieve a more accurate estimate of LTV.
But while measuring your churn rate and LTV using this method, you should ensure that you maintain a distinction between your monthly and annual plan users.
This is because monthly plan users have shorter subscription commitments, and their LTV is usually lower than annual plan users. Distinguishing between monthly and annual users can help you get a more accurate churn analysis.
That said, it’s also important to note that your CLV can vary depending on various customer segments (division of customers based on behavior and demographics). Some of your customer segments may have a higher CLV than the rest.
Understanding and calculating your CLV based on different segments can help you:
- Identify the drivers of higher CLV
- Spot opportunities to make less valuable customers more valuable
Calculated your LTV?
Here’s what you need to do next.
How To Use LTV
Once you have calculated your LTV, you should compare it with your CAC.
If the LTV you obtain is higher than your CAC, it indicates your business is doing well. But if the CAC is equal to or more than what you’re earning from each customer, then you need to take corrective steps to improve your LTV.
For example, you can focus on increasing customer retention by implementing loyalty programs or offering personalized plans and services.
You can also use strategies like upselling and cross-selling to sell additional products and services to your existing customers. (we’ll cover more LTV improvement tips shortly!)
Now let’s move on to the next question…
How Often Should You Measure SaaS LTV?
CLV is time-dependent, so you can calculate it for a set or specific time period.
The time period you select depends on your company’s needs. But you must take into account certain important elements like purchasing frequency and seasonality.
Most businesses prefer to calculate their LTV every 6, 12, 24, and 36 months.
Wondering what a good SaaS LTV is?
Let’s have a look at some benchmarks and acceptable ranges.
SaaS LTV Benchmarks
To identify what the ideal SaaS customer lifetime value for your business is, you should focus on your LTV: CAC ratio, where CAC is the cost incurred by your SaaS business to acquire a new customer.
The LTV and CAC ratio measures the relationship between the lifetime value of customers and the cost of acquiring them. Your business is profitable if your CAC ratio is lower than your LTV.
As a benchmark, a 3:1 LTV to CAC ratio is considered good. This means your LTV should be at least three times the CAC to run a successful and profitable SaaS business.
If LTV to CAC ratio falls below 3:1, it means that your customer acquisition cost is higher than what the average customer brings in as revenue.
On the other hand, if your LTV: CAC ratio is higher than 3:1, you have the scope to increase your customer acquisition budget and experiment with different marketing campaigns to boost revenue.
Now if your business falls under the first category, there are certain steps you can take to improve your LTV.
Let’s check them out.
How to Improve SaaS LTV?
A high customer lifetime value means more profits for your SaaS business.
Here are some ways to increase your Lifetime Value (LTV):
1. Improve Your Customer Onboarding Experience
The onboarding process is critical because it serves as the first point of contact between you and your customer. It’s important for creating a good customer relationship.
A good onboarding experience involves introducing new users to the product and teaching them how to use it to get the most out of it.
To make the onboarding process fast and straightforward and ensure customer success, you can offer easy-to-follow guides and tutorials to your customers. You could also personalize onboarding for different users and take the help of visual cues to guide a customer better.
When customers are properly guided on how to use a product or service, they are more at ease with the product, which increases customer satisfaction. This also goes a long way in building customer loyalty.
2. Spread Awareness About Your Product
Product education is an excellent way to retain your customers longer. It increases customer lifetime by helping them understand the value of your product and the features it offers.
Educating your customers by sharing tips, tricks, and best practices should be an important element of your customer service that allows users to derive more value from your app.
You can also use content and email marketing to educate your new and existing customers on add-on features and new products. For example, you can publish detailed how-to articles or send regular email updates and information about your new offerings.
3. Use Expansion Strategies
Expansion strategies such as upselling and cross-selling can help you increase your customer lifetime value by increasing your expansion revenue.
Upselling is a sales technique in which customers are encouraged to purchase a more expensive plan. On the other hand, cross-selling aids your existing customer base in purchasing add-ons or complementary app features on their current plans.
These strategies are excellent for increasing your average revenue per user and your customer lifetime value. At the same time, they can help lower your customer acquisition cost and improve your sales efficiency. A win-win.
4. Reduce Your Overall Churn Rate
Customer churn rate directly impacts your lifetime value (LTV).
Churn is the percentage of recurring revenue a company loses over a period of time (usually a month) and is also known as Monthly Recurring Revenue or MRR.
As your customer churn rate decreases, the subscription lengths increase, and LTV rises. On the other hand, if the churn rate increases, the subscription lengths shorten, and LTV falls.
You can reduce your overall churn rate by:
- Investing in customer success management.
- Gathering and implementing lost customer feedback.
- Implementing self-service to improve customer support.
- Offering alternatives to prevent cancellations.
Increasing the LTV of new customers by offering customer support and improving your customer service will help decrease churn and increase your company’s long-term profitability.
5. Gather Feedback from Customers with High CLV
Try learning more about customers with a higher customer lifetime value than your average customer.
This can help you understand where most of your high-value customers come from, such as inbound marketing, Google ads, email marketing campaigns, etc. This way, you can invest more in those marketing channels to target the right customer segment.
You can also determine which specific features of your product your customers value the most so that you can focus on marketing them more effectively to improve sales efficiency.
Now you might be wondering…
Is tracking SaaS LTV enough?
The answer is NO.
There are some additional metrics that can majorly impact your Customer Lifetime Value, which is why it’s important to track them too.
Let’s find out what these metrics are and how they are calculated.
4 Related Metrics to Track
Here are some related metrics that can impact your LTV SaaS:
1. Purchase Frequency
The purchase frequency allows you to measure the number of times your customers make purchases in a given period.
Here’s the formula:
|PF = Total Number of Orders / Total Number of Customers for the Given Period|
2. Average Days Between Transactions
This metric helps you adjust your onboarding program to the buying cycles. Lesser days between two transactions could indicate a high level of customer engagement. It also shows that your customers are satisfied with your services.
When customers return to make frequent purchases, it adds up to their LTV.
Here’s the formula:
|Average Days Between Transactions = (Date of the Last Order – Date of the First Order) / (Total Number of Orders – 1)|
3. Customer Retention Rate
Customer retention rate is the percentage of customers who continue to use your product or service over a specific period.
Here’s the formula:
|Customer Retention Rate = [( Number of Customers at the End of the Period – New Customers during the Period) / Number of Customers at the Beginning of the Period] * 100|
4. Net Promoter Score
Net Promoter Score measures customer loyalty by asking questions like “On a scale from 1 to 10, how likely are you to recommend our product/company to your friends and family?”.
NPS focuses on two types of customers, i.e., Promoters and Detractors.
Promoters represent a company’s most loyal customers and usually give you a score of 9 or 10. Detractors, on the other hand, are customers who give your SaaS company a score from 0-6 in the survey.
Here’s the formula:
|NPS = % Promoters – % Detractors|
Note: The customers that give a score of 7 or 8 are called Passives and are not included in the NPS calculation.
With NPS, you can measure customer satisfaction levels and the differences in the lifetime value of promoters and detractors. This can help you determine how their referral behavior impacts your revenue.
SaaS LTV or Customer Lifetime Value is an important metric for growing SaaS businesses because it gives you an overview of your company’s financial profitability. Tracking LTV also allows you to determine the effectiveness of your customer retention and marketing strategies.
And while you can increase the customer LTV by improving the onboarding experience and using expansion strategies, you also need to reach out to the right customer segment to expand your customer base.
And for that, you can contact an expert like Startup Voyager.
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