Customer lifetime value (LTV) is a key metric that should be tracked as part of the customer experience program at your SaaS. Rather than just focusing on an initial purchase, LTV gives you long-range insight into how valuable a customer is to your company. Analyzing and understanding how to calculate LTV can help businesses in developing a marketing strategy for SaaS products to acquire new customers and retain the existing ones. It can also help in making sure the profit margins are maintained.
What is Customer Lifetime Value (LTV)?
Customer Lifetime Value (LTV) is the total worth of a customer to a business over the entire period of their relationship. It takes into consideration the total revenue one single user can bring in over their expected customer lifetime. The longer a customer stays loyal to a company and continues to make purchases, the bigger their lifetime value becomes.
Are LTV, CLV, and CLTV Different?
In the world of analytics for marketing and business, you’ll often come across the terms LTV (Lifetime Value), CLV (Customer Lifetime Value), and CLTV (Customer Lifetime Value). While some professionals and resources may differentiate between these acronyms, arguing that they represent slightly varied metrics or calculations, we do not distinguish between them.
For us, LTV, CLV, and CLTV all point to the same fundamental concept: the total value a customer is expected to generate for a business over the entire duration of their relationship with your company. By treating these terms as interchangeable, we streamline our discussions and ensure clarity, keeping the emphasis where it belongs — on maximizing customer value and driving sustainable business growth.
Why is Customer Lifetime Value Important?
Customer Lifetime Value is a metric that helps businesses understand the overall financial impact of their customers and informs strategies for customer acquisition, retention, and overall growth. LTV is a powerful metric that helps businesses align their sales, marketing, and product management processes to benefit customers and increase net profits.
When you know how to calculate LTV in relation to customer acquisition costs (CAC), it also becomes possible for companies to measure ROI for every new customer that can help in estimating sales and marketing budgets.
Accurately estimating CAC with the help of LTV can also help you figure out the commissions that you can offer to your sales team for successfully closing deals. In most cases, experts recommend that customer acquisition costs be at most one third of the LTV.
Calculating the LTV to CAC Ratio:
LTV > 3 x {Sales commission + (Cost per lead x Lead-to-close ratio)}
Regularly calculate and update LTV for existing customers, then use what you learn to anticipate the value of future customers. Boost motivation and morale by rewarding your teams as that figure climbs! It has relevance across departments.
- Product management teams know the true value of your products and are adjusting based on an ever-expanding understanding.
- Marketers have increased the quantity and quality of leads.
- Salespeople have done a great job of converting leads into users.
How Does Customer Lifetime Value Impact Marketing?
SaaS marketing has two major levers for impacting revenue – lead acquisition and customer retention.
The next time you wonder whether investing in customer retention is worthwhile, consider that acquiring a new customer costs 5X more than keeping one you’ve already got.
Still need convincing? The probability of selling to an existing customer is 60-70%, the chance of selling to a new customer is just 5-20%.
A thorough comprehension of LTV and its effect on CAC helps marketing teams determine the appropriate distribution of budget and effort to put toward lead generation vs customer retention.
For instance, spending $10 acquiring a lead that ends up buying more than $500 of product may seem like a great bargain. But what if your close ratio was 5%? You would have to spend $10 x 20 leads = $200 just to acquire one customer who would spend that $500.
Knowing how to calculate LTV helps set the maximum marketing budget for both acquiring new customers, and for maintaining relationships with existing ones.
It is also important for marketing teams to understand that, just as there isn’t a simple target segment, there is also no single LTV number. Instead, you need to segment your marketing efforts according to the value of the target customer segment.
An experienced SaaS marketing agency will adjust their marketing strategies and budget allocations by linking campaign results to the lifetime values of segments for which they are looking to acquire leads.
How to Calculate LTV (Customer Lifetime Value)?
There are several ways to calculate customer lifetime value, and the right one will depend on your business processes and the different factors that impact your company’s revenue. We will be discussing two methods here. One is rather simple and straightforward, while the other is an advanced method that gives you a more accurate calculation of LTV.
Method #1: The Simple Calculation for Customer Lifetime Value
For this, you first need to calculate the following metrics:
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Average purchase value:
Divide your company’s total revenue by the number of purchases made in the same time period.
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Average purchase frequency rate:
Divide the total number of purchases with the number of unique customers who made purchases during the same time period.
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Average customer lifetime:
This is the average number of years a customer continues to purchase from your company.
Calculating the Customer Lifetime Value (LTV):
Average purchase value x Average purchase frequency x Average Customer Lifetime
For SaaS with stable and predictable cost structure, multiplying by the gross margin could add more precision to LTV calculation. However, if you are focused on growing rapidly (as most SaaS are in the early stages), then using gross margin in the formula may not be feasible or may not provide a realistic answer.
Method #2: How to Calculate LTV More Precisely
The advanced method gives you a more pinpointed LTV. Here are the variables involved:
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Monthly Recurring Revenue (MRR):
MRR = Number of Customers x Average Billed Amount Per Customer
This is the recurring revenue that your SaaS company makes in a month. It helps to average out your pricing plans and billing periods into a single consistent metric that you can track over time.
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Average Revenue Per Account (ARPA):
ARPA = MRR/ Total number of accounts
This is the revenue generated per account. In most businesses, a single customer can have several accounts and that’s how ARPA is different from MRR. Calculate ARPA at the recurring period interval that your SaaS business works at.
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Gross Margin:
Gross Margin = (Total Revenue – Cost of Goods)/Total Revenue
Your gross margin is the percent of revenue retained after backing out the cost of goods, which in the case of a SaaS company can include the cost of operations and support services.
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Net Revenue Churn Rate:
Net revenue churn rate = (Revenue lost in a specific period – upsells in that specific period) / Revenue at the beginning of the period
Your SaaS churn rate is the percentage of revenue that you have lost from existing customers over a specific period.
Calculating the Customer Lifetime Value (LTV) using ARPA:
In a situation where ARPA is roughly the same for all customers and there isn’t any expansion revenue expected over the customer lifetime, how to calculate LTV is:
LTV = ARPA x Customer Lifetime
Or
LTV = ARPA/ Customer Churn Rate
If ARPA in the equation is monthly, the churn rate and customer lifetime should be monthly too. However, if you care about being profitable vs being growth focused, apply a gross margin percentage to the equation. This will ensure that you view LTV in terms of profit, not revenue.
LTV = (ARPA x Gross margin %) / Revenue Churn Rate
What is pLTV and How to Calculate it
One more metric that analysts often determine is predictive Lifetime Value. pLTV is an estimate of the total value a customer will generate over their relationship with your company. Based on predictive analytics and historical data, pLTV forecasts the future value of customers based on their past behaviors and other data points. This predictive approach helps businesses potentially anticipate revenue more accurately and adjust their strategies proactively in response.
The formula for pLTV typically incorporates elements such as how much customers typically spend, how often they purchase, and how long they stay with your SaaS to predict future behavior and value. You can predict LTV with this formula:
pLTV = (Predicted Purchase Value X Predicted Purchase Frequency) X (Predicted Customer Lifespan)
How to Improve LTV
There are two paths to boosting your company’s bottom line: you can find new customers or you can increase the value of existing users. Retention and LTV remain critical even as you focus on customer acquisition. There are many ways to boost LTV and deciding which steps to take can be confusing. Try using this framework to help think it through.
As you implement your strategy, bear in mind that the single best thing you can do is to increase the value proposition of your SaaS. Unfortunately, value means different things to different users. Just knowing how to calculate LTV isn’t enough. Here are some tips that we recommend to increase this critical metric:
- Offer flexible pricing: Consider leveraging a tool like Clay that allows the subscriber to use Clay’s AI credits or bring their own. This flexibility makes it very appealing and maintains your base MRR or ARR while introducing variable pricing for additional features.
- Make your SaaS “sticky”: Try building additional features that make it attractive even to the most fickle members of your customer base. Change the minimum commitment, like Majestic did a few years back, or expand vertically to eliminate another SaaS that your customers might currently be using.
- Increase your gross margins: SaaS gross margin benchmarks are anywhere from 50% to 80%, depending on growth stage. If you’re not hitting the benchmarks, it might be time to cut costs.
- Improve Onboarding: Create a seamless, intuitive experience that quickly demonstrates your product’s value. Tailor the onboarding journey to different user segments, reach out with proactive support, and utilize in-app guidance to ensure new users can easily navigate and find value in your SaaS from day one.
- Create Loyalty and Referral Programs: Drive long-term engagement with programs that reward customers for repeat usage and successful referrals. Vary incentives based on program performance and customer feedback.
- Build a Community: Develop online forums or user groups to foster connections among users, enhancing their sense of belonging. Leverage community insights to refine your product and increase user loyalty.
- Offer Limited-Time Free Upgrades: Provide temporary access to premium features to showcase additional value and encourage upsells. Highlight the exclusivity and urgency of these offers to prompt quick action from users.
Looking for more ideas to increase LTV? We like the ones you’ll find here.
A Few Final Thoughts on How to Calculate LTV
If you are a small SaaS company, focus on simplicity. Don’t take shortcuts in determining how to calculate LTV, but also don’t spend months determining this answer because LTV is one cog in a bigger machine that needs to turn to make you money. Start by calculating LTV in the simplest way possible with all the metrics that you can gather. As your business grows, you will be able to acquire more customer data which will help you in calculating LTV more accurately as well as conducting more in-depth SaaS marketing analytics.
