It’s time to get your calculators and prepare to deep dive into the essential SaaS metrics. In this guide, we are exploring customer lifetime value (CLTV), and how it impacts your business’ growth potential. We’re taking the next step beyond revenue and looking at one key metric that will indicate how much revenue you can expect to receive from each of your customers.
Let’s get started.
What is Customer Lifetime Value?
Customer lifetime value (often abbreviated as CLTV, CLV, or LTV) is a metric that indicates how much a company will earn from a customer. Here’s another way to look at CLTV: It analyzes how much a customer is worth to a company over the entire span of their relationship with that company.
Customer lifetime value predicts how much an individual customer will spend on your product/ service.
It forces you to think of each customer in a big-picture scenario. You’re not just focusing on how much the customer spends on each transaction, but rather how much they spend during their entire lifetime with your business. Your customer isn’t worth how much they spent on their last transaction. Instead, your customer is worth the amount they’ve spent over their entire relationship with your business, whether that’s one month, 12 months, or 12 years.
The customer lifetime value starts as soon as the customer makes their first purchase with your business. It ends when the customer churns (i.e. leaves for good). It does not end if a customer decides to pause your service and return at a later time.
There are actually two types of customer lifetime value.
The first is historical CLTV which is the amount of gross profit you’ve earned from a customer.
The second is predictive CLTV. This metric uses historical data and customer behavior to predict how much revenue a customer will generate for a business.
Even though you can evaluate the lifetime value of previous customers, CLTV is used primarily for the future. It should help you predict future revenue per customer based on past performance. You can use your CLTV numbers to predict how much your company will profit from the average client in the future.
When used correctly, CLTV can inform your retention strategy. You’ll use what you know about the average customer lifetime value for your SaaS business to decide how much you can afford to spend to retain your current customers.
By identifying your customer lifetime value, you’ll be in a better position to grow your company and increase customer loyalty.
Your customer lifetime value is not a static, immovable number. It can change in a favorable way for your business as you track it and tweak your customer retention strategies, but more on that later.
To summarize, your customer lifetime value is an easy way to evaluate how much each customer is worth to your business over the entire relationship.
Why Do You Need to Calculate Your Customer Lifetime Value?
There are a lot of benefits to identifying your customer lifetime value. Here are the biggest reasons why you should continue to monitor how valuable your customers are to your business:
You’ll Increase Customer Loyalty
By calculating your customer lifetime value, you know how much effort each customer is potentially worth to your company. This will motivate you to nurture an ongoing relationship with your customers, instead of looking for the next one.
There’s a common attitude in the SaaS world to focus on the customer that hasn’t become a customer just yet. However, if you’re fortunate enough to win over a real, paying customer, it’s essential that you continue to nurture that relationship. If you want to increase your customer lifetime value, you must invest in building a rewarding and engaging onboarding experience. This way, the customer is more likely to stick around.
Many businesses focus on acquisition instead of retention, and that’s why old customers eventually drift away. However, if you actively look for ways to extend your customer lifetime with you, you’ll no doubt succeed.
You’ll Improve Your Nurturing Process
When you track your customer lifetime value, you become aware of how long your customers stay with you. This will inevitably lead to questions like:
- Why do some customers stick around and others leave almost immediately?
- What types of customers are most loyal to my business?
- What types of products do the most loyal customers buy?
- What can I do to positively influence how long customers stay?
Answering these questions will improve how you relate to your current customers. You can introduce processes that will increase your customer retention and keep them purchasing for as long as possible. In fact, some of these questions can help you increase your customer lifetime value if you can identify how to get customers to pay more (i.e. upgrade their service to the next level).
You’ll Save More Money
One of the biggest benefits of customer retention is that you’ll save money. It’s always cheaper to keep your customers than it is to generate prospects and then convert those prospects to customers.
Additionally, your current customers are more likely to buy from you in the future because they trust you and like you. If you’re launching a new product, your current customers are the group that’s most likely to buy it. Prospective customers don’t know you and may not be willing to take a chance.
You Can Identify Your Top Customers
By analyzing your average customer lifetime value, you can identify which of your existing customers has generated the most revenue for your business.
This is a great indicator that the customer is happy with your business and probably willing to spend more if the right opportunity comes along.
When you identify these customers, you should invest in their ongoing success with your product/ service. Provide them with tips on how to use your product, which can open their eyes to see familiar products in new ways. You can also thoughtfully suggest complementary products/ services that will extend their lifetime with your business.
You’ll Be Able to Segment Your Customers
There are a lot of great ways to group your customers (i.e. segment). However, one of the best options is to segment your customer base by their CLTV. This can help you improve your ongoing marketing.
To illustrate this, let’s say that you’d like to increase the lifetime value of a certain group of customers. You may choose to send them a specific set of emails that motivate these customers to spend more. Perhaps, to sweeten the deal, you’ll offer a free gift or a discount. But, instead of blasting this offer to all of your customers (including those who are willing to buy full price), you can limit your marketing to the most at-risk customers on your list.
And that’s just the tip of the iceberg.
You Can Identify Your Ideal Customers
By identifying your current best customers, based on their lifetime value to your business, you can then have a blueprint of what to look for in future customers. Of course, you’ll want to target the customers who are likely to spend the most with your business. You can identify these customers on your own and then analyze what these customers have in common. Once you have an understanding of who these customers are, you can then target prospective customers that are similar to your ideal customers with your future marketing strategy.
Puts a Laser Focus on Your Customer Acquisition Cost
Your customer acquisition cost, or CAC for short, is how much you spend to get a new customer. In order to determine if your CAC is too high or just right, you must consider your average customer lifetime value. If it costs more to generate a customer than you will earn from them (based on historical data of your average customer lifetime value), your CAC is too high and you won’t make a profit. In fact, you’ll lose money. You need to know your CLTV to understand how much you can afford to spend on prospecting, nurturing, and ongoing customer success.
The Bottom Line
If you don’t keep an eye on your customer lifetime value, you won’t be informed, and you also won’t be able to make wise business decisions that impact future marketing, customer retention, and the overall growth of your business.
How Do You Calculate Your Customer Lifetime Value?
Now that we’ve taken a look at some of the major benefits of knowing your customer lifetime value, let’s focus on the ways you can calculate this metric.
Yes, there are multiple ways to calculate your customer lifetime value, from simple to complex. The simpler the calculation, the less accurate it will be. However, even simple calculations will give you a good grasp of your average CLTV.
Before calculating your customer lifetime value, gather the following data:
Average purchase frequency rate – To find this number, calculate how many orders you get by the number of your unique customers.
Average purchase value – To calculate this, divide your total revenue in a time period (typically one year) by the number of purchases made in that time period.
Average customer lifespan – This is the period of time that a customer stays with your business before churning.
Customer value – To get this number, multiply the average purchase value by the average purchase frequency rate.
Customer Lifetime Value Formula #1
To calculate the customer lifetime value, multiple the customer value by the average customer lifespan.
Customer Lifetime Value Formula #2
Here’s another simple way to calculate customer lifetime value:
Divide your average customer value by your average customer lifetime.
In this formula, you’ll choose one customer to act as the average. That customer can then predict the average value you’ll get from a customer.
Customer Lifetime Value Formula #3
Another way to determine your overall customer lifetime value is by first finding out the lifetime value.
Step 1: You’ll do that by first multiplying the average value of a sale by the number of transactions. Then multiply those two numbers by the retention time period.
Step 2: You’ll discover the customer lifetime value for your business by multiplying the lifetime values and your profit margin.
Tips to Increase Your SaaS Customer Lifetime Value
- Invest in quality onboarding for your new customers. This way, your customers fully understand how to use your product from day one.
- Continue to nurture your customers after they’ve purchased for you. It’s important to shift from marketing to customer success. This will ensure that they stay engaged with your product.
- Regularly solicit customer feedback. This gives you the chance to understand what your customers like and don’t like about your product so that you can make adjustments as needed.
- Reward your customers for their loyalty by developing a program that incentivizes ongoing purchases.
- Encourage customers to reach out to you for any questions or concerns.
- Continue to educate your customers about your product and best practices for using your product.
- Incentivize customers to refer others to your business.
- Provide omnichannel customer support.
- Segment your email list so that you can communicate with your customers more effectively.
- Use retargeting ads to continue to nurture your customers when they’re elsewhere, such as social media.
What Factors Impact Your Customer Lifetime Value?
Let’s evaluate the most common factors that affect your customer’s decision to stick around and spend more with your business.
Your Churn Rate
How often do customers leave your business for good, whether voluntarily or involuntarily? An example of involuntary churn is when a customer’s credit card expires and the customer fails to update it because they don’t know anything is wrong.
Your Customer Loyalty
Are your customers happy with your business or planning to jump ship when a better alternative comes around? A customer may continue to buy your product but not be loyal. Not only do loyal customers stick around, but they also tell their friends and family about your business. This makes your loyal customers even more valuable to your business.
All of the above factors play a role in increasing or decreasing the customer lifetime value of a business’ average customer.
Calculating your customer lifetime value can help you save money and increase customer loyalty. There are no downsides to keeping an eye on this metric. Even if you’re not the world’s top mathematician, you can use the above formula(s) to quickly and reliably predict how much revenue you can earn from each customer.