SaaS Founder's 2022 Guide to Customer Lifetime Value
September 29, 2022
It is hardly a topic of discussion when it comes to the value of customers for any business.
But when it comes to measuring the exact value one single customer has for your business, it becomes a way more interesting subject. Given the importance of variables like customer acquisition and customer retention rates and the definition of customer value for a specific company, the scope of discussion widens even more.
So, in this blog post, we will be looking at:
What customer lifetime value means for SaaS businesses,
Why LTV matters,
How you can measure it,
What defines a good LTV for your business, and
How you can start increasing LTV right away
Without any more idle talk, let's start with a solid definition.
What Is LTV in SaaS?
Customer lifetime value or LTV is a key metric that is mostly used by marketing and customer success teams to overview the entire relationship of a specific customer to a business to assess their past interactions and transactions and predict their future relationship with the company. When performed for each of a business' active users and customer base, this assessment might reveal reasons for customer churn rates, justify customer acquisition costs, and empower customer retention efforts. The metric basically defines the contribution of each customer to the growth and profit of a business.
All in all, it is clear to see that LTV has a great impact on business decisions and rules over many important metrics such as churn rates and revenue per customer. It also goes as far as to shape marketing strategies and even affect business models.
While a clear impact on other metrics is present, it is also important to separate LTV from some other metrics.
For example, customer health score, which looks into the likeliness of a customer to churn, or average customer lifetime, which, as the name suggests, has a lot more to do with how long a customer is retained, are both different metrics that contribute to but not the same as LTV.
If we were to dive into the history of customer lifetime value, it goes as far back as the late 1980s; however, it is possible to say that the SaaS LTV we know today isn't necessarily the exact same basic formula.
Yet another point of discussion is, of course, why we care about customer lifetime value so much.
Let's take a look at the importance of LTV.
Why does customer lifetime value matter?
Customer lifetime value is among the most important metrics your marketing team, customer success team, or in general, any team and process within your organization can benefit from once the insights and data are laid out.
And yet, there are some solid reasons that reinforce the use of LTV even more. Let's take a look.
1- A retention-oriented mindset
LTV essentially points directly at a more customer retention-oriented mindset in all business processes. Once businesses start looking into the lifetime values of their customers, more and more efforts to make sure the high-value customers are taken care of are made.
And that is what we call customer retention.
The more a business cares about LTV, the more it will naturally care about retention.
2- More meaningful customer acquisition efforts
Much like the increase of retention efforts, LTV signals more meaningful and sophisticated advertising, promoting, and marketing efforts for a business to acquire customers.
This is simply because of the nature of customer acquisition; if it costs $5 to acquire one customer who is going to end up spending $500 on a product, it is best to try and acquire such customers (PQLs) than to get a ton of non-PQL customers, $5 each.
So, we can easily say that customer lifetime value is a natural driver of sophisticated and PQL chasing marketing campaigns.
3- Customer value awareness
It is important to realize, and I am saying this in the least mean way possible, that certain customers are more prioritized for businesses.
Let's be honest; a non-PQL customer on a basic plan and a fully committed PQL on a premium plan cannot compare when it boils down to who gets immediate care.
LTV does not only give insight on valuable customers to acquire but also on your current customers and whether they have a good enough experience with your product to stick around.
Tracking this metric thus makes sure to monitor the needs and expectations your typical customer while also working perfectly in tandem with other critical metrics like customer churn rate, average revenue per user, monthly recurring revenue, and more.
4- Higher rates of loyal customers
As a direct cause of good rates of customer retention, when LTV is used correctly, it is natural to see a rise in average customer lifespan, better business and customer relationships, and, generally, higher customer success.
These all point to but one thing: loyal customers.
And LTV monitoring is probably one of the best ways to gain more loyal customers.
5- Profit, profit, profit
A quite obvious advantage and one of the sole reasons why customer lifetime value tracking is important is, of course, the cash flow.
For a SaaS business, especially a young one, profit might be hard to acquire and even harder to stabilize. But LTV can be a solid way of stabilizing marketing spending while also scoring constant profit.
Being highly related to the acquisition, retention, and customer success, it is hardly any work for a business actively using customer lifetime value metrics to succeed in lowering annual and monthly churn rates, and elongating the average lifetime of a typical customer.
Thus, it all points to one simple outcome: profits, profits, profits.
Now that we know why customer lifetime value matters, we can finally talk about the practice of LTV.
Let's take a look at how you can calculate LTV now.
Customer Lifetime Value Calculation
Essentially, customer lifetime value calculation is a basic measurement that requires only a simple calculation. Plus, there are many different ways of calculating it.
Still, we need to go step by step to completely comprehend the calculation process since this simple calculation, though it requires no advanced calculations, has different calculations in itself.
How do you calculate the lifetime value of a customer in SaaS?
To figure out the formula for LTV, we need to know how to calculate three things; the average value of a purchase, the average frequency or number of purchases, and the average customer lifespan.
1- Calculate the average purchase value
To calculate a business' average purchase value, only a simple formula is required.
By dividing total revenue by the number of purchases, one can easily find the average purchase value of a business.
2- Calculate the average purchase number/frequency
Similar to average purchase value, average purchase number/frequency also requires a simple division.
By dividing the number of purchases by the number of unique customers, one can find the average purchase frequency.
3- Calculate the average customer lifespan
The last calculation to perform before measuring LTV is average customer lifespan, which can be calculated by dividing the sum of customer lifespans by the number of customers of a business.
4- Bring it all together
After making the previously mentioned calculations, it is time to bring it all together to find out your customer lifetime value.
By subtracting average purchase frequency from average purchase value and multiplying the outcome value by average customer lifespan, what we get is our customer lifetime value.
What is a good LTV for B2B SaaS?
Much like any metric or measurement in business, whether it is B2B or B2C, different criteria change the answer to this question a lot. And to be frank, it is not the best decision to compare a business to other businesses, especially bigger ones on the internet.
Instead, what we can work with is a ratio of customer acquisition cost (CAC) and customer lifetime value. It is important to make sure that a business' customer lifetime value is at least three times higher than its customer acquisition costs.
This gives us the CAC to LTV ratio, which is ideally higher than 3:1, B2B and B2C alike.
While a ratio of even 5 is already considered awesome, Netflix's case is good enough to explain its worldwide success.
But after all, the real question is, how YOU can achieve this or even better. Let's talk about how you can increase your LTV for your SaaS business.
How to Increase LTV for SaaS in 5 Steps
One does not simply increase the profit one acquires from a customer overnight.
But if one can apply some of the tips below, it just might be possible to increase LTV in a matter of weeks. Let's get straight to it.
1- Go after the right customers
Customer lifetime value is naturally a matter of customer retention. But making sure your customers are up to be retained is a matter of customer acquisition.
The logic is simple: if you don't acquire the right customers in the first place, you can't retain them.
Thus, low lifetime value.
But if you were to lay out a set of criteria that defines your ideal customer persona and figure out the channels through which you can access these ideal customers, increasing LTV will be no trouble from the start.
2- Invest in better customer retention
While acquiring the right customers is important, the second step in our guide is one you cannot turn a blind eye to.
If you cannot retain acquired customers, there is no lifetime to talk about the value of.
So, it is crucial that businesses invest in better ways of retaining customers, from tracking metrics like customer churn rate and customer health score to frequently asking for feedback and minding NPS surveys.
To increase customer lifetime value is essentially about making sure you can profit off of a customer for a longer time and in larger amounts. But if you do not consider the needs of the customers, this goal is no better than a dream.
So, it is important to increase the lifetime quality of a customer, the quality of the service and attention they receive from your business, to make sure they spend more on you for longer periods of time.
4- Promote long-term commitment
While it is important to make sure that customers naturally choose you over others, it is also a relief to know that they are committed to you in the long term.
To make this happen, there are several ways.
For example, as many B2B and B2C businesses like to do, it is a great contributor to higher LTV to promote your business' annual plans, preferably by making discounts.
Another good way of ensuring long-term commitment is holding loyalty campaigns and other promotions. Depending on a business's specific marketing strategy, there are endless possibilities to increase LTV.
5- Invent ways to increase loyalty
You're doing it all right; you mind your acquisition audience, you do it all to retain them, and you offer a quality experience.
And yet there are still holes in your LTV calculations.
What you can do is start thinking outside of the box. When Amazon found out that Kindle users were spending more on Amazon, they came up with Amazon Prime. When Netflix realized the wait time for delivery was decreasing their LTV, they launched web access.
There is no reason to think that you won't have a "when they realized" moment. If you can't get loyal customers that will pump up your LTV, turn the ones you have into loyal customers.
Customer Lifetime Value is a simple formula. And it is not.
The truth is, that LTV has more to it than retention and acquisition campaigns. What it takes is to create loyal customers who you can trust will keep buying from you in the long term.
Once you know how you can do that, you won't have to worry about low LTV. Of course, it is up to you to figure out your own turning point.