As a SaaS company, you have to keep account of numerous metrics. The most tricky and complex among them is customer lifetime value or simply LTV. Firstly, you may face struggles in calculating it and once you have done so, you will have no idea what to do with the values.
Today, we will reveal this metric’s mysteries and offer some deep insights so that business owners can use it in the best possible way.
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Introducing Customer Lifetime Value
Customer lifetime value is the estimation of the total amount your customers spend on your products, services, or subscriptions, throughout the period they stick to your company. As the time period is expanded throughout the relationship, you can call it the lifetime. By understanding LTV, you can move from transaction-based thinking to the long-term value of your company or organization.
For example, if a customer spends $1000 per month on your products or services and stays for 8 months, then the LTV for that customer will be $8,000.
Calculating Customer Lifetime Value (LTV): A Step-by-Step Guide
The aforementioned example is for a single customer and you will have numerous customers (at least more than 1). Therefore, you need a more reliable formula to calculate LTV. When doing so, you need to consider a couple of things. These are:
Average Revenue Per User (ARPU)
ARPU is the average revenue you generated from every customer. Let’s say, your company has 100 customers. 50 of them are on a $200/month and 50 of them are on a $300 per month plan. So, the ARPU will be $250.
LTV Formula Based on ARPU
LTV = ARPU (average monthly recurring revenue per user) × Customer Lifetime
Churn Rate
The next thing you have to consider in this regard is churn rate. It’s the No. of customers who stop paying you. Let’s say you have 100 customers at the start of the month and 10 of them left when the month ends. So the churn rate will be 10%.
LTV Formula Based on Churn
LTV = ARPU / User Churn
So, one thing is obvious, churn and LTV have an inverse relation. Hire the value of churn, lower will be the customer lifetime value. Thus you have to pay special attention to both these metrics.
Thank God! You can use Baremetrics to calculate LTV. You don’t have to manually do the whole process.
Variations In Churn
Churn can often get messy, especially in some specific cohorts or groups of customers. Let’s say you have a cohort and at the end of the month, you observe a high churn rate in that group. To your surprise, the cliff is just after the 1st month of subscription.
This is simply termed as churn variation. To nullify its impact on the LTV, a discount rate is used. Let’s say we are using a discount rate of 0 75 to calculate LTV accurately. The formula will be:
((ARPU x Profit Per User)/Churn rate) x .75
Understanding the Sample Size
It’s pretty important to understand the sample size as a scientific method often fails when it comes to SaaS businesses. If you have a short number of users or include only a few customers in estimating LTV, your data will not be valid in scientific terms.
The following are scientific guidelines to take samples to calculate LTV.
- Less than 100 Users: 50% or even 100% of customers’ data will be required.
- 1,000 to 10,000 Users: Data of at least 10% users will be required to estimate LTV in this case.
- More than 1 Million Users: Now you have a lot of customers, so you can rely on only 1% of user data to get more accurate values for LTV.
Relating CAC and LTV
Among the primary reasons why LTV is a crucial metric for your SaaS company is that it derives what you can spend on acquiring new customers. Let’s say, you acquire a customer by spending $100 and the customer spends $700 throughout the relationship. So the average amount you generated from that customer is $600.
To pace up the growth of your SaaS company, you need to keep improving the LTV and keep CAC as low as possible.
Knowing how much a customer will spend on your products and services will help you understand the lifetime value of that customer. Then you can plan how much you can spend to acquire that customer.
In general, if the LTV to CAC ratio is 3 or less than that, you are spending a lot of money on acquiring new customers.
LTV and Churn Rate
Churn is a nasty word for every SaaS company and its owners. It is the main reason why you have to witness variations in your LTV. In general, the users on the lowest price plan in your firm tend to churn more. You are already generating very low revenue from them. So, churn will make it the most dismal LTV as compared to other plans.
Can you recall what we said to you in the previous section, LTV derives what you can spend to acquire new customers. Let’s say you’re trying to acquire a customer with an LTV of $300. Spending $500 as CAC for that customer will be a pretty mindless approach.
You need to know LTV for each customer segment of your firm. Baremetrics can be handy in this case as it will make cohorts and estimate LTV for every cohort. And you can do so just after signing up in Baremetrics.
Elevating Customer Lifetime Value: Strategies to Foster Long-Term Engagement
Knowing the LTV will be nice but it’s just a few numbers and looking at them is not going to grow your SaaS company. Without using tracked KPIs, it’s almost useless.
So in the next section, we will head toward exploring the strategies to improve the LTV of your company. We will discuss LTV analysis and other tactics in this section.
Conversations with High LTV Customers
When you are aiming to improve the LTV of your company, the best point to start this journey is to get insights from the customers who have the highest LTV. You can simply do so by communicating with your existing customers.
You have to start this by shortlisting customers with the highest LTV and then conducting interviews. Make sure to ask the following questions during interviews.
- How do they know about your company or products for the 1st time?
- How are your products adding value?
- How do they use your products?
- What features of your products fascinate them the most?
- What makes them keep around your company and products?
Apart from that, you can ask any other question you think can give you insight into why they have high LTV or what keeps them around.
You cannot conduct these interviews randomly. You have to follow a stepwise guide. The first step is to find customers with the highest LTV in your firm. To find them, you can use a coupon of filters. These are:
Active Users
Make sure to communicate with active users only. Reaching out to churned customers may be embarrassing for you.
High LTV
The next filter is LTV. You cannot conduct interviews with all your customers. Therefore, only reach out to those who have LTV higher than the company’s average.
The next step you have to follow is to reach out to the customers. You have to contact them via call, message, or email and get their agreement for the interview. You can send them a proposal for the interview. If you want to engage more customers for this interview, you can offer them some discount or gift type thing.
Now you have to set the schedule for the interview. Leave this thing to the customers and ask them to tell you when they will be free for the interview. To get valuable insights, it’s not bad to work according to the schedule of your customers for a day.
Now you have to conduct interviews and start collecting data. Organize feedback in a spreadsheet and look for trends.
For example, you notice most of your customers are coming through a common channel, i.e. Facebook marketing or Google ads. You can spend more on that marketing source.
Maybe most of them are using the same feature of your products and getting value from it. So, you can focus on improving that specific feature.
Compare LTV by Cohorts
Looking at the LTV of your whole company will give you a limited view only. However, to get more action lines, you need to divide your customers into cohorts or groups and then look at the LTV of each customer segment.
You have to do so as all your customers are not the same. You have to find the LTV for every major segment which usually can be the various payment plans your company offers. Baremetrics can help you in analyzing LTV by payment plans.
It is very common in SaaS companies that the customers with the lowest payment are patented to churn more. They have low LTV and don’t improve your revenue generation significantly.
On the other hand, customers on high payment plans don’t churn very often. They have the highest LTV among your customers. They help you in generating good revenues as well.
Based on this data, you can easily conclude that spending time and money to acquire customers on high-payment plans is a good idea.
Pricing plans are only one method to make customer segments. You can use other criteria to make cohorts as well. The location of the customers, time of the signup, acquisition source, and numerous other criteria can be used to divide customers into segments.
You can slice data in tons of ways based on cohorts. However, your main aim should always be to get insights into the LTV and how to improve it.
Reduce Churn Rate
If you look at the LTV formula, you figure that it relies on two main things, the money they spend and the time they remain your customers.
So, it’s obvious that the more you manage to keep your customers around, the better will be the LTV for them. To do so, you need to look at the churn time. It’s the time customers stay around before churning.
Firstly, you need to check if the churn rate of your company is high or not. To do so, you simply have to compare it with other companies. Compare with only those companies that have almost similar LTV as you have.
If you are facing a decline in both churn time and LTV, then you need to focus on the churn rate. You have to adopt strategies to reduce the overall churn rate in your company or organization.
Improve ARPU
The other part of the LTV formula, ARPU, is also used to improve LTV. You have to improve its value to increase LTV.
Churn is inevitable, you cannot undo it. The only thing you can do is try to reduce it to the minimum extent. To improve LTV, you must focus on the revenue part as well and tend to improve ARPU. You can adopt two methods to do so. These methods are:
- Raising Prices
- Generating More Revenues
Raising prices can be a touchy subject for most owners, especially those who are just starting up. However, setting the prices too low is not good to help you in acquiring or retaining customers. It will only stun the growth of your business.
You have to review the whole pricing strategy and do proper homework before raising prices. If your LTV is not improving and growth is at a standstill, then it’s worth considering the rise in the prices of your products or services.
The 2nd tactic may be less scary for owners. All you have to do is to generate more and more revenue. You can do so by:
- Acquiring new customers
- Cross-selling products
- Upgrading the payment plans of existing customers
Set and Chase LTV Goals
We will not get into the discussion of how many chances of improvement increase by setting goals as this is not what we are trying to delve into. To keep things short, if you are someone who loves chasing goals then setting LTV goals can help you in improving the CLV.
However, you have to set some realistic goals. Don’t pick any value and set it as your LTV goal. You have to do proper homework to set goals. Setting achievable goals should be your main priority so that you can concentrate your attention on them and get some visible results.
You can get assistance from Baremetrics in this regard. It will help you in setting realistic and achievable goals within its dashboard.
What’s Your LTV?
Customer lifetime value is not just another SaaS metric as it can give you valuable insights. From the pricing of products to CAC, it says a lot about all the things related to your products or services.
To improve it, you need to track as well as analyze it. Have no idea about LTV? Don’t know how to calculate and analyze it? Baremetrics is the tool that can help you. Simply sign up in Baremetrics and enjoy its free trial.
