Among numerous SaaS metrics, customer lifetime value is considered the most mysterious one as it’s challenging for anyone to estimate it. And then, you don’t have an idea what to do with the numerical value you have as a result of your LTV calculation. Many newbies don’t even decide if their LTV is good or bad.
Hopefully, today we are going to demystify the nitty gritty details about LTV. We will show you:
- How to calculate LTV?
- Different things impact LTV.
- How can you improve it?
Get ready for useful insights into this mysterious metric.
Let’s begin with finding the answer to what LTV or customer lifetime value is. LTV is the estimated or calculated amount that a customer will spend on your products or subscriptions throughout the relationship.
This metric can assist you in moving your business away from transaction-based thinking and developing strategies for long term growth and sustainability. Let’s check out an example of LTV. Imagine you have a customer paying you $100/per month for a single subscription. And the customer lasts for 15 months. So the LTV will be $1500.
LTV Calculating Formula
The method used for calculating customer lifetime value in the above example is suitable for a single customer only. Hopefully, you will have more than 1 customer,, therefore you need to look for a more actionable formula to calculate LTV. You can use two things to calculate LTV. These are:
- Average Revenue Per User
- Churn Rate
LTV Formula by ARPU
ARPU is the average revenue you generate from each customer. For example you have 100 customers paying you $200 a month and have 100 more customers on a $100 plan. So the ARPU will be $150.
Using ARPU, the LTV formula will be:
LTV = ARPU (average monthly recurring revenue per user) × Customer Lifetime
LTV Formula by Churn Rate
The churn rate is the speed at which you lose your customers or the rate at which your subscribers stop paying you. Let’s say you have 50 subscribers at the start of June. However, 7 of them canceled subscriptions within 30 days. So, the churn rate for June will be 7.
LTV formula based on churn rate is:
LTV = ARPU / User Churn
The higher the user churn, the lower will be the LTV. Therefore you need to keep an account of the churn rate as well. Luckily you don’t have to do so on your own as SaaS analytical tools like Baremetrics are out there to assist you. You can use Baremetrics to estimate churn and other metrics.
Estimating or tracking churn often gets messy as you can sometimes observe a cliff in customers just after the first 30 days of subscription. You noticed that trend when analyzing the churn for a specific cohort.
This cliff or irregularity is referred to as churn variance. You can nullify its impact by using a discount rate. Let’s say you are using a discount rate of .75, the LTV formula will look like:
LTV = ((ARPU x Profit Per User)/Churn rate) x .75
The worst part about the scientific method is that it often falls sideways in the case of business. Therefore, you need to pay some attention to your sample size as well. Having few customers or counting only some of your customers for data evaluation may not be scientifically valid. Check out the following scientific guidelines on the sample size.
Less than 100 users: data of 50% of users will be required. 100% will be more applicable.
1,000 to 10,000: 10% of user data will be considered valid in this case.
More than 1 million: Only 1% of data can do the job there as you have a lot of customers.
How Customer Acquisition Cost and LTV are Correlated?
Customer acquisition cost or similar CAC is the amount you have to spend to acquire a new customer. When calculating LTV, you will have to subtract the Acquisition cost from it for accurate values. For example, if you spend $100 to get a customer who will spend $500 on your products or services, the LTV for that customer is $400.
So, LTV is the money machine for your SaaS company-Right??
You need to keep CAC lower and LTV higher to make your business grow well. Spending more than what you learn from a customer to acquire that customer makes no sense.
The growth of your business depends hugely on the LTV to CAC ratio. This ratio must be 3 or higher than that. If it’s lower than 3, then you need to consider some changes to increase LTV.
Correlating LTV and Churn
Churn, a nasty word for almost every SaaS business, is the most compelling reason why your LTV values are not consistent.
In general, the customer on your lowest plan also tends to churn more than any other plan customer. You must have remembered what we told you about LTV and estimating the CAC.
Based on LTV, you can decide what you can spend on a customer to acquire it. For example, if you are planning to get a customer with $100 LTV, then spending $200 to acquire that customer is a brainless point unless the customer can benefit your business in some unorthodox ways.
Therefore, you must know LTV for each customer segment. Baremetrics can help you in this regard as it can divide your customers into different segments or cohorts and then assist you in estimating LTV for each cohort.
Practical Ways to Augment LTV
Knowing your SaaS company’s LTV is a nice thing but it’s quite useless unless you utilize the results obtained to improve your company. The KPIs are of no use unless you analyze them and work to improve your LTV. Only seeing a number or graphical data as your company’s LTV is not going to help you.
Let’s move forward and explore how LTV analysis and other tactics can help you in improving your LTV and overall business growth.
Interview Customers With the Highest LTV
The first thing you need to do for LTV analysis is to interview customers. To figure out why your high LTV customers are spending so much money on your products or services is to simply ask them. You need to conduct a short interview and ask them questions to get feedback on your services or products.
During the interview, you must ask them about your products, what makes them buy your products, what they like the most about them, where did they hear about you, and anything else that is directly related to their attachment to your products or services.
To carry out this interview, you need to follow a stepwise guide. The first step will be to find appropriate customers. You cannot interview all your customers. Therefore, apply a couple of filters to find the best suitable. candidates for the interview. The filters you have to set are:
First of all, you need to keep in mind that you have to interview only active customers. Reaching out to a customer who used to have a high LTV but has already churned is not a good idea. It may make you feel awkward. Therefore, always select candidates from your active members.
The second criterion you have to look at is LTV. It is the main filter that will help you figure out the customers you have to invite for an interview. Choose from those customers only who have a higher LTV than your company’s Average.
Now you are all set to head towards the next step. In this step, you have to get customers ready for the interview. You can send them emails to contact them and invite them for a feedback interview. In an email, you can offer them a discount or something similar to this to get them ready for the interview. This tactic can help you get almost everyone up for feedback.
Once the customers accept your invitation, you must set a schedule for interviews. Leave all that to your customers and ask them to give you a date and time for the interview. You have to do so as a part of your job to grow your company. So, going with customers’ schedules is the best idea.
Then you have to conduct interviews and start collecting feedback from all your selected, high LTV customers. Once you get all the feedback data, you have to arrange it in a spreadsheet and look for trends. These trends can help you figure out what is attracting these high LTV customers and you can use them to get new customers with high LTV.
For example, if you observe most of your high LTV customers are joining you through a common channel, let’s say it is Google AdSense, then you can spend more money on this marketing type to attract more similar customers.
Or you may observe a trend that most of them are sticking with your products just because of a specific feature. You know what you have to do, improve that specific feature and advertise that specific feature the most so that you can get more customers. When trying to improve the features, make sure that you don’t change their basics as it may result in losing customers.
Comparing LTV by Cohorts
You must have noticed that seeing LTV as a single number can give you only a limited good view. In order to look beyond that limit, you need to divide your customers into segments or cohorts and then analyze LTV for each cohort. You have to do so because all customers are not the same.
After dividing them into segments, you need to find LTV for each one. You can get assistance from Baremetrics to estimate the LTV for each customer segment.
You will notice a trend that customers on the lowest payment plans have the least customer lifetime value. There is a common thing about all SaaS companies. Their customers on the lowest payment plan tend to churn more. Therefore, despite having the most number of customers at the lowest plan, the LTV remains low. These customers don’t help you in generating big revenues.
On the other hand, customers on higher plans usually don’t churn often as they are not with you for experiments only. They last longer than your average retention time. Being on high payment plans, they add more value to your revenue generation and show higher LTV as well.
Based on this data, it is confirmed that spending money and time on acquiring customers at higher payment plans is good for your LTV. However, other factors will also matter.
Pricing plans are only a single way to segment your customers and analyze LTV. You can also make cohorts based on their location, subscription time, and numerous other factors. For example all the customers from China or Japan can make a cohort.
Now you can use data in many different ways. However, your main focus should always remain to improve the LTV of your SaaS company.
Controlling Churn Rate
The whole LTV revolves around two things, which are:
- Money spent by customers
- The time they remain your customers
The next thing you can do to improve your LTV is to reduce churn. Doing so is required as churn and LTV has an inverse relationship. To do so, you first need to look at the time for which customers stay with you and keep spending on your products or services.
First of all, you need to check if your customer churn is high. You can find your customer churn by using Baremetrics and then compare it with other companies having an LTV similar to yours. Comparing KPIs with such companies lets you find if your churn rate is high or not.
The time your customers spend before canceling is termed user churn. If you are low on both user churn and LTV, then your churn rate is a big problem. You need and you must do something to control this high churn rate.
The next thing you can do is to improve your ARPU to enhance LTV. You can do so by:
- Raising Prices
- Expanding Revenues
The first one is a risky option, especially for new SaaS companies. Increasing prices may lead you to face more churn. However, you do have to randomly change your pricing strategies. You first check your products, improve them, and then change your SaaS pricing strategy. If your LTV is not improving for a long time now, then raising prices is the need of your business.
The 2nd method is not that risky. You have to expand revenues by selling more subscriptions or services. There are 3 most common ways to do so. These are:
- Attract more customers
- Upgrade existing customers to higher levels
- Sell complimentary products to your customers
If you love moving in a direction and achieving landmarks, then setting goals can do the trick to improve your LTV. We will not get into the discussion of how setting goals can increase your chances of success and other similar things.
You need to set LTV goals to concentrate all your attention on achieving that LTV goal. You will develop strategies accordingly to achieve your milestones.
Make sure that you don’t set random goals. Use base metrics to set achievable goals. Set realistic goals and then put all your efforts to achieve them. Starting from smaller and then moving toward bigger goals is the right pathway.
What’s Your LTV?
LTV is not just another metric, it gives valuable insight into your products, their features, popularity, and usage. You don’t have to track it, but analyze it as well to boost it.
Have no idea what your LTV is? How to track or analyze it? Biometrics has the solution for you. Sign up for free and enjoy its freemium trial to calculate and analyze LTV for your company.