Customer lifetime value is the estimated revenue you can generate from a customer throughout the relationship or customer\’s lifetime. You can relate it with other metrics such as customer acquisition cost to make informed decisions. Apart from that, it also helps in understanding the long-term benefits you will get by acquiring new customers.
Customer lifetime value (CLTV) isn’t a regular metric. It’s one of the most important SaaS metrics as it enables you to develop growth strategies, retain customers, and improve the onboarding process. Therefore, you shouldn’t neglect this metric. You must be thinking about how is LTV Calculated and why it’s so important for SaaS businesses. Don’t worry! We’ve got you covered. In this post, we will answer all your queries.
How to Calculate Lifetime Value (LTV)?
Calculating LTV for a single customer is very simple. For instance, you charge $200 per month for a specific service. A customer gets this service and stays with the company for 2 years. The LTV for that customer will be:
$200 × 24 = $4800
This method is theoretical and won’t be applicable in real time because you will have multiple customers. To calculate the lifetime value of a running business, you need to calculate two additional metrics, churn rate and average revenue per user. Let’s go through them with further ado.
Churn Rate
It is the percentage of customers who stop using a company’s product or service during a specific period. It is a critical metric for SaaS businesses as it indicates how effectively you are retaining customers.
For example, if you had 500 customers last year and 50 of them stopped using your services, then the churn rate will be 10%. A higher churn rate is a major concern for any company as it directly affects the revenues.
Average Revenue Per User
It‘s about the average revenue generated per user or customer during a specific period. It is commonly used by SaaS companies to assess the revenue generated from their user base.
Let’s say you have 200 customers on two different payment plans. 100 of them pay you $500 per year. Meanwhile, the remaining ones pay $1,000 per year. The average revenue per user will be $750 yearly.
LTV Formula
Based on the aforementioned metrics, you can calculate customer lifetime value. Based on ARPU, the formula will be:
LTV = ARPU × Customer Lifetime
Customer lifetime is the total duration for which a user remains active before stopping using your services or products.
You can calculate LTV by using the churn rate as well. The formula will be:
LTV = ARPU / User Churn
Tracking all these metrics and then using them to calculate LTV can be challenging. Don’t worry! You don’t have to do this manually. You can use Baremetrics to track and analyze all crucial SaaS metrics. Its user-friendly interface makes it easy to calculate any metric you want. Register now to get a free trial of Baremetrics.
Why is Knowing Customer Lifetime Value Important?
LTV isn’t a regular SaaS metric. It enables your business to achieve financial stability. The following are the key points that highlight the importance of this crucial SaaS metric.
Improves Acquisition Strategies
You have to spend a considerable amount on acquiring new customers. Tracking LTV will help you understand how much revenue you can generate from customers. Based on this, you can develop your acquisition strategies. For instance, if customers have an LTV of $500, you will never mind spending $100 to acquire them. On the other hand, spending the same amount on acquiring a customer with $200 LTV doesn’t make any sense.
Optimizes the Retention Process
Knowing LTV will help you understand the value customers are adding to the total revenue. Moreover, it helps you understand that acquiring new customers costs more than retaining the existing ones. As a result, you will develop strong strategies to retain customers with high LTV.
Maintains a Steady Cash Flow
Tracking and analyzing customer lifetime value helps you calculate incoming amounts to your business. Existing customers bring cash regularly into the business. As a result, you don’t have to worry about different expenditures and maintain a steady cash flow.
Enhances Profitability
Understanding LTV allows you to maximize profitability by focusing on increasing the average revenue per customer. This metric directly influences strategies, such as upselling or cross-selling. It ultimately ensures that your marketing and sales efforts are cost-effective and profitable.
Boosts Customer Satisfactions
LTV informs you about what drives long-term customer relationships. Analyzing it will tell you about the features of your products that keep customers engaged. As a result, you can focus more on these features to meet the needs of high-value customers. This approach will boost customer satisfaction and improve LTV.
Competitive Edge
You can compare LTV against industry benchmarks, to check your business’s performance relative to competitors. Make sure you compare it with a business of similar type and size as yours. This analysis helps you identify areas for improvement and strategic differentiation. As a result, you can focus on activities that boost their competitive edge.
Promotes Strategic Decision Making
LTV provides valuable insights into the overall performance of your business. These insights will help you make strategic decisions. It ensures that you focus on building lasting customer relationships rather than short-term gains, leading to more sustainable growth and profitability over time.
Track and Analyze LTV Using Baremetrics
Only knowing the LTV will give you a number and you don’t know what to do with it. The main thing is to analyze it to get useful insights. By doing so, you can check the overall performance of your business and take proactive steps to improve it.
You can rely on Baremetrics to track and analyze this crucial SaaS metric. It will display the information in simple formats, making it easy for you to understand and utilize it. Sign up or register now to get a free trial and start tracking crucial SaaS metrics.
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Usama Khan