What Is LTV in SaaS and 4 Easy Steps to Calculate It Right Now

December 9, 2021

Leadership

MIN

Old habits die hard.

The very same goes for the SaaS industry.

Each and every software company aims to attract customers and get them to a point where they employ products routinely.

Turning customers into loyal customers along the road might not be easy, but once achieved, it surely will add more value to your business since keeping current customers on board costs less than acquiring new customers.

Fortunately, the value they bring to the business can be estimated through customer lifetime value.

By doing so, you can measure how much a business can earn from the average customer during the interaction between the customer and the company.

Let's delve into the basics of customer lifetime value together!

What Is LTV?

The key metric LTV has many abbreviations used within the industry, such as CLV and CLTV, which refers to customer lifetime value. It is a critical metric that measures the total worth of a customer to a business over a period of time in which the customer-business relationship is maintained. In other words, it is the revenue a business can expect from a single customer to generate over their entire relationship.

The lifetime value of a customer increases as they continue to obtain more from a company. Also, as I have said above, enhancing the value of existing customers is a more rewarding practice in the long run as it costs less to retain them instead of investing in attaining new customers.

For a company, the customer lifetime value should correspond to customer acquisition cost (CAC), operating expenses, and sales and marketing expenses to maintain a viable business model. Therefore, especially customer support and customer success teams must put their minds to boosting LTV since they play a big role in the process of increasing customer loyalty and reducing customer churn rate by offering customers aid when they are in need of help and making suggestions.

How LTV can help a SaaS business

There are a lot of ways that LTV can affect your SaaS business's long-term growth, especially when it comes to making business decisions. Here are a few ways you can consult LTV when you need some assistance, especially regarding customer relationships and future cash flows. Here are a few ways LTv can help your business:

👉 LTV helps you make better decisions on what to spend on customers. Knowing what you earn from a typical customer will come in handy when estimating expenditures on customers. Therefore, you will be able to improve your profitability by increasing your LTV and reducing customer acquisition costs altogether.

👉 LTV encourages you to segment your customers based on value. By having the knowledge of what your customers pay for your product over a specific time period, you should be able to identify customer segments and target them effectively by developing new marketing strategies that will promote upselling.

👉 LTV serves as an intermediary when pinpointing issues related to the customer journey. Being able to see customer behaviors will provide you with priceless insights that will help your team observe the customer pain points with ease. Thus, solving these problems will lead to an increase in both customer retention and customer loyalty as you will be optimizing the process to meet customer expectations and needs.

👉 LTV drives growth by increasing revenue and many more in the long run. The amount of money a business makes multiplies as the amount of money a customer pays throughout their entire lifetime increases. Thus, keeping track of and enhancing LTV results in more revenue for a business. Additionally, you will be conscious of who spends more money and who can spend more money. Using this knowledge, you could easily divide your customer base and retain valuable customers while inspiring less valuable customers to spend more.

How Is LTV Calculated In SaaS?

This is where things get a little tough but worry not because I will be here to lend you my assistance till the very end.

In order to calculate customer lifetime value, get yourself familiar with the variables below:

Average purchase value: It is the average value of the sales made by your customers during a time period.
Average purchase frequency rate: It is the rate of the frequency which is directly related to how regularly a customer buys from you during a time period.
Customer value: It is the value customers get for the money they offer.
Average customer lifespan: It is the duration that the average customer continues to work with you.
Customer lifetime value: It is the worth of a customer to a business throughout the entire term of their relationship.

Now that we have acknowledged the variables you need to calculate customer lifetime value, let's visualize the formula step by step:

1️⃣Firstly, you need to find your customer value. In order to find your customer value, you need two variables: average purchase value and average purchase frequency rate. By dividing the amount of money you have made (by selling your product) in a period by the number of orders that have been placed during the same period, you will get to your average purchase value.

2️⃣Then, you will find the average purchase frequency rate by dividing the number of orders that have been placed by the number of people who have purchased in that period. Now that you have these two variables in your pocket, you can find out your customer value, which only requires you to multiply the former variable by the latter.

3️⃣You are now one step closer to calculating your customer lifetime value. Before moving on to the rest of the formula, you need to acquire a new piece of information, which is your average customer lifespan. This can be easily measured by dividing the sum of customers' lifespans by the number of customers you have in that period.

4️⃣The last step demands you to multiply the customer value you have found in step two by the average customer lifespan you have obtained in step three. By doing so, you will have reached your customer lifetime value in the end.

LTV Formula

Here is the simple formula of the customer LTV:

What is a good LTV for SaaS?

The answer to this question completely depends on your business and the amount of money you charge for subscription plans, but it should be higher than your customer acquisition costs by all means.

Fortunately, there is one rule of thumb for companies with a subscription-based business model: A true customer lifetime value should be AT LEAST three times greater than your customers' cost of acquisition (CAC). David Skok, an entrepreneur interested in SaaS, recommends your LTV-to-CAC ratio be higher than 3 to 1 as well.

For example, let's say that you spend $5,000 to acquire a new customer, and your LTV is $5,000 as well. This situation calls for trouble since your LTV-to-CAC ratio is 1—which means you have not made any money from this customer you have acquired.

Quick Tips to Boost LTV

Now that you are equipped with the importance of customer lifetime value, you must be curious about the practices that will boost your LTV. Here are five of them to improve your SaaS LTV quickly:

Improve customer onboarding to ensure that your first-time customers become the source of recurring revenue for your business. By optimizing the onboarding process thanks to tooltips that explain the features and benefits of your product efficiently, you will be making a good impression for sure.
Make sure to get feedback from your customers. Feeling that you are not heard is one of the dealbreakers for customers; therefore, you have to take action to meet their expectations and needs throughout the entire customer experience.
Do not be afraid of retargeting. One of the ways you can easily increase LTV is by using retargeting as a marketing strategy and trying to re-engage the customers who have had a previous interaction with your product—which would make a contribution to your brand name at the very least.
Use sales strategies according to customer segments to lessen the churn rate. These strategies, such as upselling and cross-selling, might encourage existing customers who are unhappy about the money they spend on your product to change their monthly plans and become more content instead of churning.
Increase customer retention rate by building long-lasting relationships with customers. In this way, your current customers will be more apt to utilize your product and have no issues with asking for customer support teams' aid when an issue arises. Also, stepping up customer experience will not only strengthen the bonds between customers and the company but also build trust—which is a factor that would ultimately boost LTV.

In Conclusion

Customer lifetime value is a measurement that shows how valuable a customer is to a business throughout the entire time the business interaction is sustained.

By comparing LTV to customer acquisition cost, you can appraise the worth of a customer and the business's potential to grow in the long term.

Additionally, LTV is a tool that provides you with valuable insights regarding the prosperity you gain from the practices you apply to your business—if these practices are not helping you maximize your profit, then your LTV result will show it from A to Z as well.

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