What is Customer Lifetime Value?
Customer Lifetime Value (CLV or LTV) helps you see the expected revenue a customer will produce during their lifetime so you know how much value they will add to your company. Knowing your LTV is important when trying to determine how successful your company currently is and how to make it more successful.
LTV is useful throughout a company, for financial projections, investor relations, marketing, etc. Today, we’ll focus on how LTV can help marketing leaders optimize their team’s efforts.
Why is Customer Lifetime Value important?
In a previous post, we talked about the importance of understanding your CAC. To understand the impact of CAC on your revenue, you also need to know how long customers will stick around and how much money they will add to your company—in other words, their lifetime value.
The truth is, some customers are worth more to your company than others. The way you distinguish between the unprofitable, the profitable, and the most profitable customers is LTV. This metric offers vital insights about how much and where you should be spending money to acquire new customers.
Understanding your LTV helps you improve customer acquisition efforts because it can help you determine which acquisition channels are most effective for your business. For example, cheaper acquisition channels often bring in a higher proportion of clients that quickly churn out, whereas more expensive customer acquisition channels add longer-term clients. However, because this isn’t always the case, it’s important to know the LTV of clients from each channel to see which channels are the most profitable for the company. Keep in mind that it doesn’t necessarily have to be one or the other, and could be a mixture.
LTV can also help you discover when to put safeguards in place, like automatic emails or loyalty offers, to retain customers after the time they would typically churn out. LTV helps you decide which customers are worth spending more money on with retention marketing campaigns or initiatives.
TIP: Aside from using LTV to determine your marketing budget, figuring out the LTV of different buyer personas helps you better understand the value of each persona, so you know which persona is the most profitable to pursue.
How is Customer Lifetime Value calculated?
All types of businesses can benefit from understanding LTV, but there are different ways to calculate LTV depending on what kind of business you have. In this post, we’ll focus on basic methods that SaaS or other subscription-based companies can use to calculate their LTV. If you’re in ecommerce, Smile.io and Shopify both have in-depth explanations of how to calculate LTV. Other industries may calculate LTV differently, but these formulas are a good place to start.
Ways to calculate Customer Lifetime Value
Calculating LTV using an Average Revenue Per Account (ARPA or ARPU) formula is a basic way to produce an LTV for your customers and is a good starting point for LTV calculation. This is the method we used to create the metric above.
LTV = (ARPA x Gross Margin %) / Customer Churn Rate
This basic LTV formula is a useful starting point but is only a rough estimate. It fails to properly account for MRR contraction or expansion and nonlinear churn.
Another way for SaaS or subscription-based companies to calculate LTV is to take the price of a monthly subscription and divide it by the Customer Churn Rate. If a company offers a product for $15 a month and has a churn rate of 7%, the calculation would look like this:
15/0.07 = $214.29
At a 7% churn rate, a customer’s lifetime value is $214.29 or about 14 months and is valued at $214.29. If you can optimize the types of customers you acquire and reduce churn to 6%, that same calculation yields $250 (rather than $214.29) and equates to a lifetime of almost 17 months.
If you have 1000 customers at a $15 a month price point and you’re able to increase their lifetime from 14 to 17 months, you will make an extra $35,000 on those customers.
TIP: If you offer different pricing options, you will probably have different LTVs for each price point. If this is the case at your company, you will want to calculate the LTV in each of your price segments so you can better optimize your efforts to increase the LTV of each price point.
How do I create a Customer Lifetime Value metric?
Creating an LTV metric can be a little tricky depending on the methods you use. The metric shown above was created in Grow. To create it, we pulled our ARPA data from Salesforce, which tracks our MRR. You can also pull this data from other CRMs or detailed finance software like Zuora or Quickbooks. We pulled our Gross Margin info from our accounting software, but it can also be pulled from Quickbooks Online, Xero, and other similar software. We pulled our Customer Churn Rate info from Salesforce, but it can also be pulled from other CRMs.
To see if your CRM and financial software are available to use in Grow, view our integrations here.