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Understanding Customer Lifetime Value (LTV) – Methods to Calculate and Improve It

Among all SaaS metrics, customer lifetime value, or simply LTV is the most mysterious one. The true mystery is in calculating this metric and once you know the LTV, you don’t know what to do with it.

Today we will demystify this metric and guide you on how to use this metric for the growth of your SaaS company.

What is LTV?

Customer lifetime value is the amount a customer spends on buying your products or hiring your services throughout the relationship. This metric can lead you to focus on the long-term values of your SaaS business.

Example: Imagine you signed a contract of 6 months for $100/Month, then the LTV for that entire relationship will be $600.

Calculating LTV: A Complete Guide

Calculating customer lifetime value for a single customer is very straightforward. But we believe you have more than 1 customer. Therefore, just estimating the net amount spent by your customers is not going to help you. You need to consider a few things to calculate LTV. These are:

Churn Rate

It is the number of customers or subscribers who stop paying you in a given period. For example, if you have 100 customers at the start of a month and then lose 5 of them, you will have a churn rate of 5%.

Average Revenue Per User

Average Revenue Per User or ARPU is the average revenue you generate from all your clients or subscribers. For example, if you have 100 subscribers on a $1000/Year program and have another 100 for $500/Year plan, then the ARPU will be $750.

Now let’s see how you can calculate LTV using these two metrics.

Customer Lifetime Value Formula/LTV Formula

LTV = ARPU (average monthly recurring revenue per user) × Customer Lifetime

You can also use the churn rate to calculate the LTV. The formula will be:

LTV = ARPU / User Churn

You can see both LTV and churn rates are equally important. Higher churn will reduce the LTV.

Luck is on your side as you don’t have to manually calculate all these metrics. You can rely on a tool like Baremetrics to calculate churn rate and ARPU. It also helps you analyze the LTV and its growth overtime.

Understanding Variations In Churn

Calculating the churn rate often gets messy. For example, when you sign a lot of subscribers contracts at the start of a month, you can experience a cliff in subscribers just after 30 days. It is referred to as variation in churn rate.

To overcome these variations, you can use a discount rate. The discount rate is simply discounting for cash flow losses that your SaaS company may experience in upcoming months.

Let’s say you are using a discount rate of 0.75. The formula will be:

((ARPU x Profit Per User)/Churn rate) x .75

Sample Size

Sample size matters a lot. When you have a lower number of users, you may enter the data of very few users to calculate metrics. Therefore, you need to understand the sample size to calculate metrics accurately.

The following are some scientific guidelines for sample size.

Less than 100 users: You need to count in the data of at least 50% users. Going with 100% is a better option.

1,000 to 10,000: In this case, you need to count in only 10 user data.

More than 1 million: 1% user data will be enough when calculating metrics.

Relating Customer Acquisition Cost and LTV

Relating these two metrics will help you understand why LTV is important for your business. In actuality, LTV guides you about the budget you can spend to acquire new customers. Customer acquisition cost (CAC) is the amount you have to spend to grab new customers.

For example, if you spend $100 to get a customer on a contract of $500 in total. It means you are printing $400. Spending less to acquire and sign contracts at high LTV is the pathway to quickly grow your business.

You need to make sure that CAC must remain as low as possible. LTV to CAC ratio must be counted before signing a contract. If the ratio is less than 3, it means you are spending a lot on acquiring new customers.

Relating Churn and LTV

One nasty word that is the reason behind all the variations in your LTV and decreasing it continuously is Churn. In general, the users who are on the lowest payment plan, i.e. spending the least amount on your products or services usually churn more.

Remember what I told you? LTV guides you on how much you can spend to acquire new customers. For example if you are spending $200 to get a customer with an LTV of $100 is a mindless decision.

Knowing LTV for each segment of customers is mandatory. Baremetrics can be helpful at that point. It can help you calculate the  LTV for every segment.

Enhancing Customer Lifetime Value: Key Approaches to Increase Revenue

It’s nice to know the LTV for your SaaS company. However, only looking at a number or graphic report is not going to help you.

You need to do something with the data you observed to keep your business growing. Improving Ltv is the key to generating more revenues.

You must have gotten an idea that next we are going to guide you about practical tactics to improve LTV.

Connect and Interview Customers With the Highest LTV

The best way to start improving LTV is to connect with those customers who are with you at the highest LTV.

You just need to contact them and get them agreed for an interview. Doing so will help you understand the reasons that make them pay so high.

During the interview, you need to ask them about the following things.

  1. Why are they using your products?
  2. How are they getting benefits from your products or services?
  3. How are they growing using your services since the time of sign-up?
  4. Where did they get information about your products or services?

Apart from that, you can ask them anything that you think may give you an insight into the reasons behind the high LTV of these customers.

The first step you need to take in this case is to find the customers with the highest LTV. Make sure you reach out to those customers only who are currently in a contract with you. You need to apply a couple of filters to select customers for interviews. These are:

Active Members: Contacting churned users is not a good idea and you may feel odd. Therefore, reach out to active subscribers only.

LTV: Only select those customers for an interview who have higher LTV than your SaaS company’s average LTV.

Once you filtered out the desired clients, it’s time to take the next step. Now you have to set up an interview meeting with them. You can contact them via mobile calls or emails. Sending them mails and offering them something like discounts is the best way to make them ready for the interview. Schedule interviews according to their time to engage more clients for interviews.

Now you have to wait for the interview date and time. After that, you just have to conduct an interview and ask them the questions we mentioned above.

Now you just have to organize the feedback you get from every interview. Organizing them in a spreadsheet is the right method. After that, you have to compare this feedback to find common points.

This data analysis will guide you about some trends. For example, if you see a trend, most of the users with high LTV are attracted to a common feature of your products, and you can spend more to advertise that feature and improve it. Similarly, if most of your high LTV customers are attracted by a common advertisement resource, you can spend more on that source to get more high LTV customers.

These interviews can be your helping hand in developing your market and keep it going in the future as well.

Comparing LTV of Each Customer Segment

It feels nice to know trends and have information about your high LTV clients. However, in order to get more applicable values, you need to check and compare the LTV and trends of each major segment of your subscribers.

You need to estimate the LTV of each major customer of your SaaS company. It’s generally around numerous price plans you offer.

Comparing the LTV of each segment must have shown you a trend that customers on the lowest payment plan have the lowest LTV despite being large in number. This is mainly because clients on the lowest payment plans tend to churn more.

On the other hand, customers on high payment plans have the highest LTV as well. This is because such customers don’t churn often.

So, one thing is clear, instead of spending time on getting several customers on the low payment plans, you need to pour your efforts to get customers at the highest possible payment plans. They will add more value by generating more revenues for you.

Pricing or payment plans are only one way to segment your clients. Using a SaaS analytical tool such as Baremetrics can help you divide your customers into segments based on acquisition resources, CAC, and numerous other factors. For example, you can compare the LTV of your customers from China with the LTV of Japanese clients.

Control Churn Rate

If you can remember the LTV formulas, you will realize LTV revolve around two main things:

  • ARPU
  • Churn Rate

So, the longer you can keep your clients engaged with your products or services, the longer they will pay you and the higher will be the LTV.

You need to check if your customer churn rate is high or not. Using Baremetrics can help you figure this out as it will compare your benchmarks with other companies that are almost equal to yours.

If you notice you are falling both in user churn and LTV benchmarks, it means you need to be serious now. It’s the right time for you to concentrate on the churn rate and put your efforts to reduce it.

Improve ARPU

Now, let’s head toward the second part of the LTV formula, average revenue per user (ARPU).

Churn is inevitable, you cannot vanish it. Relying only on reducing churn to increase LTV doesn’t seem a fair choice. You need to focus on improving ARPU as well. You can do so by opting for two methods. These are:

  1. Raising Prices
  2. Expanding Revenues

I know raising the prices of your products or services is a touchy subject, especially for those who are new to the SaaS business. However, it never means that you price your product too low. It will do nothing except stun your business growth.

You cannot just raise prices blindly. Doing proper research, understanding market conditions, and trends are the key things you need to do before making any changes to your SaaS pricing strategy. However, if you observe the LTV of your company is at a standstill for a considerable period, then you must try raising prices.

The second tactic may work for many business owners as it seems less scary than the first one. To generate more revenue, you can opt for some basic techniques. These techniques are:

  • Upgrading current subscriptions or contracts to high-priced plans.
  • Cross-selling some products calling them complimentary.
  • Offering some add-ons.

Setting Goals

If you are the kind of person who loves chasing goals, then setting LTV goals can do the trick for you. It will lead you to focus on developing strategies to achieve LTV goals.

However, you cannot just set random goals to enhance LTV. You need to set some realistic goals after proper research instead of picking any numerical value as your LTV goal. Having a look at your LTV for the last 24 months can give you an idea about setting goals.

Using Baremetrics can help you set some realistic goals depending on the current condition of your SaaS business.

What’s Your LTV?

LTV is not just a regular SaaS metric, it’s more than that. It tells you about your pricing strategy and how customers are getting value from your products or services.

You must keep in mind that tracking LTV is not going to help you as you will only get a numerical value. You need to look for methods to improve it.

Don’t have an idea about your company’s LTV or calculating it? Don’t have a clue about enhancing your SaaS company’s LTV? It’s the right time for you to get a SaaS analytical tool like Baremetrics. Sign up for free and get its free trial to get started.

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