The lifetime value of your business is an important, if not the most critical metric, that your subscription based SaaS business should be monitoring. While the monthly income of your business is vital, the subscription model makes it hard to determine whether the acquisition of customers is cost effective.
Where Monthly Sales Will Fail Your SaaS Business
Monthly sales can cloud assessment of your success. For instance, you could have 1,200 regular subscribers who are paying $25 per month to use your system. This would create monthly revenue of $30,000. At the same time, if it costs $50 to attract and convert a prospect into a customer, then after three months you are making a profit on each customer.
This might seem like you’re in a good position; but it masks several financial facts from your accounting team.
The most important factor is customer churn. If you are turning over a quarter of your customers each month (i.e. 300) and replacing them with roughly the same, you aren’t going to gain any business growth. Yet this might not seem too troublesome, after all, by three months the customer has effectively paid back their acquisition costs through their lifetime value.
It isn’t just the lifetime value costs that are important to consider though. Each subscriber will have a delivery cost. You might have to pay for staff, hosting, administration, office fees, transaction fees etc to maintain your service.
While the average gross profit margin is approximately 95.12% and the lowest recorded margin recorded is 86.27% – this is still money removed from your profit. As a worst case scenario, the profit from each customer is $21.57 and a monthly total of $25,884.
However, gross profit does not include important measures such as marketing and employee salaries. Businesses on average spend between 40 and 80% of their gross profit on salaries. For most companies, including salaries in their profit margins would be challenging as different customers need different service levels to deliver their unique orders. With a SaaS business, it is much easier because the average cost can be spread across all the customers as they all are paying the same amount. So your company could only be gaining $8.44 per client per month.
Then we need to take off the marketing costs. This is calculated by evaluating how much you spend on acquiring each customer. If you use social media marketing, pay per click, display adverts and direct mail – you might be spending $50 or more per client.
If a client is only staying with your services for three or more months, then they are only contributing $25.32 towards those marketing costs. Your SaaS business is therefore under serious financial strain as it is spending more to obtain customers than it is collecting from them.
By not knowing the lifetime value of your business, you might have not realised why your business is not making enough profit.
Where Can Lifetime Value Help Your Business?
Generally speaking there are three main problems that your customer lifetime value can identify. Once identified, you can then find solutions. The three main aspects are:
Profit Per Customer: If your customer is providing you with limited profits, then you aren’t going to have enough to pay for salaries or marketing. Find ways to reduce costs and increase this value.
Lifetime: This is the length of time that a customer spends with your service. If this is short, then there must be an issue with your product or customer service.
Retention Rate (customer churn): The rate at which customers leave. In our example it was 0.75. This is similar to Starbucks.
How To Calculate Lifetime Value
There are three main ways to calculate the lifetime value of your customer. The best for most businesses is:
Lifetime value X Subscription Price X Profit Margin
In our example that would be:
3 months X $25 X 0.3373 = $25.30
The lifetime value of your customers is one of the most important metrics for your SaaS business. By using it, you can determine the health of your business and areas that need to be supported.