How to Figure Out Your Customer Lifetime Value

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For anyone newer to the SaaS world, digging into business metrics can feel like trying to make sense of alphabet soup.

But, confusing as the acronyms may be, understanding them and what they say about your business is incredibly important when it comes to strategizing and aiming to scale.

Today we'll be focusing on the customer lifetime value (CLV) metric, why you need to keep track of it, and a few different ways you can calculate it.

What is CLV and why is it valuable?

As the name implies, customer lifetime value denotes the revenue value a customer brings to your business over their lifetime.

Working out the CLV for your business is an essential task. It can support you in your marketing budgets, ensuring you aren’t spending too much.

CLV goes hand in hand with another SaaS metric: customer acquisition cost (CAC). Together, these two metrics can help you to determine how much money you should spend to acquire new customers.

Let's say your CLV is $1000—so your customers are spending an average of $1000 at your business before they churn out. If your CAC—the amount you need to spend on sales and marketing efforts before signing a new customer—is, say, $1,200, your business is losing money because customers aren't spending enough for you to recoup the costs of signing them.

Armed with this information, you'd know you have to find ways to:

  • encourage customer retention and increase customer lifetime value

or

  • decrease customer acquisition costs.

But I'm getting ahead of myself. Step one is actually determining what your CLV is.

How To Calculate The Customer Lifetime Value

There are three common customer lifetime value calculations, though each method will produce slightly different results. One of the best practices is to use all three methods and take the average from those as your ‘true CLV’. However, this isn't necessary and sometimes one calculation is all your business needs.

To demonstrate the equations, let's use the following figures:

  • Average customer spend / month = $100
  • Average customer lifespan = 12 months
  • Margin = 15%
  • Discount rate = 10%
  • Retention rate = 60%

1. The simple method

The simple method takes very little time to calculate, and so, unsurprisingly, isn't always the most accurate. The equation for this model is:

Average Customer Spend X Average Customer Lifespan = CLV

Using the example figures above, the value would be: 100 X 12 = $1,200.

But as I mentioned, this is the quick and dirty method. This model fails to include costs your business incurs while delivering the service, so it's possible to overspend believing you have more funds available to acquire new customers.

That said, if you have very few overheads, this simple equation might be all you need to calculate your customer’s lifetime value.

2. The custom method

This is another quick and easy method, but it's a bit more comprehensive than the equation above—it allows you to include the costs for delivering your service. This is a perfect equation for those who offer a subscription for a physical product such as wine, groceries, or clothing.

To calculate:

Average Customer Lifespan X (Average Customer Spend X Profit Margin)

So with our example figures:

12 X (100 X 0.15) = 12 X 15 = $180.

The final figure here is lower than the simple version but is far more accurate and allows you to calculate a reasonable customer acquisition budget without having to worry about costs.

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3. The traditional CLV calculation

This equation is far more precise, and naturally the most complex calculation.

The new metrics used in this calculation are:

The Rate Of Discount = The interest rate used for calculating the present value of future cash flow. This number is usually between 8% and 15%. This value assumes prices aren’t going to increase in the immediate future.

Retention Rate = A calculation for a subscription business. It is simply the percentage of customers who remain with your service from month to month.

Average Gross Margin Per Customer Lifespan = This is how much profit each customer provides during their lifespan. To calculate this use your final figure from the simple method and then multiply it by the profit margin. For our example we have 1,200 X 0.15 = $180.

And so, here's our third CLV equation:

Average Gross Margin Per Customer Lifespan X (Retention / (1 + Rate Of Discount – Retention))

Using our example figures, this would equate to:

$180 X (0.60 / (1+ 0.1 – 0.6) = 180 X 1.2 = $216.

You can certainly use all three figures to calculate an average customer lifetime value, however, you might prefer to use just one of these figures.

How to use these figures

Whichever method you use, you can now calculate the budget you have available to allot to your new customer acquisition costs.

Going off our example figures and the final number we arrived at using the traditional calculation, we know we can spend up to $216 on acquiring each new customer. Sticking to this value means each customer we sign is allowing us to stay in profit over a longer period.

But, just like with any other business metric, you can certainly improve your customer lifetime value.

  • Improve customer retention rate. By encouraging customer loyalty, you increase the average lifetime value of your existing customers. After all, the longer a customer is with your business, the more opportunities they have to contribute to your recurring revenue. Don't underestimate the role customer satisfaction plays in creating loyal customers—the happier an existing customer is, the more likely they are to stick around and spend more.
  • Increase your focus on upsells. Similarly, by encouraging customers to opt for add-ons or higher-priced subscription plans, you can increase the average order value and therefore the lifetime value. Consider hiring a dedicated staff member to focus entirely on upselling.

Remember what I said earlier about CLV going hand-in-hand with CAC?

“The business that is willing and able to outspend its competition to acquire a new customer won't always win as some people say, unless they are continually reducing their lead costs while raising the customer lifetime value at the same time," says business development thought leader Jeremy Coates.

In other words, you can outspend your competitors on customer acquisition and end up with a higher customer count, but unless you're able to raise the customer lifetime value at the same time, that spend might not be worth it.

How a recurring billing system helps calculate customer lifetime value

One of the best tech tools for staying on top of your CLV, CAC, and the rest of the alphabet soup that is SaaS business metrics? A modern recurring billing system.

This software offers tons of different reports and insights that can help you dig into metrics like historical customer lifetime value, and help you more accurately forecast predictive customer lifetime value.

It also allows you to dive into analytics based on customer segments, letting you see if a certain customer demographic has a higher CLV than others, possibly informing future sales and marketing strategies.

Intimidating as they may be, the acronyms, percentages, and ratios are actually your subscription business's best friends—and by with them using the right tools, they can only help you out more.

Do you need recurring billing and subscription management software? Contact one of our experts at info@fusebill.com, call or check out the Fusebill free trial.

Tags: SaaS SaaS Strategy

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