Customer lifetime value (CLV) is an essential metric for understanding the performance and potential of a SaaS business. There’s more than one way to calculate CLV—here’s how we do it, and why, plus everything you need to know about the metric.
When you’re considering the direction your company is taking, the lifetime value (LTV) of a user is one of the most important metrics to understand. Different LTV models can inform decisions like how much you can pay to acquire a customer, the effects of losing users, and how changes to a product affect the sum-total revenue you can expect to bring in.
It’s also an easy metric to look at to see the overall health of a product in terms of both revenue and customer retention. A growing CLV means a company is doing well—customers are happy and will be giving you more money over the life of your relationship. On the other hand, a declining CLV means that a company is getting less money from each customer and needs to fix something fast.
The lifetime value of a customer is an especially important metric because it shows you a more complete picture than other figures. For example, ARPU (average revenue per user) only shows what you are charging, on average, for a customer in a given month. What it doesn’t show is whether or not your customers are going to keep paying that amount for a long or short time period, or if they are likely to upgrade and pay your company more money in the future.
Similarly, retention figures don’t tell the whole story. While customer retention shows if your customers are sticking with you, it won’t show if customers are paying more or less each month. And while revenue retention will show if your customers are upgrading or downgrading—and thus giving you more or less money—it won’t show you whether your number of customers is fluctuating.
This is why CLV is so important to understand—it fills in the blank spaces between ARPU and retention, giving you a more robust picture of where you stand and the revenue you can expect over the course of a customer lifespan with your company.
What is customer lifetime value?
Customer lifetime value (CLTV, or CLV) is the total dollar amount you’re likely to receive from an individual customer during their relationship with your company. It represents a customer’s value to your business over a certain time period. Understanding CLV is essential for evaluating the health and potential success of a SaaS business, as it allows you to account for and predict future revenue and profit.
Why CLV is important
Customer lifetime value is one of the most important metrics for growing SaaS businesses. Here’s why:
- Provides a reliable business viability measure: High CLV is a sign of product/market fit and brand loyalty, giving a clear picture of how well your product or service resonates with your customers. This also helps you evaluate how well your company is likely to perform in the future.
- Provides clarity on customer acquisition spending: Your customer acquisition costs might exceed the value of the customer’s first purchase. But that same customer could end up making you more money over time. Calculating CLV provides an actionable answer to this key question.
- Enables more efficient marketing: Understanding how your customers spend makes it easier to tailor your marketing efforts, to ensure you retain your most valuable customers while increasing revenue from less valuable ones.
- Helps achieve steady growth: CLV is a great metric to monitor and optimize for growth – essential in the SaaS industry.
Despite the importance of customer lifetime value, many companies still overlook its significance. According to a 2019 report from Criteo, many marketers struggle to leverage customer lifetime value to its full potential.
They cite challenges including lack of in-house skills, costs of monitoring CLV, and issues with the overall complexity of handling the metric. Another key challenge is difficulties in gathering enough data about the customer to build a clear picture.
With that in mind, let's dive into how to go about calculating – including how we go about it, and how you can make tracking it a breeze.
How to calculate CLV
While there are multiple customer lifetime value calculation methods, they all involve determining how long each customer is expected to stay with your company and how much revenue they will contribute over their subscription.
Traditional ways of calculating CLV
One of the simplest ways to calculate CLV is to multiply the average revenue a customer generates over a given period of time (month or quarter) by the average length of the contract.
The CLV formula for this multiplication method looks like this:
CLV = Average (monthly) revenue per user (ARPU) x average contract length (ACL)
Another simple formula for CLV calculation is based on ARPU and the company’s churn rate over a certain period of time:
CLV = Average revenue per user / Churn rate
Here’s a quick explainer of the formulas.
ARPU: The average revenue of all your currently active user accounts. You can find it by calculating monthly recurring revenue / total number of users.
Let’s say you’ve got 100 active user accounts. 50 of them bring in $50 per year, while the other 50 bring in $100 per year. That means your ARPU is $75 per year.
Churn rate: The number of subscribers that unsubscribed or stopped paying in a given period of time. For example: You had 100 subscribers last year and lost 5, so your churn rate is 5%.
This formula is a useful starting point for estimating CLV for a SaaS business. But it’s also important to consider other influencing factors, including account expansions (for example, upgrading), contraction (downgrading), and different churn patterns.
There are several different models for calculating your CLV. You can either calculate it based on historic purchase data or based on predictions of what your customers will spend in the future. Both models have their advantages and drawbacks.
Historical customer lifetime value model
Here, we use historic spending data to calculate the value of a customer. This model uses the average order value to arrive at customer value. It's a useful approach if most of your customers only engage with your business for a set period.
The main drawback of the historical model is that it doesn't account for variance in customer journeys, which can lead to inaccurate results. For example, the model considers active customers as valuable, but if they later become inactive, this can skew your results. Or perhaps your inactive customers might become active and decide to buy from you again. These uncertainties are where the predictive model comes in.
Predictive customer lifetime value model
This model forecasts the purchase behavior of new and existing customers, using predictive algorithms that learn from previous customer behavior. It's more complicated than the historical model, but it’s great for identifying your most valuable customers and which of your products attracts the most sales, as well as spotting ways to boost customer retention.
Drawbacks of these methods
One of the biggest drawbacks of these traditional customer LTV calculations is that there needs to be a large enough sample size (number of customers) in order for the LTV calculation to be meaningful.
Suppose a company has a large number of both customers and revenue. Then there should be low variation in month-to-month changes, unless the company is either doing something very right (in which case, we’d expect these numbers to increase drastically) or very wrong (decrease drastically). The problem with having a low number of revenue (or customers) is that it reduces the statistical power of the model, meaning that the model’s expectations are less reliable. Also, with fewer customers, each customer has a greater impact on the LTV calculation for that month.
If a company with a small number of customers loses 1 or 2 customers or a few hundred dollars it will cause the LTV to spike for that month, giving a chart for LTV that looks like Figure 1.
Another potential problem is that if a company is awesome enough to have 100% retention in a given month, the calculation becomes mathematically impossible because you can’t divide by zero.
Our (not so) secret customer LTV calculation model
Here at Paddle, we love to geek out on data and metrics. A lot. Probably more than we’d normally admit in public. After a lot of pondering and discussion, we feel like we've figured out a better way to deal with low customer numbers and retention by developing a unique algorithm (the technical term being “secret sauce”). This algorithm lets us better regulate small changes, as it looks at how customer LTV is trending instead. It does this by comparing this month’s LTV to last month’s to remove the spikiness caused by small samples sizes, giving an overall more accurate LTV.
Also, by looking at trends instead of using other methods to deal with highly variable data like lifetime capping—saying that an average customer lifespan is a certain number of months or years (a number that will be different for each company)—we can also better predict an LTV for all types of companies, regardless of their size, retention numbers, or growth rates. Using trends also helps deal with problems like having months with 100% or greater retention—instead of having huge unrealistic spikes, we can show a reasonable uptick in customer LTV, shown in Figure 2.
It’s much easier to see the trends and growth in the CLV for the company with our algorithm, as it smoothes out some of the spikiness found in the raw data. At the same time, the up and down fluctuations are maintained. A simple trend line won’t show these peaks and valleys, which can be important for making decisions.
Overall, our model of LTV provides more actionable data, while still ensuring that the information is presented in a reasonable and accessible way, leaving you with actionable insight, not fussing over peaks and valleys. That’s why we’re calculating CLV as we do. Who needs more charts without a clear purpose?
How CLV influences customer acquisition costs (CAC)
While understanding your CLV relative to your CAC is seemingly obviously important on the surface - LTV tells you what you can afford to spend to acquire a new customer - the metric's importance goes much deeper. Specifically, tracking customer LTV allows you to:
Optimize your CLV/CAC ratio to 3 or higher
Every quarter you should be managing your CLV/CAC ratio. As a benchmark, you want this number to net out to at least 3, meaning for every dollar you put in your SaaS machine, you're getting 3 out. Depending on tradeoffs (alluded to above), this number may be justifiably lower or hopefully much higher in the aggregate or on a per-segment basis.
Determining and tracking success (channels, marketing campaigns, sales reps, etc.)
Since customer CLV is a measure that combines how well you're monetizing (MRR) with how well you're retaining your customers (MRR Churn), CLV can be used to benchmark success across different aspects of customer acquisition. Comparing LTV across channels, sales reps, marketing efforts, etc. will give you insight into which aspects you need to eliminate in your process and which you need to accelerate with more fuel.
Determine your best customer personas
One of the major goals in SaaS is to clone your customers. SaaS as a giant math formula allows you to break down which attributes lead to high CLV, allowing you to knowledgeably build out your product, marketing, sales, etc. to maximize the likelihood of keeping and acquiring these customers.
Test if features, add-ons, and retention efforts are successful
CLV reflects customer satisfaction and ultimately encompasses how effective your retention is. The metric can be used to track the impact of different retention efforts, allowing you to advance your product org down a path that focuses on maximizing value through the product.
SaaS financial planning and growth projections
If knowledge is power, CLV gives you the ability to reasonably project your cash flows and growth as you acquire additional customers. This can be incredibly important to your cash flow, allowing you to financially plan your team growth, marketing spend, etc.
What affects CLV?
There are several other factors that influence the metric.
Do you offer a range of services at different price points, to cater to a wider selection of customers? If so, you’ll need to account for different customers having different CLVs according to the service they’re subscribed to.
Discounts can have the opposite effect that you want on customer LTV. Data shows SaaS discounting lowers SaaS LTV by over 30%. This is broadly because the customers that are attracted to discounts tend to be users with higher price sensitivity (therefore a lower willingness to pay full price for a service) and higher rate of churn than your core user group would have at full price.
Business model or product type
Is this designed for longevity, or does it naturally allow for customers to drop off after a certain period (for example when they’ve used your product to complete a finite task)? If the latter, can you adjust your business model or product offering to bump up the length of time that customers typically spend subscribed?
It's important to consider that customers might expand or contract their use of your product during their time with you, for example by upgrading or downgrading their subscription plans. This will impact customer lifetime value.
Segmenting your customers according to common features can help you tailor your marketing strategy more effectively. But using details like location or purchase history doesn’t always produce the best results. That’s where focusing on CLV can make a big difference. You can segment customers and use CLV to develop predictions about their total future value to your company. This allows you to market to each group (or individual customer) in the way most likely to maximize their lifetime value.
To help you stay on top of CLV in your business, we've put together a fact sheet with all the key takeaways from this guide. Download it now.
How do you know if you're on the right track relative to the rest of the SaaS industry? One way to do so is by knowing about the key industry benchmarks for Customer Lifetime Value.
Customer lifetime value is more valuable as a metric when you calculate its ratio to customer acquisition cost (CAC). In the SaaS industry, the benchmark for CLV to CAC ratio is greater than 3:1.
This benchmark indicates a high ROI from your sales and marketing efforts. It also allows you to save 2/3 of your gross revenue to invest in product development, operating expenses, taxes, and profit.
Customer lifetime value and other SaaS metrics
Customer lifetime value can be used alongside other SaaS metrics to provide an all-round picture of your business situation.
One of the most important is churn rate. This refers to the percentage of your customers who don't renew their subscriptions. You can analyse churn rate to calculate the amount of revenue lost from those customers.
SaaS churn rate is a critical metric because it can determine the long-term viability of your SaaS business. It also helps you see where you're going in the right direction and where you're going wrong.
So how should you think about churn rate in conjunction with customer lifetime value?
Churn rate and CLV
These two metrics are inextricably linked. When you have a low churn rate, your customers stay with you for longer. When customers stay with you for longer, they produce more lifetime value. In short: the lower your churn rate, the higher your customer lifetime value.
Average revenue per user (ARPU) and CLV
This is the amount of revenue generated by a user over a specific time period, typically a month or a year (depending on which type of subscription your company offers).
On the surface, ARPU sounds very similar to customer lifetime value. But in fact, there are several key differences. CLV measures the entire value that a single customer produces during their relationship with your business. It also accounts for variable costs such as support, transaction fees, and refunds.
In contrast, you can use ARPU on an ongoing basis to track the overall health of your business. It's also useful to help you compare how your business performs in relation to your competitors. Companies with higher ARPUs tend to be the most profitable.
Customer acquisition cost (CAC) and CLV
Much of success in SaaS hinges on balancing these two metrics. A well-balanced business model has a CAC that’s significantly lower than its CLV. The ideal ratio of CLV to CAC should be at least 3:1.
Account expansion/contraction and CLV
Account expansion or contraction happens when customers upgrade or downgrade their accounts after the initial signup. It causes a corresponding increase or decrease in your recurring revenue, which in turn affects customer lifetime value.
For B2C SaaS firms, this may be less relevant, as B2C customers tend to sign up on a specific plan and continue with that plan for their entire subscription.
However, some B2B models may include account expansion, such as those that bill based on volume (email marketing is a good example of this).
Eight powerful ways to increase your customer lifetime value
Customer lifetime value is a testament to the success of your SaaS business. The higher your customer lifetime value is, the longer you can turn profits and grow. Remember that LTV is a balancing act that goes hand in hand with your CAC. A viable business model will always yield a higher customer lifetime value.
Here are some actionable ways to extend the life of your customer and get CLV higher.
1. Make onboarding seamless
Your onboarding process is a very sensitive moment. It’s critical to get right, because it's the first time a new customer really encounters your brand. A great experience can win you a loyal customer (and boost your CLV), while a bad one can make them jump ship to one of your competitors. You should create an onboarding process that’s fast and straightforward, providing easy-to-follow guides and tutorials.
2. Invest in product education
Product education is a great way to retain your customers for longer, as it helps them understand the value in different aspects of your product. A great example of this is Neil Patel’s Ubersuggest, an SEO tool. Patel provides highly informative educational articles, which teach his customers how to strategically use a wide variety of the tool’s features, keeping them subscribed for longer. Ubersuggest’s comprehensive free content also helps to attract new customers.
3. Invest in driving cross-sell/upsells
As mentioned earlier, account expansion is when the customers upgrade their accounts. You can optimize this by up-selling (selling more features or product extensions to your existing customers.) Or you can cross-sell related products alongside your core offering. Both are great for boosting your CLV while keeping your customer acquisition costs down.
4. Make your product ‘sticky’
The strategy involves adding features to your product that draw the customer in and make it difficult for them to leave. For example, offering them a custom dashboard in which they can integrate their own data to help improve some aspect of their business.
This keeps them on board for longer, as it solves a pain point while also driving their business growth. The result? Enhanced CLV for your company.
One example of a SaaS company making great use of ‘sticky’ features is cloud-based storage solution Dropbox. The automatic sync feature seamlessly backs up your files into the cloud, without you even having to think about it. As a result, you end up staying with the service for longer.
5. Nurture customer relationships
Happy customers stay loyal customers for longer, it's a no-brainer. That's why improving your CLV involves nurturing customer relationships. One way to do this is by investing in excellent customer support. You should have an efficient, responsive team in place and offer support across multiple channels.
Another way to nurture your customers is by responding to their feedback and acting on it. Doing this regularly helps you identify when something is going wrong so you can fix it before it leads to churn. What's more, customers love it when they feel understood, so make it your mission to do so.
6. Encourage loyalty
One way to cultivate loyal customers is by rewarding them for staying with your business over time, for example by offering extra features, a month free of charge, a renewal discount or similar. By making the reward something already closely related to your product, you can be sure that they’ll find it useful.
Another way to encourage loyalty is by creating referral programs where your customers can earn rewards from referring your product to their networks. Web hosting company Bluehost is a good example of a popular referral program that offers tiered commission to its successful affiliates.
7. Target the right customers
You can't win every customer, and, as any marketing textbook will tell you, getting your target audience right is part of the battle. Try to really understand who will gain the most value from your product and plan your strategy around winning these valuable customers. They’re the ones most likely to stick around in the long run, bringing you better CLV!
8. Scalable pricing
Scalable pricing is vital to success in any SaaS business. The pricing structure should be created to scale either up or down capturing the smallest/cheapest customers, up to the largest, most valuable customers willing to pay more. The best way to do this is through what's known as a value metric (number of users, number of visits, depth of usage, etc.). Read more about value metrics and choosing the right one here.
Customer lifetime value FAQs
What does customer LTV mean?
Customer LTV is another way to refer to customer lifetime value (CLV, the overall revenue driven by a customer over the course of the entire customer lifecycle.
How do you calculate customer lifetime value?
There are multiple ways to calculate CLV. To find it for a single customer, you just need to add up the total revenue per month and multiply it by the number of months they’ve been a customer. To find your business’ average CLV, you need to divide the average revenue per user by your company’s churn rate. To automate your customer lifetime value calculation, try this CLV calculator.
Why is CLV important?
Customer lifetime value reflects how successful your company’s retention efforts are and how much revenue bring relative to the cost of acquiring customers (CAC). This ratio, CLV:CAC, is one of the best reflections of the profitability of your business, and the lower your CLV, the more unfavorable it will be.