The SaaS guide to customer lifetime value (CLV)
Customer lifetime value is an essential metric for understanding the performance and potential of a SaaS business. Here's everything you need to know about the metric and how to improve it.
What is customer lifetime value?
Customer lifetime value (CLV) is a key SaaS metric that tells you how much revenue a typical customer will bring in during their relationship with your company.
In short, CLV represents a customer’s value to your business over a certain time period. Understanding CLV is essential for evaluating the potential success of a SaaS business – and it's the foundation of subscription-based business models.
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.
It's time for SaaS businesses to master Customer Lifetime Value.
Why is customer lifetime value 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.
How to calculate customer lifetime value
Let’s say you charge $100 per month for your service and a customer stays with you for 12 months. Their CLV would be $100 × 12 = $1,200.
Here’s the basic formula for calculating CLV in the SaaS industry. It’s designed to estimate CLV for subscription-based businesses, taking customer churn into account.
CLV = Average monthly recurring revenue per user (ARPU) / Customer churn rate
Make sure that both ARPU and churn rate are taken from the same time period for which you want to measure CLV.
Here’s a quick explainer of the formula.
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%. (Read our guide on how to calculate and reduce churn)
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.
Customer lifetime value benchmarks
We've discussed how to calculate customer lifetime value for your business. But 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.
Factors influencing customer lifetime value
Benchmarks aren’t the only consideration when thinking about customer lifetime value. 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.
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.
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 use churn rate to calculate the amount of revenue lost from those customers.
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
We've talked a lot about why customer lifetime value is so essential for SaaS businesses. Now we're going to dive into a set of actionable strategies for increasing your CLV.
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. Optimize for expansion
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. Optimize your revenue delivery infrastructure
Getting your revenue delivery infrastructure dialed in can help you increase CLV in several strategic areas. Revenue delivery is a strategy for accelerating growth across customer acquisition, renewals, and expansion. All these areas combine to improve your CLV.
With a mature revenue delivery infrastructure in place, you can convert more users into customers, launch new products and expand into new segments rapidly, while reducing involuntary churn and increasing CLV.
For example, Mac software provider MacPaw increased its revenue by 200% after switching its flagship product, CleanMyMac, to a subscription-based business model.
This involved shifting its focus away from the old acquisition-based model and placing greater emphasis on customer retention, monthly recurring revenue, and customer lifetime value.
MacPaw already had a loyal customer base, so it needed to tread carefully while making this switch to avoid alienating existing customers. That meant launching an education strategy to inform customers about all the extra value they would receive with a subscription model.
After making the switch, MacPaw increased its revenue by 200% and achieved a 75% customer renewal rate.