Nothing lasts forever—and no, that’s not just a line in an emo kid’s diary. All things have an expiration date, including your customer relationships.
No matter how amazing your SaaS products are and how well you serve your customers, there eventually comes a time (could be two months after signing up, could be on their deathbed) that even your best customer offers up their last dollar. And the sooner you accept and assess this reality, the better equipped you are to determine how much you should spend acquiring and serving your customers.
That’s why SaaS companies spend so much time thinking about Customer Lifetime Value. But if you’re new to all this, you may be wondering…
What is Customer Lifetime Value?
Customer Lifetime Value (CLV) is the total amount a customer spends on your products throughout the course of their lifetime, less any costs you incurred to acquire and serve that customer.
We typically discuss CLV in terms of averages. In other words, we’re less concerned with an individual’s unique lifetime value than we are with the average CLV of your customers as a whole—or with specific cohorts of customers (e.g., premium subscribers, enterprise customers, etc.).
Understanding the average CLV of a customer cohort (or all your customers globally) has a number of benefits, not the least of which is figuring out how much you can spend to acquire and serve a given segment while remaining profitable.
How to calculate Customer Lifetime Value
Before diving into the calculation, we’d be remiss if we didn’t mention that there are two ways to assess CLV—the simple way and the more complicated, traditional way. The traditional calculation for CLV involves some extra steps to take into account fluctuations in sales over time.
We’re going to ignore the traditional calculation here because the goal of this post is to introduce you to the general concept of CLV and demonstrate how understanding CLV can guide your marketing strategy to maximize ROI. Plus, if you can assume that a given customer spends roughly the same amount year after year (which is often the case with subscription-based SaaS services), then you can probably just run with the simple calculation.
So… what’s the simple formula for calculated average CLV?
CLV = [Annual Customer Revenue] x [Customer Lifetime (in years)] — [CustomerAcquisition Costs + Cost to Service]
Example: Premium subscribers to SaaS-R-Us spent, on average, $1,000 per year and last on average 3.5 years. It costs $500 to acquire one of those customers and $200 annually, on average, to serve them. In this case, the CLV = $2,800.
Note: Customer Acquisition Costs (CAC) is the total cost to acquire a new customer through advertising, promotions, etc., and Cost to Service is the total cost over a lifetime to serve a customer, which includes providing support, creating new products, overhead, etc.
Why think about Customer Lifetime Value?
Customer Lifetime Value is an important metric, informing your strategy on a number of different levels. The following are some of the most important reasons to calculate your CLV for different types of users and different market segments.
CLV Tells you how much to invest in promotions and/or service costs
If you’re spending $1,000, on average, to acquire a customer who will spend $10,000 over the course of their lifetime, that $1,000 will typically prove cost effective (barring obvious considerations, such as watching your burn rate and not going bankrupt). On the other hand, if you’re spending more than you’re making, that could be a problem (unless your short-term strategy is to gobble up market share as quickly as possible).
It’s not rocket science, but where things get interesting is when you start looking at different segments. For example, it will probably cost a whole lot more to attain a Premium Package subscriber than to acquire a mid-range subscriber. However, if the higher-paying customer’s average CLV is disproportionately higher than that of the mid-range subscriber, the money may be well worth spending.
You can also look at how much you spend serving certain segments. For example, if your personalized onboarding process costs too much and provides too little return, you might consider automating onboarding for certain segments.
CLV Helps you set pricing
If your CLV is out-of-whack for a key segment, you can consider adjusting your prices and to see whether the market will bear those new rates.
CLV Helps inform your customer retention strategy
Churn, the loss of customers over a given period of time, is an inevitable part of any subscription-based business. SaaS companies go to great lengths to reduce churn because, on average, it can cost 25 times more to acquire a new customer than it does to retain an existing one. That data comes from the Harvard Business Review.
Of course, this figure is just an average, and your own stats might tell a very different story. CLV helps you figure out whether all that money you’re spending to retain customers within a given segment is really paying off. And if it’s not paying off, it’s time to re-evaluate your efforts.
How to maximize your Customer Lifetime Value
The other great thing about calculating your CLV is that it sets a benchmark for improvement. The more you can increase your CLV, the more money you’ll have left over to invest in growing your business.
Improving your CLV starts with delivering the products and experiences your customers want. And delivering a seamless experience and superior products begins with measuring certain key performance indicators—including Customer Satisfaction (CSAT), Product Satisfaction (PSAT), Net Promoter Score (NPS), and other key metrics that every SaaS company should track.
What’s absolutely vital when gathering this data is to go beyond the numbers themselves. Yes, asking someone to rate how likely they are to recommend you to a friend on a scale of 0 to 10 provides a benchmark, but what’s more important is to figure out why they love or hate you… and what you can do to improve those scores.
This open-ended data will allow you to tweak your Customer Experience (CX), product development, and messaging. Then you can follow up with more surveys to see what moves the needle to create happier, more loyal customers. Finally, you can double down on what works, maximizing your Customer Lifetime Value and spurring your business to greater heights.