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April 15, 2022

As a SaaS company, one of the most important metrics to track is lifetime value (LTV). While it may seem difficult to calculate at first, understanding your LTV is essential to the success of your business. This article will help you learn How to Calculate LTV SaaS.

Knowing your customer lifetime is important for your business growth. So read on and learn how to Calculate LTV SaaS and keep your business on the lookout. Click To Tweet

Your overall churn can be reduced

You’ll see that the customer LTV formula is a function of two things.

  1. How much money your customers spend  on you.
  2. How long your customers stay .

the longer you keep your customers paying you, then the greater your chances of increasing your average customer lifetime worth.

we need to consider user churn times in order to do this. How long can customers stay with your company before they cancel?

how to calculate ltv saas

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First, you need to determine if your customer churn rate is high. Our Benchmark is a great way to compare your churn times to other companies using Baremetrics.

Benchmarks will help you see how your metrics compare with companies with similar average revenue per person (ARPU). 

to increase your ARPU you need to consider this:

  1. Raising your prices
  2. Expansion revenue

It is important to note where you are in the benchmarks for customer LTV and user churn. If your churn rate for both is lower than the quartiles, it’s likely that you have a problem.

customer lifetime value (CLTV), which is a key metric for SaaS businesses, should be tracked as part the customer experience program. This gives you an indication of how valuable a customer to your company and not just their first purchase.

Understanding and analysing customer lifetime value can assist SaaS businesses in creating a SaaS marketing plan to acquire new customers or retain existing customers. It can also help to ensure that profit margins are maintained.

What is the customer’s lifetime value?

CLTV is the total worth of a customer to a business over the entire period of their relationship. It takes into consideration the total revenue one single customer can bring in and compares it to the company’s expected CLTV customer lifetime.  

The longer a customer stays loyal to a company and continues to make a purchase, the bigger the lifetime value becomes. 

customer lifetime worth (CLTV) refers to the amount that a customer will spend on your product/service throughout the relationship.

This metric will help you focus on the long-term benefit of repeat business, rather than transaction-based thinking.

The customer’s LTV would be $1,000.

your LTV may be higher or lower than you think

If you are a SaaS startup in its early stages, and still trying to get to Product/Market Fit, and If you are doing your first experiments to convert leads, don’t worry about customer lifetime value (LTV, CLTV, and other related metrics). You will need to have a good understanding about your LTV.

This is because your LTV determines how much money you can use to earn a customer. This post will discuss a variety of ways to estimate LTV, and I’ll try to explain why your LTV might not be as high or low as you think.

How to Calculate LTV SaaS:The simple LTV formula

The simplest way to Calculate LTV for a subscription business is ( customer lifetime x gross profit). Here, customer lifetime is ( 1/ customer churn rate) and gross profit is ( average revenue per account (ARPA). This is how you get:

Here’s how a CLTV  formula works. If your churn rate averages 2% per month, your ARPA would be $100 per month and your gross margin would be 80%, you can expect a CLTV of  50 month and an LTV of 4000.

you can also replace customer churn rates with revenue churn rates, so the formula becomes (Gross profit / Revenue Churn Rate). The formula takes into account contractions and expansions (e.g. This allows you to get a better estimate of LTV due to upgrades or downgrades.

This formula should calculate gross profit based on the ARPA (AKA “Average sales price” or ASP) of your new customers. Account expansions are already included in your revenue churn rate.

These formulas can be a good starting point, provided you remember a few basics.

  1. I’ve seen LTV calculations that were based solely on revenue, rather than gross profit. This is absurd. Use gross profit.
  2. When determining your churn rate, don’t mix monthly and annual plans. This is common for SMB SaaS. This is especially important If your company is young and growing quickly. This is because the number you add to your annual plan customers is greater than the number of customers who are due for renewal. Therefore, your monthly churn rate across all customers is reduced by the customers who cannot cancel (1). If you have both monthly and annual plans, calculate each segment’s LTV separately.
  3. If you have a wide ACV range, such as customers paying you $3000 per month while others pay you $100 per month, it doesn’t make sense to Calculate the average LTV across your entire customer base. Instead, estimate your LTV for each segment of your customers.

A (luxury) problem is caused by negative churn

However, the simple LTV formulas are not without their limitations. Negative churn is one of them. First, congratulations If your revenue churn is negative. If you are pre-Series A, ping me. Third, you’ll have noticed that the (Gross profit / Revenue Churn Ratio) formula doesn’t work for negative revenue churn.

The problem is that with perpetually negative revenue churn, the revenue stream for a customer cohort would continue to grow and become more valuable over time, which is clearly not possible. David Skok’s excellent article “What is your TRUE customer lifetime worth?” explains how this formula should be extended to include negative churn values.

The full article is highly recommended. But the gist of it is that If your negative revenue churn rate is, say, 12% you should consider it the result of two variables.

  • Customer turnover of, say 10% annually.
  • Your remaining customers’ spending will grow by 22% per annum, based on the original contract amount.

The trick is to assume positive customer churn rates (which makes sense since customer churn cannot be below zero and almost always above zero), and then to assume that remaining customers will spend a certain percentage of the original contract value. This will ensure that revenue lost to churned customers eventually offsets account expansions from existing customers.

This solves the problem of the simple formula. Previously, negative revenue churn was synonymous with infinite, exponential revenue growth.

Smiling cohort charts?

If churn doesn’t spread linearly over a customer’s lifetime, the classical formulas may not be applicable. In simpler terms, let’s say that in the first month of a customer’s lifetime, you lose 5% MRR to churn. Month 2 will see another 5%, month 3 will see another 3%, and month 4 will see your churn rate drop to 1.5% per month.

Poor onboarding, signing up non-ICP customers or customers who see the first month as a paid trial can all contribute to a high churn rate within a customer cohort. This is not a common pattern in SMB SaaS.

Consumer subscription companies tend to experience a greater impact. Mr. Consumer Sub Nico Wittenborn noted that consumer subscription companies typically lose between 50-60% and 10-15% of their subscribers within the first year. These companies can still be great businesses if the 30-35% who survive the first two years are loyal customers for a long time.

If some of these loyal users upgrade to a more expensive plan over time (or you’re good at re-activating/winning-back customers that churned), you’ll get one of those nice smiling MRR cohort graphs. Click To Tweet

you can use the monthly churn rate for a business to Calculate LTV. However, it is possible for the result to be too low or too high depending upon the size of the company, the pace at which it grows, and the mix of older and young cohorts. How do you calculate LTV in this situation?

you can limit your customer definition to only customers who survived the initial drop off and calculate LTV using post-drop-off Churn rate. This is a simple option. The result is that you will have fewer customers If your definition of customer is tighter. However, those customers will have a higher LTV.

This is because you care more about those customers that stay with you for a few months than about the ones who leave after a few months. It makes sense to look at it this way. The corollary to a tightened customer definition will be that your CACs will rise because you’ll divide sales and marketing spending by a smaller number, but it could be a better reflection on the reality of your business.

(2)This works well if there is a significant drop-off in the first few months followed by a steady churn rate for the remainder of the customer’s lifetime. It doesn’t work well if your churn rate drops more slowly. This is because it would be difficult to determine where to draw the line for your limited customer definition.

Interview customers who have the highest lifetime value

If your goal is to increase customer lifetime value, it is a good place for you to start by speaking to your existing customers.

To identify customers with a higher lifetime value than your average customer, consider conducting research to learn more about them. This could involve surveying current and former customers, analyzing customer data or talking to employees who interact with customers on a regular basis. By understanding what sets these high-value customers apart, you can develop strategies for attracting and retaining more of them.

you want to learn more:

  • your product should be the most valuable to them.
  • How they use your product.
  • What attracted them initially to you \(and what they learned about you)?
  • How they have grown with your product from the moment they signed up.
  • Any other insights that will help you understand why they are here.

First, find out your average LTV. I’ll grab yours from the Metrics dashboard.

Next, go to your customer list. You’ll need to create a few filters:

  1. Active customer It is best to speak to customers who are active. It can be awkward to reach out to people who have canceled.
  2. LTV Filter to show customers with LTVs that are higher than the average (in our case, it was higher than $3443)

You should now have a list with your highest LTV customers.

You can then reach out to them to ask if they are open to a brief interview to learn more about their product use and get feedback.

Here’s an example of how your email might look:

Subject: first name, your company hand picked you!

Hi first name,

Thank you for being a loyal customer of your company! I’m interested in learning more about customers and your product. Since you’re such a great customer, I was wondering how you could help me?

Would you be willing to spend 15 minutes answering a few questions or making a quick call? We’ll give you 10% off your next bill in exchange for your time.

you can get a time on my calendar link.

We look forward to hearing from you soon!

Signature

You don’t need to offer a discount to receive an interview. If you offer something of value in exchange, the person is more likely to agree. Click To Tweet

Include a link to schedule a call with Calendly or Doodle. This makes it super easy for them to set it all up.

Start collecting feedback and organizing it in a spreadsheet. you can then Look for trends that could be used to increase the LTV of other customers.

If you notice that most of these customers came via a particular channel (SEO or Google Ads, for example), then this is a sign that you should invest more in those channels. If you notice that most of these customers came from a specific channel (SEO, Google Ads, email, etc.), then you can invest more in those channels.

Maybe they use a particular feature of your product. Because customers get the most value out of that feature, you can market it more. interviews can be a great help in marketing your product.

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