Acquiring new customers isn’t enough for the long-term success of your SaaS business. It would help if you tracked metrics to provide insights into the health and profitability of your business. One of the most crucial metrics you need to focus on is customer lifetime value. It’s the total revenue you can expect from a customer throughout the relationship or a lifetime.
It not only highlights the financial worth of customers but also helps you allocate resources effectively to retain them. As a result, their value will increase over time. Analyzing LTV will help you keep high-value customers, cross-sell, and maximize profit. However, the main thing is how is LTV calculated.
Tracking and analyzing it isn’t straightforward. It involves multiple steps and tracking some additional metrics. Don’t worry! We have got you covered. Today, we will tell you how to calculate this crucial metric. Apart from that, we will also unveil some crucial factors that affect lifetime value. Let’s do so without further ado.
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How to Calculate Customer Lifetime Value?
Let’s say you are selling your service for $300 per month. A customer stays with you for 8 months, so the LTV will be $2400. However, this method isn’t practical as you will have multiple customers. You need to track the following two metrics to calculate LTV appropriately.
- Churn Rate
- Average Revenue Per User
You can calculate LTV by using the following formula.
LTV = ARPU (average monthly recurring revenue per user) × Customer Lifetime
You can estimate it by using the churn rate as well.
LTV = ARPU / User Churn
It can be more convenient as the Churn rate is the number you always have.
Factors Affecting the Customer Lifetime Value
The following section is all about factors that influence LTV.
Customer Demographics
Age, income, gender, and geographic location of customers can significantly affect lifetime value. These traits often determine how customers interact with your product and how much they’re willing to spend. It also helps you check their overall engagement with your business.
Income and Spending Behavior: Customers in higher income brackets may show a greater willingness to invest in premium services. It will ultimately boost their lifetime value. They are also more likely to stick with a service if it provides them value, especially when a strong connection between product benefits and customer needs is established.
Geographic Influence on Retention: Geographic location also plays a role in determining LTV. Customers from regions with a higher demand for certain types of SaaS solutions may show higher retention rates. For instance, your customers from an area where demand for your services is higher will tend to last longer.
Purchase History
Customer’s purchase history is an excellent predictor of their future behavior. By analyzing past purchases, you can understand their preferences and identify opportunities for upselling and renewing subscriptions. You need to focus on:
Frequency of Purchases: Customers who frequently renew their subscriptions have high LTV. Frequent transactions indicate that they are satisfied with your services or products. You can boost LTV by encouraging customers to renew or upgrade their plans regularly.
Upgrade and Downgrade Patterns: Tracking when and why customers upgrade or downgrade their subscriptions is also essential. Those who consistently upgrade their plans have a higher lifetime value potential. On the other hand, those who frequently downgrade or pause their subscriptions will churn more often and decrease their LTV.
Customer Lifestyle
It can have a significant impact on how customers use and engage with your products. Their profession, daily routines, and personal values can influence their interaction with your services. If your service or product aligns closely with their professional needs, they will use it more frequently and for a longer duration.
For instance, if you have a project management tool you will see higher engagement from customers whose work revolves around managing projects. On the other hand, customers with a busy lifestyle may not engage with the product as much as those with flexible schedules. You can focus on personalized communication and offer features that cater to their specific needs to enhance retention.
Acquisition Channels
The channels through which you acquire customers can greatly influence their LTV. Not all acquisition methods help you get high-value or long-term clients.
Organic Vs Paid Channels: Customers acquired through organic channels are often more loyal. Referrals and content marketing are some best organic ways to acquire them. On the other hand, paid channels like advertisements may not help you get high-value customers. Organic methods foster trust, resulting in longer relationships and a higher LTV. On the other hand, paid acquisition can bring in large volumes of customers, but they may not be loyal.
Impact of Acquisition Costs: You cannot neglect the impact of CAC on the potential lifetime value. Some channels may appear to generate more customers, but high acquisition costs will outweigh the revenue they bring. Therefore, you should always focus on channels that not only attract customers but also provide high LTV relative to their acquisition costs.
Pricing Strategies
Pricing models play a crucial role in determining LTV. Pricing can influence how long a customer stays and how much they spend throughout the relationship. Many SaaS companies offer freemium models. It allows customers to use a basic version of the product for free and then upgrade to paid plans for additional features. You can adapt it to attract a high number of users. However, only a fraction of them will convert into paying customers.
Offering multiple subscription plans gives customers the flexibility to choose one that suits their needs. You can also offer discounts for long-term subscriptions or annual payments to make customers stay longer. It increases their overall lifetime value. However, it’s important to maintain a balance. Offering many discounts may reduce revenue.
Takeaway
As a SaaS business owner, you need to understand the factors that affect LTV to optimize long-term growth and profitability. By focusing on these factors, you can take actionable steps to increase lifetime value.
