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Understanding and Optimizing Customer Lifetime Value (LTV)

How much are your customers worth? It’s far from a rhetorical question. Knowing the lifetime value of your customers is essential to understanding what is and isn’t working so you can identify the best ways to improve your marketing and sales strategies, acquire new customers (while retaining existing ones), and improve your long-term growth.

Let’s take a closer look at what Customer Lifetime Value is, how you can calculate this metric, and why it is so important.

What Is Customer Lifetime Value?

Customer Lifetime Value (CLV) is the total income you can expect to receive from a customer or account over the course of their entire relationship with your business. In other words, it’s the average amount of money you will make from a customer’s very first purchase to their last.

There are multiple ways you can use CLV. For instance, when compared against Customer Acquisition Cost (CAC), it can tell you whether you are actually turning a profit from your customers. Or by segmenting CLV by customer size or type, you may be able to identify potential shortcomings in your marketing, sales, or product strategies.

Once you know your CLV, your goal should be to identify ways you can increase it. Because it costs more to acquire new customers than it does to retain existing ones, increasing your CLV can be one of the best ways to grow your business.

Note: CLV can go by multiple acronyms. Some refer to it as LTV, while others may call it CLTV. While this can be confusing, all of these are the same. For our purposes, we’ll use CLV throughout this article.

How to Calculate CLV?

While there are several ways to calculate CLV, the best methods use either total average revenue generated per customer or total average profit. These allow you to assess the effectiveness of your marketing plan and whether you are recouping your expenses. For simplicity, our CLV calculation will use revenue.

In order to measure CLV, you will need to multiply the Average Customer Value by the Average Customer Lifespan. Here is that formula:

Average Customer Value (CV) x Average Customer Lifespan (CL) = CLV

So, for example, if your average customer value is $500 and they remain with your business for an average of 10 years, you will have a CLV of $5,000:

$50 x 10 = $5,000

Before going any further, let’s break these underlying metrics down some more.

CLV Metrics (H3)

In order to calculate CLV, you’ll need to know your Average Customer Lifespan and Average Customer Value.

  • Average Customer Lifespan

To find Average Customer Lifespan, simply add up the total number of years customers have purchased from your company, then divide this number by your total number of customers:

Sum of Customer Lifespans ÷ Total # of Customers = Avg. Customer Lifespan

  • Average Customer Value

Although value can be a subjective measure, in this formula we are defining it as average purchase value multiplied by average number of purchases:

Avg. Purchase Value x Avg. # of Purchases = Avg. Customer Value

First, let’s find average purchase value. You can calculate this by taking total revenue for a specific period (typically a year) and dividing it by the total number of purchases within that period:

Total Revenue ÷ Total # of Purchases = Avg. Purchase Value

Next is the average number of purchases. Calculate this by taking the number of purchases and dividing it by the total number of customers within the period you are measuring:

Total # of Purchases ÷ Total # of Customers = Avg. # of Purchases

CLV Example

Since calculating CLV involves a fair number of underlying metrics, it can feel confusing and abstract. So let’s illustrate this metric with a more concrete example.

Let’s assume you have a business with five customers, each of whom has been with you a different amount of years and has spent a different amount of money over the past year.

Here is the data:

First, we can find Average Customer Lifespan:

Avg. Customer Lifespan: (5 + 3 + 1 + 6 + 4) ÷ 5 = 3.8 years

Then, we can calculate Average Purchase Value and Average Number of Purchases:

Avg. Purchase Value: ($1,000 + $600 + $200 + $1,200 + $2,000) ÷ 90 = $44.45

Avg. # of Purchases: (20 + 10 + 5 + 15 + 40) ÷ 5 = 18

This gives us the data we need to calculate Average Customer Value:

Avg. Customer Value: $44.45 x 18 = $800.10

Finally, with both Average Customer Value and Average Customer Lifespan calculated, we can plug these figures into our CLV formula:

CLV: $800.10 x 3.8 = $3,040.38

Why Is Customer Lifetime Value Important?

CLV is a critical business metric that can help you make informed decisions in a variety of areas, including customer acquisition and retention, pricing strategies, and overall business growth. Here are three reasons why CLV is important:

Knowing Your CLV Helps You Make Better Decisions To Improve Customer Acquisition and Retention

By understanding the lifetime value of a customer, you can determine how much your business can afford to spend on acquiring new customers and how much you should invest in retaining existing ones. This information can help optimize your marketing and sales strategies to target the most valuable customers and reduce churn.

CLV Guides Pricing Strategies

By calculating the CLV for different customer segments, you can determine how much you should charge for your products or services. This information can help you set prices that are competitive, profitable, and sustainable.

CLV Can Help Predict Business Growth

A high CLV indicates that customers are loyal and engaged, which means they’re likely to continue doing business with you in the future. This translates to steady revenue streams, improved cash flow, and increased profitability. In contrast, a low CLV may indicate that you’re struggling to retain customers and may need to make changes to your marketing, sales, or customer service strategies.

How to Improve CLV

Your CLV is by no means set in stone, which can be good news if you’re disappointed by what you’ve found. There are a variety of ways you can start improving your CLV both in the short- and long-term. Here are a few strategies:

  • Improve customer retention. It costs much more to acquire new customers than it does to retain existing customers. That’s enough reason to do whatever it takes to keep the ones you have. This could involve investing in your customer success operations, launching a customer loyalty program, or simply improving your customer service.

  • Raise prices. This is one of the more obvious strategies you can take. Increasing your average order value (or average contract value for SaaS companies) will help immediately lift your CLV. Of course, you have to be careful here too. Raise your prices too much and customers may start purchasing less often. Try experimenting with small segments first before introducing broad price increases.

  • Prioritize relationships over purchases. This may sound counterintuitive, but it can produce long-term results. While some companies may simply shepherd customers toward a purchase, those that place more energy on ensuring they are delivering what customers want, when they want it, will keep them coming back again and again. You can do this by building out a tracking and cultivating customer relationships across the lifecycle, from lead to onboarding and beyond.

  • Upsell and cross-sell. Customers who have already made a purchase are more likely to do so again. This gives you a good opportunity to put in place strategies for encouraging them to buy related products or services, or upgrading to pricier options.

  • Listen to your customers. No one knows what you’re doing well and what needs improvement better than the customers you’re selling to. Take advantage of this by asking them what they think. Chances are they’ll have some valuable insights you can use to make your customer experience better – and improve your CLV.

Frequently Asked Questions

What is Customer Lifetime Value (LTV) in the context of SaaS businesses?

LTV represents the total revenue a software-as-a-service company can expect to generate from a single customer during their whole relationship with the company.

How do you calculate LTV for a SaaS company?

To calculate LTV for a SaaS company, use the formula LTV = (ARPU * Gross Margin) / Customer Churn Rate.

How can you improve LTV for your SaaS business?

Key strategies include offering a seamless onboarding process, implementing tiered pricing models, communicating consistently with customers, identifying and addressing at-risk customers, and focusing on customer success programs.

How frequently should LTV be calculated and monitored?

LTV should be calculated and monitored regularly, preferably on a monthly basis. Regular analysis helps you keep track of trends and make informed decisions about customer acquisition and retention strategies.

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