Of all the metrics you need to track as a SaaS company, lifetime value (LTV) may be the most mysterious. It feels difficult to calculate, and then once you have the calculation, you don’t really know what to do with it whether it’s good or bad.
Hopefully today we can demystify the metric and offer some insight to help you use that metric better within your company!
What is customer lifetime value?
So, what is lifetime value? The lifetime value of your customer is simply the total amount of money you’re likely to make off a given customer over the life of their account.
Say you charge $100/mo for your service and a customer stays with you for 12 months. Their LTV would be $100 × 12 = $1,200.
Why does LTV matter?
The primary reason LTV is so important for your SaaS business is that it drives what you can spend to acquire new customers. If your customer acquisition cost (CAC) is $100 and that same customer has an LTV of $500, you’re basically printing $400.
Can you say “money machine”?!?!?!
The higher your LTV and the lower your CAC, the faster you can grow your business.
Is it really that simple?
Sounds easy, right? Well, it mostly is. The kicker here is that taking the top-level view we’ve mentioned thus far isn’t a great longterm solution.
Why? Because all customers are not created equal.
You need to know what the LTV is of each major customer segment. For SaaS companies, that’s usually the various price points you offer.
Joe on your $30/mo plan will almost certainly have an LTV that is a fraction of what the LTV is of Sally on your $200/mo plan. And not just because $200 is more than $30.
LTV and Churn
The reason those LTVs will likely be so different is because of one nasty word: churn.
Generally speaking, users on your lowest-priced plans will also have the highest churn, making it your most dismal LTV compared to the other plans.
And remember what we said earlier? LTV drives what you can spend to acquire customers. If the average customer takes $200 to acquire, it makes no sense to spend that to get a customer with an LTV of $100.
Knowing what your LTV is for each customer segment is critical.
This is something Baremetrics (subscription analytics & insights) offers right out of the proverbial box, available as soon as you connect your account.
Getting nerdy with LTV formulas
Earlier I mentioned a basic way to calculate churn for a single customer, but that obviously isn’t practical for running your business (since you hopefully have more than one customer).
Let’s take a look at the actual formula for calculating LTV.
LTV = ARPU (average monthly recurring revenue per user) × Customer Lifetime
This could also be calculated using churn (which is a number you likely have more readily available).
LTV = ARPU / User Churn
The higher your user churn, the lower your LTV will be. You can see why paying attention to both LTV and churn is so critical. We covered churn in more detail in the previous lesson on SaaS Churn.