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?

Customer lifetime value (CLTV) is the predicted amount a customer will spend on your product or service throughout the entire relationship, hence – “lifetime.”

This metric can help you move from transaction-based thinking to focusing on the long-term value of repeat business.

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.

How to calculate customer lifetime value

The example above is how you’d calculate LTV for a single customer. But that obviously isn’t practical for running your business (since you hopefully have more than one customer).

To measure LTV, we’ll need two additional metrics:

1. Churn rate: This is the number of subscribers that unsubscribed or stopped paying in a given period of time.

Example: If you had 100 subscribers last year and lost 5, your churn rate is 5%.

2. Average Revenue Per User (ARPU): This is the average revenue of all your current accounts. Or, MRR/total users.

Example: If you have 100 accounts, and from 50 of them you made $50 per year, and from the other 50 you made $100 per year, then your ARPU is $75 yearly.

Now, let’s take a look at how to calculate the lifetime value of a customer.

Customer lifetime value formula

LTV = ARPU (average monthly recurring revenue per user) × Customer Lifetime

You can also calculate lifetime value using churn (which is a number you likely have more readily available).

LTV = ARPU / User Churn

The higher your user churn, the lower your lifetime value will be. You can see why paying attention to both LTV and churn is so critical.

Luckily, you don’t have to manually calculate customer lifetime value. If you use a SaaS analytics tool like Baremetrics, you can track and analyze your LTV growth over time!

lifetime value graph

Churn variance and sample size

Quite often, churn can be messy. For example, if you think about any given cohort (a group of users that subscribed in a given period – i.e., all subscribers gained in July), there’s often a “cliff,” right after the first month of that cohort’s start date.

To keep this churn variance accounted for, we can multiply our results by a discount rate. (Discount rate means “discounting” for cash flow losses that may occur in the future).

Use a discount rate of .75 to find a more conservative estimate:

((ARPU x Profit Per User)/Churn rate) x .75

ex. $1200 x .75 = $900

Sample size is also important, and unfortunately, the scientific method often falls by the wayside in business.

If you don’t have many users, or you’re counting too few users in your metric calculations, then your data may not be scientifically valid.

Here are the scientific guidelines for sample size:

  • Less than 100 users: 50% or more user data needs to be counted for valid data (100% is best)
  • 1,000 to 10,000: 10% of user data needs to be counted for valid data, (i.e., if you’ve got 5,000 users then you need to include the data of at least 500 users in your calculations).
  • More than 1 million: 1% of user data need to be counted for valid data, (i.e., if you’ve got 3,000,000 users then you need to include the data of at least 30,000 users in your calculations).

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Customer acquisition cost and lifetime value

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.

If you know how much a customer’s value will be over the course of a lifetime, then you can make smarter decisions about what to spend to acquire a customer.

A good rule of thumb is that if LTV/CAC isn’t above 3, you’re spending too much on acquisition.

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 (SaaS analytics & insights) offers right out of the proverbial box, available as soon as you connect your account.

How to increase customer lifetime value

Knowing your average customer lifetime value is nice. But just looking at a number on a graph won't help you grow your business.

Unless you do something with the KPIs you're tracking, they're pointless.

So next, we're going to talk about how to use lifetime value analysis (it's easier than it sounds) and other tactics to improve your LTV. 

All the tactics I'm going to show you can be done directly in Baremetrics. If you want to follow along, you can sign up for free here.

Interview your customers with the highest lifetime value

When your goal is to improve your customer lifetime value, a good place to start is speaking to your existing customers.

So for this first tactic, you’re going to identify the customers with a higher lifetime value than your average, and learn more about them.

Specifically, you want to learn:

  • Where they get the most value from your product
  • How they use your product
  • What initially drew them to you (and how they found out about you)
  • How they've grown with your product since the time they signed up
  • Any other insights that'll help you understand what's keeping them around

Step one is to find out what your current average LTV is. I'll grab ours from our Metrics dashboard.

average customer lifetime value

Then, head over to your customer list. We’ll need to set a couple of filters:

  1. Active customer: Ideally you want to speak to active customers. Reaching out to people who canceled could get a little awkward.
  2. LTV: Filter to only show customers with an LTV that’s higher than the average you found (in our case, higher than $3443).
customer lifetime value filter

Now, you should have a list of your highest LTV customers.

highest ltv customers

From here, you can reach out to them and ask if they’d be open to doing a short interview to learn more about how they use the product and get feedback.

Here’s an example of what your email might look like:

Subject: {first name}{your company} hand picked you!

Hi {first name},

Thanks for being a long-time {your company} customer! I’m trying to learn more about how our customers use {your product} and since you’ve been such an amazing customer, I was wondering if you’d be interested in helping?

Could you spare 15 minutes for a quick call to answer a few questions? In exchange for your time, we’ll take 10% off your next bill.

You can grab a time on my calendar here {link}.

Hope to hear from you soon!

{signature}

You don’t have to give 10% off, or any discount actually. But if you can offer them something in exchange for doing the interview, you’ll get more people to opt-in.

And always include a link to schedule a time for the call with something like Calendly or Doodle. That way it’s super simple for them to set it up.  

Then just start gathering the feedback and organize it in a spreadsheet. Look for trends that you can use to improve the LTV of your other customers.

For instance, if you notice most of these customers came from a specific channel (SEO, Google Ads, email, etc.) then you know to invest more in those channels.

Or maybe most of them use a specific feature of your product. You can start marketing that feature more since customers get the most value from it. The interviews can be a huge helping hand in how you develop and market your product going forward.

Compare lifetime value by customer segment

You’re probably starting to notice a trend here. Looking at your LTV as a single number is nice to give you a 10,000 foot view. But in order to make it more actionable, you need to break it down into smaller groups so you can identify trends.

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.

You can see your LTV by plan-level in Baremetrics.

ltv by plan

As you can see here, there’s a pretty obvious trend. Our lowest plans have significantly less LTV, despite having the most number of customers.

This is pretty common for SaaS companies. Customers on lower-priced plans tend to churn more, and they pay less. And customers on our higher-priced plans tend to stick around longer and generate more revenue for us.

Using that data, it’s clear to see that it’s worth our time to figure out how to get mid-large sized customers if possible.

Pricing plans are only one way to segment your customers though. In Baremetrics, you can create segments based on location, acquisition source, when they signed up and tons of other criteria.

For instance, we can compare the LTV of our US and Canadian customers.

lifetime value by country

As you can probably tell, you can get really nerdy here and slice the data in a ton of different ways.

But the focus should be to identify which segments have the highest LTV, so you can get more customers like them.

Reduce your overall churn

If you look back at the customer lifetime value formula, you’ll notice it’s a function of two things:

  1. How much money customers spend with you
  2. How long they remain customers

So, the longer you can keep your customers paying you, the better chances you’ll have of increasing your average customer lifetime value.

For this, we need to look at user churn time. How long do customers stay with you before they cancel?

average customer churn time

The first thing to note is whether or not your customer churn is high. If you use Baremetrics, a good way to tell how your churn time compares to similar companies is through our Benchmark.

Benchmarks will show you how your metrics compare to companies with a similar average revenue per user (ARPU) as you.

customer lifetime value benchmarks

Take note of where you fall in both the user churn and customer lifetime value benchmarks. If you’re in the lower quartile for both, then there’s a good chance your churn rate is probably a problem.

Luckily, we’ve written a ton of articles about how to reduce churn and improve your retention rate:

Between all those resources, you should be well on your way to lowering your customer churn in no time!

Increase your ARPU

Now let’s talk about the second part of the lifetime value equation—revenue per user.

Since churn is inevitable, you don’t want to rely solely on reducing that percentage. You also need to figure out how to get more revenue per customer. Like you saw in the example I gave earlier, customers who pay less tend to have a lower LTV than higher paying customers.

Keeping things simple, the two main ways to increase ARPU are:

  1. Raising your prices
  2. Expansion revenue

I know raising prices is a touchy subject for a lot of founders. But the reality is pricing your product too low is a good way to stunt your growth.

You’ll have to do a good amount of testing before you make any dramatic changes to your SaaS pricing, but it’s something worth looking into if your growth has been at a standstill for a while, and your LTV isn’t growing.

The second tactic is a little less scary. Customer expansion is all about increasing the revenue you earn from existing customers through:

  • Upgrading them to higher priced plans
  • Cross-selling complementary products
  • Offering add-ons to improve their current subscription
types of customer expansion

If you’re interested in learning more (and I highly suggest you do), I wrote an entire guide about customer expansion: How to Use Customer Expansion to Skyrocket Growth

Set a customer lifetime value goal

I saved this one for last because if put it first you probably would’ve scrolled right past it! But stick with me for a second.

I know the infamous Harvard study that states people that set goals are 10X more likely to succeed than those who don’t has been discredited, but let’s set that aside.

If you’re a person that likes to actively work towards something, setting goals can be very motivational. Goals force you to create a strategy in order to achieve them. So just by setting a goal, you’re planting the seeds to take action.

You can set a goal right inside of Baremetrics.

lifetime value goal

When you’re setting goals, make sure there’s some logic behind it. Rather than just picking arbitrary numbers.

A good way to do this is to look at your historical numbers. For instance, here’s a look at our LTV over the past 24 months compared to today.

customer lifetime value over time

We can see that in 12 months, it’s fallen by 25%, and all the changes have generally been within 20% over the past 24 months. So setting a goal to increase it by 50% in the next two months probably wouldn’t be very reasonable. 

But a goal to get it up 10% each month would be more in line with what’s possible.

What’s your customer lifetime value?

Lifetime value is more than just another SaaS metric. It says a lot about how your product is priced and how much value customers get from your product.

It’s important to not only track it, but also analyze it so you can improve it. 

If you have no idea what your company’s LTV is, or you don’t have a tool that allows you to do the level of analysis I went over, get a free trial of Baremetrics to get started.

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