SaaS LTV (Customer Lifetime Value) Guide: Running a Health Check on Your SaaS Business
For how many months or years your newly acquired customer will stay around? Is it possible that you lose your customer before acquiring his/her acquisition cost?
In this post, we are going to discuss SaaS LTV as a whole – how to calculate it, how to increase it and how important your customer LTV is to check your SaaS business health
Let’s get to it.
What is customer LTV for SaaS businesses?
LTV stands for Customer Lifetime Value and expresses the amount of money you will reasonably receive from a customer before he/she stops working with your company.
Why should you care about SaaS LTV?
Knowing your SaaS LTV gives you the freedom to do any of the following and reduce lots of marketing-related worries. You will be able to:
– Discover which customer segment brings most revenue to you as LTV is calculated per customer. Maybe customers with low-profit margins who pay less stay longer and generate more revenue, while those with high-profit margins are only a few, stay shorter and are not lucrative to acquire. And in this case, they are not lucrative because you spend a large amount for acquiring them, don’t even get your investment back because they stick around too short
– Determine how much budget to allocate for acquiring a new customer
– Know how much ROI to expect from a newly acquired customer
– Understand how much discount you can afford to do.
But you know from your experience that your customer is going to stay with you for 2 and more years, so you are OK with spending $20 and more to attract him. You will get your investment back in a long-term period and, well, long-term decisions are what make your business go ahead.
How to calculate SaaS LTV? (formula+example)
You can calculate your SaaS business’s LTV with several formulas but we are going to introduce the 2 most common ones to save you time and provide maximum results.
LTV = ARPA (average revenue per account) / Churn rate
In this case, you understand how much revenue you generate from a user/unit on average and divide that number by your churn rate.
Your second option is the following formula: CLV=average annual customer revenue*average duration of customer retention in years.
This time you calculate what’s the average amount you receive from all of your customers annually and multiply that amount by the number of years they stayed with you. As you can see, in order to make use of this formula, you should have annual subscribers to be able to calculate another SaaS metric like ARPA.
Remember that months or even a year are not the best period of time to consider because the more years, the more data and consequently the more accuracy. That’s why it’s difficult for young companies to calculate their CLV and usually, they have to rely on predictive, not real historical data.
Without any big efforts, you can input your data into a tool and know your SaaS LTV with an LTV calculator. And your customer lifetime value calculation becomes even easier.
How are SaaS Customer Lifetime Value and churn rate interrelated?
The lower your SaaS churn rate, the higher the LTV.
Customer churn is maybe the saddest moment you and your team experience because no one wants to lose a customer. Anyway, customers are free to make new decisions and change their service providers. What you have to do is to keep customer churn rate at the lowest level and look forward. Here’s how to measure the churn rate.
The total number of churned customers/the total number of customers.
For example, in a year 5 out of 100 customers cancel their subscription plans offered by your SaaS company. Your annual churn rate is 5%.
Generally, a 5-7% annual churn rate is pretty much normal for SaaS companies, though you have to keep it as low as possible because attracting new customers is always harder and more expensive than retaining the old ones.
Churn rate calculation can help you understand your CLV in case you are a SaaS startup, have been in the market in less than a year or a bit more and don’t have enough data for SaaS LTV calculation.
If you know that in a month you lost 2 out of 40 customers, it means your monthly churn rate is 5%. When you divide 100% by 5%, the result, approximately 20 months, is the period your customers are likely to continue working with you. And it will help you calculate your CLV in advance, relying on this predictive data.
Now you have to multiply the average amount of money you receive from a customer by the number of months and estimate how much he/she will contribute to your company after 13 months.
CAC stands for Customer Acquisition Cost and answers a question – how much is the average amount of dollars you spend to acquire a single customer.
This is one of the easiest metrics to calculate as it doesn’t require much data that is hard to get. Here’s the formula.
The total amount of marketing and sales expenses/number of customers acquired in a given period.
If you spent $12.000 in 2 years and acquired 41 new customers, then your CAC is about $293. But the new customer works with your SaaS company for 3 years and his/her CLV is, let’s say $1500.
The ratio between CLV and CAC, in this case, is 5:1 ($1500 divided by $293). And believe it’s a great outcome! CLV:CAC ratio should be at least 3, otherwise, it means that either you spend too much on marketing or you haven’t designed effective mechanisms to retain your customers.
How to extend Customer LTV?
1. With a successful onboarding process
Your best approach would be understanding all the difficulties a customer may face while using your software and prepare instructions accordingly.
Tutorials, user manuals, and guides with screenshots can really help people stay away from confusion and continue working with you. A number of SaaS companies even offer free online courses on how to use their products.
For example, Marketo, marketing automation software, has established Marketo University. There you can find free online training on how to use Marketo for email marketing. This process requires an introducer, video operator and editor, scriptwriter and time.
For example, Marketo, marketing automation software, has established Marketo University. You make investments but don’t forget that free education is a form of inbound marketing and free content (especially videos) attracts a larger number of users.
People love recommending a product they used and stayed happy with and also prefer buying a product that has been recommended by a colleague, friend or family member.
So follow the example of top SaaS companies and offer motivating referral programs. Because this attitude brings new customers and retains the old ones without spending huge budgets.
For example, Hubstaff, time tracking and project management software for teams, provides a 10% discount for every paying user you bring to the company. If you refer Hubstaff to 10 colleagues in a month, you get a 100% discount.
It’s important like never before. If years ago phone calls were the main means of communication and a source of information, now we have social networking sites, email services, and contact forms.
Get back to your customers as soon as possible, provide accurate and comprehensive answers and don’t forget they are unique. Inspire them to think positively about your attitude so they tell others that you are exceptional.
For example, when you send an email to a popular SaaS company’s inbox, you usually receive an automated email that tries to help you before their support team will start dealing with your question or problem.
The email looks something like this:
- “We have an FAQ section where you might find the answer to your question – here’s the link. In case your request is related to our Live Demo – get access here. You can view the status of your ticket here.”
You simply need to gather all your useful resources and links in one automated email so people find quick answers without waiting for days.
But don’t think that human interaction is not important anymore – on the contrary. Maybe a user doesn’t find his/her answer in your email, so try to clean your email inbox as soon as possible.
You design loyalty programs to encourage your customers to continue using your services and also to reward them with benefits and special offers. It’s a win-win situation as your loyal customers feel special and you feel satisfied with your SaaS retention results.
Did you know there is customer loyalty management software called Open Loyalty? That tool allows you to manage your customers based on their purchase history and anniversaries, give points for specific interactions (registration, social activities), reward with promotion after a certain action.
Which rewarding approach suits you best depends on what type of software you offer. If it’s an online streaming platform, then rewarding with points will work great. If your software is more “serious”, you can consider promotions.
5. With an annual billing system
You know that monthly and annual billings are the most popular billing systems among SaaS companies, though sometimes you can come up with multi-year plans too.
When you put your emphasis on the annual plan and attract long-term customers, you make a concession such as a 15-20% discount or 1 more month of a free trial. Because a customer agrees to stay around a year and solves a retention problem for you. Mainly annual plan subscribers are those who contribute to your LTV as their commitment excludes the case of their churn.
And if you think that you lose 15-20% because of a discount consider that a customer churns after 2-3 months and you are forced to acquire a new one. Customer acquisition cost will almost always be higher than the 15-20% annual discount you offer.
LTV is one of the most essential data you need to know as this metric leads to discovering more, not less important SaaS metrics too.
What techniques do you leverage to increase your customer LTV? Did you find some new helpful tips in our post?