CLTV, acronym for Customer Lifetime Value, is the amount of revenue, you can reliably predict a customer will generate when they subscribe to- or pay in installments for your service or product.
If a customer, for example, subscribes for only a six month-period, then the CLTV is the full sum of these six months of payment. With this prediction, you can evaluate which actions are necessary to retain the customer and thus increase your long-term profits.
CLTV can be used to grow your business, since it shifts your perspective from the emphasis on traditional one-time purchases or quarter profits to creating steady long-term growth and healthy customer relations.
CLTV is a prediction model, that helps your business to assess the long-term financial value of a customer.
This is also how Customer Lifetime Value differs from other customer assessment models, such as CP (Customer Profitability). Whereas CP looks at historical data (a customer’s current and previous financial value to a company), CLTV attempts to predict the life-time value of a customer. Its purpose is to inform future decisions and predict a customer’s worth to your company, and therefore guide you to make decisions that improve customer retention and relations.
Its predictive nature makes CLTV harder to quantify, but more useful, as the model explores opportunities for future growth by improving your relations with existing customers and reducing churn (customers leaving your service).
CLTV can grow businesses by shifting a company’s perspective from quarterly profits to long-term revenue. It helps you maximize the value of your existing customers rather than spend resources on acquiring potential customers. This approach emphasize long-term growth, rather than short-term solutions that may ultimately harm your company.
CLTV is a crucial metric, when it comes to SaaS (Software as a Service). This is because it is uniquely suited to services and products with long-term recurring value. Customer relations are incredibly important, when you’re selling a recurring service rather than trying to get a one-time sale.
Most SaaS companies spend considerably more resources and attention on customer acquisition than customer retention. This results in companies often ignoring or minimizing the value of their existing customers.
Improving customer retention can be done by spending resources on better customer service; improving the service in itself; upselling add-ons to your service to existing customers; giving benefits and discounts to customers, who plan to leave your service among others.
Calculating Customer Lifetime Value follows a relatively simple equation. It involves some other known SaaS businesses metrics, which will be explained and guided in the following.
Customer LifeTime Value Formula:
CLTV = (Average Revenue Per User * Gross Margin * Lifetime)
The final result of this equation needs to subtract the cost of acquiring customers (CAC, or Customer Acquisition Cost), in order to calculate whether or not the current business model is feasible – and where improvements can be made.
Average Revenue Per User (ARPU) is a measurement of the total revenue divided by the number of subscribers. You can raise ARPU by raising the cost of your service or offering paid improvements and upgrades, such as tiers with additional functionalities or products.
Typically you can encourage upselling by offering limited discounts and free trials of these additions to existing customers.
Gross Margin is the net sales revenue of the company minus the cost of goods sold (COGS). It can be calculated either by total sum or percentage. For example, if your business makes 100.000 dollars, and production costs for 30.000 dollars, then your Gross Margin is either 70.000 Dollars or 70%.
Gross Margins can be increased by acquiring more customers or lowering costs (product, manufacturing or maintenance).
Lifetime is the average of a customers loyalty or how long they subscribe to the service. It is typically calculated in months or years. Lifetime divides retention by churn. If, for example, half of all customer subscribes for six months, but do not resubscribe, then the lifetime is 50%.