Maximizing Business Growth Through Customer Lifetime Value
As CEO of a SaaS company that caters to B2C marketers, I’m used to advocating for Customer Lifetime Value (CLV) as an invaluable metric to evaluate the success of a business. It’s no secret why: It makes good business sense to prioritize both acquisition and retention efforts on customers who bring the most profit to your company over time. And as we know per the Pareto principle, roughly 20% of your customers will generate 80% of your future business. It’s a no-brainer that you should identify and nurture that 20%.
For B2B businesses, especially SaaS businesses, it’s also important to identify your most valuable clients. However, finding the average CLV of your client base can also help you understand and strategize for your business in significant ways. In this post, we’ll break down CLV calculations and how to use this insight as an advantage for your business.
CLV: The Calculations
While there is some debate on how to calculate CLV for SaaS businesses, we’ll focus on one that is more generally accepted. To get started, you need the Average Revenue Per Account (ARPA), as the monthly recurring dollar amount, and the average customer lifetime with your business. To calculate the average lifetime, use the below formula:
Average Lifetime = 1 / Churn Rate (monthly %)*
*Since we’ll be using the Monthly Recurring Revenue (MRR) format for the ARPA amount later, make sure you calculate the monthly churn rate for accurate calculations.
For instance, if you have a monthly churn rate of 4%, your Average Customer Lifetime would be 1 / 0.04, which is 25 months.
Then plug those variables into the following formula to calculate CLV:
CLV = ARPA x Average Customer Lifetime
If the ARPA is $7,000 per month, with the average lifetime of 25 months from before, the CLV would be $7,000 x 25, which is $175,000.
Alternatively, you can divide the ARPA by the churn rate to arrive at the same figure.
CLV can also be adjusted for gross margin for accuracy. However, since gross margin is usually quite high for SaaS companies (above 80%), I haven’t included it in the above formula.
Using CLV For Business Decisions
Once you have the average CLV amount, you can use that information to take a pulse check of your business as well as help you strategize on action plans.
1. Pulse check: CLV to CAC ratio
Compare your average CLV to the average Customer Acquisition Cost (CAC) to see if you’re overspending on acquisition.
CLV:CAC Ratio = CLV / CAC
According to leading industry opinion, a ratio of 3.0 or higher is a sign of a successful SaaS business. If your average CLV is $175,000 per the previous example, and your average CAC is $50,000, your CLV to CAC ratio would be 3.5.
2. Nurture valuable customers (& go after more of them)
We routinely advise our B2C clients that CLV is important to know which segments to nurture, but also to identify the acquisition channels that have the highest ROI.
In the same vein, use CLV on your segments to identify which group or vertical has the highest average CLV. Make sure to provide extra service to keep them engaged.
The vertical with the highest average CLV is also a good indication of being a good fit for your services. Use that information to shape your business as you grow, and go after clients you know will find value with you.
An Important Metric – But Not the Only One
CLV is definitely an important metric for SaaS companies, but it’s also crucial to note that it’s not written in stone. If you have a small client list, for instance, your CLV will be based on too small a sample size to be statistically accurate, or might fluctuate too much over time to be of significant use.
Still, even looking at the components that make up CLV can be a helpful exercise in evaluating how your business is doing. Keep an eye on the Average Revenue Per Account to think about how you lay out your pricing. Churn rate itself is a vital metric to continually check to make sure your customers are happy with your services.
These factors play into calculating CLV, but it’s important to consider them individually as well as together. Use all of them to help make decisions to maximize your business growth and potential.