Customer Lifetime Value Formula (How To Calculate For SaaS)

As you track key SaaS metrics, are you using the customer lifetime value formula? To acquire and retain high-value SaaS users, you must know what the customer lifetime value formula is.

Churn
November 2, 2021

As you track key SaaS metrics, are you using the customer lifetime value formula? To acquire and retain high-value SaaS users, you must know what the customer lifetime value formula is.

Customer lifetime value (CLV) is an essential SaaS metric that tells stakeholders how much revenue a typical customer will bring in during their relationship with your company. For a SaaS business, CLV represents a user’s value to your business over a period of time. Tracking CLV is vital to measuring and evaluating the sustainability of your SaaS business.

Venture capitalists and investors see CLV as the best metric for company valuation. If you’re committed to building an asset that’s attractive to investors, maximizing customer lifetime value must be at the forefront of your decision-making as a SaaS founder. Despite being essential to a subscription-based business model, many SaaS founders overlook the importance of CLV.

“Growth is not convoluted or magical. It’s very simple: Measure. Test. Experiment. Create a culture of experimentation and celebrate failure as much as you celebrate success.” – Chamath Palihapitiya

What is the customer lifetime value formula?

The customer lifetime value formula is critical to measuring the success of your SaaS business. Low user retention and lifetime value can have a detrimental impact on sustainability. Nothing is worse than having a user base that resembles a leaky bucket. If you’re suffering from high user churn, you must identify and address the hole in the leaky bucket for sustainable growth.

To know how to calculate customer lifetime value, you need to have a solid understanding of a few basic formulas:

Customer Lifetime Value

Customer Lifetime Value = (Customer Value * Average Customer Lifespan)

Customer Value

Customer Value = (Average Purchase Value * Average Purchase Frequency Rate)

Average Purchase Value

Average Purchase Value = (Total Revenue / Number Of Orders)

Average Purchase Frequency Rate

Average Purchase Frequency Rate = (Number Of Purchases / Number Of Customers)

Average Customer Lifespan

Average Customer Lifespan = (Sum Of Customer Lifespans / Number Of Customers)

Why should you use the customer lifetime value formula?

Here are just a few reasons why you should be using the customer lifetime value formula:

  • This metric offers a reliable business viability measure. High customer lifetime value is a clear sign of strong product-market fit and brand loyalty. The metric gives you a sense of how well your SaaS resonates with users and helps you to predict future growth.
  • CLV can help you to assess the profitability of your customer acquisition spending. While customer acquisition costs may exceed the value of the customer’s first purchase - they could make you more money over time. Calculating CLV will help to inform the amount of money you’re prepared to allocate towards customer acquisition.
  • Understanding the lifetime value of your average customer will enable you to optimize around growth. When you are utilizing a broad range of SaaS metrics to track your growth, you can make informed decisions to improve your growth trajectory.

When you’re evaluating your product-market fit, CLV will tell you whether you’re effectively meeting the needs of your target market. If you have a high CLV, this is a very clear sign that you’re experiencing high customer retention - as the SaaS customers are continuing with their subscriptions. High customer retention can only be achieved through strong product-market fit.

What is a good customer lifetime value?

In most cases, your customer lifetime value should be at least three times greater than your customer acquisition cost. If you’re spending $100 on marketing and sales efforts to acquire a new customer, this customer should have a lifetime value of at least $300. It all comes down to how much you’re investing to acquire customers in relation to what you will receive in return.

LTV/CAC Ratio

LTV/CAC Ratio = [(Revenue Per Customer - Direct Expenses Per Customer) / (1 – Customer Retention Rate)] / (Number Of Customers Acquired / Direct Marketing Spending)

What is the average churn rate for SaaS?

The average churn rate for SaaS is anywhere between 5-7%. This is what you should be aiming for. Ideally, you don’t want to have any customers choosing to cancel their subscription - but it does happen. To effectively prepare for customer churn, you need to decide what an acceptable rate of churn looks like for your SaaS company and aim to keep churn below this figure.

While it’s inevitable that some users will call it a day and unsubscribe, you must do everything you can to keep your SaaS churn rate low. A high customer churn rate will be reflected in other SaaS metrics, such as customer lifetime value. If you can boost customer retention and get your churn rate under control, this will positively impact on your metrics across the board.

How do you retain SaaS customers?

If you’re struggling with high customer churn, here are some tips to get you back on track:

  • Take a step back and reevaluate your product-market fit.
  • Consider whether you’re successfully solving a problem faced by users.
  • Develop comprehensive resources to support customer activation.
  • Provide users with incentives to stay on, such as access to new features.
  • Consistently strive to improve customer service and support.

If you’re trying to reduce churn, you should be leveraging a solution for collecting customer feedback. Raaft can help you to collect feedback and save customers with retention flows. At critical moments in the customer journey, Raaft can be automatically deployed to provide your customers with the information they need to unlock value from your SaaS.

Many SaaS founders see Raaft as their safety net. They know Raaft will automatically extend offers to customers in their retention flow. Raaft also provides founders with cancellation insights that makes it easy for customers to tell them why they’re deciding to leave. This data can prove to be invaluable for founders that are committed to making data-driven decisions.

To boost customer retention, you need to get the right systems in place to prevent churn and drive customer retention. Try Raaft for free today!

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