Lifetime Value: An Ultimate Guide For 2022
Lifetime value, in other words, customer lifetime value (LTV), is an important SaaS customer retention metric that helps you to understand an individual customer’s worth to your revenue. It is especially crucial to master LTV when you are looking for ways to satisfy your current customers and/or extend your customer base. It does not just deal with a single point of interaction between your customers and your product/service, but it keeps track of the whole relationship.
Even though LTV can be beneficial on its own, such as it can help you to make predictions about the revenue your customers will bring, it is mostly used as LTV: CAC ratio, which I’ll talk about oncoming parts of the article. LTV, therefore, is a multi-faceted metric that gives you insights about your whole customer base, individual customer, and revenue/profit.
As with the majority of metrics, calculating and understanding LTV can be a complicated process. However, once you master it, LTV can help you improve your customer engagement and make data-driven customer marketing strategies. Let’s explore how you can get the most out of LTV.
What Is Lifetime Value?
Customer lifetime value (LTV) is the measure of the worth of an average customer, meaning that LTV tracks a customer’s contribution to your revenue over the course of the relationship with your product/service. For different businesses, what LTV stands for greatly varies: For a business that sells products that are once purchased, LTV might be the sale price. On the other hand, for a business that offers products that need recurring maintenance, LTV might also contain the maintenance charges.
Therefore, it is important to determine what LTV means for your business and the aspects you are going to incorporate into it. An easy way to do it is to analyze all the charges of your product and track in which parts you are gaining revenue from your customers.
Why Is LTV Important?
LTV is a useful metric to understand the effectiveness of customer experience and your product’s profitability. These two go hand in hand: if your customers are satisfied with your customer experience, they would purchase more, which in turn benefits you as a profit. Therefore, with LTV, you track your future revenue and analyze whether your customers are engaging with your product and they are happy with it or not.
Similarly, LTV also is a good indication of customer loyalty and trust. A high LTV may suggest that each of your customers are satisfied with what you are providing them with, and therefore, they are not looking for other products. This is especially crucial to assess your current customer base and keep them as your future customers. Most of the time acquiring new customers is much more expensive and effort-consuming than keeping your current customers. Thus, trying to increase the value your current customers are bringing to your product is a great way to drive growth. With LTV, you can find your weaknesses and strengths of customer engagement and improve them to keep your current customers satisfied.
Since LTV does not only keep track of a single purchase but deals with the whole relationship over the course of the customer life cycle, it is a great metric for products that have a multi-year relationship. With LTV, you can check whether there are fluctuations of that customer’s value, assess the reasons behind it, and find ways to solve them. For example, if LTV drops after the first year, this may indicate an impairment in customer engagement or it may show you the times of the year that you profiting less than expected. In both scenarios, it is very important to also check other customer experience metrics and analyze them comprehensively.
LTV shows you how much a customer on average spends on your product; therefore, it actually gives insights about your customers’ habits and preferences. Tracking LTV can help you understand your target audience and offer you ways to best speak to them. If you have a low LTV, checking your customer demographics can be a good idea because it will give you an idea about which types of customers are not your ideal customers. By combining different metrics, you can easily change your marketing or customer retention strategies, such as offering promotions, deals, or personalized messages.
LTV is a great metric to understand whether a specific marketing strategy is creating value or not. Since LTV is a measure of the amount of profit a customer is bringing, it can give you insights into the ways you are unearthing this profit. For example, a high LTV after a change in email marketing strategy indicates that the strategy you are using affects your revenue positively. On the other hand, if the LTV decreases, this may show you that the strategy you are implementing is not benefiting. With LTV, therefore, you can assess your marketing strategies and allocate your money, time, and effort accordingly. This is especially a huge advantage because LTV would help you to not spend your valuable resources on things that will not bring profit.
How To Calculate Lifetime Value?
Before blindly calculating LTV, you need to know that there are two types of LTV:
- Historic LTV: This is the LTV that considers past events and is calculated according to them. In other words, it is the most simplest form of LTV, which we see all the time. (We’ll look at the formula of historic LTV)
- Predictive LTV: For this type of LTV, you need to run the historical data on a special algorithm that makes predictions according to past data. With predictive LTV, you can understand how long a customer relationship will likely to last and the value it will yield.
To calculate LTV, we’ll need to know churn rate and ARPU:
- Churn Rate: It is simply the number of subscribers that stops using the product/service you are offering in a given period of time. It gives you an idea about how many of your subscribers you are losing and why you are losing them.
- Average Revenue Per User (ARPU): ARPU is the average reveneu per unit/account. It is the measure that helps you to determine the worth of a customer to your business. It is one of the most useful metric to understand whether you are on the right track for growth.
With these two additional metrics, calculating LTV is pretty easy (there two ways):
- LTV = ARPU X Customer Lifetime
- LTV = ARPU / User Churn
The second method, which we use ARPU and churn rate, is the most widely used and readily available one. Therefore, most of the time, the LTV that you see is calculated by the second method. Luckily, there is no need to calculate LTV by hand: HockeyStack can track ARPU and churn rate and calculate LTV for your business quickly, easily, and smoothly.
It is also important to keep in mind your sample size to determine LTV for all subscribers because churn rate can get messy and cause errors in calculations. Therefore, it is a good idea to pay attention to the discount rate.
How To Maximize Lifetime Value?
Maximizing LTV is one of the greatest and most useful things that you would do to maximize your growth. Since LTV is directly related to your customers and revenue, putting extra effort into it will make a big impact. So, let’s look at how you can improve your LTV:
Enhancing Customer Experience
Customer experience is the building block of customer engagement, and thus, LTV. It resembles every touchpoint between your customers and your product/service, which consists of purchases, website visits, feature uses, social media, etc. Therefore, investing in customer experience and trying to optimize your product or marketing according to your customers’ specific needs and preferences is one of the quickest and easiest ways to maximize LTV. To have a powerful customer experience, you need to listen to your customers, track customer experience, and make changes according to their needs. This will increase both the LTV and loyalty over the long term.
Powerful Onboarding Process
This is actually related to customer experience because the customer onboarding process is the first touchpoint between you and your customers. Therefore, it is a process in which the customers form an idea about your product/service and whether they’re going to continue using it or not. Even though customer onboarding seems like a straightforward process, it is the one that is overlooked most of the time. To have a powerful onboarding you need to think like a customer and enhance it to make your product easier, simpler, and quicker. This will help you to hook your customers, increasing loyalty and purchases.
Loyalty programs are the easiest ways to satisfy your customers and invite them to make more purchases. By offering discounts, personalized offers, and surprises, you can show your customer that you care about their needs and preferences. This will help you to form a stronger bond, both enhancing customer engagement and helping you to keep your current customers. By offering loyalty programs, you will decrease churn and increase ARPU, which will give yield a higher LTV.
It is also a great idea to take extra care of your “best” customers. These customers are the ones that have a higher LTV or the ones that are predicted to yield the best LTV. By nurturing your relationship with them, offering specialized deals within loyalty programs, giving them early access to some features, you can increase the trust and loyalty between you and these customers. This will further help you to have better revenue and LTV.
It is inevitable to have customers that are not satisfied with the product/service you are offering. However, it is in your hands to turn the tables around. It is your actions that will decide whether unsatisfied customers going to be part of the churn rate or retention rate.
Having strong customer support channels is an easy and quick way to make your customers happy. Most of the time the reason why your customers are dissatisfied is they would have a problem that they cannot solve. Therefore, by offering them channels that will help them to solve their problems with minimal effort and time, they will appreciate it. This will help you to gain their trust and increase your LTV. However, don’t forget that if a customer is not understanding and having issues with the product, it means that your customer experience is not flawless. Therefore, listening to your customers about their problems is also a way to enhance customer experience and increase LTV.
Unhappy Customers –> Happy Customers
It is one of the greatest mistakes to overlook at unhappy customers. You might assume that these customers are part of your churn, but actually, it is far from the truth. Dissatisfied and unhappy customers are in the middle of the spectrum, meaning they are not yet a part of churn. Therefore, to reduce unwanted churn, you need to spend time and effort on your customer relationships. You can try to reconnect with these customers by sending them winback emails, enhancing your email marketing, and/or by just simply showing them your appreciation. This will help you keep them as your customers, decreasing your churn and increasing LTV.
Social media became one of the integral parts of branding and company image. Through social media, your customers or potential customers get an idea of your product/service, the way you treat your customers, and the value they will get if they continue to use your product. Therefore, having a strong social media presence is a crucial part of customer communication and relationship. By showing who you truly are and what you can offer your customers in an entertaining and rememberable way, you can easily increase your ARPU and LTV.
What Is The Difference Between Lifetime Value and ARR?
Sometimes people might confuse LTV and ARR (annual recurring revenue) since they are both based on ARPU and revenue. However, they have some nuances that differentiate the how and why they are used.
As we already know, LTV is the measurement of how valuable a customer is to your business in relation to the revenue they are bringing. Simply, it is calculated as,
LTV = ARPU / User Churn
On the other hand, ARR (annual recurring revenue) is the yearly version of MRR (monthly recurring revenue), which is the total revenue generated by your product/service from active subscribers. It is calculated as,
ARR = (ARPU X Total Number of Accounts in that Month) x 12
In other words, it is not easy to see the difference; however, the formulas make it pretty clear. While ARR deals with the total revenue gained from all accounts over a 12-month span, LTV is the measurement of the worth of a single customer. It is the data that gives you an idea about how much a single customer will add to your revenue; how valuable a customer is to you. On the other hand, ARR shows you how much you will gain in total in a year, helping you to make predictions for future revenues.
What is Customer Acqusition Cost (CAC)?
To talk about this ratio, first, we need to talk about what CAC (customer acquisition cost) is. CAC is the costs and resources you need to spend in order to acquire new customers. In other words, it is the measurement of how much you will expense to acquire a single customer. This includes all the sales and marketing expenses as well as salaries, commissions, and bonuses your marketing and sales teams will get. CAC is a very comprehensive metric that deals with a lot of variables. Therefore, you need to be careful while calculating (fortunately, HockeyStack can calculate CAC for you).
Most of the time, it is actually much expensive to acquire new customers to keep your current customers. Thus, businesses tend to spend their money, time, and effort on retention. However, understanding and analyzing CAC can help you to decrease costs by showing why you are spending too much money on things that don’t bring value. For example, even though a certain marketing strategy is one of the most popular ones, sometimes it may not work for your business. Understanding that by CAC can help you to change your strategies for the better and lower your acquisition costs.
How to Calculate CAC?
Even though there are a lot of variables, it is pretty straightforward to calculate CAC:
CAC = Total Amount Spent on All Marketing Efforts / Total Number of Acquired (New) Customers
What is LTV:CAC Ratio?
LTV:CAC ratio is an easy way to understand whether your marketing efforts are fruitful or a waste of money. It tells you about the price of acquiring a new customer and the revenue they will “probably” bring in the long run. For an ideal ratio, you should aim a ratio of 3:1 or higher, meaning you need to minimize your CAC and maximize your LTV.
When and How to use LTV:CAC Ratio?
This ratio is not useful for new startups and businesses since it relates to two metrics that are calculated over a period of time. To maximize the value you are getting from this ratio and have reliable calculations, your business needs to be in a growth process.
Here are some ways you can use LTV:CAC :
- What your target audience should be and which type of customers are the most efficient to acquire?
- What is the average amount you spend on a specific type of customer?
- How many sales and marketing representitives you should hire?
- Does the marketing strategy you are following is fruitful?
- What are your weaknesses and strengths of acquiring new customers?
The list can go on and on, but the most important thing you need to remember is that always your LTV should be greater than CAC to have growth.
One of the biggest problems of SaaS companies is understanding what actually drives revenue to the company: Is it content marketing? Customer support? Or an ad campaign? Which one brings the most engaged customers and which brings the customers that are most likely to expand their accounts?
HockeyStack allows you to answer all of these questions.
Using HockeyStack, you can build any dashboard you need with metrics from different departments. Custom dashboards allow you to connect the dots to better understand what drives revenue for your SaaS.
For example, you can build a churn by the blog post user signed up report:
A trial to expansion funnel:
An engagement by feature report:
Or an active users report:
On top of custom dashboards, HockeyStack has other features too, such as
- Step-by-step user journey
- Funnels & goals
- Revenue Attribution
HockeyStack has a free forever plan and 3 paid plans. Paid plans have a 14-day trial with a 30-day refund guarantee.
You can check out the pricing page here.
- Crisp Chat
- Salesforce (coming soon)
- Zapier (coming soon)
LTV is a useful metric to understand your current gainings from your customers and also to make predictions for the future. To increase your LTV, the path crosses from increased loyalty and trust between your customers and your product/service. Since most of the time acquiring new customers costs more than keeping your current customers, to increase your LTV, focusing on how to improve the “lives” of your current customers is a wiser idea.
Customer acquisition cost (CAC) is the total cost that you spend on acquiring a single customer. It consists of all the efforts to acquire customers such as marketing plans, hiring sales teams, social media costs, etc. It is an important metric to understand whether your marketing strategies are effective or not. It can also be used with LTV to yield the LTV:CAC ratio, which is useful for understanding whether acquiring new customers is beneficial to your total revenue or not.
While average revenue per user (ARPU) is the measurement of the value of a single customer, LTV is the worth of a customer over a given period of time. They might seem similar; however, LTV deals with churn, which separates these two metrics.